Storm clouds gather over the Gulf

Middle-Eastern markets have tanked recently as global financial turmoil has hit the region. Oil has more than halved in price since July and there has been an exodus of foreign cash. Dubai, especially, looks vulnerable.

"Storm clouds are piling up in the Middle East," says Ruth Sullivan in the FT. Over the past few weeks, regional markets have tanked as global financial turmoil has hit the region. Saudi Arabia and Dubai are now down by around 50% this year, Kuwait down 20% and the MSCI index tracking the Gulf's key markets has lost 43%. Last week, Kuwait became the third Gulf state to prop up its banking system, guaranteeing deposits after bailing out the country's fifth-biggest lender, Gulf Bank, whose corporate clients had defaulted on currency bets.

The United Arab Emirates, of which Dubai is the second-largest member, has guaranteed local bank accounts for three years and made $33bn available to the banking system amid a squeeze in local money markets. Saudi Arabia has put $5bn into commercial banks and set aside $2.7bn for no-fee loans to low-income citizens. Central banks across the region have also cut benchmark interest rates.

High oil prices have been the main source of liquidity and credit growth across the region, as Merrill Lynch points out. Now oil has more than halved since July. There has also been an exodus of foreign cash over the past few weeks. General market turmoil is partly to blame, but a key problem is that investors who had been betting that the Gulf states would let go of their dollar pegs in order to tackle double-digit inflation have withdrawn now that the dollar has strengthened and local governments haven't acted. Una Galani notes on that the UAE central bank estimated in late September that 90% of foreign speculative capital had left the country. So "there was less cash sloshing round the Gulf", as The Economist says. That has left banks strapped for cash and made it harder for them to lend, while international borrowing seized up last month, says Margaret Coker in The Wall Street Journal. The Gulf has become "stuck in its own credit crunch".

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Dubai looks especially vulnerable to the global slowdown and credit squeeze, says It has few oil reserves and has borrowed more than the other emirates to finance its transformation from a Persian Gulf trading post to a financial hub. According to an estimate by ratings agency Fitch, government-controlled firms owe around $70bn in foreign currency; even a lower estimate by Moody's, $47bn, equates to more than Dubai's GDP.

The main worry now is the real-estate market, where credit conditions are tightening HSBC will now only lend up to 70% of the value of a property, down from 85% and the property boom is rapidly cooling. Cairo-based EFG-Hermes reckons property values could slide by 20% in the next three years. "I see the risk of a real-estate bust throughout the Gulf" amid sliding oil prices and a liquidity and credit crunch, says Nouriel Roubini of New York University. And "there's a huge amount of excess capacity being built": Dubai and Saudi billionaire Prince Alwaleed are currently racing to build the world's first kilometre-tall tower.

Dubai can tap another emirate, Abu Dhabi, for cash, while the region as a whole boasts a projected $150bn in budget surpluses for 2008. The IMF thinks most Gulf states should be able to balance their budgets unless oil slides below $30 a barrel, says Andrew Crichlow on With large current-account surpluses and relatively low external financing needs, the region looks more resilient than other emerging markets, says Merrill Lynch, which has lowered its regional 2009 GDP forecast to 4.5% from 6.2%. But while the Gulf may not fall victim to an emerging-market crisis, the notion that it is a safe haven from global turmoil has been well and truly shattered.