The prices of oil have rebounded in a vigorous manner from their trough at the beginning of the year 2016, and they are expected to provide a moderate rally in the years to come (Alodayni, 2016). The slump in price has led to macroeconomic pressure on the economies that are engaged in oil exports as well as their banking systems. In the Gulf Cooperation Council (GCC) region, the slump in oil prices has led to instability in the banking system of the GCC. The major reason as to why the GCC countries are affected by the fall in the price of oil internationally is that these countries are entirely dependent on oil and hydrocarbons.
Overview of Oil and Banking System in the GCC
The major oil exporters in the GCC region are such countries as Qatar, Saudi Arabia, Oman, Kuwait, Bahrain and the United Arabs Emirates (UAE). In this regard, any fluctuations in the price of oil could have an influence on the Growth Development Product (GDP) (Sturm, Strasky, Adolf, & Peschel, 2008). The economies of the GCC can be highly affected by the decrease in oil prices due to two reasons. The first reason is that the economies of the GCC are highly dependent on oil exports in addition to gas exports. From the year 2011 to the year 2014, the largest percent of the represented exports were in line with hydrocarbons (Callen, Cherif, Hasanov, Hegazy, & Khandelwal, 2014). The fiscal dependence on revenues that were obtained from hydrocarbons is higher as it totaled 80% of the total collected fiscal revenue (Dash, 2015). It is also crucial to note that the dependence on fiscal revenue acquired from hydrocarbons has not declined in the past decade despite the fact that efforts have been made at economic diversification.
The second reason is that the linkages of macro-finance in the GCC can lead to the proliferation of the implications of the movement of oil prices over the financial cycle (Khandelwal, Miyajima, & Santos, 2016). The movements of oil prices and the policies of government spending lead to the creation of feedback loops as far as the prices of assets and credit are concerned, thereby leading to the creation of systematic vulnerabilities in respect of the financial sector. The spike in oil prices causes increased oil revenues in addition to stronger fiscal positions. Returns associated with equity markets are greater as investors highly anticipate the effects of increased oil prices on the corporate sector, thereby influencing stronger spending growth by the government (Said, 2015). Increased spending by the government consequently leads to the escalation in non-oil output growth and greater liquidity in the banking sector. Moreover, it triggers higher prices in regard to real estate and strong balance sheets. The appreciation of asset price has also positive influence on wealth. In the case of reduction in the prices of oil, the development mentioned above suspends. Taking into account the fact that financial sector in the GCC is fairly large and the presence of high volatility in line with the oil prices in this region, the systematic detection of the vulnerabilities of the financial sector might bring adverse implications for the real economy (Kammer et al., 2015).
Additionally, evidence has it that the performance of oil prices has been a crucial trigger for financial variables and business variables in the economies of the GCC. To begin with, good performance of financial variables in addition to real variables seems to be associated with the increase in oil prices. During the period between the years 1991 and 2014, the growth rates of the real spending by the government and the GDP of non-oil outputs were stronger in the event of growth in oil prices compared to the periods of slump in the prices of oil (Khandelwal, Miyajima, & Santos, 2016). Second, the occurrence of business and financial variable downturns in particular cases coincided with the reduction in the prices of oil. Credit and equity markets contractions are a sign of the movement in the prices of oil along with the global development of the financial market and consequent domestic vulnerabilities.
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The soundness of the banking sector provides a crucial buffer against the decline in oil prices in the GCC since the middle of 2014. The banks in the GCC have strong capital buffers as well as liquidity buffers starting from the end of 2014 (Khandelwal, Miyajima, & Santos, 2016). Capital buffers and the levels of provisioning were higher than in any other countries that engaged in commodity exports. The amount of non-performing loans (NPL) is low and the provisions for loan loss and loan benefits are strong. However, the conditions of liquidity have begun to tighten in the recent past (Khandelwal, Miyajima, & Santos, 2016). The growth of credit has remained robust, while the increase in deposit has slowed due to the fact that governments in addition to the entities that are related to the governments have withdrawn deposits from the system of banking.
Oil Prices in the GCC and the Implications of Low Oil Prices for the Spending Patterns of the GCC
In the global market that is experiencing low prices of oil, the sharp and prolonged drop in the prices of oil has lowered a large percentage of the revenue of the GCC members in the recent past (Abdelbaki, 2010). Consequently, the trading climate that is bleak in this region has forced the GCC countries to consider the reassessment of the strategies of public spending with a view of attempting to plug the gaps in revenue in their programs that promote nation building. With the low prices of oil, the Gulf States are forced to start rethinking the manner in which they will fund their programs of development as well as their infrastructure spending (Callen et al., 2014). In order to boost income, the GCC countries have participated in the announcement of plans with a view of introducing a value added tax (VAT) by the year 2018 on both regional citizens and regional residents (Callen et al., 2014).
