United Arab Emirates
UAE’s Economic Resilience Very High: Dr. Manu Bhaskaran 31 Mar 2011

In an exclusive interview to ECSSR Website Dr. Manu Bhaskaran, Senior Adjunct Research Fellow at the Institute of Policy Studies, Singapore, expressed his views on a number of important issues related to the aftermath of the global financial crisis, China’s excess capacity and currency peg. The interview was conducted on the sidelines of ECSSR’s 16th Annual Conference entitled “Global Strategic Developments: A Futuristic Vision”. Following are excerpts of the interview:

Q: Would you please shed some light on the new paradigm that is likely to evolve following the global financial crisis?

A: We will have a completely new landscape after the global financial crisis. The geopolitical facets that drive the global economy will change. First of all, the US has played a balancing role in many parts of the world, especially in Asia, to keep stability. This role is diminishing. If the US role diminishes, then what I call global public goods (providing stability and allowing economies to prosper) will diminish in value and the world will become a more dangerous place. Secondly, there will be a big shift in terms of ideological inputs in the economic policy with much less confidence in the operation of free market, which means more regulations of finance, more restrictions in capital flows. So, it will probably result in some kind of problems in the international financial sector. Thirdly, we will have a slower global economic growth as the US, Europe and Japan will go into a period of “refreshment” in order to resolve the problems that caused the crisis in the first place. This will take time and during this period, consumer spending will be cut, fiscal spending will be cut, and therefore demand will fall and growth will slow down.

On the other hand, China is moving to a different phase of growth, where the emphasis is not on achieving high GDP growth but on the quality of that growth. They will be targeting a lower rate of growth but a high quality in terms of the impact on the environment, income distribution and the likes. So, slower growth from China, although of high quality, still means slower overall growth for the global economy. The fourth aspect is the changing structure of the global economy. If the US diminishes in the weight of GDP, how important the dollar will be? Then, you have the rise of China, which is the most important thing to happen. Actually, one under-emphasized aspect of the global economy is not the rise of China, it is simultaneous rise of China, India and many other economies, including Brazil and Turkey. This simultaneous rise of many large economies with their hunger for resources and ability to compete in the export market has tremendous implications for the world economy.

Q: Could you elaborate on what you called China’s “excess capacity” and other related problems that would affect its prospects in the world economy?

A: Broadly speaking, China is doing nicely over the longer term. The concern is that the policy response to the September 2008 collapse of Lehman (Brothers) by the Chinese was excessive. They basically mounted a monetary not fiscal response. They unleashed a huge investment boom funded by extraordinary increase in money supply and credit. In 15 months the ratio of loan to GDP in China has increased by 30 points while the ratio of credit to GDP increased by 30 points. That is very big. So, inflation buildup (around 5 percent, which is quite high) and labor cost are rising much faster. If they don’t remove excess money from the system, inflation will become much more serious. So they have a problem now on how to remove monetary excess without causing a shock dropping of growth. In addition, corruption in China is still high. The provincial and local governments can sometimes be very corrupt and impede business operations. You could get illegal acquisition of other people’s land and property.

Q: What are the indicators of the relative decline of the United States’ rank in the global economy?

A: The US economy is not going to grow by more than 2.5 percent on average for the next 5-6 years. In contrast, China and India are growing much faster than the US. Brazil, Turkey and Saudi Arabia are also growing faster than the US. In general, most of the rest of the world, except Europe and Japan, will grow faster than the US. The weight of the US GDP is declining as well. The US dollar’s role as a unit of exchange and value will decline. At the macro level, in terms fiscal policy, public debt/GDP ratio, monetary policy and political system, the US is in trouble but at the micro-level it is not. There is no system I can see innovative and entrepreneurial and capable of building wealth as the US. In the last 10 years the US has not been doing well but China has been. But who created Google, iphone, apple, iPod...etc. It is the US. There is something about the US that allows extraordinary innovation and entrepreneurial energy. We should not underestimate the US, which will continue to be the preeminent generator of wealth, knowledge and creativity.

Q: What do you think of the economic resilience of the UAE?

A: Fiscal and monetary policies in this country are conducted with extreme caution. They are the UAE’s sources of strength. I think also the UAE central bank did an excellent job in maintaining financial robustness. The UAE had a problem in Dubai. But the speed with which this problem was tackled showed the underlying strength of the UAE system and its economic resilience. However, main problem for the UAE is export diversity and the overwhelming dependence on oil exports. What is encouraging is that the UAE policymakers are  trying very hard to use the opportunity presented by rising demand for oil and rising prices of oil to start building a much more diverse and resilient export base. The UAE has been investing in the financial sector, tourism and green technology (Masdar City), which is a very bold and visionary thing to do. The UAE seems to be on the right track. The idea of resilience is how you bounce back and the UAE has got the basics of that. So if it continues to diversify it would be a very strong economy.

To sum up, the economic resilience of the UAE is very high. The ultimate test of resilience is when you have a shock and test the system response. The UAE economy has tackled the global financial crisis and Dubai crisis. Banking system in this country is robust and absorbs the shock. Resilience is a balance between shock amplifiers and shock absorbers. You have to reduce shock amplifiers and build shock absorbers. Shock amplifiers are mainly political. You have to build good political system that does not amplify when it is hit by a shock. You have to have a robust financial sector to absorb the shock.  I think the UAE has managed to do just that.

Q: Should the UAE keep its currency pegged to the US dollar?

A: For relatively small open economies, like the UAE and Singapore, the exchange rate is the single most important price in the economy. So, if you want to have a monetary anchor, it has to be related to the exchange rate, which has to be pegged in some form. The question is what is the optimal form? Hong Kong, for example, has chosen currency peg. It works because Hong Kong economy is very flexible and its structure is very resilient. So in a very flexible economy with strong shock absorbers and very mature financial system, rigid currency peg can work. In Singapore, we have chosen not to peg to a single currency, but to a basket. It is not fixed but a crawling peg. The crawling peg will be determined by whether there is an inflation problem or not. Currently, we are on an appreciating trend because we have an inflation problem in Singapore. Otherwise, we will keep it at a relatively stable peg to the basket. I do feel for small open economies like the UAE, some kind of peg is necessary. But it doesn’t have to be pegged to the US dollar. It can be pegged to a basket, the EURO, the Yen or even to the SDR. Floating exchange rate will be too risky in this point of time.

Q: What do you think of the trading of oil in US dollar?

A: I think it is inevitable for the US dollar dominance, as the international reserve currency, to diminish. In oil trade, the dollar acts as a unit of account. There is no reason in my mind why the unit of account for oil has to be the US dollar. In some other commodities such as rubber, the Malaysian ringgit and Singapore dollar are the units of account. There is no reason why it has to be the dollar. It is just historical. But whatever you do it has to be agreed upon by other major oil producers and the OPEC. Of course, it will be easier to trade oil in one currency rather than many currencies.

The content herein does not necessarily reflect the opinion of the ECSSR