Asia-Middle East corridor struggles to connect

In January 2016, China published its first Arab Policy Paper, a white paper that offered some timely insight into Beijing’s long-term vision for the Middle East. By the standards of the Communist Party of China, it was reasonably terse, coming in at just 4,859 words.

It contained much that was vague or tailored to sound positive and unthreatening (the word ‘development’ comes out to play no fewer than 59 times).  The writers padded softly across the text, highlighting China’s attempts to build two latterday Silk Roads: one stretching to Europe overland via Central Asia and the Middle East; the other linking Beijing with the Middle East via the Red Sea and the Arabian Gulf.

But it included more specific goals, notably: strengthening monetary co-operation between central banks and expanding cross-border currency clearing and currency swap arrangements, not to mention an invitation to join its new multilateral institution, the Asian Infrastructure Investment Bank.

China wields increasing economic and financial clout in the resource-rich region of 218 million people, which stretches from Lebanon to Yemen, and Syria to Iran. It accounts for 14% of Saudi Arabia’s exports, worth an estimated $44.2bn, importing around 1.1 billion barrels of oil a day from the Kingdom, noted Raghu Mandagolathur, senior vice president, research, at asset manager Markaz in Kuwait. But the People’s Republic is not the only Asian sovereign seeking to fortify its financial and economic ties with the region, of course. According to Japan’s Ministry of Economy, Trade and Industry, Tokyo imports north of 90% of its oil needs from the Middle East, mostly from Saudi Arabia. Exports of Iranian crude to South Korea jumped 115% year-on-year in June 2016, following the slow lifting of sanctions from the country. Meanwhile, India and Pakistan have strong and long-standing commercial, financial and cultural ties with the region: wealthy Indian and Pakistani investors have long seen the mature and financially stable region as a second or third home. In addition, south Asia provides a large amount of the expatriate workforce in the Middle East.

Bilateral trade is also expanding. According to the World Trade Organization, Asia counted for 53.9% of all Middle Eastern exports in 2014, worth $694bn, up from 52.2% in 2013. Asia, in turn, exported goods and services – from Japanese automobiles to Chinese electronics goods to Korean nuclear power equipment – worth $302bn to the Middle East in 2014, an annualised increase of 12%. 

As always, hot on the heels of trade comes finance. Middle Eastern banks have in recent years begun to flesh out plans – some serious and ambitious, others tentative and diffident – to branch out into select Asian markets, in search of new income opportunities.

In November 2015, National Bank of Abu Dhabi (NBAD) announced plans to establish eight international banking hubs around the world including three in Asia, in Mumbai, Singapore, and Hong Kong.

The same month, the bank launched its inaugural retail banking operations in India, a market close to its heart (see box). NBAD’s global banking chief investment officer, Gary Dugan, has talked openly and warmly of the lender’s “love affair” with the country, and with the manifold business opportunities present in the world’s fastest growing major economy.  The announcement came the same month the bank secured a full operating licence from the Reserve Bank of India, and bought $900m worth of offshore loans to Indian corporates from Royal Bank of Scotland.

Alex Thursby, NBAD’s group CEO, has described India as an “important milestone” in the bank’s plans to build a financial services giant with operations stretching from west Africa through the Gulf, to the great economies of east Asia, a region he regularly described as the ‘West-East Corridor’.

Yet Thursby will not be around to see his plans come to fruition. He stepped down in August, one month after he announced a grand plan to merge NBAD with rival UAE lender First Gulf Bank (FGB), creating a banking heavyweight with $175bn in total assets, rivalling Qatar National Bank.

Will the Abu Dhabi lender succeed in internationalising its operations, transforming itself from a regional institution into a pan-regional banking behemoth? It’s probably too early to say, though analysts have been impressed by its ability to impose itself on new markets at speed. It now boasts a presence in 17 markets, from China to the United Kingdom, and has led a number of major refinancings for major Indian corporates including Tata Steel, Reliance Industries, and Bhira Investments.

