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GCC: 2011 Macro Outlook

Onwards and upwards

Economics January 23rd, 2011

· WeexpectgrowthtoaccelerateacrosstheGCCin2011,underpinnedby stronginfrastructureinvestmentandagradualrecoveryinprivatesector activity. Expected higher oil prices will benefit the region by making more funds available to meet infrastructure spending plans. Accumulated sovereign wealth will provide some cushioning in the event of a negative oil shock. · InQatar,weexpect17.9%realGDPgrowththisyearasLNGproduction capacityexpands. Transport and tourism infrastructure investment ahead of the 2022 World Cup will become a key driver of growth post 2012. Private sector credit growth has recovered well in 2010, and we expect lending growth to accelerate modestly in 2011. · InSaudiArabia,weexpectrealGDPgrowthof4.4%in2011asthe governmentcontinuestoinvestheavilyinessentialinfrastructure. With low levels of public debt, FX reserves at around 100% of GDP and a projected budget surplus of 10% of GDP this year, Saudi Arabia is in an enviable financial position. Although we expect inflation to moderate to an average 4.9% this year, it will remain the highest in the region. · WeexpectgrowthintheUAEtoaccelerateto3.1%thisyearontheback ofimprovingeconomicfundamentalsandhigheroilprices. The recovery in private sector activity is key to achieving our growth forecast. However, we recognise that deleveraging is likely to weigh on economic activity.

GCC: Key aggregate macroeconomic indicators, weighted by GDP 2008 Real GDP Growth (%) 7.6 CPI (average, % YoY) 11.1 Private sector credit growth (end of period, % YoY) 34.9 Budget Balance (% GDP) 21.4 Current Account (% GDP) 22.5

source: Haver Analytics, SHUAA Capital Research

Khatija Haque +9714 319 9752 [email protected]

2009 -0.3 2.7 2.0 -0.7 7.7

2010e 4.6 2.7 4.8 6.4 18.9

2011f 5.7 3.7 7.6 7.8 20.3

GCC:2011MacroOutlook

Contents

INVESTMENT CASE: POSITIVE GCC OUTLOOK, SOME RISKS REMAIN .3 REGIONAL OVERVIEW: AN INFRASTRUCTURE STORY ....................4 QATAR: LEADING THE PACK ........................................................9 SAUDI ARABIA: GOVERNMENT SPENDING DRIVES GROWTH .........13 UAE: IMPROVING FUNDAMENTALS ...........................................16

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Investmentcase:positiveGCCoutlook,somerisks remain

Publicsectorspending,particularlyoninfrastructure,willremainakeydriver ofgrowthin2011,andbeyond. Saudi Arabia, Oman and Qatar are leading the way in terms of the amount of money their governments are spending on infrastructure, relative to the size of their economies. Higheroilpricesandafavourableglobalgrowthenvironmentwillbenefitthe regionbymakingmorefundsavailabletomeettheinfrastructurespending plans. A key risk to our forecast is a negative external shock, such as a European sovereign debt default for example, that derails the global economic recovery and has a knock on impact on oil prices and global risk aversion. While we recognise that the risk of such an event is lower now than it was a few months ago, it is not negligible in our view. Significantly lower oil prices and/or another global recession could result in regional governments pushing back some of their infrastructure plans in the face of lower oil revenues and increased uncertainty. However, accumulated savings in the region's SWFs will provide some cushioning in the face of a negative oil shock. Privatesectoractivityhasbeensubdueddespitethegeneralimprovementin economicconditionsin2010.Banks that have seen their asset quality deteriorate and losses rise on the back of real estate collapse, as well as corporate and quasi-government defaults, have been reluctant to extend credit to the private sector. Thepublicsectorhasbenefittedfromthisriskaversiononthepartofbanks, and is likely to absorb a significant chunk of total credit growth going forward, continuing to crowd out the private sector to some extent. Unlesstheriskaversiononthepartofregionalcommercialbankseases significantlyinthecomingmonths,andbanksstartmakingfundsavailable totheprivatesectoratlowerinterestrates,GDPgrowthcouldbeweakerthan wecurrentlyforecast. Continued tight liquidity conditions, particularly where there is strong demand for credit from the public sector, could also result in more corporate defaults, further weakening confidence and undermining the recovery. Inflationislikelytoremaincontainedover2011-2012, with volatile food prices posing the biggest upside risk in our view.

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Regionaloverview:aninfrastructurestory

2010hasbeenayearofconsolidationandrecoveryfortheGulfCo-operation Council(GCC)states. The recovery has been uneven across the countries in the region, as governments tapped their sovereign wealth to varying extents to cushion the blow to their banking systems and to compensate for the weakness in private sector demand and investment. WeestimatetheregionenjoyedGDPgrowthof4.6%onaveragein2010, a big improvement on the 0.3% contraction of 2009. Qatar was undoubtedly the winner with estimated GDP growth exceeding 16% largely on the back of increased LNG capacity and production. SaudiArabia, the biggest economy in the region, enjoyed more modest growth of just under 4%, while the UAE was the laggard of the GCC in terms of economic growth according to our estimates. Chart 1 : Regional GDP growth

20 15 10 % YoY 5 0 -5 -10 Saudi Arabia UAE Qatar Kuwait Bahrain Oman Region 2009 2010e 2011f

