What next for policymakers?

After putting the global economy on financial life support 12 months ago, policymakers the world-over are now focused on what to do next.

Simply put, governments are nervous about the size of their liabilities which are primarily associated with measures taken to ease the ‘crunch' and stimulate recovery.

It is a catch-22 situation. On one hand politicians jeopardise economic recovery if they decide to reduce their fiscal deficits by cutting public spending and raising taxes, not to mention public support.

They worry such actions could be the trigger that slams already frail economies back into freefall. On the other hand, the longer they take to reduce budgetary deficits the more it is costing.

For the most part commentators believe that the worst of the global crisis is behind us. Although for many developed economies in the West the recession will continue to bite, early signs of green shoots are emerging elsewhere.

Advanced markets such as Australia, Germany, France and Japan, as well as most emerging countries outside Europe, paint a more optimistic picture.

Improved situation

In its recent Global Financial Stability Report (GFSR) the IMF said the world's economy has improved following unprecedented policy actions and that financial stability is growing.

However, despite this relatively sanguine scenario there are indications that the road to recovery is likely to be far from smooth.

Most worryingly, according to the Organisation for Economic Cooperation and Development (OECD), the world's leading industrialised nations could trump post-war unemployment in 2010.

This expected jobless rate of 10 per cent, or 57 million people, will translate into weak consumer demand, increased government spending on welfare payments, while also sapping lenders via higher non-performing loans.

On top of this, traditional banks are still hobbled by mounting losses and weak demand from their retail and business clients.

Additionally, a number of institutions in the West have undergone temporary nationalisation, meaning they are bound by government restrictions diminishing their ability to lend.

To make things worse, the shadow banking system, which is the term given to non-bank financial institutions, is in many areas shot to pieces.

From institutional investors and investment banks to hedge funds and venture capital — the negative impact of the last 12 months cannot be underestimated.

Furthermore, many nations are already operating under ballooning budget deficits. Governments need citizens to save more, which with rising unemployment, asset deflation and shrinking salaries seems wishful thinking.

The UAE, like all globally integrated economies, is subject to the vagaries of the world economy.

Although the country is in a far better economic shape than most, a prolonged world recession would nonetheless affect the UAE to some extent.

Firstly, a perennial downturn could affect oil prices. Recession usually leads to reduced demand which has the inevitable knock-on effect of lowering oil prices. That's exactly what we've seen over the last year.
 
However, recently the price of crude has been rising more rapidly than economic fundamentals merit.

If this trend continues while the world economy is in such a beleaguered state, oil producing countries such as the UAE, could come under political pressure from importing countries to raise production to lower prices.

Secondly, although the UAE is expected by some to see a slight GDP contraction in 2009, next year is believed by many as the year of recovery.

However, a global U-shaped or W-shaped slump could take some of the steam out of this economic resurgence as international companies operating or planning to set up in the UAE retrench financially.

Thirdly, signs of a deeper recession than was initially thought will adversely affect stock markets around the world exerting a negative influence on local exchanges.

In addition, an uncertain economic climate will always affect IPO activity, with companies reluctant to go to market when negative sentiment abounds.

Finally, tourism. Debt-burdened consumers and decreasing income levels will lead to less people being able to afford to travel to foreign shores for a holiday, further impacting tourist hotpots.

All that said, while other countries keep their proverbial fingers crossed that the global recovery is V-shaped, the UAE can be surer of its future thanks to its strong fundamentals and positive outlook.

Trevor McFarlane is editorial manager of Oxford Business Group, Abu Dhabi.