Country Report United Arab Emirates
Although the UAE’s economy is more diversified and less dependent on the oil sector than the surrounding Gulf States, it is strongly affected by the decreasing oil price since the second half of 2014. For 2015, a serious decrease of the trade and current account balances is expected together with a budget deficit of approximately 5% of GDP. Although the real estate prices have slowed down after a two years growth surge, a new speculative bubble might appear.
Author: Jan-Willem van Tongeren (trainee)
Strengths (+) and weaknesses (-)
(+) Strong external position
Although UAE ‘s economy has been affected by the decreased oil price, the government is able to finance the fiscal deficits for many years given its large net foreign asset holdings, which means the UAE is a net external creditor.
(+) Sound monetary policy
The long-standing and credible exchange rate peg of the Dirham to the US dollar has kept inflation low, averaging only 1.2% in the past five years.
(-) Weak labour market
The unemployment rate of native Emiratis is at around 15% in 2013, as they lack the job skills and incentive to work in the private sector, given high public sector salaries and government handouts.
(-) Rigid political system
The non-democratic political system means the large oil wealth is held mainly by the elite; the ruling families, while freedom of speech for proponents of political reform is highly restricted.
1. Economic growth expected to decrease on the back of low oil prices
Abu Dhabi and Dubai are the two largest emirates out of the seven and the only significant regions driving the UAE’s economic growth. Abu Dhabi and Dubai account for 60% and 30% of the UAE’s economy, respectively. Although the UAE’s economy is more diversified and less dependent on the oil sector than surrounding Gulf States (non-oil contribution amounts to 61% of GDP and 25% of the current account receipts in 2013), the decreased oil price has seriously harmed the economy. This will not only have consequences for the oil sector but also for the non-oil sector (predominantly transport, trade and logistics). As the UAE’s non-oil sector has benefitted from rising public expenditures in neighboring countries, the decreased oil price will likely urge these countries in cutting off their spending. Dubai’s tourism sector, for example, depends on visitors from the Gulf region and its logistics activities on infrastructure projects across the region. The decrease of the oil price will harm the economy in 2015, leading to an expected growth of about 3%, down from 4.6% in 2014, a very strong decrease of the current account surplus from 11% of GDP in 2014 to 1.3% of GDP, and a budget deficit of about 5% of GDP compared to a surplus of roughly 4% of GDP in 2014. This situation will not improve as long as the oil price is below the UAE’s fiscal break even oil price of USD 80/bbl. However the UAE is able to finance the fiscal deficit for a prolonged period from their sovereign wealth funds (e.g. Abu Dhabi Investment Authority).
In the past decade, the UAE has built up considerable offshore financial assets from their current account surpluses. This is also the explanation why their relative small FX reserves (import cover 3 months) is not seen as a risk. The UAE’s public debt is stable around 43% of GDP in 2014, including government-related issuers (GRI’s). The public debt is predominantly domestically held, especially by local banks. Although the banking sector is well capitalized, it is for a large extend exposed to GRI’s with non- performing loans (especially Dubai banks). The number of (non-performing) loans to GRI’s decreased over the past few years. However from 2013 onwards, banks continued to increase their exposure to the government and GRI’s again, driven by a recovering property market.
2. Asset bubble?
After the burst of the real estate bubble in 2009, property prices in the UAE fell markedly from their highs in 2008. Consequently (foreign) demand and financing for the property sector dried up. Since the end of 2011, the property market has recovered, especially the residential market. The recovery started in Dubai and Abu Dhabi followed suit. From January 2012 to the end of 2014, house prices in Dubai increased enormously, with price increases averaging around 21% annually (source: Global property Guide). As by some measures nominal residential property prices in Dubai have reached their 2008 peak, the question is if a new real estate bubble is being created. However, the situation in the real property market today is different from 2008 in that price increases still partially reflect a recovery from the crisis and demand is significantly less bank-financed. To prevent the property market from overheating and speculative demand, the UAE’s authorities have implemented new mortgage regulations (e.g. a LTV based-mortgage cap) and increased property fees at the end of 2013. It seems that these measures, combined with a continuous stream of new project launches and completions, have had the desired effect, as property prices increases flattened and even decreased at the end of 2014. It is expected that this situation will continue in 2015. However further tightening of macro prudential measures might be required if the current price decrease occurs for only short term and property prices and real estate lending would accelerate again.
3. Geo-political tensions in the Gulf region
Although known as a safe-haven in the Gulf region, the UAE is involved in several regional conflicts, as it supports the coalitions against IS in Iraq/Syria and the Houthi rebels in Yemen. The support is no longer limited by political support, but also demonstrated by taking part in military operations. These interventions and geo-political tensions can have a growing impact on the stability within the UAE and in a worst case could disrupt financial- and trade flows. The regional situation is very complicated, especially as these conflicts are predominantly based on the contradiction between Shiites and Sunnites. The UAE maintain good relations with its ally Saudi Arabia. On the other hand, the UAE can benefit from the easing of the international sanctions on Iran (nuclear program) as Iran is one of the UAE’s main export markets.
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 39% share of hydrocarbons in total GDP in 2013.
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.