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Wider diversification of economy is a must

Speaking to Khaleej Times in Dubai yesterday Dr Gerard Lyons, Chief Economist and Group Head of Global Research, Standard Chartered Bank said, “The big surge in asset prices in the UAE and the Gulf region reflects the impact of huge liquidity on the limited investment avenues. With the oil prices set to remain high in the foreseeable future, the country has a big opportunity to diversify its economy and limit the adverse impact of excess liquidity.”

Commenting on the growing recent strategic investments made by the UAE-based companies abroad Lyons said, it is a wise move to invest in high yielding foreign assets when the surplus permits.

“We are witnessing the recycling of some of the liquidity that is available in the region through these acquisitions. Of course, these acquisitions will also give rise to demand for a level playing field in the form of demand for further opening up the local economy for foreign investments.”

Lyons said liquidity is expected to remain high throughout the region in 2006, however he expressed concern over the ballooning asset prices. The UAE stock markets have gone through a round of correction recently and real estate sector is also expected witness some kind of price rationalisation in the near future.

“The key challenge for the government and the sector is to achieve a soft landing of the market,” said Steve Brice, Regional Head of Research MEPA& South Asia.

“The good news is that the demand fundamentals are likely to remain positive with good population growth, high rental yields and a new real estate law expected to be announced soon. Indeed, according to our new real estate index property prices rose 3.7 per cent in January contrary to many reports that market has already softened,” Brice said.

However, he said the market will have to face the reality of sharp increase in supply in the coming 2-5 five years in the form of a price slump. “If the demand supply imbalance is to result in a sharp decline in prices the government and developers are expected to intervene in the market to make it less severe.”

In the event of a market correction, the impact of decline in property price on the economy is expected to be muted. “There is huge fiscal surplus and government has the option to invest in infrastructure and economic diversification to minimise the overall impact.”

In the context of a weaker outlook for dollar in 2006 and beyond, Brice said both UAE and the Gulf States need currency reforms to mitigate the impact of declining dollar and surging liquidity on these economies. “With pegged currencies, Central Banks in the region have only limited monetary policy tools to contain the impact of growing liquidity. A key issue for the future is the need to embrace currency reforms in order to gain control over monetary policy and reduce the highly volatile economic cycles.”

According to Standard Chartered’s economic outlook for 2006, dollar which has a direct impact on various economic variables of UAE such as inflation and purchasing power is expected to move along its natural decline path. As the US current account deficit is difficult to be funded over a long period, the possible scenarios are a significant fall in US domestic demand or a sustained fall in dollar. Thus in the short run decline of dollar is inevitable, which could result in relative devaluation of dirham and an increase in imported inflation.