International Finance and Banking: The UAE Case Study

Interpreting Financial and Economic Stability in the UAE in the Context of Globalization

Introduction

The term globalization is defined as the internationalization of markets and production activities. In relation to financial markets, it refers to the flow of financial instruments across international borders (Cetina, 2012). Financial flows across the globe have intensified over the recent past. Financial institutions, such as banks and institutional investors, are the greatest players in the globalization of financial markets. Majority of them have penetrated foreign markets in attempts to increase their customer base (Fung, 2013). They act as intermediaries between borrowers and lenders. They use their vast infrastructure to facilitate the transfer of funds between the parties involved. Through globalization of financial markets, anyone can be a lender or a borrower. The availability of a large number of lenders has allowed borrowers to shop for cheaper loans. Consequently, globalization has forced lenders to offer loans at competitive rates. Today, governments across the world can borrow to finance development projects. The result is increased capital flow.

Financial Markets, Banking, and Globalization

Globalization of financial markets is associated with an increased flow of capital. Capital is mainly in the form of bonds and loans (Buch & Delong, 2012). Bonds are often described as instruments of indebtedness. The party that issues them owes the holder. Interest rates are charged based on the agreed terms (Buch & Delong, 2012). Payment of the debt is done upon maturation of the transaction. A business wishing to borrow capital to finance its operations can float a bond that can be taken up by both local and foreign entities. In addition, bonds are highly liquid owing to globalization of financial markets. Their ownership can be transferred from one party to another in the secondary market. Consequently, they are acknowledged as a form of loan where the holder is the creditor. A loan is similar to a bond in that it is a debt offered at an interest rate (Fung, 2013). A date of payment is agreed upon by the borrower and the lender. Due to increased globalization of financial markets, it is becoming easy to borrow capital. Firms can also borrow in foreign currency to finance their operations overseas.

As a result of globalization of financial markets, the volume of business has grown. The reason is that the development has made it easy for entities across the globe to invest (Cetina, 2012). There are a number of ways through which this is made possible. To begin with, globalization has led to an increase in foreign direct investment. A business in one country can own and operate an enterprise in a foreign land owing to the ease of flow of financial instruments across international borders. Buying shares in foreign companies is also made possible through the globalization of financial markets. Once a business floats its shares, willing buyers can purchase them regardless of their geographical locations (Buch & Delong, 2012). Trading with foreign firms has also been made easy. Payments for goods and services from another country can be made within a relatively short duration thanks to globalization.

The banking sector has been instrumental in the development of the global financial markets. The reason is that banks act as intermediaries. They are a vital link between the source of capital and its intended recipients. Today, most banks have expanded the scope of their operations to cater for the needs of customers outside the country of their origin (Buch & Delong, 2012). Globalization of financial markets and banking has increased competition between financial institutions (Cetina, 2012). Consequently, banks have been forced to come up with complex and innovative products to attract more customers. Such services are often in the form of secure money transfers across international borders at low costs. Today, banks also offer loans to foreign firms at competitive terms and interest rates.

The emergence of a global financial market and banking is attributed to a number of factors. For example, advances in information and computer technologies have contributed to the rising trend. The main reason is that the move has eased data processing and storage in matters pertaining to global financial markets and banking systems (Fung, 2013). Regulators can also monitor financial risks (Bucur, 2012). The speed at which data is processed determines the rate of flow of financial instruments from one country to another. The emergence of international financial markets and banking is a result of globalization of national economies. Different economic activities, such as production, marketing, and consumption, are done in different economies (Fung, 2013). For instance, a machine developed in Japan can be imported to another country to produce goods for export. Big firms have also built processing plants in countries where raw products are sourced from. A proportion of such goods are exported to other economies. Such activities have led to the emergence of multinational companies.

There are a number of major stakeholders in global financial markets and banking. They include governments, banks, investors, and international regulatory agencies (Bucur, 2012). They work together to ensure there is a constant flow of capital to facilitate trading and production. As a result of the high risks associated with international financial markets and banking systems, a number of regulatory bodies have been formed both locally and internationally (Cetina, 2012). The establishment of central banks is one of the interventions put in place to monitor the flow of financial instruments. Different countries have also come together to sign multilateral agreements to regulate the transfer of capital. At the global level, the International Monetary Fund (IMF) regulates financial markets and banking. With the introduction of such institutions, countries are able to remain financially stable amidst market fluctuations.

Understanding Economic Globalization and Financial Stability in the UAE

Different governments have adopted varying strategies to deal with market sensitivities. Some have resorted to the abolishment of all unconventional financial policies within their jurisdiction. Other nations, such as the United Arab Emirates (UAE), continue to formulate strategies aimed at expanding the scope of their financial policies (Grira, 2014). However, regulators in the market face the difficult task of formulating sustainable policies. To ensure financial stability within the UAE, sound macroeconomic policies have been implemented (Alshaali, 2015). Consequently, the nation’s markets have remained strong amidst various instances of global turmoil. As such, the UAE has been able to maintain its investors.

