UAE VIEWS ON GLOBAL FINANCIAL TURMOIL

S E C R E T ABU DHABI 001287

TREASURY FOR D/S KIMMITT, U/S LEVEY, U/S MCCORMICK
NSC FOR DPRICE
STATE FOR EB

E.O. 12958: DNG: CO 11/10/2032
TAGS: AE ECON IR
SUBJECT: UAE VIEWS ON GLOBAL FINANCIAL TURMOIL

Classified By: Ambassador Olson for reasons 1.4 b and d.


1. (C) Summary. On 27 and 28 October 2008, Treasury Deputy
Secretary Kimmitt and Ambassador Olson met with officials
from the UAE Central Bank, UAE Ministry of Finance and Abu
Dhabi sovereign wealth funds. Kimmitt discussed the USG
response to the global financial turmoil and prospects for
the U.S. economy, solicited input on the regional
implications, stressed U.S. commitment to open investment
principles, encouraged continued vigilence with respect to
Iran, and assured that transition planning was underway at
the Treasury Department to ensure a smooth handoff to the
next administration. End Summary.

Lehman Collapse Rattles Abu Dhabi
--------------


2. (C) D/S KIMMITT DESCRIBED U.S. STEPS TO PRESERVE STABILITY
IN THE FINANCIAL SECTOR. ABU DHABI INVESTMENT COUNCIL (ADIC)
OFFICIALS QUESTIONED KIMMITT ABOUT THE USG DECISION TO ALLOW
THE FAILURE OF U.S. INVESTMENT BANK LEHMAN BROTHERS. ADIC
MANAGING DIRECTOR KHALIFA AL KINDI REPEATED SPECULATION THAT
LEHMAN'S COLLAPSE WAS PART OF A DEAL WITH THE U.S. CONGRESS,
PAVING THE WAY FOR THE $770 BILLION EESA PACKAGE. KIMMITT
EXPLAINED THAT THERE WAS NO BUYER FOR LEHMAN AS THERE WAS FOR
BEAR STEARNS, AND THAT AT THE TIME TREASURY LACKED THE
AUTHORITY TO INJECT CAPITAL OR TAKE OTHER STEPS. (COMMENT:
ADIC'S DIRECT AND SUSTAINED QUESTIONING ON THE LEHMAN
BROTHER'S COLLAPSE SUGGESTS THAT THE SWF LIKELY SUSTAINED
LOSSES FROM HOLDING LEHMAN DEBT INSTRUMENTS. END NOTE.)


3. (C) ADIC OFFICIALS QUESTIONED KIMMITT ON THE
SECURITIZATION PROCESS AND HOW IT SHOULD BE CHANGED,
SPECIFICALLY TO CONFRONT THE CONFLICT OF INTERESTS RESIDING
AT THE CREDIT RATING AGENCIES. KIMMITT STRESSED THE NEED TO
REACT, BUT NOT OVERREACT, POINTING TO THE IMPLEMENTATION OF
SARBANES-OXLEY AS AN EXAMPLE OF AN OVERREACTION. ADIC
OFFICIALS ASKED IF WE COULD EXPECT NEW REGULATION COVERING
AREAS SUCH AS HEDGE FUNDS, SHORT SELLING AND COUNTERPARTY
RISK. ADIC STATED THAT IN GENERAL, HEDGE FUNDS ARE DOWN
30-50% ON THE YEAR, THAT MANY CANNOT SURVIVE, AND THERE WILL
BE RIPPLE EFFECTS AS THEY COLLAPSE.


4. (C) ADIA chief investment strategist Jean-Paul Villian
stated that the U.S. financial system appears poised to move
out of the crisis phase and markets are beginning to
refunction., He believes massive fiscal stimulus programs
are needed to re-inflate the economy, matching the steps
taken to support the financial sector. he noted that the
normal cycle is starting to take place, with savings up and
inflation down. Villian believes the key to a strong recovery
lies with U.S. consumer confidence.

