Financial Crisis 2007-2009 and Its Impact on the GCC Countries - Term Paper Example

?Financial crisis 2007-2009 and its impact on the GCC countries Table of Contents 3 Introduction 4 2. Literature Review 4 2 Evolvement and Concept of Global Financial Crisis 5 2.2. Measuring the extend of effect on the GCC countries 6 2.2.1. The role played by the financial sector of the GCC countries in the national economy 6 2.2.2. The Level of Openness of the GCC countries 9 3. Research Objective and Question 10 4. Research Methodology 11 5. Findings 12 5.1 Impact of Crisis on GCC countries 12 5.2 Impact on Qatar 15 6. Analysis 16 7. Conclusion 18 Reference List 19 Appendix 21 Abstract The irrational behaviour of the officials of the real estate market resulted in the financial crisis, which was a hard blow to the global financial market. Granting of loans in an uncontrolled manner, which resulted in the value of the loan exceeding that of the assets, was the root of the problem. These loans were provided to the borrowers without conducting a minimum check on their credit-worthiness. The result was that many of the borrowers failed to pay their loans back, which clearly reflected the financial status of the institutions and their inability to pay their obligations, thereby resulting into collapse. This paper investigates the severity of the impact on the GCC market. In this context, the financial market of the GCC countries has been considered along with special attention towards Qatar. The study revealed that the severity of the impact was not as huge as compared to the rest of the world. This can be due to the fact that the policy makers of GCC countries took ardent steps to mitigate the risk. Moreover, the Qatari economy did not get much affected and the banks were declared solvent in that time. However, the real estate business was seen to experience huge hit by the credit crunch. 1. Introduction In the year 2008 and 2009, the global economy was rocked by the financial crisis which was considered as the most devastating economic event, after the Great Depression in 1930s. The aftermath of this global crisis was felt in every part of the world. The global crisis was initiated by the low interest rate regime along with huge inflow of foreign funds that led to the housing construction boom and encouraged large consumption of debt-financing in USA. The Federal Government of United States made it possible for almost everyone to own a home by giving 1 percent rate on the mortgages. The loans that included the mortgages were given to almost everybody without checking the credit worthiness of the borrowers (Sivakumar and Krishnaswami, 2012). With the decline in the housing prices, the major financial institutions, which were involved in borrowing for investing in the subprime MBS, had reported significant loss. This decrease in the price also resulted in a fall in the prices of the homes that worth less than the mortgage loans, which incentivised financially the entry towards the foreclosure. Towards the end of 2008, the crisis peaked. Several banks and other financial institutions of Europe and USA failed as a result of this crisis and governments were trying hard to save these institutions by bailing them out (Kasekende, Ndikumana and Rajhi, 2009; Anon., 2009). The crisis started propagating beyond its epicentre, thereby affecting not only the advanced economy, but also the emerging economies and the rich Arab GCC countries. This paper aims to analyse the degree of impact on the GCC countries. In this context, the paper will specially analyse the situation in Qatar and other GCC countries. 2. Literature Review 2.1 Evolvement and Concept of Global Financial Crisis The term financial crisis refers to the sudden reduction in the price of the assets, which can be financial, such as, bonds and shares and can even be materials like, equipments and machinery. This sudden reduction can result from the price bubble which indicates an abrupt and huge increase in the prices ending in a sudden collapse. Moreover, the bankruptcy of Lehman Brothers, the giant financial institution and eminent bank in the financial service sector and the deep crisis and its effect on the American Insurance Group (AIG), which is the guarantor of revenue for many of the American real estate funds as well as holds the 18th place in the list of largest joint stock companies, are quite significant. Glancing over the status of the developing and the poor countries, it can be found that the turmoil was much worse and deeper, especially because of the overwhelming effect on the status of the poor people due to the presence of international food crisis. With the passage of time, the waves of inflation accelerated, which in turn led to the crisis gaining momentum and intensity. The crisis had begun as a result of irresponsible behaviour shown by those who were responsible for the real estate market of USA. The bankruptcy and stumbling of giant institutions created distrust and fear among the depositors, which became an important factor in dealing with the financial system because the main aim of the depositors was to generate satisfactory income without any loss in deposits