Monetary Policy in the UAE

Monetary Policy in the UAE

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Table of Contents

TOC o “1-3” h z u HYPERLINK l “_Toc413348612” Introduction PAGEREF _Toc413348612 h 3

HYPERLINK l “_Toc413348613” Monetary Policies in the UAE PAGEREF _Toc413348613 h 3

HYPERLINK l “_Toc413348614” Discussion PAGEREF _Toc413348614 h 4

HYPERLINK l “_Toc413348615” Implications PAGEREF _Toc413348615 h 4

HYPERLINK l “_Toc413348616” Economic growth PAGEREF _Toc413348616 h 4

HYPERLINK l “_Toc413348617” Low unemployment PAGEREF _Toc413348617 h 5

HYPERLINK l “_Toc413348618” Stable prices PAGEREF _Toc413348618 h 5

HYPERLINK l “_Toc413348619” Conclusion PAGEREF _Toc413348619 h 5

HYPERLINK l “_Toc413348620” Reference PAGEREF _Toc413348620 h 6

Introduction

The Government of the UAE employs an active expansionary monetary policy that is dedicated to growing the economy and producing the desired economic goals of stable prices, low unemployment and high and sustained economic growth as evidence by the article provided “Dubai plots return to credit markets”. Dubai is planning to sell more bonds in order to finance a more diverse economic strategy. With more money “in hand”, Dubai will move forward with plans to increase real GDP by increasing government spending on things such as infrastructure and investments in the aviation market. This is a strategy that is in lock-step with government’s fiscal policy in order to achieve the three economic goals. While the goal remains the same, the implications are more severe and potentially more disastrous. As with fiscal policy, we gain a better understanding of how this may or may not affect the three economic goals by dichotomizing the subject into Hands-on (active) monetary policy, or Hands-off(free market) monetary policy. Again, it is understood that the Hands-off monetary policy in essence means little or no government intervention which is ultimately a contradiction of monetary policy (Ellaboudy, 2010).

Monetary Policies in the UAEThe UAE owes much of its success in banking to enforcing tight monetary policies while maintaining an open and free economic zone. Espinoza & Prasad (2012) states that the UAE dirham -US dollar linkage simply shows that crude oil is sold in US dollars and that domestic interest rates will also move in tune with the US interest rates.

As an open and free economic system, the government kept to a minimum its directives on how private sectors conduct their businesses. No direct taxes are imposed on profits earned by the corporation as well as on personal income. This rule, however, does not apply to foreign banks and oil companies. In addition to the fact that trade barriers and exchange controls does not exist, capital and profits earned by foreign business can also be moved from UAE to the home base without fees. Moreover, customs duties are not only low but also has a lot of exemptions and tolerant visa policies permits easy hiring of skilled migratory workers (www.dubai.ae).

Sultan Bin Nasser Al-Suwaidi, Governor of CBU, expressed his fears in his speech during the 18th World Conference of Banking Institutes (2009) that the crisis of finance around the globe may slightly “reduce the prospects for the UAE economic growth” but to help lessen its impacts, he offers the following steps to be taken (Hebous, 2006). The UAE monetary policy will continue its direction on maintaining low official interest rates;

A “reasonable but low rate of credit expansion and restricted banking expansion will be enforced by the credit and banking policies of the UAE CBU; Comprehensive assessment of UAE banking practices is generally conducted by the International Monetary Fund (IMF) missions using available data provided by the country itself and self-assessment documentations. The IMF 2003 Report on the Observance of Standards and Codes (ROSC) as cited by e- Kamar & Ben Naceur (2007) reveals that while CBU “observes most good transparency practices regarding monetary policy,” it also has its weaknesses. For instance, there has never been a public disclosure of the process of determining the amount as well as amount of annual net profits. At present, this policy hasn’t been changed. As a whole, the ROSC recommended for the CBU to reinforce their reporting methods, especially with regards to the banking decisions and operations.

DiscussionThe UAE has been reported to be among the countries with some of the best banking practices in the world. This reputation is largely due to the monetary system employed by the United Arab Emirates. In a growing economy like the UAE, monetary policies have the power to control its economy and have the government provide for the money that it needs. However, the recent 2008 global crisis show a dwindling of this confidence and loopholes in the monetary policy of the country were noted (Kamar & Ben Naceur, 2007). The blog further opined that total monetary policy control had never been previously an issue due to an incorrect assumption that the “economy will always grow and the market will not fluctuate.” The UAE then realized that it should have had total monetary policy control, specifically in controlling the interest rates, to deflect some of the negative effects of the inflation. Among the reasons for which is the AED dirham-US dollar linkage.