Picture of a Bailout
--------------


5. (C) ADIC MD Al Kindi and UAE Central Bank Governor Sultan
al Suwaidi described the effects of the credit and equity
market turmoil on UAE finances. They pointed to a number of
events challenging UAE's banking sector, including, the
freezing of international credit markets, substantial
outflows of foreign capital speculating on a dirham
revaluation (approximately 150 billion dirham),aggressive
local lending for the last several years resulting in loans
outpacing deposits by 15%, and some CDO exposure. As a
result, local banks put 'full brakes' on lending. Where the
UAE economy grew at 15% last year, Al Kindi expects it will
slow to 4-5% growth next year. According to Al Kindi,
deleveraging in Dubai is occurring, debt instruments will
come due, banks won,t lend, and Dubai will sell assets.
Inflation will drop from 15% to 5%. (Note: $1 buys 3.67 UAE
dirham. End Note.)


6. (S) In order to support the UAE economy and financial
system, all liquid instruments from ADIC will be injected
into local banks, according to Al Kindi. he estimated that
over the next 12 months, UAE banks will need 80 billion
dirham to cover the 4-5% GDP growth, and the government will
need to inject a total of 200 billion dirham into the
financial sector. (Note:This figure includes already
announced injections and liquidity measures totaling 70
billion dirham. End note.) as a result, Al Kindi anticipates
that the UAE must come up with approx. 150 billion dirham for
the next twelve months, assuming current conditions hold.
(Note: ADIC owns majority stakes in Abu Dhabi's two largest
banks and is the primary Abu Dhabi SWF charged with backing
the growth of Abu Dhabi's economy. End note.)


7. (C) Contrasting with Al Kindi,s admissions, UAE Central
Bank Governor al Suwaidi separately stated that deposits from
Abu Dhabi SWFs into UAE banks had not come in a significant
way, and will not be needed. He said that when interbank
lending returns, normalcy should return., (Note: ADIC MD
Al Kindi is known for providing blunt and accurate
assessments to USG officials, while the Central Bank Governor
has been a more elusive interlocutor. End note.) The Governor
said the UAE banking system stands at 1.4 trillion dirham, or
slightly over two times UAE GDP.


8. (S) If Abu Dhabi decides to place a floor under the
falling UAE equity markets, ADIA and the Abu Dhabi Department
of Finance will be called upon, according to Al Kindi. During
a meeting with ADIA officials, UAE Central Bank chairman
Khalil Foulathi asked for Treasury views on emerging market
governments acting to support local equity markets, citing
Hong Kong's 1998 intervention. (Note: such questioning seems
to indicate that the UAEG is considering some form of
intervention in the UAE equity markets, which have plummeted
in the last two quarters. End note.)


9. (S) Al Kindi warned that the UAE federal guarantee of bank
deposits did not stem the flight to safety within the UAE
banking system, i.e. depositors are moving accounts from UAE
banks perceived as weaker to those perceived to have stronger
balance sheets. He said that banks will be merged and
recapitalized. He noted that ADIC was buying National Bank of
Abu Dhabi and Abu Dhabi Commercial Bank debt instruments
trading at a 12-18% annualized return, as a default on the
this paper is tantamount to an Abu Dhabi default.


10. (C) Addressing the Central Bank's attempts to increase
liquidity, Foulathi admitted that the UAE Central Bank has
never had discount window operations before. Setting up this
function both at the Central Bank and within the commercial
banks is taking time, causing under utilization of the
liquidity facilities. Central Bank Governor al Suwaidi
quantified utilization of Central Bank lending facilities at
15% of available amounts, which in his view demonstrates that
the balance sheets and liquidity positions of local banks are
stronger than expected. (Note: Governor al Suwaidi can be
less forthcoming than some of his peers when sharing problems
in the UAE banking sector. End note.)

Pressures in the Interbank Lending Market
--------------


11. (C) Regarding the debt obligations of UAE banks, Central
Bank Governor al Suwaidi stated that local banks had some
exposure to medium-term notes and Euro Commercial Paper (9.9%
of total assets); however, maturities had not come in yet. Al
Suwaidi noted that interbank lending amounted to 12.7% of
total assets, most of which is UAE interbank. Foulathi and al
Suwaidi agreed that liquidity measures and government
guarantees has eased the pressure from three weeks ago.


12. (C) Governor al Suwaidi pointed out that other GCC
countries announced similar liquidity and confidence
measures, however, UAE,s banking sector was far more exposed
to the international financial system. For example, he noted
that the UAE receives 50% of all GCC SWIFT messages.