or money. This distrust resulted into withdrawal of deposits from majority of the banks, including those that enjoyed good financial status. This again resulted in problems of bankruptcy for them. The crisis did not only affect the financial but also the political environment of the country. The officials of US tried hard to keep the crisis away from the rest of the world, but due to the meshing international relationships, economic globalization and establishment of WTO in 1995, the adverse situation in the American economy had eventually spread out to other economies (Cooper, 2008). The crisis resulted in the increase of unemployment all over the world, decrease in the expected economic development and stagnation in the long-term economic development. The crisis affected the liquidity of all countries in an unprecedented manner. In order to fight with the situation, the government together with the central banks in all the countries took urgent steps in order to increase the monetary supply in their economy by expanding the monetary and financial policies. This eroded the budget of many countries and created inflation pressures that negatively affected the poor and the developing countries. 2.2. Measuring the extend of effect on the GCC countries The negative impact of the financial crisis on any country depends on two major factors. Firstly, the contribution of the financial sector in the national economy is significant. A significant role implies that the effect of the crisis on the sector will be more intense and there exists high possibility for the effect to get transferred to the real sector in the economy. Secondly, it also depends on the openness of the national economy; greater the openness of the economy, greater will be the effect of the crisis on the same. 2.2.1. The role played by the financial sector of the GCC countries in the national economy In order to measure the significance of the role played by the financial sector of the GCC countries in the national economy, three indicators are generally used by the analysts. They are as follows: The size of the financial market in the national economy is generally reflected by M2 ratio to the gross national product, which is usually referred to as cash rate. A rise in this ratio indicates that financial sector is expanding as compared to the rest of the national economy sector (Levine, 1997). The extent of development of the financial sector especially, banks, is indicated by the ratio of demand deposits to money supply. The rise in this ratio indicates the increase in the degree of diversity in the financial sector and also, in the use of deposit money in transaction. The credit given to the non-financial private sectors by the financial institutions as a ratio to the gross national product. This indicator is considered to be the most significant among these three as they reflect the main activities, which are taking place in the financial sector (Aly, 2007; Abdelbaki, 2008). The following tables correspond to the three different indicators of the financial sector in the GCC countries during the period of 1994-2004. Figure 1: First Performance indicator of the GCC countries financial sector Source: (Abdelbaki, 2010) According to the first indicator shown in figure 1, the financial sector of Kuwait was the largest in the national economy during the period of 1994-2004, except in the year 2003, when Kingdom of Bahrain took over the highest position. A glance at the significance of financial sector of Qatar on the national economy reveals that its significance has decreased over the period, whereas that of the other countries has increased. In the year 1994, the expansion of the financial sector as compared to the national economy was the second highest among all the GCC countries, but it became the second lowest in 2004. Figure 2: Second Performance indicator of the GCC countries financial sector Source: (Abdelbaki, 2010) The second performance indicator shown in figure 2 reflects the development in the financial sector by means of diversity in the financial services. The data reveals that Kuwait was holding the first rank during the period of 1995-1997 and then again from 2002-2004. On the other hand, Bahrain occupied the first place during the years 1998-2001 and 1994. The financial diversity of Qatar had increased and in the year 2004, it positioned itself as the second most diversified in the financial sector. However, both the tables show the degree of competition between the states that are competing to evolve as the most developed regional financial centre. Figure 3: Third Performance indicator of the GCC countries financial sector Source: (Abdelbaki, 2010) The third indicator that is shown in figure 3 is the most important among all these three indicators. This reflects the principal activity of the financial sector in the national economy. According to the data, it can be suggested that UAE ranks first among the GCC countries at the beginning of the period between 1994 and 1996. After that, Kuwait occupied the highest position for the rest of the period. Qatar as per the third indicator is at the lowest position. The overall analysis of all the three indicators suggests that Kuwait, Bahrain and UAE are the states that are expected to be affected the most by the financial crisis as compared to the other GCC countries. The contagion is expected to least affect the states of Oman, Saudi and Qatar. 