Monetary policies are used to control economic factors as unemployment, inflation, international trade, productivity, and investments. Even if the UAE have some abilities in its expansion policies due to the country’s oil reserves, the UAE doesn’t have a contractionary monetary policy which uses an increase in interest and tax rates (Hebous, 2006). Although, the country may well be able to control other factors, if and when the UAE economy will mature and it still does not have total control over its contractionary monetary policy, one of its predicted results will be that the circulation of money will get out of hand.

Hebous (2006) concludes that monetary policies should give total authority on money supply, expansion, and contraction policies for the economy to become truly stable. On the other hand, Espinoza & Prasad (2012) believes that the UAE will not be affected too much by the “deflationary trap” experienced by other countries. Since the UAE pegs its dirham to the US dollar, it lacks a contractionary monetary policy; hence, the CBU cannot control inflation rates and inflation rates, in turn, tend to be erratic.

Among its effects would us that “investment decisions on the aggregate level are made according to the real rate of interest” (Ellaboudy, 2010). When the dynamics in investments become unstable, this dirham-dollar linkage would have its advantages in the long run because it ensures minimal monetary disturbances. Ellaboudy (2010) further purports that this set-up is especially beneficial for an emerging economy like the UAE.

Implications

Economic growth Buy selling bonds the UAE is stating implicitly that it believes that by acquiring the cash and issuing the bond to the purchaser at a certain interest rate, it can turn around and invest the cash into the channels it sees fit, whether this be infrastructure or aviation, and then payback the debt when the investment turns profitable. The plan faces many contingencies and hinders on the ability of the UAE to take full advantage by putting the cash to work in the most efficient way possible, and if history is any indicator Dubai’s track record of risky bets is not a sure thing. Be that as it may, the results will undoubtedly be higher of GDP due to active Hands-on monetary policy.  A Hands-off monetary policy would, in essence, require that no debt be issued, rather sufficient cash to invest would have to be literally “in hand” before forward motion could begin on any project, regardless of how profitable the investment is deemed to be. This antiquated notion of “looking before you leap” seems to be falling further behind the times with every bond issued.

Low unemploymentIn a Hands-off market economy, implementing monetary policy to achieve particular results, for example changing the money supply by selling more government issued bonds to achieve higher output of GDP, is considered bad money management and contrary to the idea of Hands-off economics. To simplify the perspective lets imagine the UAE is a small household family. Would it be sound policy for a house that is extended beyond their means to engage in more borrowing in order to achieve a higher standard of living? Even if the goal is thought to be an increase of the households overall income, the risk of “mortgaging your future” could have unintended consequences that are far reaching and generational.  The UAE could never be confused with a small household, with vast future wealth coming from a seeming less endless supply of oil. By using the Hands-on theory, Dubai will sell government issued bonds and use the cash to build roads and airports, putting its citizens to work immediately, effectively keeping unemployment low and GDP high (Ellaboudy, 2010).

Stable pricesHere, it seems, is where “the wheels fall off the wagon” when it comes to Hands-on monetary policy. To put in less contrived words, increasing the supply of money has been proven to increase overall prices and not just in the short term. It is foolish to think that monetary policy is the lone contributor to inflation, many factors must be weighed, but none seemingly have the same direct impact as monetary policy. The short-term gains are indeed popular for Hands-on monetary policy and the results are hard to argue with, but at what cost? (Espinoza & Prasad, 2012)

ConclusionThe UAE had and has been proving to be successful in its implementation of monetary policy. The heads of each state within the UAE are seemingly aligned in their lazier-like focus of achieving the three economic goals and allowing the citizens to continue their high standard of living that is on par with many western European nations. The question remains of sustainability and willingness to adapt to an ever increasing globalized economy.

ReferenceEllaboudy, S. (2010). The global financial crisis: economic impact on gcc countries and policy implications. International Research Journal of Finance and Economics, 41, 180-193.

Espinoza, R. A., & Prasad, A. (2012). Monetary policy transmission in the GCC countries.

Hebous, S. (2006). On the monetary union of the Gulf states (No. 431). Kiel advanced studies working papers.

Kamar, B., & Ben Naceur, S. (2007). GCC monetary union and the degree of macroeconomic policy coordination. IMF Working Papers, 1-33.