Preserving the UAE's wealth requires clear direction

Every once in a while I decide to torture myself and rummage through the IMF’s databases looking for interesting research and analysis. When I found a Selected Issues UAE Country Report by the IMF, I thought I’d try my luck.

The report, published this month, begins by looking at government-related entities (GREs), which is anything that the government owns shares in. It is important to note that the IMF repeatedly warns that it does not have all information on all GREs. It looks at about 60 companies, although one should bear in mind that the government holdings in some are too small to have any influence.

One of the early IMF comparisons that is striking is the return on assets (ROA) of the non-financial corporate sector across GCC countries over the period from 2007 to 2014. The UAE at 8.1 per cent a year is higher only than Kuwait. Saudi Arabia at 9.6 per cent is about a fifth higher and Oman’s 13.3 per cent is more than three-fifths higher. How then are we the commercial hub of the GCC?

In a continuing discussion of whether the government is crowding out the domestic non-financial private sector and the implications that has, the IMF calculates the representative GRE ROA over the period at 2.5 per cent a year. The private sector, consistent with all theory and research, at an 8.1 per cent ROA has outperformed the government by 225 per cent a year. Now there are plenty of arguments to be made that the IMF’s computation of the GRE’s ROA is not completely accurate, but one has to draw the line at believing that the IMF could be wrong by 225 per cent.

The IMF is diplomatic in its conclusion – leave business to businessmen.

There is some good news. The total GRE debt as a percentage of GDP has dropped strongly in Abu Dhabi and to a lesser extent in Dubai. Importantly for Abu Dhabi, the percentage of GRE debt that is loans as opposed to bonds dropped to 33 per cent from 68 per cent. This is important, as it allows private companies more room to borrow.

Abu Dhabi is showing a clear corporate governance push to stop GREs from crowding out the private sector in the loan markets.

For some fresh news, Mubadala is buying 20 per cent of Investcorp. Why? The Ipic-Mubadala merger just announced is a lot of work. And Mubadala already owns 10 per cent of Carlyle, arguably the top private equity firm in the world.

This is probably forward thinking by the team at Mubadala, a global investor. Merging with Ipic means also acquiring Aabar. Investcorp, with its long history, blue chip name and seasoned team, could make a perfect match for Aabar. A reverse takeover would make Aabar liquid again through an equity swap for Investcorp shares. As a result, the 20 per cent would go higher. But what do I know?

Maybe that’s the answer for GREs. If you cannot build a business servicing a portfolio of countries with a combined GDP of at least 30 per cent of global GDP, then do not do it.

The largest Abu Dhabi sovereign wealth fund, the Abu Dhabi Investment Authority (Adia), recently announced its results with the 20-year average return dropping to 6.5 per cent from 7.4 per cent and the 30-year average dropped to 7.5 per cent from 8.4 per cent the previous year. The drop was attributed to historical returns dropping off the rolling average, financial speak for saying the 1995 and 1985 returns were outsize ones that had pulled the average up and were now no longer being counted.

We have to make some assumptions which might not give the exact answer but should give the correct direction. The first is that it is commonly accepted best practice to use a benchmark for investment returns. A return of 40 per cent might seem high, but it isn’t so great if the market as a whole grew by 60 per cent. Similarly, a 2 per cent return might not seem so good, but it is great if the market lost 20 per cent.

One decent benchmark to use is the MSCI World Index (WI). Adia is clearly a global investor given its size and sophistication, so looking at a world index developed by the global leader in investment indexes makes sense. Last year’s return on the WI was minus 0.3 per cent. We’ll call it 0 per cent for our purposes. If we assume that Adia matched the index performance last year, then mathematically the drop-off returns for 1995 and 1985 had to be 18 per cent and 29 per cent, respectively, to alter the rolling 20-year and 30-year returns to the extend they did. The 1995 WI return was 21.3 per cent in 1995 and 41.7 per cent in 1985. This supports Adia’s assertions and points to an outperformance last year.

But what about performance across the years? The WI has a 30-year return on investment of about 9.6 per cent a year compared to Adia’s 7.5 per cent. That means that US$100 billion invested with Adia would be about $775bn today. The same amount invested in the WI would be about $1.4 trillion today. That’s nearly double. On a 20-year basis the index again yields a better return, but not by as much.

Some might argue that the WI is the wrong index to use to benchmark Adia’s portfolio. But maybe it was the wrong portfolio to construct given the sizeable outperformance of the passive index. Post hoc ergo propter hoc, anyone?

The available data indicates that passive index investing might be the more effective strategy. But how does Adia stack up against other SWFs? It is hard to do an exact comparison, as different SWFs have different mandates. But if we look at Norway’s SWF, the largest in the world, it provides an 18-year history. If we use the WI to plug in the extra two years so that we can compare to the 20-year Adia return we get an annual rate of return of 6.5 per cent. So about the same.

As an aside, I saw the names of two UAE asset managers that Norway invested in – Ajeej Capital and Rasmala Asset Management. Well done.