Today, the UAE is considered to be one of the leading financial and banking centers in the world. It is ranked top in the Middle East having outdone other big economies in the region, such as Qatar, Egypt, Beirut, and Bahrain (Grira, 2014). A lot of work has taken place to ensure that the country acquires this status. Strategy, production, and marketing are some of the contributors to the stability of financial markets and banking systems in the UAE. There are a number of strategies employed by the government to ensure financial stability. To begin with, various regulatory bodies have been established to monitor the flow of financial instruments. The Central Bank of the UAE (CBUAE) is one such body. It is charged with the responsibility of ensuring the stability of the country’s markets. One of the major tools used by the watchdog is the CBUAE rate, which regulates lending and borrowing within the country. The Emirates Securities Market (ESM) is another key regulator. It tracks the exchange of securities in the country. It plays host to other regulators, such as the Abu Dhabi Security Exchange (ADX).

Trade is another key pillar of the UAE’s economy. The country is a top exporter of crude oil in the world. The product makes up about 60 percent of the country’s exports (Alshaali, 2015). The trade has resulted in the accumulation of wealth among citizens, organizations, and the government. With globalization of financial markets, the UAE has been able to use the amassed wealth as a commodity of trade. Through the Dubai Gold and Commodities Exchange (DGCX) and the Dubai Multi Commodities Centre (DMCC), contracts worth billions of dollars have been created (Grira, 2014). The value of the trade has been rising steadily over the recent past. It rose from $57.43 billion to $372.8 billion between 2008 and 2012. With the establishment of Abu Dhabi World Financial Market (ADWFM) in 2013, the figure was expected to grow at a faster rate. As such, the UAE is likely to grow more financially stable.

The UAE has also gained financial stability through the use of intense marketing strategies. For example, Dubai and Abu Dhabi have gained widespread popularity across the globe. They are considered to be home to some of the best communication and financial institutions in the world. Dubai is also seen as one of the greatest re-export centers in the global market (Grira, 2014). Goods from Asian countries are shipped to Dubai before being distributed to different parts of the globe. Payment for these goods is often made through local banks. Owing to the huge trade volume in the country, the financial systems have become strong. The strength has led to more stability. Political stability in the region has also made the country a preferred financial destination in the world. Most nations in the Middle East are associated with civil strife. The situation has prompted most investors in the region to opt for the UAE.

The Impacts of Delinking the Dirham from the Dollar

The CBUAE is charged with the responsibility of formulating the country’s monetary policies. Stabilizing the value of the nation’s currency is one of its many duties. In 1997, it pegged the Dirham to the Dollar. The US Dollar was valued at 3.6725 Dirham during the peg (Alshaali, 2015). Over the past few years, there has been mounting pressure to de-peg the Dirham from the Dollar. However, the CBUAE has remained adamant. The authorities argue that the move would have a number of negative effects on trade deficit, inflation rates, economic growth, and financial stability.

