Reality Cheque: Will inflation be the biggest challenge to Qatar?

Inflation risks grow

In its most recent update on the country, the International Monetary Fund (IMF) highlights this dichotomy of a nation that still depends on the oil and gas industry for more than half its gross domestic product (GDP), around 85 percent of its export earnings, and about 70 percent of its government revenues. From this year, says the IMF, inflation is set to nearly double within the next three years (from three percent now to at least five percent in 2016). This worrisome increase is not solely attributable to the country’s huge hydrocarbons wealth, but also partly due to the increase in state directed spending on a vast number of major infrastructure construction projects in the lead up to the World Cup.

While the IMF projects that the high level of government spending on World Cup-related infrastructure projects (including new roads, drainage systems, a rail network, hotels, transport, communications, and stadia) will help the non-oil and gas sector grow (by nine percent of total GDP in 2012), it also highlights that the country’s economic growth overall is likely to decline (to 5.2 percent this year, against 6.6 percent in 2012, and 18.8 percent in 2011), while inflation will continue to do the opposite. Much of last year’s increase in prices, for example, says Harish Bhatia, a consultant at the international management firm Hay Group in Dubai, was attributable to such infrastructure spending, with two major projects: the US$640 million (QR2.3 billion) deal awarded to the United Arab Emirates’s Al Jaber Group for package 13 on the Doha Expressway, and the US$961 million (QR3.5 billion) deal awarded to South Korea’s Hyundai Engineering & Construction for the Lusail Expressway. This year is set for a much bigger boost to inflation from the same sector, with spending valued at US$27.5 billion (QR100 billion) on around 30 highway projects. “These ambitious plans pushed wages up by around 6.5 percent in 2012 and is likely to push them up another five percent this year,” says Bhatia.

Rising price trends

With the IMF expecting an additional US$125 billion (QR455 billion) in infrastructure spending in the five years leading up to 2016 alone, and a similar amount thereafter as part of the government’s stated priority of fully financing its budget from non-hydrocarbons revenues by 2020, and in the run-up to the 2022 World Cup, Matthew Green, head of United Arab Emirates (UAE) research and consultancy for CBRE in Dubai, expects a significant increase in the number of expats coming to live and work in Qatar. And as a corollary of this markedly higher influx of foreign money into Qatar, he also expects a bullish tone to the country’s property market that should further serve in pushing inflation higher.

Moreover, the Qatari authorities have made this inflationary rise on the property market all the more likely by implementing changes in the regulations relating to foreign ownership of property in the country, adding to the already short supply of rental accommodation, says Green. In this context, until the enactment of Law 17 in 2004, in fact, non-Qatari nationals were not allowed to own or have long-term leaseholds on property in Qatar. However, since the passing of the snappily-named law Regulating Ownership and Usufruct of Real Estate and Residential Units by Non-Qataris, foreigners have been permitted to invest in property for either their own use, or as a pure investment to rent to others. Although, as it currently stands, only three areas are available for freehold purchase (The Pearl, West Bay Lagoon, and the Al Khor Resort Project), there are another 18 areas in and around Doha that have been designated for foreigners to acquire the ‘right of usufruct’.

An increase of expatriates coming to Qatar will result in a bullish tone to the country’s property market, possibly pushing inflation higher.

Banking asset quality

A natural adjunct for Qatar of rising inflation against the near-static interest rate environment that is necessary to support current projected economic growth rates is its declining asset quality in the indigenous banking sector, and to its domestic stock market. In the course of Q1 to Q3 last year, for example, international investors withdrew a total of US$588 million (QR2.14 billion) out of Qatari equities, according to data from Deutsche Bank. Moreover, by the end of Q3 of last year, total lending by banks increased to represent 120.1 percent of deposits, according to the Qatar Central Bank (QCB), implying that Qatari banks were, at least at that point, reliant on short-term borrowing from capital markets and other banks. This reliance on volatile short-term funding was exactly the same situation as occurred in 2008, when UAE banks were taking interbank lending from the rest of the world.

In its most recent judgment on Qatar’s banking system – including both the conventional and the Islamic elements – major ratings agency Moody’s highlighted the high degree of dependence government-related business had on the domestic economy. “The economy is undiversified and heavily reliant on the oil and gas sector, and credit risks relating to exposures to the construction and real-estate sector,” underlined the agency.

Again, the official figures from the QCB bear this out. The public sector, and principally government agencies and semi-agencies, were the main drivers of loan growth, increasing by 35 percent in the year to August 2012 (the time of its last major banking sector update), to QR201.3 billion. It accounted for the majority of loans in Qatar, and its share had grown from 22 percent (QR35.9 billion) in 2007 to 42 percent (QR201.3 billion) as of August 2012.