The analysis of everything in this article, as the IMF likewise admits in its report, is less than perfect because of the understandable lack of full information. It is another reason for an effective governance body to oversee, coordinate and direct the individual and collective performance of the larger GREs and SWFs, as well as their effect on the domestic economy. After all, the boards of these entities overlap in many cases, so reducing their size to become effectively executive subcommittees and concentrating the main board members in the overall governance body could be more efficient, and it would make further rationalisation such as the Ipic-Mubadala merger much more effective.

I do believe someone once mentioned the idea of a Supreme Investment Council?

Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com.

business@thenational.ae

Follow The National’s Business section on Twitter

It’s summer, it’s hot and who wants to wade through an 800-word article? So I’ll base this article on the infamous segment “A Few Minutes with Andy Rooney” from the hit show 60 Minutes, and I’ll simply give a series of light vignettes to whet the appetite and stimulate thought, without overwhelming the senses.

The UAE’s Telecommunications Regulatory Authority frequently bans voice and video over IP (VoIP), a cheap way to communicate with the world. This is significantly beneficial to the oligopoly of Etisalat and du. Yet a regulator is supposed to be protecting the consumers. Banning VoIP because it competes with regular phones is like banning email because it competes with faxes, telegrams and letters. Dear TRA, that was a plea to allow VoIP, not an excuse to ban email. It was also a polite reminder that the consumer is your client, not the telecom companies.

Medicines are part of the agency programme whereby a UAE national gets a monopoly on importing the medicines. I have personally experienced medicines not being available because of, according to the pharmacies, a low return on equity (ROE) making the agent invest in importing other medicines with a higher ROE. Why do we even have agencies for medicine? If we are going to have them, why not regulate these? I salute the agent’s capitalism but what kind of greed and lack of compassion make an agent of a medicine neither import the medicine, nor relinquish his monopoly? Maybe he needs a course in corporate social responsibility? It might be time to review obsolete business laws.

The UAE Banks Federation’s so-called “mini-bankruptcy law” gives struggling SMEs 90 days to restructure. Nobody can restructure in 90 days. Could these 90 days just be a way to allow all the banks to sit together at the same time to feast on the carcass they killed? You know, just like it’s rude to begin eating a meal until everyone is seated at the table? And with 50 banks, it takes some time for all of them to position themselves for maximum advantage in the feeding frenzy.

Why is it that booking a hotel room in the UAE is so much more expensive than booking it from outside the UAE? We are discriminating against our own citizens and residents. The idea that hotels reward tourists but harm citizens and residents who invest in and build the country is not a long-term, economically supportive strategy. Besides, once the discrimination begins, it usually has a fast way of spreading. Then again, maybe I’m the only one being discriminated against and everyone else is getting the same discounted price the tourists are getting.

Speaking of hotels, they could consider augmenting their free market capitalistic approach when it comes to Friday brunches. The current formula often has a three-price structure depending on what you wish to eat and drink. This could be extended to also pricing in whether, and where, you wish to regurgitate said tasty fare. They could have a futures market for those who are sure that refunding their victuals is in their immediate future – a steal for those pre-gaming the brunch – as well as an options market for those who are not quite sure where the artfully prepared cuisine will be returned. Insurance companies, are you listening? Maybe the 50 banks can spare some time in their overworked schedule of mediocre service to 9 million people and look into this scheme.

How does Saudi Arabia allow 100 per cent foreign ownership of businesses but we don’t? Free zones don’t count, because you can’t actually do business in federal areas, at least not legally. Which brings me to another point. According to Wikipedia.com there are 37 operating free zones in the UAE, with another nine under construction. Is it me, or is that a symptom of inefficiency? Wouldn’t the cost of building all these free zones be better served in promoting business in the normal markets? Or maybe the free zone founders are competing with the banks and want to grow to 50?

ATMs that give out Dh1,000 bills should be banned. Or at least we need to be given the choice of maximum bill size. Let’s not blame the 50 banks. With so many of them there might not be enough lower denomination notes to go around.

The price to equity ratio is a measure of how cheap or expensive a stock’s price is relative to earnings, with a ratio of 8 to 12 considered normal. The equivalent in property is the cap rate, which equals the actual market price of the house or flat, divided by annual income (rent, maintenance and other costs). The normal is between 8 and 10. I have rented three homes in the UAE and looked at dozens more (this is all federal land). I always ask for rent and sale price. The cap rate has always been about 20. Either prices are too high or, hold on to your seats ladies and gentlemen, rents are too low. Whatever the dislocation in the property market, buyers either have negative equity or are overpaying on their mortgage relative to their rental income. I blame the 50 banks. I don’t know how, I don’t know why, but I will not rest in peace until I uncover the banks’ involvement in the high property cap rates.

This article is dedicated to the 50 – soon to be 49 – banks.

Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com.

business@thenational.ae

Follow The National’s Business section on Twitter

What the UAE's tax planners can learn from Ronald Reagan

In April, news of a municipal fee was announced on residential rents for expatriates. Since the fee is a percentage of rent, this is, by definition, a real estate tax. This comes on top of the value-added and corporate taxes announced earlier. I wonder if there is some confusion between maximising taxes and maximising tax revenue. The difference is important.

