How the bubble burst

It was once regarded as a golden land of opportunity by expatriates who flocked there in droves to enjoy a tax-free lifestyle, lucrative career opportunities and the chance to cash in on the real estate boom. But the GCC has been dealt a devastating blow by the global economic downturn, resulting in plunging property prices, thousands of job cuts and an exodus of foreign workers. BM reports on how the GCC dream now hangs in the balance.

“When one industry implodes it's not isolated, it takes many other industries with it”
-Mishal Kanoo, Deputy Chairman of the Kanoo Group

It is a Friday morning in February and thousands of passengers are preparing to board flights at Dubai International Airport. It is not, however, holidaymakers that make up the majority of the passengers today, but expatriate workers heading home for good - many of whom have fallen victim to the emirate's dramatic reversal in fortunes.

Among those about to say goodbye to Dubai are Gregory Van Rensburg and his family who moved to Dubai from South Africa four years ago. Until three weeks ago Van Rensburg worked as a sales director for a property company, which provided the family with subsidised villa accommodation and paid for the children's school fees. They thought they had it made until three weeks ago when Van Rensburg was told the firm could no longer keep him on: "Our whole life was in Dubai. Suddenly we found we had to leave, uproot the children, and set up a new life somewhere else," he tells BM. "We're devastated because we'd imagined ourselves staying here for at least another five years. The impression we'd been given when we arrived was that the good times would just keep on rolling."

It's a story that is being retold at airports across the GCC. Few could have predicted the impact on the region from the global economic downturn and the dramatic plunge in oil prices. The combination of the two factors is a perfect storm that has dealt a major blow to the economic growth plans of governments across the region and the dreams of hundreds of thousands of expatriates seeking a better life in what was once regarded as a land of opportunity.

Counting the costs
The International Monetary Fund (IMF) claims that economic growth across the GCC will slow to 3.5 percent this year, from 6.8 percent in 2008. It predicts that GCC governments' revenues from oil will plunge from US$460 billion in the glory days of 2008 to US$257 billion in 2009. This is very bad news for the US$2 trillion worth of projects currently under construction in the GCC - many of which relied on oil revenues for financing and a ready supply of expatriates to work and live in them once complete. The region's hospitality industry too will be hit hard. Across the Gulf region around US$90 billion worth of tourism-related developments are under construction - projects that now face an uncertain future.

The UAE, which accounts for around 46 percent of the GCC construction boom, will be particularly badly affected, according to the latest research note by EFG Hermes, which says the country is experiencing a "real estate crash" adding," the full trickle-down effects of this into the real economy have yet to be fully appreciated."

Its gloomy outlook for the region sees the real estate and property slumps in the UAE extending well into 2009 and claims the fall out of this will affect the country's broader economy for months to come. The emirate that has been the hardest hit is Dubai. It has invested the most in construction projects and in establishing its financial sector. This has left it dangerously vulnerable to the economic downturn. Describing the effects of the downturn on the emirate, Dr Eckart Woertz, Programme Manager of Economics at the Gulf Research Centre, said: "In terms of how the different countries are affected, Dubai was a leader on the way up. Now it is particularly hit on the way down because of its heavy reliance on the real estate sector and debt financed growth."

To ease liquidity conditions in Dubai, the UAE Central Bank has bailed out the emirate by buying the first US$10 billion of a US$20 billion sovereign bond issued by the Dubai government. Joe Saddi, Chairman of Booz & Company and Managing Director of the firm's Middle East business, said: "The biggest impact (of the downturn) has been on Dubai. Abu Dhabi's bailout of Dubai may not be enough but it is going to go a long way towards bringing the situation back to normal." The bond will enable Dubai to access funds needed to pay off US$15-20 billion worth of debt this year.

Reversal of fortune
EFG Hermes had originally forecast a 20 percent decline in property prices in Dubai this year, but is now revising this figure downwards, having witnessed falls in luxury property prices by as much as 35 to 50 percent.