Source: Haver Analytics, SHUAA Capital Research

Themaincontributortogrowthin2010waspublicinvestmentininfrastructure, fundedbystrongbudgetsurplusesandaccumulatedsovereignwealth.Thisis likelytoremainakeydriverforGCCeconomiesin2011,andbeyond. Chart 2: Public capital spending

20 18 16 14 12 % GDP 10 8 6 4 2 0 Saudi Arabia UAE Qatar Kuwait Bahrain Oman Region 2008 2009 2010f 2011f

Source: National Ministries of Finance, Haver Analytics, SHUAA Capital Research

Chart 2 above illustrates the jump in capital expenditure (capex) relative to GDP in 2009 for almost all the countries in the region. In our view this reflects 1) increased spending on infrastructure as governments pursued more expansionary fiscal policies immediately after the 2008 financial crisis and subsequent global slowdown; and 2) lower nominal GDP as a result of lower oil prices in 2009 relative to 2008. SaudiArabia spent the most on capex relative to the size of it economy in 2010, and is the only country where we expect this ratio to continue rising this year. Oman is, surprisingly, the second-biggest capex investor in the region, relative to the size of its economy. The recent announcement of the eighth five-year budget plan, amounting

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GCC:2011MacroOutlook

to some USD100bn in expenditure, underscores the Omani government's commitment to capital spending to boost the economy's capacity for growth. Qatar's strong infrastructure spending commitments will be underpinned by the country's hosting of the 2022 Fifa World Cup, and it is notable that the ratio of capex to GDP is expected to remain flat despite nominal GDP growth exceeding 20% in both 2010 and 2011. The UAE again appears to be the laggard of the GCC when it comes to the amount of public funds spent on infrastructure projects, relative to the size of its economy. Although there was an increase in capex in 2009 to over 4% of GDP, the estimates for 2010 and 2011 (less than 2.5% of GDP) are uninspiring. There are several reasons for this, in our view: 1. The federal nature of the UAE means that budgeting is decentralised, with each emirate deciding how much it will spend in each year, where the money will go, and responsible for raising its own debt finance if necessary. Although there is a federal budget to cover defence, education and some federal infrastructure spending, the size of this budget is relatively small (AED 41bn this year, versus a combined budget for Abu Dhabi and Dubai of more AED 245bn). 2. Although Dubaiand AbuDhabi have invested heavily in infrastructure over the last 10 years, not all of this spending came through the budget. In Dubai's case in particular, much of the infrastructure spending came from government related entities (GREs) and was financed by debt issued by these GREs, as Dubai does not have much oil revenue. The level of public capital expenditure officially reported is thus much lower than the actual investment in infrastructure in the UAE. 3. When we consider the 2010 budget of oil-rich AbuDhabi, it is apparent that the authorities are being conservative with their spending plans, either because they want to make up the losses incurred in 2009 when the budget recorded a substantial deficit (9.1% of GDP according to our estimates) or because they believe they may need to provide funding to struggling GREs during the course of the next couple of years. However, the UAE is as likely to benefit from higher oil prices in 2011 as other GCC oil producers, and has ambitious infrastructure development plans for the next twenty years. We believe that as the economic recovery in the UAE gathers pace, and confidence improves, we could see an increase in official government spending on infrastructure in future budgets. Financingpublicspendingwillbeeasy Budget surpluses set to widen in 2011 on the back of higher oil prices Chart 3: Regional budget Budget balances % GDP balances

25 20 15 % GDP 10 5 0 -5 -10 Saudi Arabia UAE Qatar Kuwait Bahrain Oman Region 2009 2010f 2011f

Source: Haver Analytics, SHUAA Capital Research

Although SaudiArabia and the UAE recorded budget deficits in 2009 on the back of lower oil prices and export volumes, weestimatetheaveragebudgetsurplusforthe GCCroseto6.4%in2010 from a deficit of 0.7% of GDP in 2009 as both oil prices and volumes rose. We have based our budget forecasts for 2011 and 2012 on the Bloomberg consensus estimates for WTI oil prices (as of 2 January 2011), adjusted for the difference between WTI and the OPEC reference price.

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Oil price assumptions

OPEC price, average USD per barrel

Source: Bloomberg, SHUAA Capital Research

2009 61.02

2010 77.28

2011f 84.00

2012f 90.00

Based on the above oil price assumptions, and assuming a 2-3% increase in oil production, weexpecttheregionalbudgetsurplustorisetoalmost8%ofGDP in2011, providing plenty of fiscal space for governments to push ahead with their ambitious infrastructure development plans. Accumulated sovereign wealth provides a big cushion against any negative oil shock The GCC has accumulated a substantial amount of wealth through the sale of crude oil and other hydrocarbons over the last decade. Even in 2009, with the double whammy of a lower per barrel oil price and a drop in the volume of oil exported, the GCC managed to post a current account surplus of 7.7% of GDP. Over the last five years the current account surplus for the region has averaged just over 20% of GDP. Since the region has little to no external debt that needed to be repaid over this time, and has consistently run budget surpluses, much of this cash has effectively been invested abroad, or saved in the form of gold and FX reserves. Chart 4: Regionalaccount surplus surpluses Regional current current account

