By Babu Das Augustine, Deputy Business Editor
Published 00:00 28 November 2009
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Those of you who thought that the good old days of banks chasing you with mortgages, personal loans and multiple credit cards are over: please don't give up hope. Some contacts of mine are telling me that another round of the liquidity festival is round the corner.
Last week I had the opportunity to interact with maybe half a dozen economists in Dubai. Some of them said that it could be a matter of just a few months that we head into another boom cycle, since international capital looking for higher yields might head in this direction.
Dubai World's credit restructuring and its impact on investors was not something that was anticipated by these experts. Yet, despite the potential effect on Gulf assets, the prospects generally here over time are clearly better than in the US and the West.
For more than a year the US Federal Reserve has priced credit at next to zero. With interest rates in the US and other advanced economies set to remain low for an extended period, and Gulf economies poised to recover at a faster pace, capital flows into the region are likely to pick up.
Driving force
The International Monetary Fund (IMF) has recently highlighted that low interest rates in the US, plus an apparent ‘one-way' bet against the dollar, has created a global dollar carry-trade that is driving capital flows into emerging markets.
A currency carry trade is a strategy in which an investor sells a currency with a relatively low interest rate and uses the funds to purchase different currency/assets yielding a higher interest rate. In fact it is effectively a leveraged play, as the sold currency has typically been borrowed for the purpose, with its minimal cost of funding being a critical element.
Although the scope for pure interest-rate arbitrage is not a likely driver of hot money flows into the UAE, owing to the currency peg, rising oil prices and a declining dollar, amplified through further investment hedges in oil and rising expectation of higher returns, could direct more capital flows this way.
Distortions
While higher capital flows and rising reserves are not intrinsically bad, in the absence of monetary policy flexibility and mechanisms to absorb the excess liquidity they will inevitably result in domestic price distortions and pressure on currency revaluation.
We've seen it before, not so long ago. The UAE had 12 per cent inflation in 2008, before the economy went into reverse upon capital flight as the global credit crunch took grip. Now, Standard Chartered economists have recently forecast 6 per cent inflation for the UAE in 2010.
Inevitably, not all agree, and some say it is too early to worry about hot money inflows and asset bubbles in the UAE.
I checked with an economist friend as to the divergence of views on a seemingly straightforward question. He did not give me a straight answer, but referred me to two laws of economists:
With the most recent developments in Dubai, the potential hot money inflow to the region could be much cooler than has been suggested. But now I am more convinced about the laws of economists.