‘Problem of plenty’

DUBAI — For most countries managing their economies is a struggle to optimally allocate the scarce resources among various competing needs. In the UAE, the reverse is the case with abundant resources chasing limited investment options.

By Babu Das Augustine

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Published: Fri 19 Aug 2005, 12:26 PM

Last updated: Thu 2 Apr 2015, 4:15 PM

In the context of growing inflow of money into UAE from oil revenue and foreign investments many economists and bankers feel that UAE Central Bank should seek aggressive monetary policy measures to neutralise the excess liquidity in the economy.

Rising oil prices, inflow of repatriated regional investments from abroad, and a strong flow of regional investments into real estate and the stock market have created a strange economic situation in the UAE in the form of ‘problem of plenty’.

According to the Central Bank Annual Report for 2004, the domestic liquidity has expanded substantially by Dh15.39 billion (11.3 per cent), in addition to the expansionary impact of net domestic credit of Dh41.26 billion (27.1 per cent).

The escalating liquidity has brought in its share of economic woes, primarily in the form of inflation. To put it simply, the large quantities of money inflow into the country from oil revenue and foreign investments have driven up the cost of goods and services.

Last week, the UAE Central Bank revealed its plans to issue longer term Certificates of Deposit (CDs) with maturities of up to five years to neutralise the inflationary pressures from liquidity-fed economic boom. Many economists say, currently, the UAE has limited monetary policy options to curtail the impact of excess liquidity. “The interest rate adjustments usually followed across the world as a monetary policy tool to suck out the excess liquidity in the financial system is absent in the UAE as the base rates here follow the US interest rates because of the currency peg,” said the treasury head of a foreign bank.

The huge liquidity is driving the economic boom primarily led by the real estate and the service sectors. The impact of excess liquidity has been evident in the local stock market, which has been trading at astronomical market P/E of 40 times prior the mid-July correction, compared to the leading emerging market average of 13 times earnings.

Although the Central Bank estimates place the current inflation rate at 4.7 per cent, a recent IMF forecast has said that the UAE consumer prices will rise more than 6 per cent in 2005. Independent studies estimate the inflation to be well above 8 per cent. Under most inflation targeting monetary policies, open market operations are used to achieve and maintain a target interest rate. This target interest rate is periodically reviewed. Under such a scheme inflation is typically defined and measured using a consumer price index.

Under the existing monetary policy options in the country, inflation targeting is almost missing. “In the context of large sums of money flowing into the country in search of higher return, the central bank should turn to more effective measures to curb liquidity and its impact on inflation,” said an economist.

The UAE Central Bank seem to be less inclined to use aggressive measures for the fear of hurting the local stock market and the pro-investment environment. Although the bank had been considering an increase in the reserve requirements on demand deposits held by commercial banks, the Central Bank Governor has been quoted as saying that such a measure is not required now due to the recent stock market correction.

Bankers and economists believe that the decision to sell CDs in the open market will have negligible impact on the excess liquidity situation. “As the size of the liquidity available in the economy is enormous, and banks have enough avenues to lend at higher rates than the rates offered on CDs, it will have virtually no impact on domestic liquidity. If the apex bank is looking seriously at curbing liquidity, stronger monetary policy measures including higher mandatory cash reserve requirements and possibly the introduction of a statutory liquidity ratio on time and demand deposits will help," said a senior banker.

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