Countries with real estate exposure most at risk

The threat of US recession and wayward inflation felt worldwide has put the global economy in a fix. Central bankers, both from the developed countries and the emerging markets are spending time in the "war room" drawing up strategic approaches to tackle the potentially catastrophic outcome.

In the latest survey released by BNP Paribas, it said the spillover effects of US recession "will only partly develop via trade", arguing that "rising funding costs and banks restricting funding is the real issue". Yet currencies of countries with high foreign funding needs and real estate exposure are most at risk, it warned. Under the present scenario, currency reserves growth would slow.

BNP Paribas' claim was anchored on the belief that the US currency will rally once the spillover effects become visible, forcing the G10 central bankers to adjust monetary strategy.

The major concern of policy-makers is on the impact of emerging market trends, saying that the undervalued and fixed foreign exchanged rates, combined with competitive production costs, allowed Asia to grow rapidly.

BNP Paribas said the current financial sector crisis has been caused by "glut of Asian savings, combined with greed".

It said that under the present banking policies, local credit all the more increases money supply, sending the bank's balance sheet to implode, while reducing the assets' value. Hence, the study suggested that emerging markets should tighten monetary policies and countries in deficit should maintain their currency levels. However, the surplus countries should continuously fight inflation, it added.

For example, in the Gulf Co-operation Council member states, the International Monetary Fund was critical of the group's handling of inflation weights, describing it as "outdated and inherently skewed".

"Expatriates enjoy different benefits than locals" and outnumber them, "but have different spending patterns and their housing cost tends to be underestimated by current measures". Besides, in the region as a whole, services like education are very expensive in private schools, but free for public schools.

BNP Paribas moreover pointed out that fiscal surplus does not necessarily entail tighter policy.

Supporting its contention, BNP Paribas cited a number of studies showing that fiscal surplus correlates positively with money growth through the increase in net foreign asset. Expenditures are key to understand the dynamics of fiscal policy, the study said, adding that "fiscal policy can help remove bottlenecks… if used appropriately", for example, by increasing housing.

In the region, UAE has the largest net foreign assets, followed by Saudi Arabia, Kuwait, Qatar, Bahrain and Oman at $600bn (Dh2,202bn), $450bn, $400bn, $70bn, $20bn and $10bn, respectively.

BNP Paribas further said that since the region's currencies are pegged to the dollar – with the exemption of Kuwait which severed its ties over record high inflation in the country – local monetary authorities are forced to import US monetary policy, and whatever the US Federal Reserve Board undertakes.

It added the currency peg regime is effective in a stable synchronised economy "but in the case of large surplus economies, it contributes to create global liquidity through the surge in foreign currency reserves".

However, under the present developments diverging trends between the US and other pegged economies put to test the rationale for the peg, forcing policy-makers to make hard choices as to whether to keep the ties and accept inflation, de-peg to restore control over monetary policy, or abandon capital account openness but then risk isolation, BNP Paribas said. The report also noted that money supply has been growing rapidly since 2004 and has forecast an acceleration.

The report forecast that, considering the still weak US economy, the US currency would remains bearish despite the softening of the huge current account deficit and the global de-leveraging suggests that the greenback's weakness would be directed to where its is required to correct global imbalances.

The euro, on the other hand, is forecast to be under pressure in the second half of this year and in 2009.

With increasing signs that "the global slowdown is now spreading in Europe as weak economic data suggest – the Spanish housing market slide, the German retail sales collapse, the drop in French consumer confidence – the European Central Bank was seen to relax its firm hold on interest rates.

"A change in ECB tone is expected in the fourth quarter as inflation peaks," BNP Paribas study said.

With the expected divergence seen in the eurozone inflation data, the report said that ECB's task of "applying a one-size-fits-all monetary policy is becoming increasingly difficult, and potentially negative for the euro over the medium term".

Moreover, the British economic outlook is not even promising as its house price data turned negative early this year. With consumer sentiment already under pressure, the Bank of England might succumb by cutting rates earlier than expected.

Overall, the report painted a continuation of the credit market tension as demand in emerging markets continues to accelerate.