The United Arab Emirates and other Gulf countries could face major financial repercussions if the eurozone debt crisis spreads from the bloc's peripheral states to its core and infects global markets, the International Monetary Fund said.
Risks are particularly serious for economies that depend on foreign financing and have financial links to Europe, the IMF said in a report dated 27 April, which it prepared for consultations with the UAE and released in June.
"While vulnerabilities have decreased since 2008, the results of this analysis nonetheless suggest that the (UAE) authorities need to remain vigilant to global shocks and continue to strengthen buffers."
The banking system of the UAE, the world's No. 3 oil exporter, is only moderately exposed to Europe, the IMF noted. Foreign liabilities are about 19 per cent of its total liabilities, while Europeans hold about 20 percent of UAE banking system assets.
"While the estimated level of financial spillovers to Dubai is once again increasing, it is still below 2008-09 levels. European countries, Greece in particular, have been key contributors."
The IMF also said the UAE banking system did not show any signs of distress now, while the probability that all its banks would experience large losses simultaneously was very low.
However, the report added: "The results of this analysis show that risk is concentrated in a few banks; these banks will need stronger supervision and closer monitoring of their cross-border and their domestic interbank exposures."
Any worsening of the pressures on euro zone governments and banks to fund themselves would pose a direct risk for the UAE, the IMF said. Despite solid economic growth last year, Dubai is still recovering from its 2009-2010 corporate debt crisis.
"While the funding situation of local banks has stabilised, a foreign funding shock could generate some liquidity tightening in the banking sector," the report said.
It predicted the asset quality of UAE banks would deteriorate this year and the number of bad loans would rise, although the banking sector would be able to handle a significant increase.
Seven out of 26 listed companies in the UAE's real estate sector, with total liabilities of $12 billion, have operating losses or do not have sufficient operating income to service their debt, it said.