25 20

% GDP

15

10

5

0 2008 2009 2010e 2011f

Source: Haver Analytics, SHUAA Capital Research

WebelievethatthetotallevelofGrossFXreservesattheendof2010ishigher thanayearago,andbackatpre-crisislevels. SaudiArabia's net FX reserves fell to USD 405bn in 2009 as the government used some of its accumulated wealth to finance the budget deficit, before rising to almost USD440bn by the end of last year, according to our estimates. SaudiArabia's net FX reserves are now equivalent to the size of its entire economy. We expect the UAE is in a similar strong position despite tapping its sovereign wealth fund to finance the 2009 budget deficit. Giventheprojectedbudgetandcurrentaccountsurplusesfor2011andindeed 2012,mostGCCcountrieswillcontinuetoaccumulatesavingswithwhichto financefutureinvestment,evenifoilpricesarelowerthancurrentlyforecast.

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Debtrestructuringsanddefaultsstillweighontheprivatesector Private credit growth has been weak One of the most obvious consequences of the global financial crisis on the GCC was the sharp deceleration in private sector credit growth, from almost 35% YoY at the end of 2008 to just 2% YoY at the end of 2009. Chart 5: Private sector credit growth in the GCC

40 35 30 % YoY 25 20 15 10 5 0 Dec-08 Dec-09 Dec-10 (f) Dec-11 (f)

Source: Haver analytics, SHUAA Capital Research

Although this would have been expected in an environment of slow GDP growth and weaker private sector demand, the situation was compounded by other factors: 1. Many commercial banks were perhaps over-exposed to collapsing real estate sectors (including in Dubai and Qatar), resulting in a deterioration in their asset quality. The impact on their balance sheets reduced their ability and willingness to extend credit. 2. Corporate defaults and quasi-government debt restructuring triggered by higher interest rates and increased risk aversion on the part of commercial banks. 3. The negative spiral of corporate/ GRE defaults increasing banks' risk aversion further. WeestimateGCCprivatesectorcreditgrowthdidaccelerateto4.8%YoYbyend2010,buttheperformanceacrossthecountrieshasvariedwidely. This reflects to some extent the measures that each government implemented to boost liquidity and support their banking systems. In Qatar, the government took significant steps to not only boost liquidity in the commercial banks but also undertook a balance sheet clean up by purchasing real estate assets at book value. Consequently, we estimate private sector credit grew by 10% YoY by end Dec-2010 from just 1% YoY in 2009. Bahrain,Omanand SaudiArabia are all expected to post private sector credit growth between 5 and 10% by end-2010. In contrast, the UAE's private sector credit growth for the same period is estimated at just 1% YoY, and Kuwait's only marginally higher at 1.7%. In2011weexpectloangrowthtotheprivatesectortoaccelerateaseconomic fundamentalscontinuetoimprove, the worst in terms of "bad news" on the corporate/ GRE debt front is over, and confidence is restored to a greater extent. We expect GCC private sector credit growth to pick up to 7.6% YoY by the end of 2011, with Qatar and SaudiArabia showing the fastest rates of growth. Banks prefer lending to the public sector Public sector credit, including GREs, has grown sharply across the GCC in 2010, reflecting commercial banks' risk aversion but also strong demand for credit from the public sector on the back of strong infrastructure spending and in some cases (such as the UAE), the need to finance maturing debt. We expect demand for credit from the public sector to remain high going forward, including in the UAE where an estimated USD 20bn in GRE debt is expected to mature this year. As a result, we continue to expect some "crowding out" of the private sector, even if the anticipated increase in demand for credit from the private sector starts to materialise.

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Inflationisthemainbeneficiaryofthecrisis GCC consumer inflation fell sharply to an average 2.7% in 2009 from 11.1% in 2008, largely on the back of much lower rents and an easing in food prices from the highs of 2008. Housing and food account for the bulk of consumer price baskets across the GCC, with the combined weights for these two components ranging from 39% (Bahrain) to 53% (UAE). Inflation remained at 2.7% on average for the region in 2010, but we expect this to rise to 3.6% in 2011 as higher global food prices in 2H10 feed through to consumers, and consumer demand starts to recover. Chart 6: Average consumer inflation in the GCC

12 10 8

% YoY

Average consumer in ation in the GCC

6 4 2 0 2008 2009 2010e 2011f

Source: Haver Analytics; SHUAA Capital Research

Inthefollowingsection,wetakeacloserlookatdevelopmentsinSaudiArabia, theUAEandQatarindividually. We have focused on these three countries as together they account for around 80% of the region's nominal GDP, and from a financial markets perspective, account for 80% of the region's market capitalisation. According to our 2010 GDP estimates, the three largest GCC countries are actually SaudiArabia, UAE and Kuwait.However, we expect Qatar to overtake Kuwait as the third biggest GCC economy this year after five years of 20% average growth, while Kuwait has suffered from a lack of political consensus on economic reforms. How big are the GCC economies?

