Dubai: The Gulf economies are not immune to the global financial crisis. Governments of the GCC countries should draw lessons from this experience and develop new strategies to better manage their assets, a top official said, cautioning that everything is not rosy in the region.
Hamad Bu Amim, director general of the Dubai Chamber of Commerce and Industry, said: “Now that GCC economies are also in the middle of this turmoil, GCC governments should draw lessons from this experience and develop new strategies to better manage their assets.
“They need to speed up cooperation and use the economy of scale in establishing the GCC single currency and monetary union.''
They need to review their financial risks management and establish a common institutional floor to build up future financial systems, Bu Amim told Gulf News in an e-mail interview, in which he elaborated his views on the latest global meltdown.
Gulf News: The global economy appears to be in a mess. What is your view on how it all happened?
Hamad Bu Amim: When property prices started to decline, it triggered a sub-prime crisis in the US. This was exacerbated by the so-called Credit Default Swaps (CDS), which ballooned from nothing into a $55 trillion (Dh202.29 trillion) market.
CDS became the fastest growing market of financial derivatives. Its value exceeded 2.5 times the US stock market capitalisation of around $22 trillion, and it became seven to eight times the value of the US mortgage market of $7.1 trillion and more than 12 times the value of the US treasuries market valued at $4.4 trillion.
Most US banks are trading in CDS holding exceeding $13 trillion. A CDS is a contract whereby the buyer pays a premium and the seller agrees to make a certain payment in case an event occurs; if a bond defaults for example.
The reality is that there was a housing bubble, which supercharged the US economy and now it has burst, and if prices of property continue to fall there will be more foreclosures and the problem will get worse. CDS also consist of bets on other people's debt and that is exactly what winners in the subprime debacle did. Hedge fund star John Paulson of Paulson & Co., for example, made $15 billion in 2007, largely by using CDS to bet that other investors' subprime mortgage bonds would default.
The CDS market became the world's largest unregulated casino.
Gambling in the US has strict government regulations but CDS market does not have. A casino gambling offers the assurance that the winner gets its money, the CDS market does not. In spite of this, the US congress passed in 2000 a bill to prohibit regulation of CDS.
This is why some have called derivatives “financial weapons of mass destruction''. Bad loans and CDS have created holes in the banks' balance sheets. If US bailouts are paying a fair value for these assets, it will not repair the holes. These holes should be repaired in very transparent way, which is not happening. The US government is not addressing the foreclosure problem.
Have the bailout plans that have been introduced in several economies addressed the real triggers of the crisis?
The bailouts certainly have their flows; they approach the current financial crisis as if the fundamental problem is a crisis in confidence.
Confidence is no doubt part of the problem, but the failure of confidence is because the US financial markets made very bad loans. In 2006, more than 40 per cent of US new mortgages were extended to sub-prime borrowers, with high loan to value ratio, and with insufficient purchasing power and high financial risk exposure.
What do you think will happen to the UAE economy? Are we in safe territory?
Unlike the US and other Western economies, about 95 per cent of UAE enterprises are small and medium-sized family companies, employing mostly family equity with much less dependence on international capital markets.
Therefore, the impact of the financial crisis on family enterprises is assumed to be mild and might be limited to indirect impact through reduced global demand for re-export.
However, there is the need to protect minority shareholders, to regulate bankruptcy, to regulate further development of the financial market etc. These policies should be governed by transparent laws and regulations with the required institutions to maintain and internalise them.
What are the challenges facing the GCC economies under the current circumstances?
The UAE financial market is not immune to negative effects from Wall Street; no single market is immune to it. Small markets are normally speaking relatively much more vulnerable and dependent on large economies than larger ones. Iceland case is a good example for demonstration.
Luckily, the UAE is in a very fortunate position. The UAE economy is fairly isolated from the US market and is more oriented towards Asian markets.
The UAE is a net exporter of foreign direct investment, and its economic absorption capacity and potential to grow are significant, as in the GCC. The GCC's total assets in the US have exceeded $2.5 trillion.
But with recent financial turmoil they could have reduced in value. Now that GCC economies are also in the middle of this turmoil, GCC governments should draw lessons from this experience and develop new strategies to better manage their assets.