The former US president Ronald Reagan oversaw one of the strongest economic growth periods in America. His plans, dubbed Reaganomics, were and remain hotly debated by economists. Understanding them is instructive. But first, let us agree on some terms.

Governments basically have two methods to influence the economy. The first method is monetary policy, which is the control of the money supply in the system, and this is usually effected through the central bank or equivalent. The central bank in turn manages the money supply using two methods.

The first is by setting short-term interest rates. The higher the interest rate, the more people save, and you get a reduction in money supply, which is called a contractionary policy as it slows down the economy. The reverse is what has happened since about the year 2000, when Alan Greenspan brought rates to basically zero, so people were not incentivised to save but instead to spend. This is called expansionary monetary policy.

The second method that the central bank can use to enact monetary policy is by buying or selling financial assets. The Troubled Assets Relief Program in America did this when bad assets were bought by the Fed. The Federal Reserve continued this in its multiple quantitative easing programmes by buying fin­ancial assets, basically bonds, as it could not lower interest rates any lower than zero.

As explained in my previous article on austerity, the UAE cannot control monetary policy because of its dollar peg and internal regulations. That leaves only fiscal policy as a potential tool for managing the economy.

Fiscal policy also has two methods. The first is how much a government spends. In an expansionary fiscal policy the government would increase spending and this would stimulate the economy. The reverse, contractionary fiscal policy, contracts the economy. This is what has happened recently under the aim of austerity, and I argued against this idea in my austerity article.

The other fiscal policy tool that governments have is taxes. Expansionary policy means cutting taxes so people can invest and spend, while contractionary policy means raising, or introducing, taxes, which leads to people having less to invest and spend.

Back to Reaganomics. In 1980, when Reagan took office, the American economy was in trouble. The issues he faced were far more complex than what we face in the UAE today, but there are elements of his economic policies that we can learn from.

Up to that point in time classical Keynesian economics had prevailed, and this included demand-side economics, which looked at creating consumption. Reagan moved towards the idea of supply-side economics, and that is that consumer spending is not the cause of economic expansion, it is a result, and ultimate goal, of economic expansion. One of the pillars of Reaganomics, and a radical change to decades of economic behaviour, is that stimulating production by allowing people to invest in and build businesses was the most effective way to expand the economy. The way to do that was through expansionary monetary and fiscal policies.

Reagan reduced taxes and he slowed the growth of federal spending, but he did allow it to grow. He did this by borrowing. The national debt increased by about 300 per cent over eight years. On a yearly basis, Reagan was borrowing an average of US$237 billion, up from his predecessor’s $57bn. This means that, roughly, Reagan was spending an extra $180bn a year. There needs to be an offset for tax reductions, but dir­ectionally this shows what was happening.

Contrast the expansionary monetary and fiscal policies of Reaganomics with today’s austerity approach that Germany has imposed on the European Union. Italy is not allowed to save its banking system, whereas the Americans did it and are fine. The destruction of 30 per cent of Greece’s GDP over a four-year period was unnecessary and not wholly Greece’s fault.

America’s GDP is about 25 per cent of global GDP. It chose expansionary policies and is an economic powerhouse. The EU’s collective GDP is slightly less. It is an economic basket case. By the way, the population of America is about 320 million, whereas that of the EU is 510 million. America’s GDP per capita is nearly twice that of the EU. Talk about efficiency.

So what does that mean with regard to the 3 per cent rental tax? If Reagan was right, it means people will have less to invest in the economy and will lead to a longer contraction. Then again, maybe the German minister of finance Wolfgang Schäuble is right and the light he sees at the end of the tunnel that he steered the EU into is not an oncoming train.

Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com

Ipic-Mubadala merger does not have to follow a template

Ipic and Mubadala, two major Abu Dhabi investment funds, have been mandated to merge. The outcome does not have to be a single company. In this article I will look at an innovative option for the Ipic-Mubadala merger to result in more than one company and how such a multi-result merger can support Abu Dhabi’s Economic Vision 2030.

I recently wrote in detail on what strategies the NBAD-FGB merger could take and in a subsequent article I delved into a major challenge such a merger might face. The detail was possible because both NBAD and FGB are listed companies and have strong disclosure requirements.

When discussing Ipic and Mubadala, we are talking about two privately held institutions and as such there is less public information at this time. This does not stop us from conducting a thought experiment, if you will, to try to understand the options available.

The key issue we will look at today is that a merger does not have to be about acquiring market share or new business lines. A merger can be about rationalisation and refocus.

If you want to know where you might go you need to know where you are, and if you want to know where you are then you need to know where you came from.

Ipic stands for the International Petroleum Investment Company. Just from the name, its mandate when it was formed in 1984 is clear. It has a wonderful web page describing the hydrocarbon chain, making it clear how Sheikh Zayed had the vision very early on to expand our focus on our greatest financial asset at the time, crude oil, to include many different parts of the petroleum sector.

The investment portfolio clearly reflects that vision. Yet in recent years Ipic has grown from an institution investing internationally and in the hydrocarbon sector to investing in multiple asset classes, not only internationally but domestically as well.

