How will a UAE stock market correction impact on the real economy?

The UAE stock market seems to have entered a period of sharp correction and has retraced more than a quarter of its value since the end of June. If this textbook adjustment follows the normal pattern, there should be more volatility and a further downward shift, with perhaps a bear-market rally along the way down.

But UAE observers with longer memories can be forgiven a sense of déjà-vu. This sudden upsurge in share prices, with shares in Emaar Properties leading the upward charge, is remarkably similar to what happened in 1998. Then, as now, the market was driven to unsustainable valuations by mindless speculators who got burnt when the market headed south.

It is interesting to reflect on what happened to the UAE real economy in 1999 and 2000. It is true that one or two projects got cancelled in this period, a $500m theme park for example, but not much else followed. Property rental prices stabilized, but those who were waiting for a crash were disappointed.

The recent Nomura report on 'The Great Arabian Bubble' drew a neat comparison with the performance of the Chinese stock market in the early 2000s. The Chinese bourse also hit unrealistic highs and crashed from a peak in August 2000 and has still not recovered today. Yet the real economy in China has boomed in this period.

Could the same pattern be repeated in the UAE in particular and GCC in general? With oil trading at record levels above $60 a barrel this is surely the most likely scenario. Even with oil at $10 a barrel in 1998, the UAE still underwent a shallow downturn rather than a recession.

Today a stock market crash would have some implications, but it might actually have some benefits too. Some of the projects with more economically-challenged business cases might be cancelled, as the IPOs and rights issues to fund them will now be impossible.

This is a sign of capital markets working to protect share values and preventing excessive investment by over-optimistic managements. In a very real sense the market itself is judging what level of investment the UAE economy can handle, and is saying 'hey, hold on a minute guys, isn't this getting a little out of hand?'

So could a share price correction in the UAE bourse at this stage actually prove beneficial to the real economy and protective of existing and many planned projects? This might seem another over-optimistic conclusion but it could be the correct one, and the recent experience of China suggests this is likely to be true.

The other pertinent question is where does the investment capital go to next, if a stock market correction undermines the stock exchange as a home for spare cash?

To take the Chinese example again, real estate is the most likely beneficiary. Shanghai house prices have undergone their own correction this year but have increased several fold since the 2000 stock market correction. Dubai's new commodities exchanges should also benefit as an alternative investment opportunity, and private equity funds.

Thus a UAE stock market correction is probably only a serious problem for the individuals who get caught long on falling share prices. Sadly some real hardship for them is bound to follow. But the real economy will roll with the punch and bounce back, particularly if the authorities are clever with liquidity management.