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Capital Markets

United Arab Emirates: Central bank moves to avert bursting of credit bubble

A week after Lehman Brothers collapsed, the United Arab Emirates central bank announced a new credit line of a dirham equivalent of $14 billion. Was it a signal to investors that the federation would not sit by and watch as the economy of Dubai – its second-biggest constituent – went into free fall?

The view that Dubai’s property boom would soon become a bust has become increasingly prominent in recent weeks, as share prices of developers in the emirate crashed, and spreads on their debt widened dramatically.

Putting it all together — 2009 is the year to watch

Dubai real estate – supply and demand projections

Source: Colliers, Morgan Stanley Research estimates


Economists agree that the new central bank facility was precipitated by surging credit growth, and banks’ inability to collect sufficient deposits to back it. Monica Malik, head of macro-analysis at regional investment bank EFG Hermes, says: "There was a tightening of liquidity in the UAE even before the global turmoil intensified. Earlier in the year, speculative funds betting on currency reform had driven down inter-bank rates, further spurring credit growth. As the currency speculators reversed when the dirham neither revalued nor de-pegged from the dollar, the demand for credit remained, but deposit growth was not as strong. The bond market in the region has dried up. So inter-bank rates rose." Another issue that has led to a contraction of liquidity in the UAE and elsewhere in the Gulf, say market sources, is the large amount of foreign exchange losses incurred recently by local banks’ treasury departments. One source in the Gulf says lax foreign-exchange risk management, on the back of the apparent safety of the currency pegs, caused losses when the US dollar unexpectedly fell in value after Lehman’s bankruptcy. There was a subsequent scramble to implement hedges, says the source, followed by further losses when the dollar regained ground against other currencies on the news of potential US state intervention in the market.

According to the latest central bank figures available, credit growth in the UAE is up 49% year on year, compared with an increase in deposits of only 36%. But these figures were from June – when the full effect of the exodus of the currency speculators had still to be felt.

As Euromoney went to press, inter-bank borrowing rates in the UAE were about 3.7%, up from about 1.9% in April.

"There was a tightening
of liquidity in the UAE even
before the global turmoil intensified"

Monica Malik,
EFG Hermes

Unfortunately, as far as inflation targeting is concerned, these rates are still far too low. For much of 2007, inter-bank rates were around 5%. Yet inflation, according to official figures, was 11%, even in 2007. In 2008, while inter-bank rates are lower, the cost of consumer goods will have risen by about 13% by the end of the year, according to estimates from EFG Hermes. It is a strange time to loosen monetary policy, and free tens of billions more dirhams. But one of the problems in the UAE is that persistently unattractive interest rates on deposits over the past few years have encouraged speculative inflows into the property market. One source says this has led to a situation where loan-to-value ratios of 99% or higher can be obtained for property purchases, with banks in some cases dressing-up real estate lending as other types of loans.

Many market observers say banks in Dubai in particular are dangerously exposed to that emirate’s property market. "The central bank is trying to reassure people that liquidity would be there if needed," says Malik.

However, Morgan Stanley said in research released in August that it expected a property-price correction in Dubai from the end of 2009, as excess planned supply is combined with the current negative sentiment (see graph).

"The central bank has a tough balancing act," says Marios Maratheftis, regional head of research at Standard Chartered in Dubai. "Credit growth needs to decelerate, but not so much that there is a dramatic fall in property prices and a severe slowdown in economic growth,"

Other countries in the Gulf are also experiencing tightened liquidity. Omani authorities have signalled that they could make more money available through the central bank. Kuwait too has reportedly injected more funds into the local banking system via the central bank. The Kuwait Investment Authority even said last month that it would pump more money into the stock market – like other stock markets in the region Kuwait Stock Exchange has fallen dramatically in recent weeks. There are rumours that sovereign wealth funds in Abu Dhabi could make a similar move.

Inflation targeting in the Arab-speaking Gulf has been constrained by currency pegs to the dollar. Still, many countries have taken steps to avoid asset bubbles. Kuwait, for example, has introduced measures preventing banks devoting an undue proportion of their loan books to certain sectors, including real estate. Saudi Arabia has gradually increased banks’ reserve requirements over the past year. Other Gulf central banks have also tightened loan-to-deposit ratio requirements.

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