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It is interesting to compare and contrast the approach of the UAE Central Bank to the global economic crisis with that of the Federal Reserve and Bank of England.

Local bank interest rates have been allowed to rise in the UAE because the real estate boom had gotten out of control and caused excessive borrowing from the banks which are now suffering a liquidity squeeze. However, banks have been allowed generous special drawing rights and their capital ratios are secure.

Measured response

This appears a more measured approach than in the US or UK. Immediately reflating a construction boom would stop the necessary adjustment process that will result in lower rents and lower house prices, and make further construction uneconomic thus eliminating the over-supply of property.

Lower rents will attract service sector business to the UAE as it will become economic to locate new businesses here, both from the point of view of the cost of residential and commercial accommodation which are crucial for success in the service sector.

In short, the UAE will recoup the competitive advantage that it has been in danger of losing in the recent boom. The supply of cheaper property will then gradually be filled up until more is eventually required, and then rents will start to rise encouraging more construction.

For the UAE Central Bank the necessity to take emergency, some might say reckless and foolhardy, policy decisions is just not there. It needs to ensure adequate liquidity to the banking system but does not have a mandate to try to eliminate the local business cycle by pumping cash into the economy.

Fittest survive

It is surely good, after a lively economic boom, to have a shake-out so that the best firms survive and thrive, and not to support weaker companies whatever the economic forces against them. That is how the US has ended up with companies like General Motors (NYSE:GM) and Chrysler.

Of course, taken to excess this is a formula for violent booms and busts but the UAE Central Bank will know when to stop. For example, the creation of a new federal home loan institution is proceeding apace and will doubtless help the real estate sector avoid an unnecessarily deep recession.

All the same badly run companies with excessive debt levels have to be allowed to fail in order for the fittest to survive. These are the companies that will deliver future economic growth through higher levels of productivity and not by holding out a hand for government cash.

The UAE also has less to worry about in the global economic slump as it can rely on the stimulus packages of other countries to raise the oil price and inject cash back into its coffers. That is another good reason for the UAE not to get carried away with market intervention.

Source: UAE Keeps Market Intervention Down, Trusts Economic Forces