Is this bad? A clear answer requires knowledge of the internal strategy of Ipic. My view is that a strong investment vehicle with an intelligent and proactive team started seeing attractive opportunities outside its mandate, and as such Ipic evolved into a broad investment manager, in particular using its subsidiary Aabar. That is where we are today.

Mubadala is the brand name for the Mubadala Development Company. Again, the name says it all. Its vision is to support Abu Dhabi’s ambition to transform its economy and develop a new generation of leaders. Again, its portfolio predominantly supports this vision. But once again we see investments that seem to be more about a pure financial return. Indeed, there is even an interactive portfolio on its site that has as one option “capital investments”.

Again, the question of whether there is something wrong with this comes to mind. Without detailed information, my best guess would be no, that in fact a team of smart asset managers saw opportunities and took them.

Ipic and Mubadala have shown the ability to innovate and evolve that pushes economies forward. But the shareholder, the government of Abu Dhabi, has its own plans. In the end the entrepreneurial spirit shown by Ipic and Mubadala needs to be aligned with Abu Dhabi’s Economic Vision 2030. The government did not micromanage its portfolio companies, and that is a good thing. But it has macro-managed them and should continue to do so.

Now that we know where we came from and where we are, let us talk about where we can go. The idea of creating a super sovereign wealth fund with multiple departments has been discussed by others. I would like to consider a different idea.

If you read Vision 2030 and add to it some simple analysis, it seems that there is a three-pronged strategy. The first is managing our large, albeit depleting, crude oil assets – think Ipic, Adnoc and the Supreme Petroleum Council (SPC). The second is managing our large, and hopefully increasing, financial assets – think Adia and Adnic. The third is developing our people and economy to become self-sustaining, think Mubadala. Such a strategy clearly makes sense. So how to enhance it?

My view would be to look at the Ipic-Mubadala merger as three-phased. The first phase is to restructure along business lines. It makes far more sense for Mubadala to hand over energy assets to Ipic and Ipic to hand over development assets to Mubadala. They both should hand over their purely financial investments to Adia or Adic as might be necessary.

The second phase is learning from each other. We always talk about global best practices. Well, Ipic and Mubadala are both global and I have no doubt that they not only follow best practices, they evolve them.

The third phase would be a rebirth, with Ipic reborn as the Global Energy Investment Company (GEIC) and Mubadala refocused on its economic and leadership development.

An endnote: I spoke about the three-pronged strategy and the need for the occasional rationalisation of subsidiary entities. We seem to have a framework for that; it just needs a little further to go. For oil, or energy, the SPC’s governance mandate could be widened and have Ipic or the newly formed GEIC report to it. For development we already have the Executive Council, which oversees Mubadala and many other institutions, which also could be rationalised as part of Mubadala. We are missing a Supreme Investment Council to oversee and rationalise the likes of Adia and Adic. If we have an SPC for our depleting asset, shouldn’t we have an SIC for our accreting asset? Just a thought.

Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com.

business@thenational.ae

Follow The National’s Business section on Twitter

How the NBAD and FGB merger can reach its full potential

In my last article I talked about the two main paths that the merger of FGB and National Bank of Abu Dhabi could take. The first is simply extending the current business of each by using the path of acquisition rather than organic growth. The second is to trigger a radical redesign of the business model. I concluded that it made strategic sense for FGB and NBAD to take the second path. In this article I touch on how that can happen.

FGB and NBAD are banks and banks, in the end, are predominantly about service. The product part is simple. Money: you can deposit it with them and you can borrow it from them.

The price part, interest rates, is also simple. It has nothing to do with the cost of manufacture as banks don’t manufacture money and besides it is mostly electronic. No, price is driven by the human resources running the banks as well as market supply and demand of money. Since this is driven by people, we can conclude that banks are in the services business.

Service companies can benefit from technology, processes, procedures and a host of other tools. But the main asset by far in a services company, such as a bank, is the people. So how do we optimise the output of people? Humans, by their very nature, are driven by their emotions. Their emotions at work are driven primarily by their interactions with their colleagues at work.

Therefore the greatest effect on the effectiveness of the human assets of a bank is culture. The trap that many companies that merge fall into is in developing integration plans for their technology, their branding and signage, their accounting procedures, client acquisition processes and so on but rarely, if ever, is any thought given to culture. This can be lethal.

How does one integrate culture? Again, there is usually the misconception that one would have to choose either FGB’s culture or NBAD’s culture and enforce that on the other company. The winning culture is usually chosen by defaulting to whichever chief executive remains. This approach has the immediate result of alienating not only the employees of the bank whose culture is being discarded but also by the clients of that bank.

Why is this so? People don’t like change. They especially don’t like change when they feel that the way that they have been doing things is being discarded because it has been judged inferior. The loss of clients who might feel that they will be second-class citizens to the “winning” bank’s clients is even more painful.

This phenomenon is recognised by most merging companies. Their usual solution of mixing and matching from both cultures rarely ends up with a culture that employees, clients and other stakeholders like. Instead, you end up with a Frankenstein’s monster of a culture that everybody hates.