The impact of the downturn on Dubai's construction sector has been the most obvious indication of how badly the UAE has been affected. Billions of dollars has been poured into projects ranging from the record breaking 818 metre high Burj Dubai skyscraper to Dubailand - a three billion square foot theme park, designed to attract 15 million tourists by 2015. But today cranes and bulldozers at building sites across the country stand idle as the cash flow to see these projects transformed to bricks and mortar runs dry. A report by the Dubai-based market research firm Proleads has revealed that around 53 percent of the projects in Dubai's US$582 billion property portfolio have been suspended. It claims that only US$698 billion is still in operation on active construction projects - in a sector worth an estimated US$1.3 trillion.

Job cuts have been widespread across the real estate sector with the likes of Emaar and Nakheel announcing hundreds of redundancies. Construction workers have been the worst affected. A report by the UAE daily newspaper Emirates Business 24/7 claims that Air India and other Indian carriers were preparing to accommodate 20,000 of bulk bookings for construction workers in March and that the consulate had witnessed a doubling in requests for out passes - from 200 applicants a month in 2008 to 400 a month in January 2009. These numbers will account partly for the mass exodus of expatriates that is expected from the country in 2009. At current levels, 1500 visas are cancelled every day in Dubai and the emirate's population as a whole is expected to drop by eight percent this year. Figures released by Dubai's Ministry of Interior Naturalisation and Residency show that 54,684 residency visas were cancelled in January 2009 compared to 29,418 in January 2008 - an 86 percent increase. Of those, the majority were for expatriates who had worked for private sector companies.

Those leaving the country are not just construction workers. The impact on the sector has sent shockwaves through the many other industries that rely on construction for business. These include media companies, which depend heavily on the real estate sector for advertising revenues, architecture and engineering firms and facilities management providers. Arab billionaire Mishal Kanoo, Deputy Chairman of the Kanoo Group says: "Obviously the industry that has been the most seriously affected is the property market. That has completely imploded in on itself. And unfortunately when one industry implodes it's not isolated, it takes many other industries with it. One of the worst affected is the advertising industry, which had been propped up by the property industry."

After construction, the other main driver in the UAE economy is travel and tourism. Travel and tourism research firm STR Global has revealed that revenue per available room in Dubai plunged by 25.9 percent in December 2008 compared to the previous year. Overall revenue dropped by 2.2 percent in 2008 but the numbers for 2009 are expected to show an even more dramatic change. Meanwhile, hotel occupancy rates dropped by 4.9 percent in November across the UAE with occupancy rates in Dubai experiencing the biggest drop of 5.6 percent. An even more negative picture is painted by Dubai's Ministry of Tourism, which claimed in January that hotel occupancy rates fell by 14 percent in the third quarter of 2008 compared to the same period the previous year.

Banks across the UAE have suffered heavy losses as a result of the economic downturn across all sectors and have tightened lending practices as a result. Among those that have been affected are Emirates NBD, the UAE's largest banking group, which suffered a seven percent fall in profits in 2008 compared to the previous year; National Bank of Fujairah, which posted a full year loss of US$13.7milion for 2008; Mashreq, which has cut four percent of its workforce; and Abu Dhabi-listed Invest Bank, whose profits dropped by a massive 98.4 percent in 2008. Describing the reaction by banks, Dr Ajit Karnick, Professor of Economics at the Dubai-based University of Wollongong, says: "Banks have become very stringent about finance as many property speculators have found themselves overstretched and have left the country. The banks are worried about the money that they have already lent and their main priority is to retrieve that. As a consequence new loans are becoming extremely difficult to obtain.
Saddi adds that this more cautious approach to lending also extends to corporate finance, which is leading to reluctance on the part of banks to finance some large-scale infrastructure projects: "The other thing to consider is bank liquidity and the extent to which they are lending to good projects like infrastructure. There are instances where we see banks being reluctant to extend large-scale financing."

