Communication key to central bank policy making

They say communication is the key to any good relationship, which presents an inherent stumbling block for central bankers. Take Alan Greenspan, the former US Federal Reserve chairman. Cryptic, Delphic, enigmatic, but expressive? Not that mug. Central bankers possess a degree of inscrutability shared by poker champions, kung fu masters and nightclub bouncers. We can only wonder what must be going on in those minds of theirs, if anything.

You may therefore be aware of the tizzy in the UAE's financial community over the Central Bank's move not to cut its benchmark interest rate last month along with the Federal Reserve. Alright, it was really more of a kerfuffle than a tizzy. In fact, it is highly likely that you missed it entirely. Normally the Central Bank doesn't need to explain its interest rate decisions. The UAE and most other Gulf nations keep their currencies pegged to the dollar. Whatever the Fed does, therefore, they usually mimic. The Fed cut its key rate on Oct 29, and like clockwork Bahrain, Kuwait and Saudi Arabia all announced that they were cutting rates.

The Central Bank did nothing, and in so not doing sprouted something it has hitherto not had - a monetary policy. Most central banks explain monetary policy decisions with long and often bewildering statements, even when their decision is to do nothing at all. Mr Greenspan was famous for his convoluted, indecipherable messages. Central Bank Governor Sultan bin Nasser al Suwaidi appears to have one-upped him with a Zen-like strategy of keeping silent.

So economists and investors have been left to guess. Lowering the benchmark rate would, in theory, make money more available to banks, which lately have found cash in short supply. Many people, therefore, expected the UAE to follow the Fed with its own rate cut. They are still waiting. Others, however, divined that the bank had figured out that lowering rates wouldn't make much difference to the nation's banks. The Central Bank in September provided them with a facility for cheap financing, yet few have taken full advantage of it. So instead, the Government has been depositing its own money at the banks to make sure they have enough.

Cutting rates doesn't make sense if it isn't going to do any good. It reduces the amount the bank can cut later, if it needs to stimulate the economy. And by standing pat, economists reasoned, the bank may also have been hoping that it could lure back some of the foreign investment that has been flooding out of the country. Much of that money came in, after all, betting the Central Bank would stop moving rates along with the Fed and let the dirham rise. Once investors realised that the peg was here to stay, they took their money out, which is what triggered the credit crunch in the first place.

If luring some of that money back was the Central Bank's intention, it hasn't worked. Foreign funds are still pulling out, as evidenced by the stock market's continued decline. The interbank lending rate, after easing slightly from a peak of 4.79 per cent, has settled at 4.48 per cent. Some say this is a symptom of the global credit crunch and that funds are just too tight to respond to such a slight difference - only a quarter of a percentage point - between the Fed's new rate and the UAE's. But markets in Asia and elsewhere in the Gulf responded positively, if temporarily, to rate cuts there. So clearly there is still enough money out there to move markets.

Bankers say a more likely reason is that in an increasingly fearful world investors decided that the slight premium the Central Bank created for buying dirhams with dollars wasn't enough to compensate for the risks. Reports of an imminent correction in property prices in the UAE have reached foreign shores. And no one can fail to notice the declining price of oil. But another area of concern has centred on debt levels, particularly Dubai's. With no official numbers available, bankers were worrying out loud this summer that Dubai may face US$60 billion (Dh220.3bn) in refinancing costs.

Taking a different tack than the Central Bank, Dubai's authorities are striking back with an information cruise missile, throwing their books open to credit-ratings agencies and letting facts speak for them. The result has been perhaps the clearest ever look at Dubai's financial wherewithal. The agencies' subsequent reports reveal a much less gloomy situation than many had imagined. Dubai's debts do indeed exceed the size of its economy and will continue to outpace economic growth, according to Moody's. As a result, Dubai is likely to need federal financing to ensure that slower growth and tighter funding do not leave it unable to pay its debts before its big projects start generating cash.

But the situation is not nearly as dire as some supposed. Fitch examined the maturities of Dubai's debts and determined that the emirate would only need about $5bn for the rest of this year, and only another $5.3bn next year. The crunch time won't come until 2011, when Dubai's refinancing needs will jump to more than $20bn. Even then, the agencies noted, with oil revenues still flowing into Abu Dhabi, the UAE has more than enough money to cover every fil of Dubai's debts.

Bankers say they wish the Central Bank would take a page from Dubai's book. Bank lending isn't recovering, they say, because the Central Bank has yet to spell out just how its liquidity boosting measures work. What kind of collateral do they need to borrow under the bank's liquidity support facility, they wonder? Interbank lending is guaranteed, but how? Which banks can receive the Government's new long-term deposits, and which have to?

Inscrutability is a useful attribute when transparency would reveal one's weaknesses. But in times of crisis, as Dubai has ably demonstrated, transparency is a more powerful confidence builder. Inscrutability risks being mistaken for bluff. [e-mail]