2.2.2. The Level of Openness of the GCC countries Economist uses the level of openness of the GCC countries for measuring the extent of relationship between the national economy and that of the rest of the world. This signifies the extent of changes in the world economy that would affect the economy of a particular nation. Several models have been suggested by the economic literature in order to measure the level of openness of the national economy. The most popular one is the summation of both exports and imports as a percentage of the gross national product. The same has been used to derive the figures shown in figure 4. Figure 4: Indicator of level of openness of the economy Source: (Abdelbaki, 2010) The figure 4, which indicates the level of openness of the GCC countries shows that in the years 1994, 1995 and 1997, Kuwait was the most open economy. The economy of Qatar was the most open one during the period of 1998-2004. In the years 1998 and 1995, Saudi Arabia was ranked as the second most open economy in the world. In the years 1994 and 1996, the first and the second places were occupied by the Qatari and Kuwaiti economy, respectively. 3. Research Objective and Question The above literature review gives a mixed picture regarding the openness of the national economy and the contribution of the financial sector in the economy. Though the previous researches have revealed that Kuwait, Saudi Arabia and Bahrain can be impacted by the global economic crisis, there was no confirm indications regarding the other GCC countries. Some other research scholars have suggested that the impact of the crisis on the GCC countries was much mild as compared to the rest of the world. Therefore, the main objective of the research is to unearth the impact of the global financial crisis on the GCC countries. In this context, the research intends to find the answers to the following questions: What was the impact of the financial crisis on the financial sector of the GCC countries? What was the impact on the banks of the GCC countries, with special consideration of Qatar? How far were the policies framed by the government and the policy-makers of the country successful in saving them? 4. Research Methodology The main objective of the research is to find out the impact of the global financial crisis on the financial market of the GCC countries. The event which is being considered in this study is an historical event and the research requires the analysis of that particular time span. In order to clearly understand the impact of the event, the study requires an analysis of the historical data, which is the data between the time period of 2006 and 2009, the post and pre-recession phase. Therefore, the data required for the research will be collected from the secondary sources. However, in order to find the answer to the last research question, focus group interview will be conducted on the managers of the banks that are operating in the GCC countries. The secondary sources comprise of journals, books, news articles and various government websites that provide data related to that period. The primary source of data that the paper uses include the data collected from the focus group interview (Jain, et al., n.d.). The questions for the focus group interview are mainly open-ended questions. While conducting the focus group interview, random sampling will be used; this will provide equal opportunity to every respondent to participate. The sample size will be restricted to six (Fowler, 2009; Lim and Ting, 2013). The data that are collected for the purpose of accomplishing the research objective will be analysed in both qualitative and quantitative manner (Grinnell and Unrau, 2008). In quantitative analysis, the results will be interpreted through number, whereas in case of qualitative research, the results will involve real life interpretations. 5. Findings 5.1 Impact of Crisis on GCC countries Due to the global financial crisis that erupted in 2008, the stock price of the GCC countries were seen to fall rapidly in a similar manner as in case of other developing economies. The total stock market capitalization of the GCC countries had fallen by approximately $320 billion from September 10 till October 15, 2008. This was almost 38 percent of the total combined GDP of all the GCC countries in the year 2007 (Batini, Levine and Pearlman, 2009). With the rising shortage of liquidity on a global basis, the international banks and other financial institutions had become more exposed to risk and cost of borrowing for the GCC countries rose sharply. Along with this, the de-leveraging created by the foreign banks reduced the accessibility to liquidity and raised the cost, thereby leading to the reduction in the demand of the GCC assets. Figure 5: Pre and post stock market scenario (Source: Ellaboudy, 2010) The banks that operated in GCC countries were less impacted by the crisis, with some exceptions