Nominal GDP (USDbn) Saudi Arabia UAE Qatar Kuwait Bahrain Oman

Source: Haver Analytics, SHUAA Capital Research

2008 476.3 298.8 110.7 148.8 21.9 60.2

2009 375.7 260.8 98.3 109.5 20.6 46.1

2010e 434.7 286.2 123.3 132.9 22.8 52.9

2011f 477.9 307.4 151.3 146.8 24.8 59.0

Chart 7: GCC by GDP

Bahrain Kuwait Saudi Arabia Oman

Qatar

UAE

Source: Haver Analytics, SHUAA Capital Research

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Qatar:Leadingthepack

DoubledigitGDPgrowthsettocontinuein2011 Qatar has enjoyed phenomenal GDP growth over the last five years on the back of investment in LNG production capacity and more recently, related upstream and downstream industries. Even the 2008/09 global financial crisis left Qatar's economy relatively unscathed, thanks to prudent fiscal and monetary policies, and growth has likely returned to double digits in 2010. We estimate growth at 16.2% last year Chart 8: Real GDP growth

30 25 20 % YoY 15 10 5 0 Real GDP growth Hydrocarbon Non Hydrocarbon

2008

2009

2010e

2011f

2012f

Source: Haver Analytics, SHUAA Capital Research

WeexpectrealGDPgrowthtoreachalmost18%YoYin2011 as LNG production capacity continues to expand, before slowing sharply to single digits from 2012 when a moratorium on new gas production kicks in. However, non hydrocarbon infrastructure investment beyond 2012 will continue to support GDP growth over the medium term, particularly within the framework of preparations for the 2022 World Cup. Qatar could spend almost USD87bn (or 90% of 2009 GDP) on infrastructure over the next 10 years, including transport, hotel and tourism infrastructure, as well as the football stadia. While much of this (about USD55bn) was already planned infrastructure spend on roads, airports, ports, railway networks etc, there is now additional infrastructure planned to provide tourism, sports and related facilities specifically for the 2022 event. Qatar: Estimated spending plan for the 2022 World Cup

Project Rail network New roads Hotel and tourism infrastructure Airport Deep water seaport Construction/ renovation of 12 stadia Qatar-Bahrain causeway Crossing from airport to Doha Total estimated cost

source: Reuters, SHUAA Capital Research

size (USD bn) 25 20 17 11 5.5 4 3 1 86.5

Financingthisinfrastructurespendingshouldberelativelyeasy BudgetsurplusesinQatarhaveaveragedmorethan10%ofGDPoverthelast5 years,withabouthalfoftotalrevenuecomingfromhydrocarbons. Qatar's nonhydrocarbon budget revenues have increased by almost 37% per annum between 2005 and 2009 as a result of Qatar's investment income and diversification of the economy. We estimate that Qatar will record a budget surplus of 12.2% of GDP for FY2010 (which ends 31 March 2011) and we expect budget surpluses to exceed 12% of GDP in FY2011 and 2012, despite double digit growth in capital expenditure.

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Chart 9: Development spending and the budget balance

14 Capex Budget balance

12

% GDP

10

8

6

2008

2009

2010e

2011f

2012f

Source: Haver Analytics, SHUAA Capital Research

Qatar has indicated that it will be financing all its World Cup related infrastructure spending out of its budget, without resorting to debt issuance. Based on our budget forecasts at this stage, this seems achievable. When we consider Qatar's external debt ratios, this approach seems desirable as well. Externaldebtlevelsarehigh,butnotacauseforconcernrightnow QatarhasfinancedmuchofitsLNGinfrastructureandprocessingfacilities throughexternaldebt. We estimate that total external debt rose sharply in 2009 (to almost 77% of GDP), both as a result of the decline in nominal GDP and increases in the external debt stock ­ the government issued USD3bn in Eurobonds in 2009, and there was external borrowing by the corporate and the banking sectors as well. While the stock of external debt is likely to continue to grow, the pace of growth should be more modest resulting in a gradual decline in the external debt to GDP ratio. Chart 10: Total external debt

80 70 60 50 % YoY 40 30 20 10 0 2008 2009 2010e 2011f 2012f

Source: Haver Analytics, SHUAA Capital Research

With much of this borrowing used to finance the expansion of highly productive assets which are likely to generate additional export revenues over the medium and long term, we do not anticipate any problems with debt servicing of the existing debt. However, if Qatar does decide in a few years time to raise debt to finance infrastructure specifically for the World Cup, there is a question over whether this type of infrastructure will generate sufficient income beyond 2022 to pay for itself. Externalsurplusesremainstrong The growth in hydrocarbon exports, combined with higher oil prices in 2010, would have contributed to an almost USD20bn current account surplus (16% of estimated 2010 GDP), in our view. We estimate FX reserves reached a record high of USD 27.4bn by end-2010. The outlook for the current account and balance of payments is positive as energy prices are expected to be higher than current levels in 2011-12, and greater production capacity will lead to increased export volumes as well.

