Banking sector in the UAE needs an instant push for the economy to sail through the impacts of global crisis, Standard Chartered said.
An additional Dh100 billion of funds in the form of deposits to balance the deposit ratio of the banks and a permanent repo window are few of the measures required to lead to a recovery by the second half of 2009.
Standard Chartered has estimated growth to contract between 0.5 per cent to 1.0 per cent this year.
"It will be a tough 2009, and a tougher first half. But with the right kind of measures we could see a recovery by the second half of 2009," said Marios Maratheftis, Regional Head of Research, Mena, Standard Chartered.
Bearish on developed economies, Standard Chartered said recession will continue this year and there could be a stagnation by 2010. However, the impact on developing markets is not as severe and the recovery too would be quicker.
The region is relatively insulated, not immune, from the happenings worldwide, the bank said, recommending extraordinary measures for the Gulf Co-operation Council (GCC) countries.
Emphasising on an immediate need to increase government spending, the bank said that during the boom years, government spending does not necessarily have to be high. It is now that heavy government expenditure is required even if it means a budget deficit.
And in the UAE, there is a lot of scope for spending to be increased further, said Standard Chartered.
The UAE authorities, it said, have announced expansionary budgets for 2009, both at federal and individual emirate levels. Federal spending is up by 21 per cent and Dubai's spending is budgeted to rise by 9.2 per cent.
"This is indeed positive for the economy, but we believe there is scope for spending to increase further."
The massive surpluses in previous years are a reason for the scope to raise spending. "Government spending is crucial and deficit is better than surplus at this time," said Maratheftis.
He said the UAE is relatively stronger than many economies and has some insulation' but "we have to use what we have accumulated in the last few years. Policy response is crucial for this region to see an improvement by the second half of 2009".
Budget deficit in the UAE is sustainable.
"It can be seen as a temporary phenomenon here," said Alex Barret, Global Head Of Client Research at Standard Chartered.
Stating that the main problem of pro-cyclicality in the UAE relates to monetary policy, Standard Chartered said the UAE monetary policy is constrained by the US dollar peg, short-term money inflow in 2008 and high market rates.
Throughout 2008, the region received capital inflows as markets anticipated a revaluation of currencies.
However, the inflows were largely speculative and short-term in nature.
"This created a problem as bulk of the short-term deposits ended up being loaned out for longer term, creating a gap between loans and deposits. The deposit ratio of banks which should be 100 went much higher."
According to estimates by Standard Chartered, an additional Dh100 billion of funds by authorities in the form of deposits in banks are needed to bring the advance-to-deposit (A/D) ratio below 100 per cent after which they can start lending. It would also lead to less competition for funds among banks due to which they have been resorting to increasing interest rates on deposits.
"It is not a bailout. An additional injection is needed to fulfil the void created when hot money left."
Permanent repo window
Liquidity injections are critical but are not sufficient, says standard Chartered.
Maratheftis said if oil exports were excluded, the UAE ran a trade deficit of 10 per cent of the GDP
"These are therefore significant leakages from the economy. This highlights the need for a permanent, fully functioning repo window whereby commercial banks can borrow from the Central Bank. This would provide banks with more funding at low cost, which they can use for lending and thereby revive credit growth in the economy."
Maratheftis said protectionism was among the biggest risks economies stood exposed to in the present situation. It could lead to a deeper recession.
As the region sees tightened liquidity and job losses, analysts do not expect consumption to rise.
"Retailers have been reducing prices. It is very tough to see any growth in consumption. We see a contraction." For growth in investments, lower interest rates are needed. Presently, interest rates are very high and risk appetite too has failed due to which investments could record a decline, according to Standard Chartered.
Standard Chartered does not see the UAE facing a risk of crowding out, which means pushing out private investment when government spending increases.
On the contrary, private investment can be expected to jump of government spending is increased.
Pro-cyclicality tends to amplify the business cycle and can lead to an overheating of the economy. Standard Chartered said that tone of the key mistakes in previous recessions was that as the recovery started, there was a tightening of liquidity.
In the UAE, even though the fiscal policy is expansionary and the authorities are working hard to improve liquidity conditions, monetary policy is tight with interest rates for one-year deposit in some cases, exceeding even seven per cent.
The implications of pro-cyclical policy can be more damaging during the downswing o the business cycle when such policy can end up pushing the economy deeper into recession.
The government spending should be focused towards infrastructure and other productivity areas, said Standard Chartered.
Maratheftis said reduced investment towards real estate could actually be a blessing in disguise for the UAE. "Most investible funds went to real estate sector. Now those could go to other more productive areas." This led to a sustainable rally in property prices. The value of announced projects in the UAE was estimated at $1.3 trillion last year and 75 per cent was in real estate.
According to analysts, major chunk of investment should take place in sectors that will improve productivity and have long-term prospects. The correction in real estate segment could actually lead to higher investment in sectors that can create more jobs and improve productivity. "Real estate should not be the main driver of growth. It should be one of the segments that benefits during growth."
If policy measures are implemented without delay, we can expect a recovery soon.
While 2009 would be a tough year, the region can actually see some recovery by the second half of this year itself and hope for a better 2010.