They need to speed up cooperation and use the economy of scale in establishing the GCC single currency and monetary union. They need to review their financial risks management and establish a common institutional floor to build up future financial systems.
All governments are now reviewing their financial systems. There are clear moves towards nationalising significant parts of the financial systems, and reviewing domestic economy control systems and re-establishing good governance's checks and balances. It is almost certain that in the future, many economies will reduce their financial dependency on global financial markets.
Do you think the aftershocks of the turmoil will affect the UAE, particularly, the manufacturing, financial and real estate sectors?
Business ownership structure in the UAE differs from that in the US and other Western countries. About 95 per cent of UAE enterprises are small and medium-size family enterprises.
Most family enterprises operate in the trading sector and employs mostly family equity with much less dependency on international capital markets. Therefore, the impact of the financial crisis on family enterprises is assumed to be mild and might be limited to indirect impact through reduced global demand for re-export.
Again in the manufacturing sector, the UAE differs from the US, where industrial structures require huge capital commitments. The UAE economic structure is very flexible; particularly Dubai is a commercial hub and not a production centre that requires huge long term funds.
In the UAE's financial sector, the banks, for which past government support has been crucial, and in many of them government co-own equity, have become serious international players, they have been very profitable in the past and were able to grow remarkably, with presently huge reserves.
UAE banks are relatively less dependent on external financial markets. According to the UAE Central Bank, banks financing from the European Commercial Paper issues (ECP) and Medium-term notes (MTN) to total bank assets is not more than 9.9 per cent; for the interbank deposits percentage, it is 12.7 per cent to the total assets and most of these are owned by UAE banks.
Banks capital reserves present 11.02 per cent of bank assets, which is considered high according to Basel II standards. National banks and branches of foreign banks operating in the UAE are constructed on safe and sound foundations.
The Emirates Interbank Offered Rate (Eibor) increased due to liquidity reduction brought about by significant liquidity withdrawal by speculators after the government decided not to revalue the dirham, and as response to similar international developments and international revaluation of risks.
An increased Eibor means that UAE banks are facing a serious credit crunch locally.
The fact that much less than 10 per cent of the Central Bank emergency facility has been applied for so far is explained by reluctant banks not willing to express their liquidity needs and their fear of losing reputation.
It goes without saying that a high Eibor is a remedy against bad loans and it will go hand in hand with international market development taking international risks into consideration. In brief, there are sufficient facilities being put in place to allow banks to resolve their problems.
What are your views on the country's real estate sector, which appears to be undergoing a sharp correction?
Demand still seems to be exceeding supply. In the worst case scenario, due to the liquidity crunch we may see a reduced demand and a softening of real estate prices.
If more supply will emerge from real estate hoarding by speculators and developers seeking liquidity, the gap between demand and supply might be reduced even further. However, as the level of real estate hoarding is so far unknown, it is difficult to predict the eventual impacts.
Stabilisation of prices will reduce the number of new real estate development and if liquidity dries up further it won't be a lucrative sector for speculators any more.
If the impact of the financial crunch in the real estate becomes visible, there might be a sort of dual real estate market developing, meaning that a dual market may develop to consist of two heterogeneous sectors: (1) a constructed sector, which generates rent, and (2) an off-plan sector which is still in the planning or under construction phase. We expect slight risks for the first sector, which might emerge from the reduction in real estate hoarding of which the level is unknown, but there are some risks of a liquidity crunch for the second sector.
That is, if no new liquidity will enter the latter segment, there will be many postponements and or cancellation of development projects.
If that happens to the second sector, this will depend on the pace of price stabilisation and the decrease in future supply in terms of time it takes to slow down and the magnitude of price adjustment.
However, soft corrections of the real estate market are wishful as it will open new opportunities for other sectors to grow.
On recalling previous experiences and your knowledge about the current position of the UAE economy, do you think it is capable of standing the world financial storm?
The UAE economy has proven in the past to be able to successfully face several financial crises. The secret is the young and dynamic economy with a very high degree of flexibility. For example, we don't need to worry about unemployment; we worry more about lack of qualified labour.
An overheated real estate has absorbed substantial resources and perhaps needs to slow down. A slowdown would enable real estate stakeholders to recap and consolidate their positions to face new challenges in the future.
What we are sure about, for the time being, is that in any case, economies always get back in the medium term to new equilibrium.