Oil matters
While the UAE is experiencing heavy losses across all industry sectors, the fact that it has worked so hard to establish sources of revenue beyond oil, could ultimately place it in a stronger position than the likes of Saudi Arabia which relies on oil almost entirely for its GDP, as Woertz of the Gulf Research Centre explains. "Bahrain and Oman will have deficits with oil below US$70, in Saudi Arabia the threshold is around US$50, which would mean a slight deficit at current price levels. The same is true for Kuwait. Only the UAE and Qatar would be able to maintain smaller surpluses with oil prices beyond US$40." Dr Karnick adds: "In terms of how the individual countries will be affected, those that depend heavily on oil will be badly hit. For instance, 80 to 85 percent of Saudi Arabia's GDP comes from oil."

There is debate among experts as to how badly Saudi Arabia has been affected by the downturn. In its report, EFG Hermes said it expects the Kingdom - along with Qatar - to outperform most GCC markets because of oil and gas surpluses. However, figures show that firms in the country have suffered significant losses from falling oil prices. A report by the Global Investment House revealed that overall profitability decreased by 7.6 percent in 2008 compared to in 2007 and that "the slump in crude oil prices during the fourth quarter totally reversed the outlook for the petrochemical sector". One of the country's biggest companies, Kingdom Holdings, posted net losses of US$8.26 billion for the fourth quarter of the 2008 financial year. Across the board, lower profit margins were posted by the cement sector, real estate, banking, petrochemical, insurance and food industries. The industrial investment sector witnessed the biggest profitability drop while the construction and hospitality sectors also suffered losses.

Economic strain in the country has had a knock-on effect on the country's property market - though less so than in the UAE. The country's daily Saudi Gazette reported last month that the sale price of new apartments and villas in the Kingdom had fallen by around 12 percent. Meanwhile, the country's construction sector has been so badly hit by the cash flow crisis that contractors have called on the government for urgent financial assistance.
Government aid will also play a large part in helping to ease the effects of the economic downturn on Kuwait, which like Saudi is heavily dependent on oil revenues. The country's government has launched a US$5 billion economic rescue plan which includes state guarantees of up to 50 percent for any new loans given by banks to local companies. It will also guarantee 50 percent of all loans local banks provide to investment companies who reschedule their debts and 25 percent of loans issued to foreign creditors.

Kuwait is likely to be the first GCC country to face a full blown recession, experts, including analysts from Standard Chartered Bank, have warned, because of plans by the government to cut spending. The head of the Kuwaiti parliament's budget committee told reporters this month that the country would slash spending to US$23.77 billion for the 2009/10 fiscal year, based on an initial estimate of oil at US$35 a barrel. The country's cash flow has also been hit by losses of around US$30.9 billion in foreign investments, made by the country's sovereign wealth funds - which included investments worth US$5 billion in Citibank and Merrill Lynch.

In Kuwait it is the country's financial sector that has been hit the hardest. Investment firms make up over half of the country's listed companies, and have borrowed heavily to fund the country's infrastructure projects. Both Global Investment House - Kuwait's biggest investment bank - and Islamic Investment Dar have called for government aid. GIH has announced that it has defaulted on most of its debt, while IID has requested US$1 billion in loans to lift itself out of debt. Meanwhile, the government-owned investment company, Gulf Investment Corporation, has had its long-term credit rating lowered by Standard & Poor's, which cited the impact of "global and regional market conditions" as the reason behind its decision. Not surprisingly, widespread job cuts are expected across the country's private sector and the government has warned that as many as 27,000 private sector employees could lose their jobs unless more is done to increase the value of shares in local companies.

Oman, the GCC's smallest market, only produces 750,000 barrels of oil a day so is less drastically affected by the fall in prices. Moreover its construction sector is, compared to Dubai, in its early stages and is financially supported by the government. However falling exports of petrochemicals and aluminium from the country will slow economic growth in the country to three percent in 2009, the Sultanate's Ministry for Commerce and Industry has warned. While not on the scale experienced by Dubai, this represents a significant drop for Oman, which experienced growth of seven percent in 2008.