“NBAD’s expansion has been rapid and Asia accounts for 5% of the total deposits of the bank,” noted Mandagolathur.

“This is remarkable as the Asian banking industry is a crowded one and one of the most difficult regions in which to operate owing to higher regulatory oversight.”

NBAD is not alone in seeing opportunities in Asia. In May 2016, First Gulf Bank poached the head of structured finance, commercial real estate and corporate advisory at HSBC-owned Hang Seng Bank, Mimi Cheng, to run its representative office in Hong Kong, a further sign of the scale of its Asia ambitions. Last year, the bank opened its first representative office in Seoul, adding to its existing Asia branch network in Singapore, Mumbai, and Hong Kong.

In truth, there are few sizable Middle East lenders that do not have at least some semblance of an Asia plan. Other lenders with an Asia presence include Abu Dhabi Commercial Bank, Doha Bank, Mashreqbank and Qatar National Bank

Asian lenders are expanding into the Middle East, too. China’s Big Four state run commercial lenders – Agricultural Bank of China (ABC), Bank of China (BOC), China Construction Bank (CCB) and Industrial and Commercial Bank of China (ICBC) – have all upgraded their licences at the Dubai International Financial Centre to full branch status. Talks are ongoing with two other mainland lenders to open subsidiary offices in the Emirate’s financial free zone.

The investment is already yielding results. In the first quarter of 2016, the DIFC said China’s biggest state lenders had doubled their local balance sheets in the previous 18 months. In addition, BOC listed an Rmb2bn ($300m) bond on the DIFC’s global financial exchange in 2015, with ABC listing its own Rmb1bn bond the previous year.

“Dubai is emerging as a crucial hub along China’s New Silk Road,” Arif Amiri, chief executive officer of DIFC Authority, the central body that oversees the DIFC, has said.

Ben Simpfendorfer, founder and managing director of Hong Kong-based, pan-Asian consultancy, Silk Road Associates, believes that China’s lenders will in the long-term become as powerful a presence in the Middle East as European and North American lenders are now. For the time being, he notes Beijing’s big lenders are mostly focused on providing cash management, treasury and project financing services to China’s army of leading state-owned enterprises.

“There is an opportunity for ICBC and CCB,” Simpfendorfer told Asiamoney. “But it in part depends whether they follow the same track as the big global banks in terms of organisational change – such as hiring more local employees and managers – as well as developments in China itself around rising bank non-performing loans and capital constraints.”

China’s slow press into the Middle East is being bolstered by the increasing influence of its currency, the renminbi. According to data from Swift, 60% of all payments in value terms, completed in 2015 in Hong Kong and mainland China by Qatar-based corporates and lenders, were processed in RMB. When it comes to UAE-based institutions processing payments in Greater China, that share rises to 74%.

Sido Bestani, head of Middle East, Turkey and Africa, at Swift, notes that the use of the RMB is rising fast across the Middle East.

“Adoption has been supported by developments such as the establishment of an RMB clearing bank in Qatar last year — the first in the Middle East — and the recent memorandum of co-operation signed between the People’s Bank of China and the Central Bank of the United Arab Emirates to set up RMB clearing arrangements in the UAE,” he said.

“We anticipate these and similar efforts will continue to drive RMB adoption across the region.”

But for all the progress the US dollar continues to dominate despite efforts to get commodity prices quoted in RMB. When the rest of Asia is taken into account, most two-way payments between Asia and the Middle East are still denominated in US dollars, and are intermediated mainly by US clearing banks.

To Markaz’ Mandagolathur, a key reason for the renminbi’s inability to break out into the mainstream, and become a favoured settlement currency in the Middle East, is due to the current low commodity prices and sluggish growth. “During times of low oil prices we feel that the investors would use the tried and tested dollar as their primary investment currency rather than using the Chinese renminbi.

“The rise of the Chinese RMB in the [Middle East] is a bit far-fetched at this juncture. Governments in the region have used the dollar as their main trading currency and are unlikely to change that anytime soon.”