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Inflationissettorisein2011 As with many other GCC countries, the global financial crisis precipitated sharp corrections in the real estate market in Qatar, and rents have continued to decline through 2009 and 2010. As housing accounts for over 30% of the Consumer Price Index in Qatar, headline inflation declined an average 4.9% in 2009, and we expect it to average -2.4% YoY in 2010. However, as the rental market stabilizes and food prices continue to exert upward pressure on consumer inflation, we expect headline CPI to rise 3% on average in 2011, although the annual rate could exceed 4% during the course of this year. Beyond2011-2012,theriskstoinflationinQatarareontheupsideinourview. Given the small size of Qatar's economy (just under USD100bn in 2009) there is a risk that the aggressive investment in infrastructure could push up input costs, while the inflow of expatriates to work on the new infrastructure projects would fuel demand-driven inflation. Chart 11: Average annual inflation

20 Inflation 15 10 % YoY 5 0 -5 -10 2008 2009 2010e 2011f 2012f

Source: Haver Analytics, SHUAA Capital Research

Privatesectorcreditgrowthsettoacceleratefurtherin2011 Monetary statistics for Qatar's banking system are very out of date; the latest private sector credit statistics are for March 2010 and the latest money supply data are for July 2010. However, the monthly banking statistics suggest that private sector credit growth has accelerated to 5.1% in the year to November 2010 from 1% at end-2009, while deposit growth has been strong at 24% in the first 11 months of 2010. Due to a low base effect in December, we expect private sector loan growth to jump to 10% YoY. However, as has been the case in most other GCC states, public sector credit growth in Qatar has outstripped lending to the private sector. Although we expect private sector credit to continue to pick up during the course of this year, domestic public sector borrowing is likely to remain high given Qatar's infrastructure plans.

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Qatar: Key Macroeconomic Indicators

2009 National Income Nominal GDP (QARbn) Nominal GDP (USDbn) Population (mn) GDP per capita (USD) Real GDP Growth (%) Hydrocarbon growth Non hydrocarbon growth Monetary Indicators (% YoY) M2 growth (eop) Private sector credit growth (eop) CPI (pavg) External Indicators (USDbn) Exports hydrocarbons Imports Trade balance % GDP Current account balance % GDP FX Reserves Total External Debt % GDP Fiscal Indicators (% GDP) Budget balance Revenue Expenditure

Source: Haver Analytics, SHUAA Capital Research

2010e 448.9 123.3 1.70 72671 16.2 23.0 9.5

2011f 550.6 151.3 1.78 84887 17.9 25.0 10.0

2012f 623.6 171.3 1.87 91563 8.3 7.0 10.0

357.9 98.3 1.63 60241 8.6 7.7 9.6

16.9 1.0 -4.9

24.0 10.0 -2.4

18.9 13.0 3.0

16.3 12.0 4.0

42.8 36.4 22.5 20.3 20.7 11.0 11.2 18.4 69.5 70.7

62.6 56.2 31.7 30.9 25.1 19.7 16.0 27.4 81.5 66.1

83.3 75.0 36.2 47.0 31.1 40.4 26.7 86.5 57.2

89.5 80.1 41.8 47.7 27.8 44.1 25.8 91.5 53.4

13.0 43.2 30.2

12.2 41.2 29.0

12.1 38.0 25.9

12.2 37.6 25.4

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SaudiArabia:Governmentspendingdrives growth

HealthyGDPgrowthin2010 Economicgrowthlastyearacceleratedtoanestimated3.8%(higherthanour forecastof3.4%)from0.6%in2009, according to the authorities. The oil sector, which still accounts for about half of Saudi Arabia's economy, grew by an estimated 2.1% (in line with our forecast) as the global economic recovery gathered momentum. However, non-oil growth was stronger than we had anticipated at 4.4% YoY, with utilities; transport, storage & communication; and non-oil manufacturing all expanding by more than 5%. Chart 12: Saudi Arabia's GDP growth

8 6 4 2 % YoY 0 Real GDP growth Hydrocarbon Non Hydrocarbon

-2 -4 -6 -8 2008 2009 2010e 2011f

2012f

Source: Haver Analytics, SHUAA Capital Research

GovernmentspendingoninfrastructureprojectsunderpinnedGDPgrowthlast year, with total expenditure rising to a record SAR626.5bn, up 5% on 2009. The impact of government spending is reflected in the official GDP estimates for last year, which show that the government sector expanded by almost 6% YoY in 2010. Despite the 16% overspend in 2010, significantly higher than budgeted oil prices allowed the kingdom to post a budget surplus of SAR108.5bn (6.7% of GDP). Weexpectgrowthtoaccelerateto4.4%thisyear,underpinnedbygovernment spendingandrecoveringprivatesectoractivity,aswellasmodestexpansion(2% YoY)intheoilsector. Privatesectorisexpanding,butnotveryfast. Chart 13: Private sector GDP growth and credit growth

30 25 20

% YoY

5 Private sector GDP growth, rhs Private sector credit growth, lhs 4

3 2

% YoY

15 10 5 0 1

2008

2009

2010e

2011f

0

Source: Haver Analytics, SHUAA Capital Research

PrivatesectornonoilGDPgrewbyamodest3.7%YoYin2010,largely unchangedfrom2009. This was mirrored by the relatively slow recovery in private sector credit growth, which we estimate reached 6.3% YoY at the end of 2010 from zero in 2009. Banks' risk aversion post the Saad/ Al Ghosaibi defaults as well as structural factors, including the reliance on "name lending" and regulatory limits on exposures to a single

