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Earlier this year, Mohamed al-Mady, influential chief executive of Saudi Basic Industries Corporation, the kingdom’s petrochemicals behemoth, pinpointed access to credit as one of the most prominent challenges to the Middle East’s tentative economic recovery.

“We are concerned about the high cost of financing and tight supply,” he said in February. “The current situation can’t be sustained. It will limit investment to only the biggest companies with the strongest income statements.’’

There have been few signs of improvement since Mr Mady spoke out. Credit growth is feeble across the region. While larger, state-owned conglomerates can still rely on banks and capital markets – albeit at a markedly higher price

than many are used to – small and medium-sized enterprises are struggling to raise financing, analysts say.

“There are some countries where credit growth is more robust, but overall it is pretty weak,” says Farouk Soussa, chief Middle East economist at Citigroup. “Lending to SMEs is an area where banks often aren’t very involved, and if they are, it is often at punitive rates due to the risks.”

Lending initially froze in the wake of the collapse of Lehman Brothers, the US bank, in September 2008, but since then domestic developments have made banks even more cautious.

Intense competition and healthy economic development ahead of the financial crisis led to rampant credit growth, and many banks ventured into riskier areas, such as lending to share trading, real estate developments and unsecured retail customers.

The result has been a sharp jump in non-performing loans across the Middle East. Analysts say some banks are compounding the problem by failing to recognise swiftly the losses, and preferring to roll over – or “ever-greening” – loan portfolios.

Retail customers were not the only cause of the loan problems. Last year, it emerged that two of Saudi Arabia’s largest family-owned groups were unable to service total debts of more than $20bn – spreading fear across the region’s financial system, where “name lending” to blue-chip families is common.

Lending appetite was further depressed by last November’s shock announcement by Dubai World, the government-owned conglomerate, that it needed to restructure roughly $26bn of debt. Other large state-owned companies in Dubai are now also negotiating with creditors to extend loan repayments.

“Banks in the region are still in balance-sheet repair mode,” says Kamran Butt, regional head of research at Credit Suisse. “Until the industry feels that provisions are large enough to cover bad debts, they’re not going to be active lenders.”

The lack of bank lending is particularly problematic in the Middle East, where alternative sources of capital for companies are limited.

Though several governments have tried to kick-start nascent bond markets, bankers say it will take time before they become a viable financing avenue to anyone but top-tier, state-linked companies.

At the end of 2007, debt securities made up just 4.8 per cent of overall capital markets – the total outstanding value of bank loans, bonds and equities – in the Middle East, according to research by NBC Capital, the investment banking arm of one of the largest Saudi lenders.

Equity financing has also become tougher to raise. The local venture capital industry is tiny, and private equity funds have stayed largely on the sidelines. Depressed stock markets make initial public offerings a tricky proposition.

Some banks have started to explore more exotic funding, such as mezzanine or structured finance, but it remains expensive and complicated to arrange, and is unlikely to become a common source of capital, analysts say.

“The lifeline for SMEs has been bank lending, but that lifeline has constricted due to increased lending standards over the past two years,” Mr Butt says. “This is a global concern, not just a regional one, but this region has always depended substantially on bank lending.”

Analysts say some healthier companies may be able to fund modest expansion and investments from internally generated revenue, thanks to a quickening economic recovery in the region this year.

Barclays Capital forecasts that economic growth in the Middle East and north Africa will rebound from 2.5 per cent in 2009 to 4.9 per cent this year, and 5.4 per cent next year, partially because of a public spending spree in countries such as Saudi Arabia, the largest Arab economy.

However, Mr Soussa says that while SMEs can benefit indirectly from aggressive government expenditure, many are “left in the cold”, with most government-related business going to state-owned conglomerates or the sprawling business empires of well-connected merchant families.

On the other hand, many Middle East governments have established dedicated SME funding initiatives to surmount the banking industry’s reluctance to lend to smaller, riskier ventures.

Abu Dhabi’s Khalifa Fund for Enterprise Development was set up three years ago, and since its launch it has provided assistance to roughly 250 companies. Dubai has the Mohammed bin Rashid Establishment for Young Business Leaders, which has a Dh700m ($191m) fund, while the Saudi Industrial Development Fund has set up a programme with capital of SR200m ($53m) to guarantee loans and encourage financing to SMEs.

Nevertheless, analysts say success in government support of smaller companies has been patchy, and they predict that corporate funding difficulties will remain until local and international banks step up their lending.

Some analysts and business executives have voiced hopes that a successful resolution to Dubai’s debt restructurings could encourage a lending recovery, but many remain sceptical. “Dubai World masks a larger issue,” says a senior international banker. “A resolution will help, but there are other, larger issues at play. The local banks simply aren’t lending.”

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