• Impacts on Trade Deficit
  Trade deficit describes a negative balance of transactions. It occurs when the value of imports is higher than that of exports. It is not necessarily an indicator of a failing economy (Talley, 2015). The reason is that it tends to correct itself over time. It means that a country is not producing enough to cater for the needs of its population. For a long time, the UAE has experienced a positive balance of trade. The highest levels were recorded in 2013 at 128%. In 2014, the figure dropped to 97%. The sharp decline is mainly attributed to falling oil prices in the global market. The move to de-peg the Dirham from the Dollar would result in a negative balance of trade in the UAE (Kassem, 2014). The reason is because the local currency would be exposed to fluctuations often witnessed in international financial markets (Alshaali, 2015). A decline in the value of the Dirham would mean that the country would spend more on exports. The currency would purchase fewer goods and services.
  De-pegging the Dirham from the Dollar also means that the country will sell its exports based on the Dirham. As it depreciates against other world currencies, the value of the country’s exports will reduce. It is important to note that crude oil is the main export commodity in the UAE. It accounts for 60% of the total value of exports in the country (Alshaali, 2015). The commodity is sold in the global markets using the Dollar. A depreciation of the Dirham against the Dollar would translate to a further decline in the value of the country’s exports. As such, the value of goods imported into the UAE would rise as the currency depreciates. Eventually, the total value of imports will surpass that of exports. The UAE would also stand to lose a large number of investors following the decision to De-peg the Dirham from the Dollar. The reason behind this is that most of these traders would fear a decline in the value of the country’s currency. The pulling out of investors from the country would mean that business operations in the UAE will not be sufficiently financed. As such, the amounts produced will likely go down. Increased imports and a declining currency would further push the balance of trade to the negative side.
• Effects on Inflation Rates
  Inflation is an economic phenomenon characterized by a general increase in the prices of products in a sustainable manner. It tends to lower the value of each unit of currency held by an individual or entity. The reason for this is that fewer goods and services will be purchased using a given unit of the currency. Currently, the inflation rates in the UAE stand at 4.53 percent. Although this is one of the highest in the recent past, it is low compared to other economies across the globe (Alshaali, 2015). The reason for this is the strict monetary policies maintained by the US (refer to Appendix 1) [Talley, 2015]. Pegging the Dirham to the Dollar means that the UAE has to adopt monetary policies that are similar to those in the US. Consequently, the CBUAE has to closely monitor changes in the global financial markets. The strong dollar shields the UAE against imported inflation.
  In most exports and import businesses across the globe, valuing of goods and services is done based on the US Dollar. A move by the CBUAE to de-peg the Dirham from the Dollar would result in a weakening local currency. As a result, businesses in the country would have to spend more on products. Customer preferences would no longer be met since the currency will not be strong enough to buy the same quantity of goods it did in the past. The move to de-peg the Dirham from the Dollar would also lead to imported inflation (McKinnon, 2012). More money would be required to import products from nations whose currencies are performing better compared to the Dollar. The CBUAE estimates that inflation rates would be as high as between 6 and 7% at the close of the year.
• Impacts on Economic Growth
  Economic growth is the term used to describe an increase in the value of products in a particular country. The effects of inflation are put into consideration when determining this value. The phenomenon is also described as the rate of increase in GDP. In 2014, the economy of the UAE grew by 4.6%. The expansion can be attributed to the fact that the country has a commodity-based economy. Crude oil previously accounted for about 60% of the total value of exports. However, the decline in oil prices has seen the figure drop to about 40% (Alshaali, 2015). The result is that investors in the oil sector are making huge losses. In spite of the decrease, the country still registers a positive economic growth. Most analysts have attributed this to the decision made by the authorities to peg the country’s currency to the Dollar. The strong US currency shields the country from potential declines (McKinnon, 2012).
  A move to de-peg the Dirham from the Dollar would mean that the UAE is no longer shielded from the effects of declining oil prices. As a result, revenues will decrease, leading to a slow economic growth. As the value of the Dirham declines, the rate of economic growth would further plummet. Eventually, negative GDP growth rates would be reported in the country (Alshaali, 2015). Investors would also move away from the UAE markets in a bid to avoid making losses. Consequently, the amount of capital available to finance businesses in the UAE would decline, resulting in decreased productivity (Kassem, 2014).
• Effects on Financial Stability
  Since the 2000 global financial decline, the UAE has been committed to the achievement of financial stability. The CBUAE acknowledges that shielding the currency from fluctuations is one of the ways through which financial sustainability can be achieved. The decision to continue pegging the Dirham to the Dollar is one of the ways through which this has been achieved. The reason behind this is that the US currency is considered to be an international standard (McKinnon, 2012). Pegging ensures that the value of the currency remains constant even amidst fluctuations. In spite of the declining oil prices, the confidence of investors in the UAE has remained high as a result of the pegging the local medium of exchange to the Dollar (Alshaali, 2015). The strong Dollar has also made it possible to keep interest rates constant despite the many uncertainties experienced in international financial markets and banking systems (refer to Appendix 2) [Talley, 2015].

Delinking the Dirham from the Dollar would result in loss of investor confidence in the UAE. Persons holding the currency would sell it immediately to avoid losing the value of their investment (Kassem, 2014). Such a move would lower the value of the country’s currency. Fluctuations that would follow in the country would also scare away potential investors (Bucur, 2012). The situation would worsen when oil prices fall. As such, de-pegging the Dirham from the Dollar would be a wrong move.

References

Alshaali, A. (2015). Pros and cons of Dirham’s peg to the dollar. Web.

Buch, C., & Delong, G. (2012). Banking globalization. Oxford Handbooks Online, 12(1), 34-47.

Bucur, C. (2012). The globalization of the banking sector: Evolutions and predictions. Web.

Cetina, K. (2012). Financial markets. The Wiley-Blackwell Encyclopedia of Globalization, 2(29), 61-66.

Fung, H. (2013). International financial markets. Bingley, U.K.: Emerald.

Grira, F. (2014). UAE financial markets ‘a bridge between East and West’. Web.

Kassem, M. (2014). Economists see no reason to scrap US Dollar-Dirham peg. Web.

McKinnon, R. (2012). The Dollar as a worldwide nominal anchor. The Unloved Dollar Standard from Bretton Woods to the Rise of China, 12(27), 30-47.

Talley, I. (2015). Threats to global financial stability are rising, the IMF says. Web.

Appendices

Appendix 1: The US Federal Reserve Policy to Normalize Interest Rates

Appendix 2: Benchmark Interest Rates in the UAE and Peg to the Dollar