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borrower, were all contributors to the weak private sector credit growth in Saudi Arabia. To some extent, the government has provided an alternative source of funding through its specialised credit development institutions and financing programs. However, as the economic environment and liquidity conditions continues to improve in 2011, we expect commercial banks to resume growing their loan books, and we forecast private sector credit growth at over 9% YoY by end-2011. Fiscalpolicytoremainsupportiveofgrowthin2011 The2011budgetstatementsuggeststhatthegovernmentwillmaintaina supportivefiscalstance, despite the official expenditure projection of SAR 580bn (down 7.5% on actual 2009 spending). We note that the authorities are always conservative on their revenue and expenditure projections, overspending by 22% on average every year for the last 10 years. Consequently, we estimate that total spending will rise by almost 6.5% in 2011 to reach SAR 667bn. The spending priority remains infrastructure projects that will boost the economy's capacity over the medium term, as well as create employment opportunities. Saudi Government Budget (SAR bn)

2009 Budget Revenue Expenditure Budget balance 410 475 -65 Actual 510 596 -86 2010 Budget 470 540 -70 Actual 735 627 108 2011 Budget 540 580 -40 SC estimate 848 667 181

source: Ministry of Finance, Haver Analytics, SHUAA Capital Research

Financingtheexpenditureisnotaproblem Based on an average OPEC oil price of USD 84 per barrel in 2011, webelievethebudget willstillrecordasubstantialsurplus(10.1%ofGDP)thisyear,evenwiththe anticipatedoverspend. Furthermore, Saudi Arabia has likely recorded substantial surpluses in the balance of payments in 2010, which is reflected in the increase in SAMA's FX reserves to USD 434bn in the year to November. Effectively, this puts SAMA's foreign reserves back at 2008 levels, before being drawn down to finance the budget deficit in 2009. Chart 14: Saudi Arabia's FX reserves (USDbn and % GDP)

500 450 400 350 300 250 200 150 100 2007 2008 2009 2010e USD bn (lhs) % GDP (rhs) 115 105 95 85 75 65 55 45 35 25

Source: Haver Analytics, SHUAA Capital Research

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With FX reserves of around 100% of its GDP, no external public debt, and domestic public debt of just 10.2% of GDP at end-2010, Saudi Arabia is in an enviable financial position, with very little constraint on its spending capacity in the near term. It has been argued that over the longer term, ever-increasing government expenditure is simply making Saudi Arabia more reliant on higher oil prices to break-even, and thus more vulnerable to a negative oil price shock. While this is true, we argue that the type of spending being undertaken by the authorities (transport, education, health, utilities infrastructure) is appropriate and indeed necessary to increase the kingdom's capacity for growth in the long term. We believe that the infrastructure spending being undertaken is more likely to crowd-in private sector investment over the medium term than crowd it out. In our view, the growth in public spending should slow as private sector investment and demand accelerate, but in the current economic context, we view the authorities' fiscal stance as appropriate. Inflationishigherthanexpected,butshouldeasein2011 SaudiArabiawastheonlycountryintheGCCthatshowedanincreaseinaverage inflationin2010. Consumer prices in the kingdom rose 5.4% in 2010, as the shortage of housing supply continued to put upward pressure on rents, which account for 18% of the Cost of Living index, and food prices rose an average 6.3% (but account for 26% of the index). Nevertheless, we expect inflation to moderate to 4.5% in 2011 as our real estate analysts forecast new supply in the housing market and the introduction of mortgage loans which should reduce the demand for rental housing. Food prices continue to pose an upside risk to inflation in 2011 however. Saudi Arabia: Key Macroeconomic Indicators

2009 National Income Nominal GDP (SARbn) Nominal GDP (USDbn) Population (mn) GDP per capita (USD) Real GDP Growth (%) Hydrocarbon growth Non hydrocarbon growth Monetary Indicators (% YoY) M3 growth (eop) Private sector credit growth (eop) CPI (pavg) External Indicators (USDbn) Exports hydrocarbons Imports Trade balance % GDP Current account balance % GDP SAMA's Net foreign Assets Fiscal Indicators (% GDP) Budget balance Revenue Expenditure Public debt

