Country Report United Arab Emirates
The economy of the oil-rich United Arab Emirates is estimated to grow between 3-4% in 2013. Diversification efforts are increasing to reduce the dependence on the oil sector. Steady and continuous revenues from oil exports have resulted in a healthy fiscal position and a strong external (liquidity) position. The real estate sector in Dubai, which collapsed in 2009, has been recovering since 2012. The UAE has hardly been touched by the political turmoil in the Arab world, although youth unemployment is rising and is a source of potential unrest.
Economic structure and growth
The UAE is richly endowed with oil resources and is home to around 10% of the world’s total proven oil reserves. The UAE consist of seven emirates. Abu Dhabi is the largest and most powerful, oil-based traditional emirate. Dubai, which lacks oil resources, has a more modern atmosphere and depends on international retail, tourism and financial services. The other five emirates have always played a minor role. For almost four decades, oil and global finance have driven the UAE's economy. The UAE has accumulated substantial wealth, since the country’s per capita GDP is now on a par with those of leading Western European nations. In regional perspective, the emirates have, due to successful economic policies, a relatively diversified and open economy with a 25% share of hydrocarbons in total GDP in 2012.
But the economy's openness made it vulnerable to the global economic crisis of 2008-2009. Financial services, manufacturing, retail, as well as the hospitality and real estate sectors were severely hit by the downturn in regional and global growth, especially in Dubai. Dubai's property market collapsed in 2009. Real estate prices fell by as much as 60% as a result a host of ambitious projects was mothballed. The real estate market showed signs of recovery in 2012, even though prices remain below their 2008 peaks. A number of factors contributed to this recovery, including progress in Dubai on refinancing and restructuring its debt and the regional turmoil, which bolstered Dubai’s safe-haven status for foreign investment. Although the UAE emphasizes the importance of other non-oil sectors for future economic growth, the real estate market remains an important constituent of the UAE economy. In 2012, the real estate and the business services sectors accounted for 10.2% of GDP and construction for 11.4% of GDP in real terms (the latter also includes large commercial and infrastructure projects). Hence, property market trends will continue to have a bearing on the UAE's wider economic recovery.
Going forward, we expect oil output to fall and global oil prices to decline, which implies that the non-oil sector will be the main driver of economic growth in 2013. Also, consumer spending and investment should hold firm, since the UAE continues to benefit from its relative stability on the social-political front. Credit growth remains sluggish and is unlikely to increase significantly in the forecast period. The banking sector in general has remained well-capitalized and profitable, as the net interest margin has remained comfortable, despite a slight rise in non-performing loans in 2012. Going forward, we believe that UAE banks have worked toward healthier balance sheets, which should provide for improving credit conditions in the year ahead.
Economic growth is forecast at around 3-4% in 2013, but several downside risks exist. If tensions in the Middle East, such as the conflicts in Syria, Yemen or between Israel and Iran, would escalate, the drop in consumer and investor confidence would negatively affect trade, tourism and foreign investment in the UAE. More broadly, sluggish economic growth in the US and lingering eurozone crisis will subdue global oil prices. Also, UAE’s largest export partners are Japan, South Korea and Thailand, which are all dependent on exports to the US and Europe. Falling demand from the US and Europe, will therefore, in turn, reduce Asian demand for UAE’s exports.
Political and social situation
Historically, the UAE has one of the most stable political systems in the wider Arab region. The federation has maintained stability since unification in 1971. Even though the political system is inflexible and characterized by an almost complete lack of political freedom, there have been no reports of imminent upheaval since 1971. Political parties are not permitted, the President is Khalifa bin Zayed al-Nahyan. The distribution of power between the emirates and the federal government is hardly contested, with the overall balance of power firmly and increasingly tilted in Abu Dhabi’s favor due to its relative large size and wealth, but latent rivalries between and within individual emirates do exist. Government institutions may change, but society will remain overwhelmingly tribal and dominated by clans and patronage.
The UAE has hardly been touched by the political turmoil in the Arab world. The economic and social factors that have contributed to the unrest elsewhere in the region are less pronounced in the UAE. With more than 80% of the labor force consisting out of expatriates, the country’s small national population of less than one million enjoys a high living standard in a - from a regional perspective at least - relatively open and tolerant society. Nationals enjoy financial advantages through generous social security and housing programs. But unemployment among nationals is high, estimates hover around 20% of the national labor force, especially among the youth, and concentrated in the smaller Emirates. ‘Emirization’ of the labor market is thus a high political priority. The income disparity (millionaires vs. underpaid migrant workers) is extremely wide and a potential source of social tensions.
The UAE government has not been outspoken on the Arab Spring protests in the region. There is no doubt the government is concerned about the potential longer-term fallout, not least given the heightened tensions in Bahrain. With regards to Bahrain, the UAE has similar fears as Saudi Arabia; it not only fears the possibility that a Gulf monarchy could be overthrown, but also the possibility of a Shi'a state emerging on the Gulf that could serve to boost Iran's sense of influence and power in that area. Yemen's continued descent into political turmoil is another major concern for the UAE due to Al-Qaeda's resurgent presence in the country. The UAE will likely continue to take pro-active measures to mitigate domestic social tensions, while aligning its regional response with that of its fellow Gulf Cooperation Council (GCC) countries.