Confusion reigns, however, over the state of the economy in Bahrain where talks to agree the country's 2008/2009 budget collapsed in February. The Bahraini Finance Minister Shaikh Ahmed bin Mohammed Al Khalifa has warned that plans to increase government spending in the coming year could be disastrous. "Our spending has to be decreased and any unnecessary spending during the global financial crisis will harm everyone," he told the Gulf Daily News. Such uncertainty could damage Bahrain's reputation as a financial pioneer in the region and could also put the country's many construction projects in jeopardy. The original draft for the budget had included funding for all key government-backed construction projects. Already one of the country's most high profile projects, the Al Dur power and water project, which is jointly owned by Gulf Investment Corporation of Kuwait and GDS Suez of France has been put on hold due to a tightening in the criteria of international lending practices. The country is now reported to be bracing itself for widespread job losses, particularly in the private banking and construction sectors.

The road ahead
Just as no expert could predict the extent of the economic downturn, neither does anyone know when the economy will begin to pick up again. This hinges mainly on oil prices and it is only when these rise that the GCC too will show signs of recovery. Kanoo believes that it will be just six months before economic recovery will begin: "I'm guessing that by summer this year things will stabilise and by the fourth quarter of the year, there should be an uptake," he says, adding: "While it lasts though I can tell you that every company will be hurt by this economic situation no matter how big or intelligent that company is." Professor Karnik, however, argues that it won't be for at least a year that full-blown recovery will start. "There is a general concensus that 2009 is not going to see the situation dramatically change. There's a feeling among economists that in the second half of the year things might start to bottom out. Full-blown actual recovery is unlikely in 2009. This is more likely in 2010."

In the meantime however, like all regions around the globe, the GCC countries have been forced to take any measures necessary to stem the cash flow crisis draining their economies. The economic downturn has come at the worst possible time for the GCC - and could have far reaching long-term consequences for the region.

It is at a crucial stage in its development and building work is in process on major infrastructural and real estate projects and on establishing the region's stock markets on the world economic stage. Not only are crucial sources of finance to fund these changes running dry, but the skills and experience needed to make them happen are also draining away.
A survey by the international HR consultancy ORC Worldwide has found that 53 percent of GCC companies have implemented a freeze on hiring new staff and 17 percent more are planning to do so in the next 12 months. Of those surveyed, 15 percent said they had already cut jobs and a further 20 percent said they planned to in the coming months. This skills drain could represent the biggest threat to the future of the GCC - where expatriate workers make up around 40 percent of the total population - a figure that rises to 90 percent in the UAE private sector.

Eventually the GCC, like the rest of the world, will recover from the economic downturn and the wheels of change and progress will pick up pace once again. But as long as the exodus of expatriates from the region continues, places like Dubai could find themselves facing a critical shortage of talent in the long term. The many expatriate workers boarding planes bound for home at the region's airports played a crucial role in the GCC's success story. And it's not just their belongings that they will be taking with them but the skills and industry knowledge that the GCC will need so desperately in order to rebuild its bubble once again.

Airport becomes vehicle dumping ground
As the glitzy, tax-free Dubai lifestyle turns sour for those expats who find themselves jobless and in debt, some are simply abandoning their cars at the airport and fleeing the city. Reports put the number of vehicles left in and around the airport at 3000, mainly luxury SUVs and saloons. Keys have been left in the ignitions, while some glove boxes contained maxed-out credit cards. Under local law, defaulting on debt, including bouncing a cheque, can mean prison. Not wishing to run the risk of jail, many debt-laden foreigners are choosing to leave their rented homes and cars behind before boarding flights out of Dubai. This is confirmed by Dr Ajit Karnick, Professor of Economics at the University of Wollongong in Dubai. "A lot of cars have been abandoned at the airport by people who had taken out loans to buy vehicles and had lost their jobs. Many of them just drove to the airport then left the country but they are not going to come back because they have an unpaid loan against their name." Dr Karnick says the banks are now lumbered with thousands of cars that they cannot sell. Police have issued warrants against the owners of the dumped vehicles, while those who choose to return risk arrest once they set foot back in Dubai.

