GCC Countries Advised to Weather the Financial Storm and Prepare for the Future

Impact of the global downturn on infrastructure developments in GCC countries ‎widespread, but government prioritisation and collaboration with banks and other ‎stakeholders will ensure continued development.  ‎

The global economic downturn and sharp decline in oil prices are significant challenges for GCC ‎governments working to build the infrastructure required to support future economic growth and ‎social development. Given the GCC’s rapid growth, countries need to prioritize investment in their ‎infrastructure. Governments, banks, and other stakeholders must collaborate to prioritize sector ‎investment and provide or attract financing to enable infrastructure development to continue, finds ‎a new report by Booz & Company.‎

Governments should prioritize projects that focus on long-term strategic objectives and establish ‎the right legal and regulatory framework to attract and foster private-sector investment; and ‎market its attractive growth prospects to global investors and developers. “Governments can also ‎support the creation of dedicated infrastructure investment vehicles within the region and ‎structure deals that facilitate easier debt and private financing,” commented Fadi Majdalani, a ‎partner at Booz & Company.‎

Banks, lending institutions, and private-sector investors should avail of the significant growth ‎opportunities in GCC infrastructure project financing. An array of investment vehicles are ‎available to facilitate this.‎

The Immediate Future of GCC Infrastructure‎

Infrastructure projects in GCC countries have increased at unprecedented rates. From 2002 to ‎‎2008, GCC governments awarded approximately US$720 billion worth of projects. Yet spending ‎has not always kept pace with economic and population growth: Kuwait still lacks capacity for ‎peak load electricity production, Saudi Arabia and other GCC countries face water shortages, and ‎the UAE is experiencing overloaded sewage plants and congested highways. ‎

“GCC countries have not been spared from the global financial crisis and economic recession, ‎with sharply reduced oil prices, decreased liquidity, and falling share prices on regional stock ‎markets, which have impacted infrastructure developments in two ways,” explained Walid Fayad, ‎a principal at Booz & Company. Lower oil prices threaten the fiscal health of GCC governments, ‎potentially impairing their ability to spend on infrastructure; and the tight credit markets and ‎disruptions in the loan syndication market limit the availability of long-term financing for it. ‎

The Impact of Sharply Reduced Oil Prices on Governments’ Infrastructure Spending

GCC governments continue to rely on oil exports for the bulk of their revenues despite recent ‎diversification High oil prices allowed GCC governments to fund major development activities, ‎including infrastructure, even while generating comfortable budget surpluses. Spending on ‎infrastructure had risen to as much as 30 percent of the budget in some countries. ‎

But with recent oil-price falls, governments face the possibility of running fiscal deficits. ‎

Sovereign wealth funds (SWFs) and government-owned investment companies (GOICs) may ‎step in to finance infrastructure projects as other pressing requirements compete with it for ‎funding. “It’s important that SWFs and GOICs take a profit-driven approach when they participate ‎in infrastructure development. They would also benefit from a broad effort to rationalize the ‎current large number of funds and companies,” explained Fayad.‎

The Impact of the Credit Crisis on Infrastructure Financing

In recent years, loans granted by banks for PPP infrastructure financing rose to unprecedented ‎levels, often fueled by governments’ willingness to back them. These totaled more than $48 ‎billion in GCC countries in 2007/2008. High oil prices and increased liquidity drove growth in local ‎bank deposits from governments and wealthy individuals, allowing banks to extend infrastructure ‎loans. Infrastructure funding demand however rapidly outpaced local banks’ available funds, ‎requiring participation from foreign banks. In Saudi Arabia, the UAE, and Qatar—European, ‎Asian, and U.S. banks have provided most of the debt financing. ‎

“In this new era, credit and loan syndication markets are disinclined to pursue long-term project ‎finance deals and banks are reluctant to underwrite loans for large infrastructure projects, fearing ‎the syndication overhang in a world of constricted liquidity,” stated Majdalani. The cost of debt ‎has also risen, affecting the financial viability of many projects. ‎

Developers are having difficulty securing competitive underwritten loans, and, should the crisis ‎persist, they will be more reluctant to commit to new projects. “Because of this, a wave of planned ‎infrastructure projects relying on syndicated infrastructure loans will probably be set aside, re-‎tendered, or delayed,” Majdalani stated.‎

The Way Forward

The global downturn may affect the growth and spending priorities in the GCC region. ‎Infrastructure stakeholders need to take immediate measures to support infrastructure ‎development:‎