In fact, in Saudi Arabia, the deputy crown prince announced that the kingdom will engage in seeking the ways to escalate revenue (Ebrahim, Inderwildi, & King, 2014). From a general point of view, the GCC countries enjoy the smallest amount of debt-to-GDP ratio in the world, thereby making them comfortably borrow money from international markets. In spite of the above-mentioned reason, the governments in the GCC region inevitably experience budget deficits. In fact, this is the major reason why these governments are collectively considering the possibility of economic diversification. For instance, Saudi Arabia that is the largest nation in the GCC region is continuing to pursue policies toward diversification. However, its economy is constantly dependent on hydrocarbons (Sturm et al., 2008). On the other hand, the success of the United Arabs Emirates (UAE) is reliant on tourism compared to that of Saudi Arabia.
The environment of oil prices played a crucial role in the event of Iran to join Saudi Arabia, thereby becoming the leading producers of oil in the region. The GCC countries hold 30% of the proven reserves of oil in the world, with Saudi Arabia leading with 15.7% (Coface, 2015). Kuwait then follows with 6%, while those of the UAE number 5.8% (Coface, 2015). Collectively, the GCC countries produced a total number of 28.6 million barrels of oil per day in the year 2014 (Coface, 2015). This amount of oil production can be translated to 32.3% of the total world production of oil (Coface, 2015). The economy of the UAE can be termed as the most diversifies, as compared to other GCC countries, hence its resilience in line with the drop in the prices of oil. Revenues obtained from hydrocarbons total up to 25% of the GDP in addition to 20% of the total revenue collected from exports (Coface, 2015). Furthermore, domestic demand in the GCC is powered by strong retail sales that rise confidence. The retail sales in Dubai are estimated to escalate as a result of the increase in tourism. Thus, in respect of the question whether the GCC will be in a position to adjust to the falling prices of oil, it can be concluded that most of the GCC countries are considering the diversification of their economies.
The current prices of oil provide an opportunity for the governments in the GCC region to change their economies for the future generations. Reforms in energy subsidization are not controversial in the environment of low prices of oil (Dash, 2016). Apart from this, the citizens of the GCC countries are aware of the implications of the low prices of oil as a result of the efforts of the governments to provide information on the potential effects of the fluctuations in the prices of oil. In this regard, they are much susceptible to the comprehension of the measures that ought to be taken by their governments with a view of avoiding adverse effects on their economies.
The sharp fall in the government revenue as a consequence of the reduction in the prices of oil has suspended economic growth in the GCC countries, besides decreasing the respective budget of each nation. However, the scale of fiscal challenges varies from one country to the other in the GCC region (Coface , 2015). Saudi Arabia, as the largest player in the production of oil, faces the highest fiscal challenge. Currently, this country experiences a deficit in budget up to 20% of the gross domestic product (Coface, 2015). The country has, thus, been forced to engage in liquidating a considerable sum of money related to foreign reserves in addition to participating in local debt issuance program. In the United Arabs Emirates, a drop has been experienced in government deposits regarding domestic banks. In the future, the impact of the fall in the prices of oil on the financial status of the GCC countries will be more pronounced.
The Effects of the Fluctuations in Oil prices on Banking Systems in the GCC
As stated in the discussion above, the fluctuations in the global price of oil affect the economic growth of the GCC and, thus, the banking system of the GCC (Alodayni, 2016). The oil price has implications for the NPLs in the GCC countries in respect of the link that exists between the prices of oil and real developments. Moreover, there is a strong connection between the financial development in these countries and the observed behavior regarding bank capital, besides provisioning in light of indicators of financial and business cycles (Khandelwal, Miyajima, & Santos, 2016). On the basis of data provided by the International Monetary Fund (IMF) from 2000-2014 on the balance sheets of individual banks in the GCC in line with the amount of non-performing loans (NPLs), the rate of lending interest, average price of oil, growth of credit, stock prices as well as housing prices indicate the lack of indexes in relation to housing prices in the GCC region (Khandelwal, Miyajima, Santos, 2016). In this region, there is the subsidization of water and electricity as a result of housing prices. Apparently, the same as the prices of oil, housing prices in the GCC are also a major determinant of the stability of the systems of banking in the GCC region. From various researches conducted by the IMF on the banking systems and the economies of the GCC countries, data is provided on the potential dynamics of slumps in the prices of oil in the economies that are engaged in oil exports and the channels of transmission to the balance sheets of banks (Said, 2015). In most cases, the fall in the prices of oil has a direct impact on the decrease in economic growth in the GCC countries, besides influencing financial choices in the banking systems.