13. (C) The Governor advocated greater cooperation among GCC
states to dampen the impact of the crisis. in particular, he
pressed the need for the GCC to announce a GCC guarantee on
all GCC interbank lending, as the interbank market in the UAE
and between the UAE and foreign banks was not
functioning., He advised that the GCC countries were split
over this issue, with some members afraid that such a move
would signal a bigger problem to already nervous investors.

Necessary Rebalancing in Sight
--------------


14. (C) UAE Central Bank Chairman Khalil Foulathi explained
that risk taking in the UAE increased as oil prices rose,
resulting in greater lending in the commercial and retail
sectors. Bank lending went from 300 billion dirham in 2004 to
900 billion dirham in current year. During the currency
speculation period, Foulathi explained, the Central Bank
tried to sterilize the massive increase in the money supply,
but banks got excited and over lent as if the hot money
deposits were a stable base to lend against. He likened the
situation to a 'dream' and a 'party;' the banks got caught
when the currency uncertainty dissolved, credit markets froze
and oil prices dropped.


15. (C) Looking down the road, Foulathi noted the positive
outcome of the crisis in that a healthy dose of reality will
be served into real estate growth and prices. During the
correction, the government may need to support some firms in
the real estate sector in order to manage confidence and
ensure an orderly transition.


16. (C) Commenting on the real estate market in the UAE,
Central Bank Governor al Suwaidi suggested that according to
economic data, the UAE needs more hotel rooms and hotel
apartments, as high prices were discouraging foreign
tourists. hHe offered that some developments intended for
other purposes may reposition into this market. In the leased
apartment and office market, he speculated that most
buildings are controlled by single owners with deep pockets
who will not have to sell at low prices. As such, the
Governor does not expect a disorderly correction in the UAE
real estate market.


17. (C) The Central Bank Governor expected inflation to be
reduced dramatically, likely coming in under 10% for 2008
annualized. He pointed to anecdotal data that steel and
cement prices were off 50% from their recent highs. UAE
Ministry of Finance Under Secretary Younis al Khoori advised
that the UAE was in the process of reformatting its consumer
price index. He expressed appreciation for the support
received from the U.S. Treasury Department,s Office of
Technical Assistance, which is currently evaluating UAE,s
request for assistance in standing up a fiscal policy unit.

A New Day for Central Bank Oversight?
--------------


18. (C) ADIC MD Al Kindi stressed that the financial sector
needs better oversight by the Central Bank to prevent
excessive risk taking. He complained that local banks do not
respect the Central Bank and advised that a new board was put
in place that will strengthen the institution,s regulatory
and oversight functions.


19. (C) Acknowledging criticism of poor regulatory oversight
by the Central Bank, Governor al Suwaidi informed that the
regulator is gearing up for thorough revision., He said
that the UAEG is planning to be very harsh in its review of
bank balance sheet and lending practices. He admitted that
real estate is a significant portion of bank exposure and an
important source of doubt internally and externally. The
Governor stated that the they would publish all numbers and
be transparent,, a process he anticipated would be
painful.,


20. (C) The Governor said that going forward, UAE banks will
only be allowed to grow as deposits grow. If they are
overleveraged, they must shrink their leverage first.


21. (C) The Governor announced that a decision has been made
at the federal level, but not implemented, to integrate
banking and insurance regulation under the Central Bank. This
move will leave only capital markets outside of Central Bank
regulatory authority, and better position the UAE to move
ultimately to a single regulator.

Praise for SWF Initiative
--------------


22. (C) ADIA board member and Abu Dhabi Executive Council
member Hamad al Hurr al Suweidi praised the collaborative
work of ADIA, GIC and U.S. Treasury on SWF best practices,
and expressed satisfaction with the Santiago principles. He
thanked Treasury for its support and noted Kimmitt,s January
2008 Foreign Affairs article that served to anchor and frame
the public debate. Hamad described ADIA,s outreach efforts
to introduce ADIA to recipient countries, including visits to
UK, France, Germany, Japan, Australia and other nations. He
noted that ADIA has always advocated the U.S. approach to
foreign direct investment, and has encouraged other countries
to emulate the U.S. CFIUS process, which keeps the U.S. open
to foreign investment and only reviews cases with national
security concerns.


OLSON