GCC governments cannot afford to overlook the fact that continued infrastructure spending is ‎crucial to long-term economic development in GCC countries. “GCC governments need to ‎prioritize the infrastructure projects most in line with its strategic objectives. This will provide ‎governments a clear framework for aligning regulations, incentives, and capital toward those ‎deemed most critical,” explained Fayad.‎

Governments also need to make sure that they have the appropriate legal and regulatory ‎framework in place to foster private-sector investment, decrease risks to lenders and developers, ‎and provide required incentives, especially to the emerging class of regional infrastructure and ‎private equity funds. Steps to take include: ‎

  • Establishing transparent foreign direct investment and concession laws tailored to ‎attract private-sector investments under PPPs and public finance initiative schemes.

  • Granting sovereign guarantees to lenders and developers.

  • Making favorable, secured off take commitments in concession agreements, and ‎establishing frameworks that minimize the private sector’s long-term demand risks, in ‎order to guarantee adequate returns. ‎

The governments also need to support the creation of infrastructure investment vehicles ‎managed for profit. These should facilitate access to infrastructure financing in the region, so ‎necessary projects can move away from reliance on foreign banks for funding. “These vehicles ‎can be used to attract financing from a variety of sources, including local and global banks and ‎alternatives like private equity funds,” commented Fayad.‎

Finally, GCC governments must structure deals that facilitate easier debt financing and private ‎financing, by breaking projects into smaller pieces to make them more digestible to the credit ‎markets and accessible to single developers. When breaking up these projects, governments ‎need to ensure a continuity mechanism through public–private financial agreements. They can ‎also facilitate project financing by allowing for incomplete debt syndication, with the remaining ‎debt requirements being covered by sponsor-guaranteed bridge financing, and by avoiding ‎projects that require competing underwriting bids, which limits the pool size of lead arrangers. ‎

Banks and Lending Institutions
Although governments create a framework for infrastructure projects that is favorable to debt ‎financing, banks must also do their part in promoting and facilitating infrastructure financing, ‎especially for their long-term financial health and growth. These projects require large volumes of ‎debt at lower margins, but with government support, they carry the benefit to banks of ‎proportionately lower risk. ‎

To successfully and profitably support infrastructure developments, banks and financial ‎institutions should consider the following: ‎

  • Banks should disintermediate themselves and take a more proactive approach to ‎financing infrastructure projects relying more on the capital markets.

  • Banks should step in to provide short-term financing where necessary, provided they ‎receive government and sponsor guarantees. ‎

Banks should participate in state-sponsored infrastructure investment vehicles to reduce their overall ‎risk while providing good investment return opportunities. ‎

Industry Players and Other Equity Investors
In recent years, the average ratio of private to government expenditure in GCC countries has been ‎below the OECD average, suggesting strong potential for more private sector involvement in ‎infrastructure development.‎

“Governments can boost private sector investment through encouragement and support, but a long ‎term strategy is required, as through recent initiatives such as privatisation of government assets and ‎initial public offerings of public sector infrastructure companies,” Majdalani stated.‎

Industry players and developers willing to demonstrate their commitment to the region by ‎investing time, effort, and capital have the chance to secure a leading position in the GCC ‎infrastructure market. Participation now also means a chance to establish market share, and a ‎chance to benefit from debt recapitalization once the credit markets ease. ‎

“Private-sector companies need to select specific sectors and projects based on their potential for ‎financial performance and competitive advantage,” Majdalani explained. They must construct ‎fact-based industry perspectives to help them anticipate the post-recovery structure of these ‎industries and position themselves for future growth opportunities. ‎

The private-sector should consider tapping into the capital markets to obtain additional and ‎cheaper sources of financing and reduce dependence on syndicated bank loans. One avenue is ‎private finance initiatives (PFIs), which allow the raising of funds in capital markets through the ‎sale of corporate bonds issued by the company running the PFI. PPPs can also go this route, ‎with the project company issuing bonds or sukuks directly. Where bank lending is unavoidable, ‎developers may need to give extra reassurance to lenders in order to secure credit: “Developers ‎should consider reaching out to secure sovereign guarantees or themselves deviating from non-‎recourse project finance schemes,” Fayad commented.‎

Finally, debt financing support may be obtained by private entities from foreign funds or export ‎banks. Such arrangements require attracting foreign players into local infrastructure ‎developments through such vehicles as joint venture collaborations.‎