The whirlwind of speculation about whether currencies of the Gulf Cooperation Council would depeg from the dollar sparked an unprecedented influx of foreign investors to Middle Eastern local debt markets at the back end of 2007. But they left as quickly as they came, when, by mid-2008, the depeg rumours in the United Arab Emirates and Qatar were firmly quashed. To date, Kuwait is still the only GCC country to have delinked its currency.
"A lot of hot money came in by 2007, and liquidity in the system on the primary and secondary side shot up," says Saadaat Yaqub, head of debt capital markets at Noor Islamic Bank in Dubai. "But strong signals from the governments that there would be no depegging made it vanish. The depegging discussion is now no longer there."
The disappearance of these foreign investors, who descended on the market in the hope that depegging would make local currencies appreciate, did not leave a complete void. A regional bid for local currency transactions returned instead until markets around the world went into meltdown in September, and Middle Eastern banks and investors got caught up in the storm. Kuwaits banks were particularly badly hit, with Gulf Bank suffering big third quarter losses and having to recur to an emergency rights issue in December.
It is not just the notion of depegging which has been quashed in the last year, but also that of the decoupling of the Middle East economies from the rest of the world. Bankers no longer contrast the lack of liquidity with the deep pool of local currency liquidity available across the GCC: Middle Eastern banks are nearly as parched of UAE dirhams, Qatar riyals and Bahrain dinars as they are of dollars.
Local currency sukuks to sufferThis is not just bad news for local markets, but for the international funding scene too. Many Western banks had switched their sights to local currency sukuks, and were bookrunners on a string of transactions in the first three quarters of the year.
The bulk of these came out of Dubai, with borrowers such as property company Tamweel tapping the market for dirham issues as recently as July. Only a few months ago, bankers were hailing the beginning of a new phase for local debt markets, after the departure of the foreign speculators, and pinning their hopes on local liquidity staying strong.
In May, real estate developer Nakheel was credited with opening the true dirham market when Middle East accounts dominated the order book for its Dh3.6bn sukuk.
"Strong participation by local investors highlights the extent to which the dirham market has become a market growing on its own merits," was the comment from one of the bookrunners at the time. Dubai Islamic Bank, JP Morgan and National Bank of Dubai Investment Bank led the issue.
The international syndicated loan market also came to rely heavily on the local currency bid in the Middle East last year. With many domestic banks turning their backs on dollar-denominated facilities, loan arrangers structured deals with local currency tranches to entice local participants.
But by the end of 2008, even that strategy was failing, as local liquidity began disappearing too.
"The dollar/dirham issue is still there, but its not as acute, as dirhams are scarce too," says one loans banker, describing the fate of loan transactions in Dubai.
No cross-border lendingThe interaction between local and international debt markets in the Middle East has never been so pronounced, but proclamations that the local debt markets were coming into their own have been premature.
Cross-border lending between GCC countries never really took off at the best of times, and bankers in the Middle East are expecting this interaction to slow down completely.
"Local banks will not be lending to each other for a very large part of 2009," says one banker in Dubai. "Saudi Arabia has the biggest pool of liquidity, but this has never benefited other GCC countries."
In 2009, with troubled Middle Eastern banks expected to turn even more closely towards their home markets not unlike banks in Europe and the US cross-border lending in the region is unlikely to take off. Middle Eastern banks will be focusing on domestic lending instead and any leftover local liquidity will be swept up by international banks.
"The switch towards dirham facilities and multi-currency options to include other GCC currencies in deals will continue," says one loans banker.