The solution then is clear: a completely new culture should be created. A new culture should not only to appease employees but inspire them towards the new strategy: in this case, a supra-regional strategy. The selection of Abdulhamid Saeed, the managing director of FGB, to be the chief executive of the merged banks over their current chief executives allows for the introduction of a new culture.

So what does it mean to introduce a new culture? Culture is the behaviour of the employees and the beliefs and values that drive them. Sure, certain behaviour is detailed in an authorities matrix as well as in processes and procedures. But employee behaviour, mostly, is not and cannot be written down and dictated. It is driven by senior executives modelling it for their direct reports and so on downwards.

A successful integration of FGB and NBAD therefore requires, first, that a new culture is developed in the merged company. Technology integration, for example, cannot happen if there are two teams each using a different culture in terms of communicating, in decision making, in escalating issues, etc. The result would be a mess.

Often there is a rush to finish the integration of two merged companies. This can be a mistake. Consider how long it would take either of FGB or NBAD to grow organically to the size of the newly proposed merged entity. It would take years, as it requires the effective doubling of the asset books. Why then would one expect that a merger could so easily and quickly short-circuit the organic process?

If FGB/NBAD can get the culture right, a culture consistent with that of a supra-regional group, then the integration of actual operations will be almost automatic, albeit still challenging.

If your team doesn’t know the unwritten rules on how to behave they will then waste time evolving a mutually acceptable culture – rather than having one introduced, thus allowing them to get on with their jobs.

Sabah Al Binali was formerly head of the treasury and investments division of Union National Bank, a senior executive at Credit Suisse Saudi Arabia and Shuaa Capital, a board member at Credit Suisse Saudi Arabia, vice-chairman of Shuaa Capital Saudi Arabia, vice chairman of the UAE SME lender Gulf Finance, and chairman of the Saudi SME lender Gulf Installments

Analysis: Merging FGB-NBAD should make a big leap of faith

This article was meant to be about managing a merger. It turns out that this is hard to explain without first understanding the goal of the merger. There has been little information made public in terms of the thinking behind the FGB-NBAD merger, with some commentary from analysts. Here I will discuss various ideas on the merger.

1 So why might FGB and NBAD have decided to merge? One oft-quoted reason is that it was a political decision. But to what end? I’m pretty sure that politics do not drive commercial decisions.

2 Next is the idea of cost savings. Merging the two companies does not only offer the possibility of eliminating overlapping functions, there is also the possibility that FGB’s cost effectiveness, as measured by a cost/income ratio of about 20 per cent, can bring down NBAD’s same ratio of about 38 per cent. That would be a big savings indeed. But in the end it is no different to FGB growing assets organically. A merger doesn’t necessarily make it faster, after accounting for merger costs, it might be the same.

3 Another idea is that NBAD’s lower cost of funds could give FGB an advantage. But that might just be offset by NBAD’s lower return on equity. Worse, if the merger is not handled well, the new entity could end up with FGB’s higher cost of funds and NBAD’s lower return on equity.

There are a few more such arguments that I could bring up, but in the end it boils down to either increasing the assets and liabilities via acquisition rather than organically, or acquiring human resources rather than hiring them. It is more of the same, just a different path.

4 There is another, far more exciting, reason for the FGB-NBAD merger, and that is to transform two local banks to a true regional, if not international, bank. That is the one thing that a bigger balance sheet gives a bank that is not simply more of the same: at some point a quantum jump is made to the ability to be a full-service bank in multiple countries. Not just one or two branches, or a small subsidiary, mind you, but a bank that competes with the local banks. Think HSBC or Standard Chartered. Why not? If we’re going to think big, let’s actually think big.

Maybe, just maybe, the idea is to create a supra-regional bank that can enter the wider Middle East and Africa region, South East Asia, some of the “Stans”, China and Russia. Why not follow where our businesspeople are going?

In such a case, this merger would be the first step. Use it to create a permanent acquisition and integration team, acquire ADCB next and then UNB. At the same time, but separately, merge Al Hilal Bank and ADIB. Maybe Noor would be open to an approach.

This is how these banks, too big for the UAE but too small for the region, could reach the size that they need to get a substantial geographic footprint.

Of course, once FGB-NBAD created a critical mass by adding ADCB and UNB, that does not mean that they have to stop. As they expand in their target markets there will be tempting targets in the new geographies, all the easier to approach given the critical mass FGB-NBAD would have achieved and with their experienced acquisition and integration team.

The No 1 lesson from the banking industry that we have learnt is that the bigger you are, the greater your strategic advantage. Your credit ratings go up. Your brand goes up. Your perceived counterparty risk drops. Your regulators are more open to discussions, although approvals will of course remain strictly compliant.

There are other issues than size that are relevant to the success of a commercial bank: service levels, product selection and interest rate levels, both on deposits and loans. But clearly asset size is a key determinant to dominance of a market.

The FGB-NBAD merger might mean just more of the same, only bigger. I am, however, excited to think that it is a quantum leap forward and the first of many more.

In my next article I will talk about how to make the FGB-NBAD integration work based on the assumption, my hope, that they are going for the quantum leap.

FGB/NBAD, let’s go big.

Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com.

business@thenational.ae

Follow The National’s Business section on Twitter

Brexit drove me to review the European Union and see if there are lessons to be learnt, especially in light of the economic challenges some of the member states have faced. The conclusion I have come to is that it is frighteningly easy to make well-meaning mistakes that can destroy an economy.

It is instructive to compare the United States and the European Union and see what light it sheds on how the UAE might make decisions about its economy. A full analysis would require a book; I will focus on a few directional ideas that might inspire.

When facing a financial test of the economy, conventional wisdom points to four solutions. The first is to inflate the economy out of it. This requires the ability to print money, something that the US Federal Reserve is able to do but no single EU member state can do, as they gave up that ability when they adopted the euro. The UAE is closer to the EU in this respect, as the dirham is pegged to the US dollar.

The second method is to devalue. For similar reasons as above, neither the EU nor the UAE can do this.

The third method is to inject massive amounts of liquidity by lowering interest rates, something the Fed has done so often that it has gained the name of the “Greenspan Put”. The ECB and the UAE’s Central Bank cannot do this, as they do not or cannot conduct open market operations – buying bonds to inject cash into the system, although the UAE’s sovereign wealth funds can repatriate large amounts of financial assets. Furthermore, the UAE Central Bank keeps its rate in lockstep with the Fed because of the dollar peg.

The more advanced Toxic Asset Relief Program had the Fed transfer banks’ toxic assets to its own balance sheet. The ECB certainly does not do this. The UAE does a form of this but does not use the central bank’s balance sheet, instead usually using sovereign wealth funds.

The final method, and the one preferred by the EU, is austerity. I think that when austerity destroys a member state’s GDP by 30 per cent in four years one should take notice and review this option.

Austerity means the government cuts its budget so that it remains balanced. As we saw with many EU countries, cutting the budget led to a further contraction of the economy, which led to lower tax revenue, and the vicious circle is refusing to end. This argument also challenges the concept that introducing taxes will help balance government budgets as taxes put a brake on business. The EU experiment reinforces such an idea.

In the UAE’s case the budget cuts and large layoffs are largely driven by oil price drops. So there is no vicious circle from a tax point of view. But as the government is such a large part of the economy, directly and indirectly, the vicious circle is manifesting itself in an ever-decreasing economy.

There is worse to come. Foreign markets are increasingly borrowing to finance a contracting economy that is driving large numbers of expatriates, with their savings and spending, out of the country. This leveraging, usually through the banks as intermediaries, is happening at a low cost because of the implicit sovereign guarantee of the government of Abu Dhabi. Think about it – if Abu Dhabi were to firmly state that there was no implicit guarantee, what would the banks have to pay in a true competitive market? What about Dubai Inc?

This lack of a competitive credit pricing mechanism based on the efficiency and effectiveness of institutions removes incentives to act in any capitalistic manner. It also drives the whole economy to overleverage. If investors hold off from deploying their funds, we could move to ever greater leverage, the liquidity trap that fuelled the Great Depression.

What to do? First is to understand that austerity should have happened when the times were good. That is when we should have worked to become more efficient. When times are difficult is the time to actually have an expansionary budget. We created jobs when we did not need to and are now cutting jobs precisely when we need to do the opposite.

The second is to understand that the goal of the economy is not austerity, it is consumption. Frightening people with no hope of getting a new job ends spending and further exasperates the slowdown.

Austerity sounds good: we are doing something. We are being sensible. We are being responsible. But history has shown us that this path is not the most effective. The EU is struggling while America, which has been under almost constant quantitative easing for the past seven years by borrowing to spend, is doing great.

This is the time to invest and spend. This is the time to focus on the domestic private sector and not the balance sheets of state-owned entities and Government-related entities investing abroad or on marquee projects. This is not the time to think of how many jobs we can cut – it is the time to think of how many jobs we can save and create.

Increasing employment is like planting seeds that grow and nourish our economy. Decreasing spending is like not watering our economy and leaving it to whither. Increasing employment, not decreasing spending, should be our aim.

Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com.

business@thenational.ae

Follow The National’s Business section on Twitter

Brexit drove me to review the European Union and see if there are lessons to be learnt, especially in light of the economic challenges some of the member states have faced. The conclusion I have come to is that it is frighteningly easy to make well-meaning mistakes that can destroy an economy.

It is instructive to compare the United States and the European Union and see what light it sheds on how the UAE might make decisions about its economy. A full analysis would require a book; I will focus on a few directional ideas that might inspire.

When facing a financial test of the economy, conventional wisdom points to four solutions. The first is to inflate the economy out of it. This requires the ability to print money, something that the US Federal Reserve is able to do but no single EU member state can do, as they gave up that ability when they adopted the euro. The UAE is closer to the EU in this respect, as the dirham is pegged to the US dollar.

The second method is to devalue. For similar reasons as above, neither the EU nor the UAE can do this.

The third method is to inject massive amounts of liquidity by lowering interest rates, something the Fed has done so often that it has gained the name of the “Greenspan Put”. The ECB and the UAE’s Central Bank cannot do this, as they do not or cannot conduct open market operations – buying bonds to inject cash into the system, although the UAE’s sovereign wealth funds can repatriate large amounts of financial assets. Furthermore, the UAE Central Bank keeps its rate in lockstep with the Fed because of the dollar peg.