Of course Chinese banks are not the only Asian lenders active in the Middle East.  A slew of Indian lenders have longstanding offices in the region, including Axis Bank, HDFC Bank and ICICI Bank. But the interest is visible beyond Asia’s two largest economies.

In the first quarter of 2016 for example, Taiwan’s Mega International Commercial Bank opened its first office in Abu Dhabi; like most outwardly expansive Taiwan lenders, it will focus on providing wholesale banking services to its domestic customers.

Nor is the ever-closer bond between the two regions limited to currency swaps, choice words, and a few bank branches. Asian and Middle Eastern lenders, keen, in a low-interest-rate world, to secure a smidgeon of extra yield, have become avid buyers of one another’s debt.

Qatar National Bank Finance made a splash when it printed $1.1bn worth of two-year floating Formosa notes in Taiwan in May 2016, completed in separate tranches over a two-day period. Two months later, it was back, issuing $330m in five-year floating notes in a deal managed by Crédit Agricole and Cathay United Bank.

Conversely, when Saudi Arabia announced its first international debt sale earlier this year, set to raise around $15bn and spurred on by slumping energy prices, the barrage of interest from Asian investors convinced Riyadh to revisit its plans and consider a longer pipeline of deals from the sovereign and state-linked firms.

“The demand from Asia [on the Saudi issuance] was frantic,” said Markaz’ Mandagolathur. “Asian banks have become major subscribers to [Gulf region] sovereign bond issues due to their high credit rating and reasonably good yield.”

Then there’s Islamic banking, which already has strong footholds in Asian countries such as Malaysia with deals from the country regularly being sold into the Middle East. The sector is now getting the attention of China.

At around 20 million, China may only have a relatively small Muslim population. but Party leaders in Beijing view Islamic finance as a simple way for the country to expand its economic influence across the Middle East. That, to an extent, explains why state run Chinese banks are so keen to boost their presence in the Gulf. And why mainland corporates are increasingly looking to tap offshore pools of Islamic funds. That ambition loops back around to the administration’s New Silk Road strategy. A host of mainland firms are weighing up the pros and cons of issuing Islamic bonds.

“China’s banks want to distribute Islamic banking products – and there is demand across the product suite,” noted Bill Stacey, a former banking analyst, now a director at Hong Kong-based consultancy Lion Rock Institute. “Islamic banking has offered an impetus to Asian banks putting branches in Dubai. Dubai is overwhelmingly the centre of choice in the Middle East, which shows that the focus of the region is very much on the institutional side and a lot about distribution of products rather than lending origination.

“The key point is that they are not interested in lending into the Middle East, rather they are distributing Asia credit exposures to investors in the region.”

But for all the economic, cultural and political links between Asia and the Middle East, there are challenges ahead before these connections become more substantial. Banking analysts interviewed for this story, were united in their belief that financial and economic trade between Asia and Middle East was on an inexorable uphill curve. Yet they also professed surprise that lenders from each region had been relatively slow to roll out physical branch networks.

“There’s activity, but not to the level I would have predicted,” said one Hong Kong based analyst, whose employer does not comment publicly on rival financial institutions.

Growth – or the relative lack of it – is a factor too. A few years ago, when the Western world was slumping, the only major sources of growth appeared to be in east Asia and the Middle East. Both those regions are now struggling. The former is hampered by a heavily indebted and slowing (but still growing) Chinese economy, and a Japan that, however hard current premier Shinzo Abe tries, refuses to get up off the carpet. In turn, the Middle East as a broad collective continues to struggle with oil prices and a concomitant pressure to reduce social spending.

Still, the moderate growth rates developed economies in Europe and North America seem set to post in the years ahead stand in stark “contrast to higher growth rates that could potentially be witnessed in the Asian region”, notes Markaz’ Mandagolathur. “This might show a shift in preference for the Gulf countries, in terms of them looking to deepen their trade relations with the Asian region.”