Dubai: Deflation path to Recovery

Sitting on the inside, watching the economic crisis is not more a secluded exercise. This economic meltdown is a world wide episode, with ramifications that have not been quite fully understood, especially by the actors who are expected to bring about a change in this scene we stare at. As the global crisis has unfolded its own unique economic tsunami the effects of it have manifest itself in each country in a rather different way. While focus has remained on the United States in terms of the sheer size of its economy, large consumer economies like China and India has been better placed to absorb the tidal waves given that there is a basic level of consumer demand that does need fulfillment.

Dubai has received a great of attention from the world media, and understandably so; during the boom years it was the darling of the media world, and as it is learning, in the down days the same writers who showered accolades are the first ones to throw eggs. This does not mean that the entire negative press is not without foundation, but more like exaggerated to the point of sensationalist fear. For the record yes the recession has hit Dubai hard, and understandably so as it had the most grandiose of plans in the region. The debate rages over the size of its financial commitments and what it will do to revive the economy.

I would say three decades in the region, two of which were in banking, gives me more perspective than a reporter who perhaps would think of a story over a month at best. First of all Dubai has been what I have always called an 'enabling economy', whereby it has created the infrastructure for private sector to thrive. Though, understandably, over the past decade over zealous government officials donned the entrepreneurial hat and goaded the government to become in effect the biggest business conglomerate, having the disadvantage that it pushed the cautious private sector to the sidelines and yet having the advantage that government funding would ensure completion of the grand design. We must remember it was not the real estate sector that caused the problem it was a combination of financial issues within the banking sector and the effects of the global economy that started the downward spiral.

To explain this further one has to appreciate that in middle to late 2008 there was widespread speculation and debate that the UAE will delink the Dihram from the US dollar, a fixed rate that has been unchanged since 1970's. This speculation drove through most of the early part of 2008 substantial funds from Hedge Funds in Europe and elsewhere into the banking system in the UAE expecting a delinking will mean a stronger UAE Dihram. This did not happen and when in September or so last year the UAE Central Bank made its position public that there was no such delinking on the cards, billions of dollars playing this trade and sitting in the banks here too flight. Ofcourse in a sense the hedge funds had their own problems brewing with the sub prime crisis and a stock market that was not entirely comfortable.

The problem would not have been more than that it seems had some fundamental errors not taken place. So lets say $15 billion comes to the banks here, is laying in deposit waiting for the delinking, the delink does not happen the money leaves so no big deal. However, our clever bankers, and I was one of them a decade back, had lent a substantial part of these funds to domestic borrowers, so when the delink did not happen and the funds went back almost every bank was caught with their loan to deposit ratio (which is normally 80-85%) suddenly find they had more loans on their books then deposits to fund them. Well established banks with loads of liquidity were caught with a ration of close to 135% on loans to deposits. Given that international banks were stuck with their own problems even the inter bank market was struggling to fund the banks here.

The timing of all this was smack in the middle of the meltdown happening thus closing the door to the one thing that could have made this crisis less dramatic; the access to liquidity. If the banks had not been so exposed then in a nervous market more monetary moves to increase liquidity in the banking system would have given the buffer to soften the blow. This is what happened in India where huge amounts of liquidity were pumped into the banking system to make sure the consumer did not panic.

This does not mean the real estate crisis would not have happened. I am only arguing that it would not have been so serve and more importantly one has to then question was the rationale for the development model for Dubai wrong? I do not believe the model was wrong, but two things needed adjustment that just did not happen.

1. The size and scale of the development was not tuned into the sustainable demand levels.
2. The role of private sector should have been the bigger chunk of the development cake rather than end up making government owned companies the biggest competitor to the private sector.

I am often asked a question about how long this recession will last and how will Dubai come out of it?

In the first place the recession is a global event and while France, China, India and Germany have shown signs of weathering the storm better, the chances are that towards the fourth quarter of 2009 the financial elements needed for a recovery will be in better shape. This deflation we have seen globally, and in Dubai, was needed for two reasons, one to slow down an over heating economy, and secondly to bring some value back to the process of development. I believe that consumer confidence will stabilize towards the end of this year and net investments will begin to show an increase in the first quarter of next year. Yes this is totally contrary to what some leading bank researchers are saying that we have another 18 months of hardship, but trust me I know that crowd well, they are the same researchers who a year back were predicting some very exuberant predictions.

The way Dubai will come out of this is actually simpler than it looks. While the current funding of Government Bonds of $ 20 billion as a first step forward Dubai has a good collection of companies it can privatize, from airlines to hotels and property companies too. The question is the timing of such privatizations and whether this is the route to take. I believe the enabling element of Dubai's economy means in the region it is the best suited in terms of ease of business and infrastructure to be the place of first choice for regionally based companies. I believe a spending spree in Iraq on account of rebuilding the country will commence early next year, this backed up with a higher oil price will bring stability to the region and a demand led economy will emerge, but gradually. UAE and Dubai are best positioned to take advantage of the support role it will perform and this is where there base of the demand side of the equation will come to the economy.

This does not mean that the government of Dubai should not rethink their role in the economic model. I think they should go towards being more an enabler and privatize some of the business concerns, perhaps with the timing of the first offerings to be in the early part of next year. There should also be a revisit to some of the more grand projects and these should be put on the back burner and bring back the confidence that with some projects shelved the expect financial load will be substantially less. As I said to someone the other day "You can still plan to do all you wanted but just don't do them at the pace you were trying to.'