RaboResearch - Economic Research

United Arab Emirates: weathering low oil prices on the back of large buffers

Country Report


UAE flag

Although the UAE’s economy is more diversified and less dependent on the oil sector than the surrounding Gulf States, low oil prices will continue to negatively affect economic and fiscal metrics. Despite the expected twin deficit in 2016 and 2017, we won’t expect any problems in meeting financing requirements due to UAE’s considerable sovereign wealth fund.

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.

(+) Attractive business climate

The business environment is reasonably attractive, with high quality infrastructure and flexible labour market institutions. In addition, the long-standing and credible exchange rate peg of the Dirham to the US dollar provides economic stability.  

(-) 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.  

Key developments

1. Widening twin deficit is manageable

The rapid drop in oil prices that began mid-2014 will continue to put pressure on economic activity within the UAE economies. At least until 2018, a sharp rebound in oil prices is not be expected, as e.g. the return of Iran to global market will contribute to a situation where supply outpaces demand for hydrocarbons. We expect economic growth to slow to 1.1% in 2016 and 1.7% in 2017, coming down from 4.6% in 2014 and 3.3% in 2015. In addition, the current account shows deficits as well, suffering from plunging export values as a result of the low oil prices. Oil and gas account for roughly two-thirds of general government revenues.[1] In order to mitigate the negative impact of low oil prices on the fiscal balance, the government has taken aggressive spending cuts in 2015 by more than 20%. Among other things, public investment project have been cancelled and energy subsidies have been brought down. These measures in combination with larger revenue contributions from non-oil activities have reduced the breakeven oil price from $80/bbl in 2014 to $62/bbl in 2016.[2] However, this is still not sufficient to prevent the budget balance to dive deeper into the red: -7.6% in 2016, down from -3.9% in 2015. Despite the large expected twin deficit and rapidly rising public debt ratio (76% in 2016, up from 44% in 2014), the UAE won’t face any problems meeting its financing requirements. First of all, the UAE has accumulated much of its financial surpluses from oil revenues over the last decades into substantial sovereign wealth funds (SWF’s). The sheer size of these funds is enormous: UAE’s SWF’s would be able to cover 32 years of 2016/2017 budget deficits (assuming a 0% return). Second, the UAE is much more diversified than its Gulf peers: the non-oil sector contributed roughly two-thirds to GDP in 2014.[3] In addition, the growth perspectives of the non-oil sector are still promising, which improves resilience of the UAE economy to weather continuing low commodity prices. The World Expo 2020 in Dubai will provide a boost to the construction sector and tourism. More in general, tourism in the UAE will continue to benefit from the persistent political instability in the MENA area, as places such as Dubai are considered relatively safe by both tourists as well as investors. The lifting of economic sanctions against Iran beginning of this year provides trade and investment opportunities, most notably for Dubai, which poses a relative accommodative stance towards Teheran compared to other Gulf states.

Figure 1: Oil price well below breakeven
Figure 1: Oil price well below breakevenSource: IIF, Rabobank
Figure 2: Large oil reserves and SWF
 Figure 2: Large oil reserves and SWF Source: BP, SWI institute, PWC, Rabobank

Declining oil revenues have dampened the growth of new deposits at banks, while loan growth has continued at a steady pace. In response, some local banks went overseas for funding, increasing their exposure to foreign liabilities. Nevertheless, banks are still well capitalized and we would expect the government to claw back SWF assets overseas, in case of liquidity or funding problems of banks.

 2. Fed rate hike poses a challenge

The UAE currency’s (emirate Dirham) peg with the US Dollar is regarded as an important contributor to economic stability. However, the anticipated rate hike by the Fed would have to be followed by UAE monetary authorities. Although the higher interest rate would help to somewhat reduce the relatively fast increasing inflation, the appreciation of the Dirham could hurt competitiveness of the non-oil sector, making tourism more expensive and pushing up real estate prices. However, de-pegging the Dirham is not an option. Although oil revenues and the non-oil sector would benefit from a depreciation in the short term, investors would be spooked, which could possibly trigger substantial capital flight and cause inflation to accelerate at an even higher pace.

3. Political stability will remain in place

From a political standpoint, the UAE is one of the most stable Gulf states, with no history of terrorism, homegrown tendencies towards extremism or political disputes whatsoever. The UAE, however, is actively involved in the war against Islamic State in Iraq. UAE’s sophisticated security apparatus will prevent any attacks resulting in large-scale casualties, but so-called ‘lone wolf’ incidents cannot be ruled out, which could potentially harm tourism. Meanwhile, the UAE will continue its careful balancing act in managing political ties with both Saudi-Arabia and Iran. Finally, the imminent transition of leadership from ailing president Khalifa bin Zayed to crown prince Mohammed bin Zayed won’t undermine political stability, as much effort has been put into strengthening cohesion between the federation.

Factstheet of UAE
Factstheet of UAESource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

[1] IMF (2015), IMF Country Report No. 15/220.

[2] IIF (2016), UAE: Resilient, but facing challenges.

[3] BMI (2016), United Arab Emirates. Country Risk Report, 2016Q2.

Background information

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. From a regional perspective, the emirates have, due to successful economic policies, a relatively diversified and open economy with a 34% share of hydrocarbons in total GDP in 2014. The business environment is reasonably attractive, characterized by high-quality infrastructure, a flexible labour market institutions and beneficial taxation regime. But the state also has substantial progress to make, with investment in education and training of Emiratis as well as decreasing fiscal vulnerability as the most prominent areas of improvement. Historically, the UAE has one of the most stable political systems in the wider Arab region. 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. 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. Although Khalifa bin Zayed still is president of UAE, crown prince Mohammed bin Zayed has been consolidating his power ever since the president fell ill in 2014. 

Economic indicators of UAE
Economic indicators of UAESource: EIU  
Hugo Erken
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 6 2223 1650

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