The more advanced Toxic Asset Relief Program had the Fed transfer banks’ toxic assets to its own balance sheet. The ECB certainly does not do this. The UAE does a form of this but does not use the central bank’s balance sheet, instead usually using sovereign wealth funds.

The final method, and the one preferred by the EU, is austerity. I think that when austerity destroys a member state’s GDP by 30 per cent in four years one should take notice and review this option.

Austerity means the government cuts its budget so that it remains balanced. As we saw with many EU countries, cutting the budget led to a further contraction of the economy, which led to lower tax revenue, and the vicious circle is refusing to end. This argument also challenges the concept that introducing taxes will help balance government budgets as taxes put a brake on business. The EU experiment reinforces such an idea.

In the UAE’s case the budget cuts and large layoffs are largely driven by oil price drops. So there is no vicious circle from a tax point of view. But as the government is such a large part of the economy, directly and indirectly, the vicious circle is manifesting itself in an ever-decreasing economy.

There is worse to come. Foreign markets are increasingly borrowing to finance a contracting economy that is driving large numbers of expatriates, with their savings and spending, out of the country. This leveraging, usually through the banks as intermediaries, is happening at a low cost because of the implicit sovereign guarantee of the government of Abu Dhabi. Think about it – if Abu Dhabi were to firmly state that there was no implicit guarantee, what would the banks have to pay in a true competitive market? What about Dubai Inc?

This lack of a competitive credit pricing mechanism based on the efficiency and effectiveness of institutions removes incentives to act in any capitalistic manner. It also drives the whole economy to overleverage. If investors hold off from deploying their funds, we could move to ever greater leverage, the liquidity trap that fuelled the Great Depression.

What to do? First is to understand that austerity should have happened when the times were good. That is when we should have worked to become more efficient. When times are difficult is the time to actually have an expansionary budget. We created jobs when we did not need to and are now cutting jobs precisely when we need to do the opposite.

The second is to understand that the goal of the economy is not austerity, it is consumption. Frightening people with no hope of getting a new job ends spending and further exasperates the slowdown.

Austerity sounds good: we are doing something. We are being sensible. We are being responsible. But history has shown us that this path is not the most effective. The EU is struggling while America, which has been under almost constant quantitative easing for the past seven years by borrowing to spend, is doing great.

This is the time to invest and spend. This is the time to focus on the domestic private sector and not the balance sheets of state-owned entities and Government-related entities investing abroad or on marquee projects. This is not the time to think of how many jobs we can cut – it is the time to think of how many jobs we can save and create.

Increasing employment is like planting seeds that grow and nourish our economy. Decreasing spending is like not watering our economy and leaving it to whither. Increasing employment, not decreasing spending, should be our aim.

Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com.

business@thenational.ae

Follow The National’s Business section on Twitter

Britain’s referendum result on exiting the EU has been met with a flurry of responses from politicians and financial markets. The almost uniform negativity of the responses would, by itself, alarm the average global citizen. But I smell a rat.

I have a simple maxim that has served me well in life – when you want to know who won and who lost, listen for the most negative response. They are the losers.

The financial markets are being driven by the political arena and when there are sharp movements in financial prices it usually means that investors are overreacting, which always presents opportunities.

The current political narrative is that Brexit is a disaster for Britain as the EU will be closed for trade and employment and will also no longer benefit from being part of a large market and political block. Not only that, but we’re told that Brexit will now trigger the break-up of Britain as Scotland and Northern Ireland secede. But is this the only possible scenario? Could there be other scenarios from which one could profit?

Let us look at the idea that Britain will suffer. Using nominal numbers from last year, Britain has the second highest GDP in the EU after Germany. Its GDP is about 24 per cent larger than that of France, which holds the No 3 position. In terms of per-capita GDP, Britain ranks sixth, ahead of Germany, which is ninth, and France, which is 11th.

Britain’s GDP growth rate was 30 per cent greater than Germany’s and nearly double that of France. As for unemployment, Britain’s rate ranks as third lowest after Germany and the Czech Republic.

What about what Britain has to gain, net, from the EU?

There are a lot of numbers being thrown around, mostly because the gross gain and most of the gross benefit that Britain gives and gets are hard to compute. One detailed analysis earlier this year by The Telegraph estimates that the net contribution by Britain to the EU is about €11 billion (Dh44.73).

That makes for the argument that in terms of the economy Britain has far less to lose than the EU. Perhaps Britain will lose political clout? Let us take a look. Britain is arguably the closest ally to the world’s most powerful nation – the United States of America. As part of its close relationship with the US, Britain is part of the Five Eyes, a global alliance that shares intelligence information. With America as the lead member in the Five Eyes and Britain as the only EU member, that is another major loss for the EU in these difficult times.

Let us not forget the Commonwealth, an organisation of 53 countries that gives Britain a tremendous advantage in trade outside the EU, especially with emerging markets. Britain is also one of only five permanent members of the United Nation’s Security Council, giving it the power to veto major UN resolutions. Finally, Britain’s military is rivalled only by France’s in the EU.