like, the banks of Qatar and UAE. The reason behind this was the abundance of financial resources for the country and the initial macro intervention of the government that helped in mitigating the adverse impact of the global financial crisis. As compared to developing economies, where more than 50 percent liabilities of the banks are financed by foreign entities, the banks present in Qatar, Dubai and other GCC countries has less than 22 percent (Ellaboudy, 2010). In addition, the banks in GCC countries are directly exposed to structured and securitised financial products, which are less impacted by the financial crisis. By the end of 2008, the GCC countries had accumulated $2 trillion foreign assets among which 60 percent were in US dollars. This had aroused the concern regarding asset depreciation (Ellaboudy, 2010). Possibly, the GCC countries were not exposed to the structured toxic assets, but the real-estate project finance market and their infrastructure was directly affected by the decreasing number of credit finance banks and the increasing borrowing cost. Very small numbers of banks in the GCC countries had reported about their exposure to the fallout of AIG and Lehman Brothers. These exposures were in form of structured investment products, bank bonds and other derivative instruments like, Credit Default Swap (CDS), guaranteed by companies like, AIG. Figure 6: Foreign assets of GCC (Source: Ellaboudy, 2010) The exposure of the GCC banks to the subprime was $2.7 billion, which was quite small as compared to trillion dollars of exposure of US and Europe (Geisst, 2009). However, the accurate determination regarding the exposure is not possible because of the lacking transparency in the financial institutions. This owes to the fact that majority of the GCC assets were not under the management of the bank, but under the control of Sovereign Wealth Funds (SWFs) like, Kuwait Investment Authority (KIA) and Abu Dhabi Investment Authority (ADIA). The data available with moody investors and Bloomberg had suggested that a sizeable portion of 40 percent of the investment was exposed to the current market turmoil, which was of significant amount (Geisst, 2009). Though the GCC countries were not directly exposed to the crisis; however, the indirect exposure increased the cost of funding, mismatches in the maturity and credit exposure to the project, local consumers and real estate financing. Before the financial crisis, the inflation of the GCC countries were in double digit and the interest rates were lower with single digit growth that led to negative real interests rates that did not encourage the people to save. Moreover, dollar got strengthened and the GCC banks, which were opting for refinance in the capital markets, had to face increase in the cost of capital from September 2008 to March 2009. One of the major reasons for such a scenario was the deterioration of the bonds issued by Dubai, a major portion of which comprised of the GCC bond market. This was a major source of finance to support the infrastructural development of Dubai. The bond market of the GCC market started to deteriorate in the beginning of 2007, which eventually turned into a major issue for Bahrain and UAE and this unfavourable conditions continued till 2009. 5.2 Impact on Qatar In order to realize the impact of financial crisis on Qatar, the managers of Qatar Central Bank and Doha bank was considered. The managers said that in the year 2008, the economy had achieved a growth of 16 percent at the macro-level. In the year 2009, when developed countries were expecting a growth of only 2 percent, they were anticipating a growth of about 7 percent. The major reason behind such an expectation was the optimistic outlook of the Qatari economy that was highly based on mega projects related to petrochemical, gas and other sectors. During the time of financial crisis, most of the banks were facing bankruptcy and financial turbulence. In most of the developed economies, the banks were unable to play the role of creditor. In such a situation, the Qatari banks and other financial institutions were enjoying financial stability and high solvency. The Qatari banks showed 29 percent increase in their net profit and about 34 percent growth in the total assets. Therefore, the Qatari banks had maintained a total capital adequacy ratio of 15 percent as prescribed by the Basel standards and was one among the highest. On being asked about the measures that were taken by the authorities, the managers of Doha bank had said that the Qatar Investment Authority had decided to buy about 10 to 20 percent of the capital from some of the Qatari banks. Apart from this, the Government had also decided to buy the portfolio of local shares held by the Qatari banks at the purchase value of the banks after subtracting the deduction. The Ministry of Economy and Finance had also taken ardent steps for allocating the resources to the infrastructure projects, despite the decline in the oil prices. The managers of Qatar Central Bank (QCB) emphasized on the regulations implemented by the central bank regarding the mitigation of credit risk, risk in financing the real estate sector and purchase of shares. The corporate governance directives that were issued by the QCB were also significant in this aspect. 