Markets and Finance: When Keynesianism works in reverse

During the course of the past two weeks, I've been overloaded with information on the regional economies.

Early last week the International Institute of Finance (IIF) unveiled its Middle East economic outlook. A few days later the Dubai International Financial Centre organised the Middle East North Africa and South Asia (Menasa) Forum, which was followed by a presentation by the International Monetary Fund (IMF) on the regional outlook.

At all these events economists, policymakers and bankers discussed the impact of the financial crisis on the Gulf, particularly the UAE and Dubai.

The overwhelming consensus in these events was that the Gulf region as a whole is poised to record the second strongest GDP growth rate this year after Asia. The UAE is set for strong economic recovery.

The IIF outlook observed that Dubai's debt refinancing challenges are manageable and should be viewed in the context of the global crisis. The IIF estimates Dubai's debt at about $107 billion, equivalent to 136 per cent of its GDP. The UAE had a net foreign asset position of $280 billion at end-2009, or about 130 per cent of GDP.

The IMF economic outlook was positive on the intrinsic strength of the UAE economy and the banking system to deal with the local debt issues.

Global rating agency Moody's commented last week that the impact of Dubai World's debt restructuring on the UAE's banking system will be limited. "This exposure by itself would not jeopardise the solvency levels of the rated banks," the rating agency said.

But one of the most reassuring and logically sound comments came from Khatija Haque, an economist with Shuaa Capital. Giving a local and international context to Dubai's debts she said: "Dubai debts were not the result of fiscal profligacy as was the case in many other parts of the world. The silver lining Dubai has is that it has built infrastructure with its debts that will support its growth for several decades ahead."

"The infrastructure funded by the borrowing could help Dubai recover from recession," Stephen King, chief economist at HSBC Holdings said on Thursday.

In retrospect it appears to me like the Keynesian fiscal policy prescription is at work in reverse order in Dubai.

Poised for next big leap

During the Great Depression Keynes argued that the solution to recession was to stimulate the economy through a combination of two approaches: a reduction in interest rates and an increase in government spending (through deficit financing) in infrastructure. Investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth.

Despite the speculative forces playing their role, Dubai got its fair share of both employment and investment multipliers during the boom years of 2003-07. In the aftermath of the global recession, credit became scarce and growth stalled. But during the boom the city built a world-class infrastructure for itself including the Metro, roads, ports, airports, industrial clusters, free zones and tourism facilities with cheap and abundant liquidity.

Of course, now the debts have to be repaid, and that has to be managed, but the framework for growth has been built, and the city is poised for its next leap as and when the global economy recovers.

By contrast Western economies have piled up debts during the past few years to rescue the financial system and to stimulate their respective economies. Their current policy efforts are directed towards fiscal discipline through austerity and higher taxes. Despite these, eventually the accumulated public debts will have to be monetized.

In either scenario, the disposable incomes in these countries are going to be undermined by taxes or inflation for a long time to come.

Dubai seems to be quietly going ahead with the debt restructuring and preparing itself for the next phase of growth. Clearly it is not an easy task to climb out of the respective debt burdens here or in the West. But Europe's malaise appears deeper and prolonged in nature, whereas a significant part of the Dubai story concerns real investment which will stand it in good stead in the years to come.