Gulf Rift Clouds Outlook

Political Rift Creates Uncertainty

Saudi Arabia, UAE, Bahrain, Egypt, Jordan and few other allied countries have cut diplomatic ties and transport links with Qatar, the largest (liquified natural gas) LNG exporter in the world, citing national security concerns and differences over foreign policy. This escalating political rift has created much uncertainty and is likely to impact the flow of people, trade and capital which could delay the execution of projects as Qatar prepares to host World Cup 2022.

As of this writing, Qatar has not retaliated and Kuwait’s Emir has started shuttle diplomacy to intermediate. While we expect a resolution of the crisis in the next few months at the latest given the high stakes, the countries imposing the sanctions have downplayed chances of a quick settlement. The Institute of International Finance (IIF) examines some of the key economic and financial linkages.

Dollar Peg To Remain

The Qatari authorities are committed to their dollar peg (which has been fixed at QR 3.64 per dollar since 1980), believing that the peg safeguards economic stability. Import and export volume elasticities with respect to real exchange changes are very low, given the limited domestic manufacturing and non-oil tradable goods sector in Qatar.

However, following the recent decision by several Arab countries to cut diplomatic ties and transport links with Qatar, pressures increased on the riyal as indicated by the dollar-riyal 12-month forward points, which rose from 202 on June 2 to about 400 on June 7, 2017 and the CDS spread widened/ This means that traders desiring to exchange Qatari riyal for dollars 12 month from now would have to pay QR 3.69 per dollar using outright forward contracts.

Drawn Out Rift Could Lead To More Serious Repurcussions

In a more pessimistic scenario which assumes that sanctions remain in place for an extended period and ties deteriorate further, headline growth could decline to 1.2% in 2017 and 2.0% in 2018, principally due to lower non-hydrocarbon growth impacted by increased uncertainty weighing on investment and a tighter financial environment and perhaps deposit flight which could raise the cost of funds.

Cuts in financial ties and increased counterparty concerns could hinder ease of doing business and trade finance.

Banking System Stable, Risks Amplified

While the banking sector is well positioned, with a capital adequacy ratio of 16.1% and non-performing loans to total loans of 1.2% at the end of 2016, risks and uncertainty from the sanctions by neighboring countries could have serious repercussions. Liquidity pressures could increase if the government opts for more withdrawal of its deposits with domestic banks to finance the deficits. Also, private non-resident deposits could decline from their peak level in April 2017.

Authorities publish stress tests simulating heightened rollover risk and deposit flight which indicate that the banking system would be resilient so long as the repo window remains open. Nonetheless, adverse confidence effects on the private sector and tighter liquidity conditions in the banking system could amplify negative spillovers to the non-hydrocarbon sector.

With credit growth to the government growing rapidly, the Qatari banking system has increasingly tapped external funding and deposits of non-residents have risen sharply in the past eight months. However, we believe most of this funding is from European or Asian sources attracted by the interest rate differential.

With liquidity hit by the oil crash in other Gulf Cooperation Council (GCC) states, funding from the GCC has remained limited and we estimate that GCC funding was about 6% of total liabilities for four domestic banks which account for about 70% of the banking system at the end of 2016.

About Garbis Iradian

Based in Washington, D.C. as chief economist for the Middle East and North Africa Department with the Institute of International Finance (IIF), Garbis Iradian focuses his work and research on Morocco, Egypt, Lebanon and the United Arab Emirates (UAE). He received his BBA and MBA from the American University of Beirut, and his PhD in economics with an emphasis on macroeconomics and econometrics from the University of Freiburg, Germany. He is fluent in Arabic, English, French and German and has published several articles and working papers, including: “What Explains the Rapid Growth in Transition Economies”, and IMF staff paper, November 2009.

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