The general focus of the UAE’s economic policies is to diversify the domestic economy and support economic growth. The UAE sees its status as a trade and tourism hub as vital to economic growth, especially since the focus has shifted somewhat away from real estate. Dubai’s government recently announced the resumption of projects worth USD 1.1bn that had been postponed in 2009 after the burst of the real estate bubble. The government also announced plans to develop a mega-project entitled Mohammed bin Rashid City, which will boast the world's largest shopping centre and 100 hotels. Abu Dhabi will also spend heavily on large-scale infrastructure projects such as the Khalifa Industrial Zone Abu Dhabi (Kazid) and Masdar City. Diversification and rapid growth in electricity usage will put pressure on gas supplies, encouraging the government to forge ahead with the development of alternative energy sources. As part of this effort, it has awarded a license to build the first of four 1,400-mw nuclear reactors. While the UAE will continue to diversify its economy away from oil, it will also invest in increasing oil output in the longer term. The federal government will, furthermore, continue to improve the business environment to encourage foreign investment. A concentrated effort will be made in the forecast period to expand employment opportunities for Emiratis in the private sector, although public-sector wage increases will undermine efforts to entice Emiratis away from public-sector jobs.
The aggregate fiscal position of the UAE is in healthy shape. The 2013 budget envisages a 6.7% increase in spending. However, despite increased government spending, the fiscal balance is expected to remain in surplus (3.1% of GDP) in 2013, as a 7.7% increase in revenues is anticipated as well. Abu Dhabi National Oil Company’s profit transfers and Abu Dhabi Investment Authority’s (ADIA) investment income are the most important sources of revenues. Furthermore, there are no income taxes, while only foreign banks and foreign energy firms pay ‘charges’. Introducing broader taxation (on incomes and a VAT) is still under consideration. Therefore, revenue levels are largely determined by international oil prices developments. At the level of individual emirates, non-oil-endowed and indebted Dubai continues to report deficits. These are decreasing and are compensated by the abundant oil-based surpluses of Abu Dhabi. The minimal oil price needed to break-even the consolidated budget increased from USD 30 per barrel in 2003 to around USD 92 per barrel in 2013. This higher minimum break-even price reflects much higher government expenditures and is a risk in the event of declining oil prices. We expect public debt to decrease to 35% of GDP in 2013 from 40% in in 2012.
Average annual inflation is down from around 12% in the boom years to only 1-2% since the financial crisis of 2009, as especially easing rental prices kept inflation low. Inflation is expected to average a modest 1-2% in 2013 as well. Although the decade-long, uncontested and still credible peg of the UAE dirham to the low yielding USD severely restricts the use of interest rate policies to steer the economy, the peg provided some degree of economic and financial stability over the past decades. In 2009, the UAE withdrew from the dollar-dominated Gulf Co-operation Council monetary union project, due to UAE-Saudi rivalry over the location of the seat of the GCC’s central bank. The present peg is expected to remain in place.
Balance of Payments
The current account is in healthy shape. It has posted an average surplus of 5.7% of GDP in the past five years and, in 2013, is expected to post a surplus of 5.4% of GDP. The trade balance is the main pillar of these consistent current account surpluses, with an expected surplus of 18.2% of GDP in 2013. The UAE structurally records large trade surpluses ranging from 15-26% of GDP due to its large oil exports. These are supplemented by small surpluses on the income balance (profits and interest); a surplus of 0.1% of GDP is expected in 2013.The services and transfer balances show structural deficits, which in 2013 amounted to 9.9% of GDP and 2.9% of GDP, respectively, due to expatriates (8% of the population) transferring funds to their families abroad. No significant changes are anticipated in 2013, but a significant and unexpected swing in the oil price or an accelerated growth slowdown in Asia, the UAE’ largest export market, represent important downside risks. The consistent annual current account surpluses are reflected in the stock of official FX-reserves, which is expected to grow to USD 47bn by end-2013, up from USD 42bn end-2012.
The external debt of the UAE amounted to 41% of GDP in 2012 and is expected to decrease to 35% of GDP in 2013. Most of the external debt is owed by Dubai, whose high external debt burden has reached over 100% of its own GDP. Total gross foreign assets of the UAE are difficult to estimate, as the ADIA does not publish any data, but estimates range from USD 300bn to USD 600bn. With total foreign debt at USD 158bn end-2012, this would result in a substantial positive net external asset position. Moreover, the net external position of the UAE is projected to improve further, given the expected continuation of current account surpluses.
The UAE’s external liquidity indicators are not as strong as those of many other oil exporting countries. Official FX reserves cover less than 3 months of imports, but when the foreign assets of government regulated and owned ADIA are included, the import cover increases dramatically to around 20 months. Similarly, other liquidity indicators improve dramatically as well. In terms of ability to pay there is little to fear in the medium term for federal UAE or exposures explicitly backed by Abu Dhabi.