Markets 'are interconnected more than people thought'

Dubai: In an increasingly globalising world, the latest financial and economic crisis has demonstrated that no one is immune from its effects.

Gulf countries were suddenly faced with a liquidity crisis when overnight cross-border funds came to a stop and the central banks had to inject Dh120 billion to ease the situation.

Stock markets have witnessed a precipitous decline this year, accelerated since July when foreign investors started exiting the markets.

But the region is better placed than many other regions, believes Howard Davies, former chairman of Financial Services Authority UK and currently the director of London School of Economics and Political Science.

In a freewheeling interview with Gulf News on the sidelines of World Economic Forum, Davies said that the first lesson that everybody has to learn and now starting to apply to this part of the world is that markets are much more interconnected than people suspected.

"And even till quite recently as the summer there were people saying that the Gulf will not be affected by this crisis because our situation is very different here. They were saying that in August, but they are not saying that now."

It is evident after the liquidity dried up and markets crashed that local companies and investors realised the interconnectedness with the world and have started to have an understanding that whatever happens in the major capital markets is going to feed through here some way.

"That leads to lessons about your exposure to global capital flows, and understanding potential vulnerability to short term capital flows even if fundamentally you are very strong in terms of solvency, in liquidity terms you may find yourself adversely affected," Davies said.

What lessons to take from the global crisis?

"The first big lesson is that indebtedness is risky, and a high degree of leverage is bound to create risks in global financial crisis," he said.

"Another important point to make is understanding the integrated nature of financial regulation. Financial regulation involves looking at what's going on in the macro economy, in the banking system, securities market, insurance market and this crisis has tragically shown that they are all linked together in complicated ways which requires you to have a broad across the board understanding."

"Also, I think in the long run, financial markets will expect countries to have a stable fiscal framework. Now, in this case, that is really probably not the issue. You have fiscal surpluses etc. But if you were to engage in investment projects, the market will not be particularly active about bringing forward government projects, which don't seem to have a good economic rationale, equivalent of digging holes and filling them up. I think market will be quite careful to discriminate in terms of projects."

As for local markets, he fears there will be collateral damage for emerging markets because there has been a natural tendency to pull capital back to support the parent balance sheet. But all is not too bleak, he feels, because of the strength of the fundamentals.