Source: Haver Analytics, SHUAA Capital Research

2010e 1630.0 434.7 25.81 16839 3.8 2.1 4.4

2011f 1792.2 477.9 26.33 18152 4.4 2.0 5.5

2012f 1983.3 528.9 26.86 19694 4.8 2.0 6.0

1409.0 375.7 25.31 14848 0.6 -6.7 3.8

10.7 0.0 5.1

5.2 6.3 5.4

11.0 9.2 4.49

11.7 11.6 4.28

192.2 163.1 86.4 105.8 28.2 21.0 5.6 405.3

236.9 204.8 95.0 141.8 32.6 58.4 13.4 437.3

263.9 227.1 114.0 149.9 31.4 61.4 12.9

290.5 248.2 136.8 153.7 29.1 78.7 14.9

-6.1 36.2 42.3 16.0

6.7 45.1 38.4 10.2

10.1 47.3 37.2

9.1 44.4 35.3

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GCC:2011MacroOutlook

UAE:Improvingfundamentals

Growthhasrecovered,albeitslowly WebelievetheUAEhasemergedfromrecessionin2010onthebackofan improvingexternaleconomicenvironmentandhigheroilprices. Improving global growth was reflected in increased international trade and the UAE (particularly Dubai) has benefitted from this recovery. Exports grew almost 40% YoY in Jan- Sep 2010, and reexports grew almost 20% over the same period. The transport sector has also benefitted from the increased global and intra-regional trade flows. Tourism has likely seen growth in 2010, partly in response to price discounting and promotions on the part of hotels and airlines. Stronger global growth has also been reflected in higher oil prices, and the UAE has consequently expanded its oil production by about 3% in 2010. Thebell-weatherDubaiWorldrestructuringwassuccessfullycompletedinQ4 2010, and the country made some progress (albeit slowly) in tackling the structural constraints to economic recovery, including strengthening the legislative framework in the real estate sector, moving towards establishing a sovereign debt management office, creating a national credit bureau and imposing stricter provisioning requirements on banks. In our view, there is still much that could and should be tackled on the structural reform front, but a detailed discussion of these issues is outside the scope of this report. Allofthisisreflectedinthemoderationofthesovereignriskpremiaduring thecourseoflastyear. In particular, Dubai saw its CDS spread decline from a peak of 631 in February 2010 to a low of 380.5bp in October 2010, immediately following the completion of the Dubai World debt restructuring. However, uncertainty about the extent of Dubai's GRE debt (including that of Dubai Holdings and the still-to-be-concluded debt restructuring of Nakheel) pushed Dubai CDS back up to 418bp by year end. Chart 15: Dubai and Abu Dhabi CDS spreads

700 600 500 400 300 200 100 0 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Abu Dhabi Dubai

Source: Bloomberg, SHUAA Capital Research

Butprivatesectoractivityhasbeenweak We believe domestic demand was relatively weak last year as the government held back on spending and confidence was negatively affected by the uncertainty surrounding the GRE debt restructuring, continued weakness in the real estate sector and concerns over the deteriorating asset quality of commercial banks. Privatesectorcreditgrowth wasveryslow,atjust1.2%YoYonaverageduringthefirst10monthsof2010, reflecting banks' unwillingness to lend to the private sector as well as weak demand for credit.

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GCC:2011MacroOutlook

Chart 16: UAE private and public sector credit growth

14 12 10 % YoY 8 6 4 2 0 -2 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 public sector private sector

Source: Haver Analytics, SHUAA Capital Research

Chart 17: Certificates of Deposits issued by the UAE central bank

85 80 75 AED bn 70 65 60 55 50 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10

Source: Haver Analytics, SHUAA Capital Research

CDs issued by CB

Chart17aboveshowsthatbankshaveaccumulatedcashanddepositsatthe centralbankratherthangrowingtheirloanbooks,astheyfocusedonreducing theirloans:depositsratio. Where they have extended credit, banks have shown a preference for lending to the public sector rather than the "riskier" private sector. The robust growth of public sector borrowing through 2010 probably also reflects stronger demand from public sector entities for (re)financing, particularly as access to international capital markets was limited in 1H2010. Theprivatesectoristhekeytoanupsidegrowthsurprise We expect private sector demand and activity to gradually recover in 2011. We forecast private credit growth reaching 6.5% by the end of this year from an expected 1% at end2010. As the macroeconomic environment continues to improve, and risk aversion eases, banks are likely to look for opportunities to grow their loan books. However, demand from public sector entities is also likely to remain high ­ the IMF estimates almost USD 20bn in GRE debt will fall due in 2011, excluding the DW debt that has been restructured. However, this figure includes the debts of some GREs currently in the process of debt restructuring. Most of this will likely be refinanced in our view. While some GREs will no doubt turn to debt issuance in the form of bonds and sukuk to raise the required capital, many firms will seek to roll over or refinance their debt through commercial bank loan facilities. The extent of this "crowding out" will depend on how willing the commercial banks are to take on more risk. Giventhesheersizeofthe financingrequirementfor2011,weexpectcorporateandGREdeleveragingto continuetoweighongrowthin2011. HighoilpricesshouldgiveAbuDhabiroomtomaneuver... Buoyantoilpricesshouldgivetheauthoritiesroomtoboostspendingon2010 levels,withouthavingtorunadeficitinourview. As we noted in our September 2010 UAE Macro Outlook, Abu Dhabi appears to have taken a relatively conservative approach to spending in 2010, following a substantial budget deficit in 2009. To the extent that the authorities are more willing to boost infrastructure spending on the back of higher than budgeted oil revenues in 2011, this should support non-hydrocarbon growth in Abu Dhabi and the UAE as a whole.

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GCC:2011MacroOutlook

...butexternaldemandtoremainakeydriverofgrowthin2011 WeexpecttheUAEeconomytocontinueitsrecoveryin2011,growing3.1%from anestimated1.8%in2010. The economy is likely to benefit from a favourable external environment as well as government spending on the back of buoyant oil prices, which are forecast to rise to an average USD84 per barrel in 2011. Indeed the sectors that have seen the strongest growth in 2010 ­ non-oil exports, logistics, transport, tourism and other services ­ are likely to be the main drivers of growth this year, particularly as the US economy gathers momentum and global trade continues to increase. DubaiisparticularlywellplacedtobenefitfromworldGDPgrowthandincreased globaltradevolumes,givenitsstronginfrastructure,transportandlogistics networks. Further restructuring of Dubai's GRE debt (including the completion of the currently ongoing Dubai Holdings Commercial Operations Group and Nakheel debt restructurings) is expected to contribute to improving sentiment in the Emirate in 2011. Consequently, we expect Dubai to grow by 2.9% in 2011, well above our 2010 growth estimate of 0.8%, despite its still weak real estate sector. WeexpectAbuDhabi'seconomytoexpandby3.3%thisyear from an estimated 2.5% in 2010. We expect the hydrocarbon sector to grow by around 3% this year, similar to 2010, while we forecast non hydrocarbon growth at 3.5%. Inflationislikelytoremaincontainedin2011 Consumer price inflation fell sharply in 2010 on the back of the real estate collapse (housing accounts for 39% of the CPI basket) and weak domestic demand. Although food prices and transport exerted some upward pressure, average inflation declined to 0.8% in Jan-Nov 2010, down from 1.6% in 2009. Looking ahead, and given the projections for further modest easing in rents across the UAE, we expect inflation to remain contained at 2% on average in 2011. However, food prices pose an upside risk in the UAE, as in the other GCC states. Chart 18: UAE average inflation

