Markets in meltdown

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Gulf economies have been hit hard by the fallout from the US financial crisis and more bad news could be on the way as debt markets contract and the cost of lending looks set to soar, threatening trillions of dollars in planned investment.

It is a quarter past midday on the floor of the Dubai Financial Market. A sea of worried faces is bathed in the red glow of the tickers. Above them, a bank of trading screens paints a gloomy picture - a market in meltdown, hemorrhaging investors and shedding points at a record rate.

"Foreign investors have been liquidating since the start of 2008, and our market has turned into a bear market," says Zaid Al Nafoosi, a stockbroker at Dubai-based Al Sharhan Stock Center.

"Foreign investors are selling more than buying, and we're talking about millions and millions of dirhams per day."

Earlier in the day, the world's financial systems were rocked by the news that Lehman Brothers, the fourth largest investment bank in the US, had filed for bankruptcy protection. The shockwaves are being felt across Europe and Asia, and come just hours after Merrill Lynch, another large US investment bank, agreed to a surprise $50bn takeover by the Bank of America.

Before the week is out American International Group, the nation's largest insurer has been brought under direct government control to avoid the possibility of another cataclysmic collapse.

Thousands of miles away in the Gulf, the tremors emanating from the seismic changes on Wall Street are now being felt. In the week to September 17, 2008, Saudi's Tadawul, the Middle East's largest exchange, dropped 9.1 percent. The DFM was down over 7.4 percent, and Qatar down 7.7 percent.

"What happened today was because of Lehman Brothers, but the falls over the last two months have been due to global markets, such as the credit crunch and concern over investments in the US, which have dropped severely," adds Al Nafoosi. "We've had serious losses over the last couple of weeks, and there is no indication of a change in the downward trend."

While the credit crunch has left a trail of destruction across markets worldwide, the major economies of the Gulf have not been impacted to the same extent. Regional bourses have been buoyed by record oil revenues and a building boom which has helped some of them - including Kuwait, Qatar and Oman - produce returns that were among the best in world in the first half of 2008.

But sentiment is changing fast and a retreat of foreign investors has left some equity markets fragile, while debt markets are now also contracting.

Earlier this month Merrill Lynch reported that the cost of protecting Dubai government bonds from default had doubled in the past three months, on concerns that the emirate will be unable to maintain the borrowing that has driven its real estate boom.

Credit default swaps (CDS) protecting Dubai debt for five years traded at 220 basis points, according to CMA Datavision prices, up from 110 at the beginning of June. Contracts on Abu Dhabi bonds rose 57 percent in the same period to 74 basis points.

The cost of protecting other government bonds in the region has also soared, according to Bloomberg data. By close on September 16 credit default swaps protecting Qatar debt for five years traded at 127.5 basis points, up from 75 basis points just a week earlier, while in Bahrain they traded at 155.7 basis points - up from 130 points a week earlier.

"The spreads have gone up around the Gulf, and they are likely to continue to rise because of a potential liquidity issue," says Jan Plantagie, regional manager for the Middle East at credit ratings agency Standard & Poor's. "The spreads are going to continue to go up because when something becomes scarce, the price goes up."

Real estate developers could be hurt most by the rising cost of debt. Projects such as Saudi's $26.6bn King Abdullah Economic City, Qatar's $5bn Lusail project, and Bahrain's $3bn Financial Harbour, are all at least in part, dependent on borrowed money.

"There's a lot of infrastructure including residential and commercial real estate that needs to be funded across the Gulf," says Plantagie. "It may be challenging to raise the required levels of debt, and going forward over the next one to three years, I think there will be projects where they will not be able to attract the funds."

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