Register for our free newsletter

Latest News

Looking for Goldilocks

Looking for Goldilocks

As the UAE central bank injects cash into the financial system, Standard Chartered says managing the economy will be “a tough balancing act.”

September 22, 2008 4:18 by

Those who have read that the Gulf is a haven of liquidity amidst the global credit crisis might have been surprised to read that the UAE central bank recently set up a Dh50bn ($13.6bn) bank facility to inject some much needed cash into the local banking system.

It’s difficult for those who aren’t well-versed in economics (and we include Kipp in that group) to interpret this move. Most national budgets in the region were set assuming that oil would trade at around $30 to $40 a barrel, and even with the recent drop in oil prices, it remains above $100.

Despite talk of diversification, most Gulf economics, including the UAE’s, are still heavily dependent on oil revenue. So high oil prices have led to massive surpluses.

In 2007, the M1, the standard measure of money supply, shot up an astronomical 51 percent. In layman’s terms, that’s a lot of cash coming into the country.

Why, then, is the central bank suddenly concerned about liquidity?

Part of the reason is that UAE households have been on a borrowing binge. After all, with inflation in the double digits and interest rates relatively low, it makes more economic sense for a family to borrow money from the bank and buy that new bedroom set now rather than waiting until you’ve actually earned the money.

Banks, therefore, need lots of cash to keep up. “Everyone needs money. There is a massive shortfall,” Jason Goff, head of treasury sales at Emirates NBD, told Reuters. “These funds are going to help. They are definitely required.”

The central bank seems to be concerned not so much with liquidity as such, but with sudden changes in the interbank lending rate, the rate at which banks borrow money, which could trigger a panic if not managed carefully. Interest rates remain relatively low, despite the interbank rate shooting up 170 basis points (or 1.7 percent) since early June to 3.61 percent today.

According to Standard Chartered, the real problem is credit growth – people borrowing too much money. Domestic credit grew 49 percent year-on-year in June. That’s worrying, considering what just happened in the US.

“With inflation running in the double digits, there is a need for the central bank to contain credit growth. If left entirely up to the markets, the correction in credit growth can be very sharp, as we saw in the case of the US economy,” Standard Chartered says in a note. “The intervention of the central bank through the provision of the credit facility needs to ensure that any fall in credit growth happens in an orderly way.”

The bank continues: “The authorities need to adopt a Goldilocks approach – not too hot, not too cold, but just right. In other words, the authorities have to ensure that there is enough liquidity in the system to keep the economy going, but at the same time, bring down credit growth from 49 percent to more sustainable levels. This will be a tough balancing act.”

Tags: , , , , , , ,

Leave a Comment