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Fix GCC macro policy: IMF

Change would limit systemic danger as dependence on oil, real estate is risky

The International Monetary Fund, or IMF, warned that the GCC’s reliance on volatile oil revenues and the growing importance of real-estate sector are sources of risks, and said refining macro-prudential policy was key to better manage financial cycles.

The Washington-based fund said the experience of the boom and bust in 2008-09 demonstrates the vulnerability of the GCC member countries to credit and asset price cycles.

A construction site in Doha. The IMF estimated total public external assets in the GCC at nearly $2 trillion, which could be used to make up for any shortfall in oil revenue. — Reuters

“Heavy reliance on volatile oil revenues, the importance of real estate as a major asset class for investment, and the shortcomings in crisis resolution frameworks all underline the importance of having a deep macro-prudential policy in the toolkit in the member countries of the GCC to limit systemic risk in the financial system,” the IMF said.

While higher oil revenues increased liquidity in the banking sector, the hike in government spending and bank lending boosted activity in the non-oil sectors of the economy, particularly construction in some countries, the Fund pointed out.

Credit and asset prices rose, moving closely with the oil price cycle, it observed.

“The credit and asset price boom came to an abrupt end as the global financial crisis hit the member countries of the GCC in late 2008. Real estate prices fell significantly, lending cost increased, and external funding conditions tightened,” it noted.

The IMF pointed out that the experience of Gulf countries during the crisis brought home the importance of expanding central banks’ traditional mandate to include financial stability as a key objective.

An IMF team, comprising Ananthakrishnan Prasad, Zsofia Arvai, and Kentaro Katayama, looked at the role of macro-prudential policies in the GCC and recommended a framework for more sound implementation of the macro-prudential policies — a set of tools that financial authorities and regulators use to preserve stability in the financial system and reduce the frequency and severity of financial crises.

The IMF team pointed out that a general goal of macro-prudential policy is to limit the risk of system wide distress that has significant macroeconomic costs to the economy. “The other major objective is to strengthen the resilience of the financial system to unfavourable developments.”

The IMF noted that GCC countries were ahead of many countries in implementing some macro-prudential measures.

“However, there is still scope for refining the existing macro-prudential institutional and policy framework to better manage financial cycles.”

In a recent forecast, the IMF had predicted GCC economic growth to be 4.4 per cent in 2014 as oil production rises and the non-oil sector benefits from the large infrastructure projects being implemented. However, because of the volatility inherent in oil prices, the IMF expects downside pressures during 2014, as well as longer-term structural challenges.

The IMF had noted that most GCC countries have accumulated large official external assets and would be able to comfortably weather temporary declines in oil income. Total public external assets in the GCC are estimated at nearly $2 trillion, which could be used to make up for any shortfall in oil revenue.

In the latest survey, the IMF team felt that further steps could be taken to build appropriate buffers and to limit credit booms in good times.

Such steps would include the strengthening of the institutional arrangements.

“Macro-prudential policies have been implemented by the [GCC] central banks without a formal framework or adequate legal backing. A more formal and transparent macro-prudential institutional and policy framework would help ensure that responsibilities and coordination among regulators and other relevant parties are well-established.”

THE IMF recommended that GCC central banks be given the formal mandate to ensure financial stability, “since they can bring the expertise and incentives to the task of mitigating systemic risks”.

The second step, according to the IMF team, is to develop effective early-warning systems further and conducting regular systemic assessments such as macro stress testing.

The IMF urged the GCC to refine the existing macro-prudential toolkit by building and maintaining sizeable capital buffers in the banking sector and by introducing time varying loan-to-deposit and loan-to-value ratios to help alleviate booms in credit and asset markets during good times.

It also proposed using sectoral exposure limits, particularly for real estate and personal loans, to limit the build-up of excessive exposure to targeted sectors or borrowers.

The fourth step, according to the IMF team, is to implement structural measures to support macro-prudential policy by developing domestic interbank money and debt markets to support liquidity management. Also required is modernising of insolvency regimes and strengthening crisis management and resolution systems, it said.

— issacjohn@khaleejtimes.com