Survival of the fittest?
The country least affected by the economic downturn in the GCC is Qatar, according to several experts. A report published by Merrill Lynch notes that while the Qatari banking sector has tightened since the first half of 2008, banks in the country are in a "comfortable liquidity position", and are "less exposed" to the downturn compared to the UAE. The government in the country has already taken steps to ensure the country's financial sector remains in a strong position by forbidding local banks to extend more than 15 percent of their equity to finance real estate projects. In addition, a mandatory 35 percent deposit is required from any customer that wants to take out a mortgage.

There is clear evidence too of domestic liquidity with deposits at local banks having risen by 63.6 percent in 2008. The country's GDP is set to double within the next five years and Qatar's economy is expected to expand by around 8.5 percent this year. The report stated that Qatar would be the fastest growing economy in the Persian Gulf as gas production in the country increases by 80 percent in the next two years. One of the main reasons for the strength of the country's economy is the expansion of its natural gas production facilities. Qatar expects to double its exports of liquefied natural gas this year.
The overall strength of the economy has led the country's government to capitalise on the global downturn by making strategic investments overseas through its sovereign wealth fund, which is believed to be already worth around US$580 billion. It now plans to acquire at least three international blue chip companies.

"When one industry implodes it's not isolated, it takes many other industries with it"

3.5% - Amount economic growth in the GCC will slow to in 2009 according to the IMF

Talking heads
We asked six experts their opinion on the economic downturn in the GCC.

The talent spotter
Rabea Ataya, CEO and Chairman of Bayt.com, the Middle East's leading recruitment website:
"The bayt.com November 2008 Consumer Confidence Index Survey shed some very interesting light how on how GCC residents view the economic downturn in the region. When asked ‘currently, how easy or difficult would you say it is to find a new job in the country you live in?' 43 percent of GCC respondents, the majority, indicated there are very few jobs available and only 19 percent said there are plenty available. Moreover when asked ‘In what way do you expect availability of employment to change in a year's time?' the majority at 31 percent felt there would be fewer jobs available versus 28 percent who thought there would be more available. There is news of widespread job cuts and consolidation in certain sectors that have been suffering globally such as real estate and financial services. The GCC has not been immune to the woes these sectors are suffering overseas and this has probably been accentuated by the fact that these sectors in the GCC went on marked hiring splurges in 2007 and early 2008.

"However, as companies trim down certain excesses to regain competitiveness on a global footing there remains a demand for seasoned staff at competitive salaries that can see these companies through the more difficult times. Today there is still a demand for top talent in most sectors, but employers are more discerning when it comes to sourcing and screening professionals and they are aware that in a market saturated with seasoned top calibre talent they can demand top qualifications at competitive salaries without having to engage in the heady price wars of 2007 and early 2008. Many companies are using this market correction as an opportunity to lay off some relatively less competitive professionals and replace them with top talent laid off from ailing companies or who are looking to relocate from overseas as a result of economic turmoil in their home countries".

The insider
Mishal Kanoo, Arab billionaire and Deputy Chairman of the Kanoo Group, one of the largest family-owned independent groups of companies in the GCC:
"We tend not to use the word recession here. We talk more about a correction. The economic downturn globally was the instigator for the economic downturn in the GCC. But it would not have affected it so badly if major issues did not exist here in the first place. The main reason why the property market imploded was that you cannot sustain year-on-year growth of 30 to 40 percent without a major correction occurring eventually. This correction would not have been as spectacular if people had been buying property for their own use rather than speculating. People's greed got the better of them and they ended up speculating on something that was not there. I remember someone telling me I could buy the 48th floor of the Burj Dubai for US$73 million. When things reach that point you know there's a problem. For that price I could buy a significant building or several smaller buildings.

"I actually believe that the correction in property prices is the best thing that could have happened for Dubai because now all those cowboys and fly-by-night operators will hopefully leave. We will have a few months of pain but post that - say six months down the line - those that did survive will come back in a better financial position and will have better relationships with the banks. Then the economy will start to blossom again."