The Quality of Bank Asset and Macro-Financial Linkages
There is a growing number of empirical studies regarding the quality of bank asset and macro-financial linkages. While taking into consideration macroeconomic and bank level data, it is possible to make a conclusion that the ration of NPL grows following a decline in the economic growth, while the rates of interests and risk aversion increase (Alodayni, 2016). From a study targeted on the economies of the GCC regions, there is a strong short-lived effect in terms of feedback from weaker conditions of balance sheets from the banks to economic activity. The price of oil, non-oil GDP, stock prices as well as interest rates are the key determinants of non-performing loans (NPLs) in line with the GCC banks, thereby influencing financial stability in this region.
The shock of credit risk seems to cause the propagation of disturbance in respect of the non-oil GDP in addition to the growth in credit in the GCC region. An increased level of NPLs leads to the restriction on the credit growth of banks, thereby impeding economic recovery in the economies of the above-mentioned region mentioned (Kammer et al., 2015). Therefore, this suggests an assertion that disturbances in the system of banking lead to economic consequences that are unwanted in the real sector. Counter-cyclical policies that cause the GDP slowdown eventually precipitate the promotion of financial stability in the GCC region. Policymakers with the possession of objectives that promote financial stability ought to be aimed at monitoring developments in relation to global oil markets in addition to handling the effects of the potential spillover effect on the banking system of the GCC region.
Additionally, the current financial crisis triggered financial instability in the banking systems (Abdelbaki, 2010). Therefore, this suggests an implication that there is a strong relationship between real economy and financial instability in relation to the banking system. Moreover, the prices of oil have an adverse effect on the credit risk regarding the banking system in the GCC. As a result, instability in the system of banking in the GCC region might lead to the occurrence of another instance of financial crisis in this region. In fact, this is grounded on the data provided by the financial crisis of the 1990 in line with the emerging economies which give an indication of credit risks in the systems of banking which typically cause a crisis in currency (Callen et al., 2014). Consequently, a crisis in currency deepens the banking systems’ crisis, thereby spreading it to the economy in general.
Movements in Bank Capitals in Addition to Provisions in the GCC Region
An empirical approach is employed to shed light on the behavior that is counter-cyclical regarding the provisions for loan loss as well as capital ratios in the GCC countries (Said, 2015). A comparison of developments in the provision for loan loss in addition to capital adequacy ratio (CAR) is made in relation to key business movements and indicators of financial cycle, including the credit to non-oil GDP gap, the growth in real credit and the growth in real non-oil GDP. With a view of determining specific factors in the GCC, the price of real oil is taken into consideration (Kammer et al., 2015). The assessment counter-cyclical movement degree is made while employing the correlation coefficients that exist in regard to NPLs or CAR provisions, while involving four indicators of business in addition to the indicators of financial cycle. Positive correlation coefficients regarding the significance of statistics suggest an indication that NPLs and CAR provisions are counter-cyclical. However, it is important to note that the ratios of correlation coefficients increase when the GCC region thrives. Moreover, research conducted on the GCC banks provides ways to handle heterogeneity among individual banks in the GCC in line with correlation coefficient.
Therefore, the GCC countries ought to become more resilient in order to cope with the implications of the falling prices of oil for their economies and stability of their systems of banking (Ebrahim, Inderwildi, & King, 2014). The governments of these countries should devise effective and efficient strategies targeted on the creation of their citizens’ awareness in line with the effects of the fall in oil prices on their nations and their engagement in the creation of possible solutions to these effects (Alodayni, 2016). The reason is that from the ongoing discussion, it is quite evident that the revenues obtained from the production of oil are not fully sufficient. Thus, more channels of revenue collection ought to be identified for stronger economic growth and sustainability of systems of banking.
The fall in the prices of oil has brought negative implications for the GCC countries. In general, the reason is that most of the GCC countries are dependent on the revenues collected from oil exports as well as hydrocarbons. Therefore, it is important to take into consideration the fact that the prices of oil in the world and economic development in the GCC are two aspects that have an adverse influence on each other. Therefore, this suggests the assertion that an escalation in the prices of oil leads to an increase in the economic growth of the GCC countries, while the slump in the prices of oil causes a decrease in the economic growth of the GCC countries. Moreover, changes in the economic growth in the GCC counties has adverse effects on the systems of banking of these counties as they impact various factors associated with the banking system such as the rate of borrowing, the interest rates and provisioning in the banks. In this respect, the only strategy that can be used by the GCC countries to avoid the adverse effects of the fall in the oil prices on their economies and banking systems is to engage in the diversification of their economies.