This analysis is by Bloomberg Intelligence Senior Analyst Tomasz Noetzel. It appeared first on the Bloomberg Terminal.
A better understanding of emerging-market (EM) risks and opportunities can be gained by studying the major influences — including contagion from China’s economic slowdown, an oil price nearing $100 and US Federal Reserve rates — all of which form the basis of this combined Bloomberg Intelligence/Bloomberg Economics analysis. Typifying the varied challenges, we explore the diverging monetary policies across EMs — with easing in Brazil vs. tightening in Turkey — and explain why Gulf countries often have to follow Fed tightening, despite their need for easing.
The EM investment landscape was historically subject to significant volatility due to macroeconomic and political gyrations, often leading to currency crises, rampant inflation and capital flights, making it somewhat of a global-economic litmus test.
Banking institutions in emerging and developing economies generally have far higher growth rates, margins and returns-on-equity than developed-market peers, with low credit penetration underpinning growth scope and interest-rate volatility and lack of competition affording pricing power. Geopolitics, oil prices and inflation are key valuation drivers.
Oil above $80, end to tightening and contained geopolitics
Gulf banks fell 2% since Friday on weaker sentiment across emerging markets, yet the conflict between Israel and Hamas has been contained geographically. Gulf banks trade at a median 1.2x forward price-to-book ratio, or 10x P/E on 2023-24 numbers, with their valuations mirroring local economies’ trajectories. Oil above $80 a barrel offers indirect exposure to the energy sector and project pipelines worth over $1.6 trillion. The price of crude declined since 2H22’s peak, but the current level aids fiscal spending and non-oil economy expansion.
Catalysts for banks include an oil price over $80 a barrel and a downward shift in Fed rate policy. That’s because further Fed rate hikes would be hard to pass on to borrowers, even though rising rates enabled margin expansion last year, particularly for UAE and Saudi lenders.
EM bank rating realigns amid diverging policy making vs. reality
Diverging inflationary pressures and policymakers’ responses can be observed in emerging-market bank valuations. Plotting price-to-book (P/B) ratios vs. return on equity is a useful tool, with Turkish banks’ 0.6x P/B vs. for a 20%-plus ROE reflecting hyperinflation. A hawkish Fed stance and high funding costs drove Gulf bank (bar UAE) deratings over the past year, with $1.6 trillion of projects underpinning the region’s rosy growth prospects. Philippine peers’ (sub-0.4x P/B for 9%) are the lowest, with property risk weighing on Chinese banks (sub-0.6x P/B ). Polish and South African lenders have similar expected ROEs in 2024, with the former’s P/B at below 1x vs. 1.2x for the latter.
Higher-for-longer interest rates make liquidity expensive for Gulf banks and bring asset-quality risk as the impacts filter into the economy.
$1.6 trillion investment pipeline underpins banks valuations
Valuations for Middle East banks, in particular Gulf lenders, are backed by a construction pipeline worth more than $1.6 trillion over five years, according to August’s data from MEED. Saudi Arabia leads with $574 billion of project value, followed by the UAE’s $226 billion. Qatar has a smaller list, but any spillover from LNG terminal expansion is unlikely to be captured yet. Construction spending may allow UAE banks’ wholesale credit to achieve a CAGR of 5-7% over five years, assuming 50-70% utilization, or 2-4% on a utilization rate of 20-40%. Saudi corporate loans could rise at a 12-15% CAGR in five years for credit utilization greater than 50%, or 5-10% on utilization of 20-40%.
An easing of Fed policy is essential for banks to gather cheaper dollar deposits for funding a large project pipeline.
Gulf dollar liquidity is costlier after rapid Fed rate hikes
The total cost of dollar funding for Gulf banks, as measured by the yield to worst on the GCC Dollar Credit Index, has risen to 5.8%, the most since the Fed began tightening. But the dollar credit spread has stayed low, due to higher oil prices and the absence of geopolitical risks. The aggressive Fed moves have triggered a divergence in regional monetary policy, as Gulf central banks try to balance domestic inflation expectations, the need to retain dollar liquidity and their ability to support currency pegs. Saudi banks may follow Qatari cohorts in relying on dollar liquidity to fund infrastructure projects that would likely need dollar credit lines to import materials.
