In the period of a scant few years, the United Arab Emirates (UAE) spent nearly US$300 million on an indoor ski slope in the middle of the desert, $8.5 billion to start construction on the largest airport in the world, and upward of $30 billion on a series of man-made residential and commercial islands in the shape of a palm tree. But while the Gulf states were developing creative architecture that generated buzz around the world, their infrastructure was struggling to keep up — the roads and bridges, the grids and pipelines, the neighborhood upgrades and communications networks. Although the governments of the Gulf Cooperation Council (GCC) invested generously in some of the biggest development projects, their combined infrastructure outlays of $720 billion between 2002 and 2008 fell far short of what the region needed to support economic growth that topped 6 percent in 2008 and burgeoning populations that have grown more than 20 percent in the past decade.
This puts the GCC governments in a thorny position. Just when they most need to focus on infrastructure, oil revenues are falling and global capital markets have dried up. Until recently, European, Asian, and U.S. banks had provided most of the debt financing for government-sponsored or privately backed infrastructure projects in much of the Gulf. In 2007 and 2008, these institutions underwrote more than $48 billion in infrastructure loans. Now, however, banks around the world are becoming more reluctant to support large infrastructure projects, fearful of tying up expensive and elusive capital in efforts that may be delayed or never completed. It doesn’t help that GCC governments, no matter how much they would like to turn their attention to infrastructure, face pressing short-term needs that make it difficult to guarantee loans. Among their priorities: propping up struggling stock markets, meeting IMF financing responsibilities, and bailing out banks and companies whose health is crucial to their countries’ economies — all of which are expensive endeavors, especially when government funds are less plentiful than they were when the oil prices supporting them hovered above $120 a barrel.
Faced with these challenging conditions, GCC governments cannot avoid infrastructure development without giving up on economic development at the same time. Therefore, they must find creative ways to support and fund infrastructure projects. For starters, they could tap into public and private pension funds, which in the Middle East are primarily invested in equities, but tend to be focused on multiyear instruments better aligned with the long-term needs of retirees in other parts of the world. In addition, GCC governments should facilitate debt financing by breaking projects into phases, making them more digestible to the credit markets and accessible to single developers. Recent successful deals in western Europe’s renewable power sector suggest that smaller projects are most likely to obtain financing in the current economic environment. And these governments must do a better job of fostering private-sector investment — particularly an emerging class of regional infrastructure and private equity funds — by putting their full weight behind promises to guarantee loans and by providing incentives for lenders and developers, such as subsidizing part of the interest rate (as high as 7 percent in the region) or covering currency exchange risks.
GCC governments must also make a strong effort to market the region’s positive economic growth prospects in general, and targeted infrastructure projects in particular, to global investors and developers. To do so, they will need to show their own willingness to invest even if there is less money to go around, as Saudi Arabia and the UAE did in 2009, when they dedicated billions more dollars to government expenditures than they had in the previous year. This is the sort of action that builds credibility for these governments as partners in infrastructure development. In addition, such illustrations of government fortitude need to be well publicized throughout the world to demonstrate to international investors and developers that the region is indeed committed to using its accumulated surpluses to advance economic growth.
If the GCC governments take such steps, banks will be more eager to take advantage of the hospitable environment. That won’t immediately bring the return of big investment pools, but banks would at least provide short-term financing, helping to initiate necessary projects that are ready to break ground but cannot secure long-term loans. For global and regional banks, this approach would reduce their overall risk while offering solid opportunities for a return on investment. And for smaller banks, whose ability to participate in financing for large-scale projects is limited even in the best of times, this could be a chance to gain exposure to the infrastructure sector, while diversifying their current lending operations.
In recent years, the ratio of private to government expenditure in GCC countries has been below the Organisation for Economic Co-operation and Development (OECD) average, suggesting strong potential for more private-sector involvement in infrastructure development. GCC governments have already made efforts to encourage that investment, privatizing government assets and completing initial public offerings of public-sector infrastructure companies. For example, in July 2008, the Abu Dhabi government put out to bid the first private road development project in the Middle East, an estimated $2.5 billion undertaking that will traverse the stretch of desert and flatlands between Abu Dhabi city and the Saudi Arabian border. And power plants in Saudi Arabia, the UAE, Bahrain, and Qatar — traditionally government-owned facilities — have been recently offered to international investors. These efforts, coupled with the difficulty of obtaining financing from traditional banking sources during the current credit crisis, represent an opportunity for the growing number of private equity and infrastructure funds operating in the GCC to step in.
Private-sector developers should select specific projects based on their potential for financial performance and competitive advantage. It would be foolhardy, for instance, to back an electrical plant in a locale that already has many utilities, or to support a project to build roads on a route with a high-speed rail line. The returns would be less than desirable. But for well-chosen projects, private infrastructure developers willing to demonstrate their commitment to the region will not only build market share, they will also reap the benefits of debt recapitalization once the credit markets ease.
To finance infrastructure projects, the private sector should consider tapping into the capital markets, which are generally less expensive than bank loans. For example, developers could float so-called private finance initiatives, which can raise funds through the sale of reasonably stable long-term corporate bonds, a relatively unknown instrument in the Middle East. For cases in which bank lending is unavoidable, developers may need to find ways to give extra reassurance to lenders in order to secure credit, such as securing sovereign guarantees or putting their own balance sheets on the line.
In many ways, the GCC nations are suffering less from the global economic crisis than much of the rest of the world. The region’s sovereign wealth funds made good use of oil revenues when prices skyrocketed, diversifying their assets across industries and around the world. A relatively young and affluent population keeps demand fairly high for local products and services, from consumer goods to telecom service. In a number of sectors, GCC companies are better capitalized than their global peers. While the U.S. and Europe fell into recession, growth merely slowed in the GCC region.
All in all, the region is poised to recover quickly and to continue its climb toward becoming an economic superpower once the crisis ends. Its deficient infrastructure, however, could derail these aspirations. It will take a large degree of political will and financial creativity for local governments as well as private builders and banks to overcome the obstacles to infrastructure development in the Middle East. Failure to do so may jeopardize future growth.
- Ibrahim El-Husseini is a partner with Booz & Company in Beirut. He leads the Middle East energy, chemicals, and utilities practice, with a focus on strategy, organization, operational improvement, business development, and program management.
- Fadi Majdalani is a partner with Booz & Company in Beirut, leading the transportation practice in the Middle East. He focuses on large-scale transformation programs for the aviation, travel, postal and logistics, rail, and maritime industries.
- Alessandro Borgogna is a principal with Booz & Company in Dubai. He focuses on governance, strategy development, operational improvements, infrastructure planning, and public–private partnerships in the aerospace and transportation industries.