So, the starting point for Britain does not seem to be nearly as weak as the current narrative would have us believe. But what does the future hold? Jean-Claude Juncker, the president of the European Commission, has turned completely hostile, and I would argue hysterical, to Britain and is demanding that it invoke Article 50, which begins the maximum two-year process for Britain to exit. Chancellor Angela Merkel of Germany has been much more balanced. Why the difference?

One reason is that Britain simply does not have to invoke Article 50 unless it wants to. If Mr Juncker continues to try to bully Britain, it could conceivably stay in the EU negotiating terms and bullying Mr Juncker back by vetoing everything that comes up in the EU parliament. This leads to the counter threat of the EU invoking Article 7 and suspending some or all of Britain’s rights, but at that point you are effectively killing the EU to get back at Britain. Germany will not allow it, no matter how much of a tantrum Juncker throws.

What might actually happen? Everyone could keep having a fit for a couple of months, at which point they will probably calm down. Then, either the EU could be “fixed” to satisfy the issues that Britain – and quite frankly many other countries – have with it, or Britain departs and negotiates trade and other mutually beneficial agreements that are similar to what are currently in place.

Is my line of reasoning 100 per cent correct? No, I cannot see into the future. But I believe that there is enough of an argument to be made that there has been a terrible overreaction. Now to figure out how to monetise it.

Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com.

business@thenational.ae

Follow The National’s Business section on Twitter

UAE must look at exports to spur economic growth

The recent contraction in the economy, poor performance of SMEs and large layoffs in the UAE have made clear the oft-cited statistic that two-thirds of the UAE’s economy is non-oil related is incorrect. At least it is indirectly related to the price of oil. So how can the private sector further diversify away from oil? The answer is exports.

The economy of the UAE can never be independent of oil if it remains insular. With about 1 million nationals, the size of the UAE’s economy, even with its ability to attract expats, will always be dwarfed by oil income in the near and medium term.

If this is the case then growing true non-oil GDP requires a rethink. One path to growth that is relatively independent of the domestic markets is exports. Export demand is dependent on international markets, most of which will have low correlation to our markets.

So what leads to exports? For emerging markets it is usually excess supply of production, often agriculture but sometimes commodities such as – surprise – oil. As countries become more developed, their exports become driven by lower production costs, higher efficiency and exchange rate advantages. An exchange rate can provide such important advantages that it has been the source of a long-running row between the US and China.

The pinnacle of export drivers is innovation. Think Apple.

Growth in exports allows a nation to become much richer than if it depended on its local economy only. The parallel is a person who sells more than he buys. It is important, then, to understand that the difference between exports and imports, known as the trade balance, is the important number.

The trade balance is not only integral to a nation’s GDP, it also affects its currency’s exchange rate. If the trade balance is positive and more goods are exported, gaining more foreign currency, than imported, selling less local currency, then the national currency strengthens. If the trade balance is negative then there is pressure on the national currency to devalue.

This means that the much vaunted dirham peg to the dollar will come under tremendous pressure to devalue when oil runs out and if there is no export-based economy. This is precisely why there is pressure on the Saudi riyal to devalue – lower oil prices mean lower exports, weakening Saudi Arabia’s trade balance.

This brings us to the question of how the UAE is doing on this front. The Federal Competitiveness and Statistics Authority provides us with some data. I will provide a directional discussion for 2014 on the non-oil trade balance and will ignore re-exports, which have a tertiary effect.

For 2014, the UAE’s non-oil trade balance was a deficit of Dh564 billion. To give this number context, if oil averaged US$100 in that year and the UAE exported 2.5 million barrels per day, then the revenue would have been about Dh335bn. That means that with oil exports the UAE had a negative trade balance of Dh229bn. That is cause for concern.

Looking at the breakdown, the greatest deficit comes from “pearls, stones, precious metals and its articles” for a total of more than Dh136bn. The UAE in 2014 had net imports of jewellery that was more than half the total oil sales in that year.

What I found fascinating was the entry “footwear, umbrellas, articles of feather & hair”, where we had net imports in excess of Dh5bn. We live in the desert so I assume umbrella imports are minimal. Hair would be wigs and hair extensions. Feathers, believe it or not, are far more versatile than you would think but still not a luxury item.

Which brings us to footwear. Let us assume, for illustrative purposes, that the only footwear imported in 2014 were Jimmy Choo pumps averaging $1,000 a pair. Let us also assume that umbrellas, wigs and feather products imported were valued at Dh1bn. That would imply that the UAE imported more than 1 million Jimmy Choo pumps. If we accept that women are not only buying Jimmy Choo pumps and that men are not into stiletto heels but more sensible, and cheaper, shoes then we are faced with the horrifying proposition that the population of the UAE might just have a shoe fetish.

The bottom line is that talking about GDP alone, even if we clarify non-oil related versus non-oil dependent, is not enough to diversify our economy. We need to look at exports. And we are way behind.

Sabah Al Binali is an active investor and entrepreneurial leader with a track record of growing companies in the Mena region. You can read more of his thoughts at al-binali.com.

business@thenational.ae

Follow The National’s Business section on Twitter