The economist
Dr Ajit Karnick, Professor of Economics at the University of Wollongong in Dubai:
"Construction and tourism are two of the main drivers behind the UAE economy and both have been badly affected. Hotel occupancy rates at this time of year would normally be 85 to 90 percent but this has dropped to around 60 percent and even lower. A number of major construction projects have been shelved indefinitely and that includes projects by the major players such as Nakheel and Emaar. This means that use of construction equipment has fallen steeply and cranes are sitting idle. Banks have become very stringent about finance. Previously, credit cards were being given out randomly but it is very difficult to apply for either them or for loans now.

"Oil prices will affect government operations. About a month back Dubai announced its budget which showed a massive increase in spending. Since then oil prices have fallen and the economy has slowed even further. There really isn't any information about where the funding for the budget is going to come from. It can only come from taxes, oil wells, borrowing or the creation of money. Each of these is problematic. For the budget to remain in balance and for the targets to be achieved revenues will have to pick up over the next 11 months."

The researcher
Dr Eckart Woertz, Programme Manager of Economics at the Gulf Research Centre:
"We predict that in the GCC current account and budget surpluses will be significantly reduced or turn into deficits in some countries because of the oil price slump. Growth rates will retreat from solid single digits to only slightly positive in some cases.

"Maybe some of the speculative excesses in the real estate sector and stock markets could have been avoided by more determined regulation and lending restrictions. But this is a global downturn and the possibilities of the GCC countries, whose combined GDP is comparable to that of the Netherlands, are limited. In a recession oil producers suddenly find themselves on the price-taker side and can only manage the decline by production cuts. In the long run, however, oil prices will go up again, because oil supplies in many regions of the world are declining and necessary investments in production capacity are not undertaken at current oil price levels."

The analyst
Joe Saddi, Chairman of Booz & Company and Managing Director of the firm's Middle East business:

"There is no part of the world that can claim to be insulated from what is happening. The International Monetary Fund forecast global GDP growth at 2.5 to three percent in 2009. This is compared to five to six percent in the MENA region, and three and four percent for GCC countries. But this depends on the oil prices. This represents a small, albeit positive growth, if you compare it to the Eurozone where most nations have slipped into recession and in the US where the economy has been shrinking. Overall, the GCC may be one of the few regions with positive growth, although it will be at a lower growth rate than the last couple of years.
There will be cuts in jobs at real estate and construction companies particularly in Dubai, with projects being delayed or worse, and the financial sector, too. However, this is not a common phenomenon across the board in the GCC. It is relatively localised and there is strong liquidity that should help the situation.

"You have to be a magician to know when the global economy is going to come out of this but when it does the demand will pick up again and this will drive oil prices up. The region is dependent upon high oil prices. Everyone in the industry agrees that anything above US$100 was driven by pure speculation. The US$40 price is driven by weaker demand from the developed countries, as well as less growth in countries like China and India. Most countries in the GCC have built up significant reserves in the past couple of years however so they should be able to weather these lower prices. GCC governments need to continue to do certain things. They need to ensure that they have strong regulation in place, ensure liquidity and possibly introduce better regulation of the real estate sector from a financing perspective in order to avoid huge speculation. They need to continue to have more transparent fiscal policies and continue to drive GDP."

The people's voice
Joao Neves, Regional Research Director at YouGov Siraj which carries out regular surveys of GCC residents:

"We interviewed a sample of 725 respondents for the first Reality Check survey and one of the most startling findings was that 65 percent of the respondents said they felt there was a lack of transparency in the UAE regarding the current financial situation. What is happening is that people are hearing more and more in the media and from friends and family about job losses and companies shutting down. But because there is a perceived lack of transparency they feel they are not being told the full story about what is happening with the economy here. Around 38 percent of the Reality Check respondents said the current economic environment in the UAE is making them consider the possibility of relocating to another country.

"People are feeling very nervous about their job situations. They are really tightening their belts and spending their money more cautiously. Two-thirds of respondents said they were switching brands to make more economical purchases and 67 percent said they are avoiding easy credit solutions because they are concerned about debt.

"When people first started hearing about the credit crunch in America they didn't think the Middle East would be affected so badly. But now it's very obvious that the real estate sector and many others are really struggling and people are bracing themselves for the long term. Having said that though, 60 percent of the respondents said they felt the UAE is still in a better position than other parts of the world."