Rebalancing via deleveraging

One of the defining characteristics of the current recession has been a painful process of global deleveraging following an extraordinary credit boom earlier in the decade. An abundance of liquidity, innovations in finance and lax regulation facilitated unprecedented financial sector growth and leverage. While the unsustainability of credit creation was widely seen as a key factor behind the crisis, two years on, the correction of these excesses is well advanced. Although the process will likely prove slow and may be tested by low interest rates, it looks certain to have fundamental global repercussions for the imbalances that emerged between the West and the emerging markets.

• Sustainable global economic growth is likely to depend on the substantial elimination of the high imbalances that emerged between the West and the emerging markets. The progress made in this regard to date has relied heavily on a cyclical correction that has boosted savings at the expense of consumption. The main concern, going forward, is that a very permissive monetary policy stance potentially risks creating some of the distortions that led to the crisis in the first place. Successful rebalancing of the global economy will thus rely heavily on effective regulatory reform, another area where progress has been slow and uneven.

• Leverage has become increasingly common in the Gulf as well, although it is uneven and lower than in the West. In contrast to their Western counterparts, the GCC governments exercised prudence in retiring most of their debt during the oil boom. However, high returns for investment in the region had encouraged greater leverage among corporates. In addition, rising personal incomes and a structural shift in preferences, led the Gulf to increasingly converge with the western pattern of debt-driven consumption.

• The rapid growth of leverage left the GCC vulnerable to a shortage of liquidity in the financial system. Asset price corrections, concerns over asset quality and capital adequacy and subdued consumer confidence have amplified the reversal. Nonetheless, the substantial room for fiscal support has helped contain the downturn. Fast deleveraging and higher oil prices paint a generally favorable outlook for the region starting next year.

• After a sharp correction this year, Saudi growth can be expected to return to trend in 2010. Government intervention has effectively sustained the diversification agenda and boosted economic activity. Barring a sharp deterioration in global conditions, we believe remaining downside risks look relatively minor. With permissive government policy and improving fundamentals, we expect the economy to return to growth next year.

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