ABU DHABI // Analysts say the Central Bank's new foreign-currency swap facility, announced on Wednesday, is a complex but important step toward unlocking bank lending and assuring that companies get the funds they need to keep trade flowing despite the global credit crunch. The bank announced it was creating a swap facility under which it would buy US dollars from banks in exchange for dirhams and sell those dollars back later for the same amount of dirhams, plus a premium.
"It is coming at a good time because it is needed," said Khaled Masri, a partner at Rasmala Investments. "There are still constraints within the banking system and interest rates in the local market are too high." Although complicated, the new facility essentially enables banks to use dollars as collateral for borrowing dirhams at a rate equivalent to the Central Bank's existing repurchase rate. The difference is that, while the Central Bank has been fixing a repurchase rate since late last year, it did not have a properly functioning repurchase facility, economists say.
With hundreds of millions of dollars in foreign exchange reserves and hundreds of billions more in accumulated assets, the UAE was an unlikely victim of the credit crunch. But a wave of speculative investments in the early part of the year pushed down the cost of funding and accelerated an explosion of credit that helped fuel the nation's property boom. But the global credit collapse in August and September sparked a dramatic reversal of this so-called "hot money," forcing local banks to look overseas for loans to finance demand for new loans.
With global investors pulling in credit amid mounting losses, that credit quickly dried up, prompting UAE banks to curtail lending. Perhaps the most dramatic illustration of the impact is the Emirates interbank offer rate, or Eibor, the rate local banks charge each other for short-term loans. After dropping to a low of 1.86 per cent in April, Eibor shot up to 4.79 per cent in October. In September, the Central Bank stepped in with a Dh50 billion (US$13.6bn) facility that allowed banks to borrow the reserves they are required to deposit at the Central Bank. But amid complaints that rules governing that facility were unclear and interest rates were too high, few banks availed themselves of it.
The Ministry of Finance followed that in October with Dh70bn in long-term deposits at banks, with banks required to pay the Government 1.2 percentage points more than the rate on five-year US government bonds, or 4 per cent, whichever is higher. With the US five-year bond most recently yielding 1.949 per cent, banks have to pay the UAE Government 4 per cent on those deposits. At the same time, the Central Bank has been trying to use its official lending rate to try to lure foreign liquidity back into the country, economists say. After pushing its official repurchase rate below the US Federal Reserve's benchmark discount rate for much of the crisis to discourage hot money inflows, the Central Bank in the past two months has allowed the rate to float above the Fed's.
But economists say the global liquidity crunch, combined with concerns about the local property market and the health of banks, have combined to keep foreign investors away. As a result, Eibor has remained high, at 4.425 per cent and banks have continued to reduce credit, raising the minimum down-payments for homes, blocking loans to individuals in vulnerable industries such as property development, reducing car loans and reducing credit-card limits.
The problem for the Central Bank, said Standard Chartered economist Marios Maratheftis, has been that its own foreign currency operations have been exacerbating the UAE's liquidity crunch. "The monetary policy transmission mechanism in the UAE is not functioning properly," he said. According to Mr Maratheftis, the UAE runs a trade deficit if oil exports are excluded. When they import goods, companies buy them with US dollars. They go to their commercial bank to convert dirhams into dollars, and their bank in turn goes to the Central Bank to convert its own dirhams into dollars. The result is that more dirhams, or AED, are sucked out of the local economy and into the Central Bank. "The problem is that when the Central Bank is given AED in exchange for USD, the AED is taken out of circulation. The Central Bank needs to have an efficient way to recycle AED back into the system to ensure that liquidity does not evaporate," Mr Maratheftis explained. "This highlights the need for a permanent repo market, essential to the functioning of most financial markets."
The new swap facility appears to create this repurchase, or repo, arrangement. In a repurchase agreement, a borrower agrees to sell a security to a buyer and then buy it back at a later date at a fixed price. It is tantamount to a cash sale with a forward transaction, which is exactly how the Central Bank has outlined its new swap facility. "These operations will begin by the Central Bank buying US dollar against the dirham (spot) and selling US dollar against the dirham (forward) at the same time," the Central Bank said.
* additional reporting by Sara Hamdan @Email:firstname.lastname@example.org