6. Analysis Financial innovation was a major reason for the financial crisis due to which the lenders were confident and keen to grant subprime loans that were risky in nature. The loans were aggregated and sold to the investment banks, which in turn bundled these loans into high yielding mortgage-backed securities (MBS) and then were sold to the investors all around the world. This financial innovation enabled the investors and the financial institutions around the world to invest in the housing market of U.S. The credit rating agencies along with the investors failed to properly price the risk that was involved with the mortgage related financial products. The decision-makers, politicians and experts from all over the world had suggested that the economic crisis that originated from U.S. was deep and dangerous and was going to continue over a period of two to three years. The statistical reports suggested that number of unemployed people present globally would increase over the next two years by 51 million. The global economic growth was anticipated to decrease by 3 to 4 percent. This also signified that the depth of the crisis would lead to a decline in the financial indicators in both regional and international money market, thereby creating huge volumes of consecutive losses. The above findings suggests that in case of the GCC countries, the overall impact was less as compared to the rest of the world, but certain countries like, the UAE and Bahrain had experienced major drawbacks. This was due to the fact that UAE at that time was undergoing huge infrastructural development and a major portion of it was financed by the bond market, which had experienced great setback from the crisis. The countries also suffered liquidity crisis and fall in the demand of oil. Moreover, after the crisis, the value of dollar also deteriorated, which lowered the value of the foreign currency reserves that were held by the countries for many years. The stock market was also seen to fall. All these suggest that the GCC countries were also impacted, but not so much as the other economies. However, a glance towards the Qatari economy suggests that the economy was less impacted by the crisis because of the less openness of their financial sectors. Moreover, the interviews of the managers suggest that the policies that were framed by the central bank had favoured the fight against the crisis. 7. Conclusion This financial crisis that originated in U.S. had soon spread out to the other countries, leading to a global downturn with uncertain duration and severity. The U.S. financial institutions, that were highly leveraged, with large amount of toxic assets in form of debt insurance investment as derivatives like, credit default swaps and mortgage backed securities, had faced credit crisis that had eventually led to insolvency in the country. The failure of the financial sector had adversely affected the activities of the real economic sector and had become increasingly evident. The GCC countries had not only experienced a direct, but also an indirect impact from the financial crisis. The study suggested that the indirect impact such as, the liquidity problems, were very severe in case of the GCC countries. Many of the credit rating agencies such as, Moody’s were seen to downgrade the rating of many of the companies. The real estate and mega-infrastructural projects were seen to be severely hit by the credit crunch. Therefore, it can be concluded that the hit of the credit crunch in the GCC countries was not as severe as compared to the rest of the world and it could be owing to the measures taken by the government and the lack of transparency. Reference List Abdelbaki, H., 2008. Maximization of benefits from FTA with USA: An applied study on Bahrain, the strategy studies journal. Bahrain Centre for Studies and Researches, 4(12). Abdelbaki, H.H., 2010. Assessing the impact of the global financial crisis on GCC countries. Journal of Business & Economics Research, 8(2), pp. 139-152. Aly, H., 2007. Bahrain financial sector: Development and performance. Manama: Bahrain Country Profile Seminar. Anonymous, 2009. Impact of the Global Financial and Economic Crisis on Africa [pdf] Tunisia: African Development Bank. Available at: [Accessed 13 December 2013]. Batini, N., Levine, P., and Pearlman, J., 2009. Monetary and fiscal rules in an emerging small open economy. 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Financial development and economic growth: Views and agenda. Journal of Economic Literature, 35, pp. 688-726. Lim, W.M. and Ting, D.H., 2013. Research methodology: A toolkit of sampling and data analysis techniques for quantitative research. Munich: GRIN Verlag. Sivakumar, N., and Krishnaswami, S.R., 2012. Global financial crisis: Dharmic transgressions and solutions. International Journal of Social Economics, 39(1/2), pp. 39-54. . Appendix Questions for the managers: 1. Scenario faced during the financial crisis? 2. What was the level of severity? 3. What were the policies undertaken to control the same? Read More