In its latest GCC brief, NBK reports that, they may not always be published promptly, but recent releases of official monetary statistics by the Central Bank of the UAE (CBUAE) help to provide fresh details about the state of the country’s battered financial system. The broad thrust of the latest data suggest that – although helped by a combination of emergency policy measures, rising equity prices and improved confidence of late – the monetary system remains in a fairly fragile state, with few signs that banks are set to resume lending in a way that would help generate a decent rebound in economic growth.
Deposit growth subdued
Growth in key measures of the money supply has decelerated sharply over the past year or so, a reflection of weaker economic activity and the withdrawal of foreign funds from the local market. As chart 1 shows, annual growth in the broad M2 measure of the money supply fell to 6% in June, the lowest since recent records began. Admittedly, it has now risen for three straight months in a row in month-on-month terms, which suggests that the rate of decline could be easing. But month-to-month changes in the data can be bumpy, and the figures are not adjusted for seasonal trends.
Chart 1: UAE money supply
(% y/y)
Source:ThomsonReuters Ecowin
Moreover, the narrower measure, M1 has fallen for three of the past four months and is declining at an annual rate of 11%. Because it is a more liquid measure, M1 is often more volatile than its broader counterpart and could be exaggerating the degree of slowdown in economic activity. And even here, the month-on-month declines have been less vicious than in 2H 2008 – again, hinting at a degree of stabilization. But nevertheless, the sharp change of gear in the liquidity environment has been a huge shock to the financial system. Some slowdown in money growth was desirable after the heady increases of 2007 and 2008: easy money no doubt helped fuel speculative lending to the property sector, excessive risk-taking and inflated the value of financial assets. But these types of numbers look consistent with falling output – not the type of slowdown that the authorities had in mind.
Lending grinds to a halt
Clearly, the weak economy has been both a cause and a consequence of the change in the financial environment. But it is also striking that such weak monetary growth has come about despite the much-vaunted increases in government expenditure outlined in the budgets of the Federal and Dubai governments for this year – 21% and 11% respectively. In resource-based economies, changes in fiscal policy can be as crucial in determining liquidity conditions as changes in monetary policy.
Various factors may be at work. One is that the fiscal boost may not yet have fully worked its way through the system – we are only half way through the year, after all. Another is that much of the extra money has leaked out of the country via imports and/or capital repatriation. But the most important factor could be that money is not circulating through the system properly, with hesitant banks looking to hoard money and preserve capital rather than extend or renew credit to customers. As a result, the boost provided by rising government expenditure – while certainly helpful – is much less powerful as an economic stimulus than it would have been a couple of years ago, when banks were in expansion mode.
The data support this view. Between end-2003 and end-2008, bank credit growth to the private sector averaged a massive 35% per year. Since then, however, loan growth has been more or less stagnant, rising by just 1.5% in the first six months of 2009. (See chart 2.) And this is not just a result of newly-found bank conservatism. The aggregate loan-to-deposit ratio remains above the mandated 100% level, providing a further impetus for de-leveraging. In January, the gap between bank loans and deposits stood at AED 90 billion (US$25 billion) – an LDR of 110%. It has since fallen back, but continued reductions could be tough or painful if deposit growth remains weak or negative.
Chart 2: Loans by UAE banks
Source: ThomsonReuters Ecowin / NBK
Central bank’s balance sheet highlights policy shift
The data also reveal significant changes in the size and structure of the CBUAE’s balance sheet. Over the past few years, the CBUAE’s total assets have increased sharply commensurate with the accumulation of foreign currency generated by the UAE’s huge oil revenues, as well as speculative inflows. Between 2003 and 2007, the CBUAE’s assets rose by 51% per year. Traditionally, almost all of these assets have been stored in foreign government securities or deposit accounts abroad. These were low risk, but earned the bank some AED 3.8bn in 2007. Most of the subsequent profits were transferred to the government or kept on permanent deposit at the CB.
This pattern all changed in 2008 when, as the financial crisis hit, the CB began to focus more on shoring-up liquidity in the domestic banking system. As chart 3 shows, between end-2007 and end-2008, the CBUAE’s overall balance sheet shrunk by around one-third to AED194bn (US$53bn), reversing much of the expansion seen in 2007. To a large extent, this fall was the counterpart to the withdrawal of funds by foreigners who had invested in the UAE. But there was also a major change in the composition of the CB’s assets. Foreign currency deposits and holdings of foreign securities fell sharply – by 55% and 70% respectively – and were partially replaced by purchases of domestic assets, notably debt originally issued by the Ministry of Finance. This was presumably a means of providing funds to local financial institutions.
The large rise in the ‘other’ category in chart 3 is also a reflection of efforts to support domestic liquidity; it is largely comprised of CBUAE loans to local banks secured against certificates of deposit.
Chart 3: CBUAE’s balance sheet (assets)
(AED billion, end year)
Source: ThomsonReuters Ecowin / NBK
N.B. ‘Other’ category largely comprises loans to banks against certificates of deposit
Significant though these shifts have been, it is important to note that they do not equate to changes in the UAE’s ‘income’. Nor do they reflect any change in overall strategy regarding the country’s huge total stock of foreign assets, the bulk of which are managed not by the CBUAE but by the Abu Dhabi Investment Authority (ADIA). Rather, they reflect the immediate liquidity needs of the local banking system and the relative merits of deploying those funds at home and/or abroad.
The balance sheet data also reveals that take-up of CBUAE loans to local banks under the AED 50bn Liquidity Support Facility (LSF) has been extremely muted, at just AED 4.5bn by end-2008. The facility was launched in September 2008 in order to provide banks with a new window through which they could access central bank funds. On one level, the lack of interest in the scheme sounds encouraging. But rather than a sign of reassurance, it is more likely to reflect the somewhat unfavorable terms attached to the loans (banks had to pay 150bps over the repo rate up to the value of their reserves, and more for larger amounts), the risk associated with borrowing against bank reserves, or an unwillingness to be associated with distress borrowing. The overall data suggest that banking sector activity remains constrained. Until there are more concrete signs of improvement, the authorities will want to ensure that policy remains extremely supportive of prospects for economic recovery. □