Indeed, according to the Central Bank, the financing of large capital investments in developing the country’s infrastructure has been the key driver of public sector loan growth. It added that government agencies, semi-agencies and large corporates, which are engaged across economic sectors, are expected to continue to be the main driver of loan growth given the large development programme and infrastructure projects underway, and to be implemented in the short to medium term. Fitch ratings agency, notes in its 2013 GCC/Middle East Banks Outlook that balance-sheet constraints, intense competition (exacerbated by the decision of the Qatar Central Bank to separate conventional and Islamic banking operations), and undiversified funding portfolios are posing challenges to the growth of Qatari banks, and that the sector’s loans/deposits ratios are gradually creeping up.

Anti-inflation strategy

None of these relatively negative factors, though, have escaped the attention of the relevant Qatari authorities. On the thorny issue of rising inflation, to begin with, Qatar’s State Cabinet has stressed this year that measures must be taken to introduce amendments to some key provisions of Law Number 12 of 1972 which gives the right to the Minister of Business and Trade to fix the maximum wholesale and retail prices of a number of items, mainly food and hotel room tariffs. Those found violating the new trading parameters would face increased jail terms and fines. The issue of broadening and deepening its domestic capital markets (through which banks’ asset quality could be markedly improved) is likely to prove a little trickier. Certainly, says Neil Beveridge, senior Middle East oil and gas analyst for Sanford Bernstein, mergers and acquisitions activity and IPOs are highly unlikely to see much of an increase in activity in Qatar in the foreseeable future. “Qatar has very little interest in divesting any of its companies to anybody else, but rather they will continue to build up stakes in companies abroad, as they have been doing to great effect over the past few years,” he tells The Edge. In this respect, Industries Qatar’s decision last September to increase the amount of shares that foreigners can buy in it - to 12.25 percent from 7.5 percent - is likely to prove something of a false dawn for foreign investors, who, in any event, may not be particularly interested in acquiring such assets ahead of the likely worsening in the country’s economic profile ahead of 2022, thinks Sebastien Henin, portfolio manager at The National Investor, in Abu Dhabi.

“Qatar is unlikely to see much increase in activity in the areas of M&A and IPOs as firms have very little interest in divesting any of its companies to anybody else, but rather they will continue to develop stakes in companies abroad.”

Neil Beveridge, senior Middle East oil and gas analyst for Sanford Bernstein.

Indeed, it is something of a vicious circle in this respect, as imposing strict limits on foreign ownership of shares (typically only up to 25 percent of a company) has been the main reason why Qatar failed to enter the MSCI emerging markets index on several occasions (most recently, last July) when it was an attractive prospect to foreign investors.

Broadening the capital base

An altogether brighter prospect for improving its financing options was recently delineated by QNB Group that, along with others, expects regional companies will continue to drive bond issuance higher in 2013 for a number of reasons. Firstly, it says, tapping debt markets has the benefit of broadening the investor base of Qatar’s companies. Secondly, these companies will be keen to take advantage of the prevailing low interest rate environment. Thirdly, strong growth is expected in Qatar, albeit at a rate that is less than the country has been used to, which will drive continued demand for project financing. And, finally, with the introduction of Basel III standards that call for greater market liquidity and collateral obligations, more banks in the country are likely to regard raising core capital through debt issuance as a the most efficient and cheapest way of doing so. 

In this respect, given Qatar’s sovereign rating of AA- with a stable outlook from Standard & Poor’s, and Aa2 with a stable outlook from Moody’s, domestic firms should find financing at affordable levels (certainly better than could be achieved through any available equity financing structures, and without the concomitant loss of shareholder control over the company involved).

QR2.14 billion

The amount in billions international investors withdrew out of Qatari equities in the first three quarters of 2012 (Q1-Q3) last year, according to data from Deutsche Bank.

Islamic finance expansion

Finally, underlines Roger Nightingale, senior global strategist for Pointon York investment fund, in London, Qatar’s efforts to position itself as an Islamic financing hub in the Middle East are likely to gather impetus, despite the recent setback when NYSE Euronext reduced its ownership level to 12 percent in the Qatar Stock Exchange (QSE).

The quid pro quo for China’s granting on 11 December of a US$1 billion quota for Qatar Holdings - the investment arm of its US$120 billion (QR 437 billion) sovereign wealth fund, the Qatar Investment Authority - to invest in China’s capital markets, is widely believe to be a similar reciprocation for the Chinese to invest in QSE. Jiang Yang, vice chairman of the China Securities Regulatory Commission (CSRC) and Yang Maijun, chairman of Shanghai Futures Exchange (SFE) have been in Doha for a week discussing future relations between the two bodies and the QSE. Any deal, says Nightingale, could well be a precursor to tie-ups between the two countries in the realm of Islamic financing as well (the size of Islamic banking sector in Qatar is around US$35 billion (QR127 billion), accounting for an estimated 19.3 percent of the country’s total banking assets).

Interestingly in this regard, Qatari officials are believed to have been in discussion with Cheng Guoping, the Vice Foreign Minister of China who is acting as the point man for the development of Islamic finance in the country, which has around 20 million Muslims in its population (around 1.5 percent of the total). Indeed, in June of last year, Cheng informed Ekmeleddin Ihsanoğlu, secretary general of the Organisation of Islamic Cooperation, that Beijing wants to be granted observer status in the organisation.