Cost of borrowing has dropped, but interest is limited

One of the best pieces of news this region has had in recent months is that the price borrowers here have to pay international investors has been falling.

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One of the best pieces of news this region has had in recent months is that the price borrowers here have to pay international investors has been falling. This is a sign that confidence in the region's prospects are rising, but also that confidence is rising globally, and so the cost of borrowing is going down almost everywhere. That's good news for those struggling to repay debts they racked up when times were good and repayment seemed easy, such as Dubai and the companies it controls. Now times are tough, money is tight and servicing Dubai Inc's US$85 billion (Dh312.21bn) debt has become a Sisyphean task. Falling borrowing costs can only help.

But the easing interest rates on foreign borrowing are also the result of a more pernicious trend, one that appears to afflict this region, the UAE in particular. Since the global credit crisis erupted just over a year ago, many economists and policymakers have warned that recovery would depend on deleveraging, whereby banks, companies and consumers try to wriggle out of the credit binge they indulged in. The economy is terrible, unemployment is up and business prospects dim. Few banks want to lend. Few companies or consumers want to borrow. It's a nightmare for policymakers because no matter what they try, the players in the economy insist on sitting on their hands, waiting for the other guy to blink. So deleveraging is a necessary evil, one that in the process makes the recession seem longer and more painful.

The result is that policymakers are compensating by pushing their lending rates to nearly zero, making money cheaper in the hopes that people figure there is no point waiting to invest or spend. The US Federal Reserve has been maintaining a zero, or at least near-zero, interest rate policy - it will lend banks money for next to nothing. Sweden has taken interest rates into negative territory. In the UAE, too, nothing the Central Bank does seems capable of goading banks into lending. Why would they? Their most creditworthy borrowers are not silly enough to take out new loans.

The problem is that governments are also compensating by borrowing and borrowing big. The US government is borrower number one; borrowing so much that its overall debt is projected to surpass $14 trillion next year. With interest rates in the US so low and so many dollars being borrowed, investors are rushing to move their dollars offshore in search of higher returns, reviving the very liquidity bubble whose collapse plunged the world into a recession in the first place.

In a world where no one wants credit, who is taking advantage of this explosion of cheap dollars? In this region, it appears to be primarily governments, which are leveraging up even as the private sector slims down on debt. As a result, the GCC and the UAE are not deleveraging. They are decapitalising. The latest numbers on fund-raising from Thomson Reuters illustrate the trend. The overall amount of money being raised in the GCC shrank by two thirds in the first nine months of this year compared with the first nine months of last year (before the collapse of Lehman Brothers). In the UAE, fund-raising fell by almost three quarters.

Merger activity across the region suffered the equivalent of a coronary, dropping 70 per cent, according to Thomson Reuters. In the UAE, it died, dropping 98 per cent. Sales of stock - either through initial public offerings or rights issues - also dried up, falling 87 per cent across the GCC. In the UAE, there were no public equity sales at all. With banks nursing their wounds after the credit binge of recent years, it is no surprise that lending also collapsed. Loans across the GCC dropped 82 per cent; in the UAE they fell by 86 per cent.

The only bright spot was bonds. Bond issuance across the Gulf actually rose in the first nine months by 61 per cent, led by Saudi Arabia, where bond sales more than doubled. Despite tight liquidity and persistent worries about Dubai's debts, the UAE managed to sell 6 per cent more bonds in the first nine months of this year than last. This is in some ways good news. Analysts and economists have been urging the region to reduce its reliance on bank lending and instead promote bond markets as a way of diversifying its sources of capital and reducing the politically influential role banks play. On that score, the region is doing well. The proportion of funds raised from bond sales jumped from just over 10 per cent last year to more than half this year.

The problem is that the region's overall reliance on borrowing is rising relative to its ability to sell equity. Obviously, a certain amount of leverage is healthy and given the region's impressive accumulation of assets and reserves, its debt levels are nothing to worry about. Many economists, moreover, say countries that have been net savers, such as in Asia and the Gulf, will need to borrow more to put the global economy on a more even keel.

Nonetheless, in a country already facing investor scepticism over its ability to service Dubai's debts, it cannot be reassuring that in a deleveraging world, its reliance on leverage is increasing. While debt capital represented 81 per cent of the UAE's fund-raising in the first nine months of last year, that proportion rose to 99 per cent this year. Bank borrowing was cut in half. Bond issuance nearly tripled.

If only it were private companies selling those bonds. Almost all were sold by governments and government-owned companies, specifically those from Abu Dhabi. There was the Abu Dhabi Government's bond sale of nearly $3bn in April, and Mubadala Development's $1.75bn bond sale in May. The Tourism Development and Investment Company sold $1bn of bonds in July. Dolphin Energy sold $1.25bn; National Bank of Abu Dhabi $850 million; and Abu Dhabi National Energy, or Taqa, $1.5bn.

Clearly, Abu Dhabi is in a better position than just about anyone to shoulder new debt, so taking advantage of cheap rates to finance its development is smart. And if borrowing money allows Abu Dhabi to offset the contraction in private investment, so much the better. But in a nation that was before the crisis struggling to promote the private sector and reduce the Government's stranglehold on the economy, news that the only people willing to risk borrowing money are government employees may not be cause for rejoicing.