14 12 10 % YoY 8 6 4 2 0 2008 2009 2010e 2011f 2012f Inflation

Source: Haver Analytics, SHUAA Capital Research

Healthyexternalsurplusessettocontinue WeestimatethecurrentaccountsurplusoftheUAEwidenedto9.8%ofGDP in2010, from just 3.0% of GDP in 2009, on the back of both higher oil export volumes and prices as well as non-oil exports (import growth was relatively muted in 2010 reflecting weak domestic demand). In 2011, we expect the current account surplus to remain broadly flat in USD terms (USD27.4bn) and moderate slightly to 8.9% of GDP as remittances out of the UAE increase.

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GCC:2011MacroOutlook

UAE: Key Macroeconomic Indicators

2008e National Income Nominal GDP (AEDbn) Nominal GDP (USDbn) Population (mn) GDP per capita (USD) Real GDP Growth (%) Hydrocarbon growth Non hydrocarbon growth Abu Dhabi real GDP growth (%) Dubai real GDP growth (%) Monetary Indicators (% YoY) M2 growth (eop) Private sector credit growth (eop) CPI (pavg) External Accounts (USDbn) Exports hydrocarbons Imports Trade balance % GDP Current account balance % GDP Fiscal Indicators (% GDP) Consolidated budget balance Revenue Expenditure 17.9 41.1 23.1 -6.8 27.1 33.9 4.7 29.8 25.1 5.9 30.6 24.7 6.3 31.1 24.8 239.2 102.1 176.3 62.9 21.1 22.3 7.5 192.2 67.9 150.0 42.1 16.2 7.8 3.0 221.4 84.7 157.5 63.9 22.3 28.1 9.8 238.0 94.4 173.3 64.7 21.0 27.4 8.9 257.2 106.5 190.6 66.6 19.9 28.3 8.5 19.1 50.3 12.3 8.8 3.3 1.6 7.0 1.0 0.9 12.0 6.5 2.0 14.0 9.0 2.5 1096.4 298.8 5.13 58236 6.2 3.1 7.2 4.6 5.7 957.2 260.8 4.93 52887 -3.4 -12.7 -0.2 -2.7 -4.5 1050.4 286.2 4.91 58292 1.8 3.0 1.1 2.5 0.8 1128.3 307.4 5.05 60916 3.1 3.0 3.1 3.3 2.9 1227.1 334.4 5.21 64136 3.7 3.0 3.8 3.6 3.8 2009e 2010f 2011f 2012f

vSource: Haver Analytics, SHUAA Capital Research

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GCC:2011MacroOutlook

Research

Head of Research Amer Halawi +9714 3199 609 [email protected]

Economics Khatija Haque +9714 3199 752 [email protected]

Real Estate & Construction Roy Cherry +9714 3199 767 [email protected]

Telecom, Media & Technology Simon Simonian, CFA +9714 3199 763 [email protected] Rawan Oueidat +9714 3199 713 [email protected] Technical Analysis Adel Merheb +9174 3199 793 [email protected]

Strategy Ahmad M. Shahin +9714 3199 742 [email protected]

Transportation & Logistics Kareem Z. Murad +9714 3199 757 [email protected]

Banks & Diversified Financials Sofia El Boury +9714 3199 716 [email protected] Ghida Obeid +9714 3199 729 [email protected]

Heavy Industries & Utilities Data Kareem Z. Murad +9714 3199 757 [email protected] Jessica Estefane +9714 3199 834 [email protected]ital.com Ahmad M. Shahin +9714 3199 742 [email protected] Design Jovan Ruseski +9714 3199 759 [email protected]

Client Services:

800 SHUAA (74822) ­ UAE only 800 124 7482 - Saudi Arabia only +971 (4) 319 9603 ­ International [email protected]

Sales Trading Desk:

+971 (4) 319-9700 +971 (2) 409-0777 [email protected]

January 23rd, 2011

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Vision2009- UAE Equity Markets

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This document has been issued by SHUAA Capital for informational purposes only. This document is not and should not be construed as an offer or the solicitation of an offer to purchase or subscribe or sell any investment or subscribe to any investment management or advisory service. This document is not intended as investment advice as to the value of any securities or as to the advisability of investing in, purchasing, or selling any security. SHUAA Capital has based this document on information obtained from sources it believes to be reliable. It makes no guarantee, representation or warranty as to its accuracy or completeness and accepts no responsibility or liability in respect thereof or for any reliance placed by any person on such information. All opinions expressed herein are subject to change without notice. This document may not be reproduced or circulated without the prior written consent of SHUAA Capital psc.

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