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27 January 2019

UAE: Present tense, future perfect?

A few years of low oil prices may have proved bitter medicine, but the UAE’s economy is now fighting fit


When fireworks spurted from the Burj Khalifa on 1 January 2019, the UAE greeted a very uncertain world. A crescendo of populist policies, trade tensions and jittery markets have left investors’ nerves in shreds. Political chaos endured in the US while political paralysis continued in the UK. China, whose economic growth has defied critics for years, is nursing a sharp downturn.

Brexit, trade tensions and higher interest rates may be conspiring to end 10 years of steady, albeit modest global growth. Fortunately, the UAE is facing whatever 2019 may bring from a position of strength. S&P recently surmised that the Abu Dhabi Government’s substantial net asset position will shield it against almost all possible external shocks, and the UAE’s capital will be generous towards the other emirates should they need support.

The rating agency predicts that economic growth will steadily recover and that the country’s fiscal position will remain strong over the next two years. “The exceptional strength of the Government’s net asset position provides a buffer to counteract the effect of oil price swings on economic growth, government revenues, the external account, and increasing geopolitical uncertainty in the Gulf region,” the rating agency said.

 It seems lower oil prices from 2014 were a blessing in disguise. While the economy spent a few years in the doldrums, UAE governments stepped up their diversification efforts and began weaning the country off hydrocarbons. Now prices are rising again, the UAE can underscore its investment in broadening the economy.

A happy combination of rising oil production, government infrastructure spending in Dubai, as well as Abu Dhabi’s fiscal stimulus package should all help its cause. Moody’s has forecast a GDP growth of 2.2 per cent in 2018 and 2.9 per cent in 2019, following a slowdown to 0.8 per cent in 2017.

Plans to loosen its purse strings and moderately increase spending will help support the UAE’s economic revival. In early June 2018, the Abu Dhabi Government announced a stimulus package of AED 50 billion over the next three years to encourage foreign investment and improve the business operating environment.

Golden rules

The country has also etched a number of new laws which will open new revenue streams and nurture businesses. In 2018, the UAE introduced a new foreign investment law that will allow 100 per cent foreign ownership in certain sectors, which could support a rise in investment. There are also plans to introduce long-term visas for professionals, and ease licensing requirements and business fees.

The International Monetary Fund (IMF) agrees that, compared to 2017, growth will strengthen over the next few years. Overall growth is projected to strengthen to 3.7 per cent this year from 2.9 per cent last year. The introduction of VAT in 2018 was a historic milestone; and, while it might encourage consumers to fasten their wallets in the short-term, it is expected to substantially strengthen and diversify government revenues in the coming years.

 “The UAE economy has been adapting well to a prolonged decline in oil prices since 2014. A gradual recovery in nonoil activity is under way,” said Natalia Tamirisa, Assistant to the Director of the Research Department at the International Monetary Fund. “Inflation is projected at 3.5 per cent this year owing to the introduction of the value-added tax and should ease afterwards. The fiscal deficit is expected to remain stable at about 1.6 per cent of GDP this year and turn to a surplus next year.

The current account surplus will exceed seven per cent of GDP this year.” Abu Dhabi’s authorities also plan to issue domestic bonds in 2019 for the first time. In October, last year, the UAE federal government issued a law permitting the issuance of sovereign debt. This legal framework could pave the way for other emirates to issue their own domestic bonds.

“Given large fiscal buffers, ample spare capacity, and rising investment needs for Expo 2020, the Government has appropriately switched to providing stimulus to the economy,” said Tamirisa. “Front-loading stimulus measures and focusing them on productive spending, consistent with the Vision 2021 goals of diversifying the economy and raising productivity, would augment their impact on growth.

“Over the medium term, as the economic recovery gains momentum, a return to the path of gradual fiscal consolidation would help save an adequate portion of the exhaustible oil income for future generations.”

Emerging opportunities

Looking further ahead, the Dubai Chamber of Commerce and Industry is optimistic that things will stay on the up. In a recent analysis, it forecast that the UAE will achieve an average real GDP growth rate of 3.8 per cent between 2019 and 2023, supported by an increased investment and higher consumer spending.

The outlook for the non-oil sector is also brighter than in recent years; the analysis predicted that it will grow by an average of 4.1 per cent between 2019-2023, compared to the 2.8 per cent per cent accounted for in the 2014-2018 period. The chamber thinks that the UAE’s GDP growth over the next five years will be driven by the country’s transport and communication sector, which is set to record GDP growth of 7.9 per cent, followed by construction (4.2 per cent), and real estate and business services (3.8 per cent).

Recent measures to reduce the cost of doing business in the UAE are also expected to cultivate more small businesses. While the global economy may have peaked, the pockets of the world intrinsic to the UAE’s export market are forecast to fire on all cylinders. Emerging markets are expected to see average real GDP growth of 4.8 per cent between 2019 and 2023, outperforming advanced economies and the global average, which the IMF puts at 3.7 per cent.

Emerging markets in Asia, Sub-Sahara Africa, and the Commonwealth of Independent States (CIS) are expected to outperform the rest of the world over the next five years, with real GDP growth projections of 6.1 per cent, 4.1 per cent, and 4.1 per cent, respectively. Latin America’s economic recovery is set to continue in the medium term, with the region’s real GDP growth forecast to reach 2.9 per cent over the same period, supported an improving outlook for Brazil and Argentina.

Happily for the UAE, the Middle East and North Africa accounts for the largest share of Dubai’s exports (41 per cent), followed by ‘Emerging Asia’ with 26 per cent, Sub-Sahara Africa (18 per cent), CIS (one per cent) and Latin America (0.8 per cent), trade data for the first nine months of 2018 revealed.

Chemicals and allied products was the top-performing product category for Dubai’s exports to Asia, which includes perfumes and cosmetics, and fluorides of aluminium. Within Sub-Sahara Africa and Latin America, wood pulp and paperboard was the top category for Dubai exports, while vegetable oils dominated the emirate’s exports to the CIS region.

Bolstering banks

The UAE’s banks are also in a strong position for 2019, with the recovering economy expected to nourish their balance sheets. In S&P’s view, liquidity in the banking sector has improved, banks are adequately capitalised and enjoy strong profitability. “The banks’ financial situation should allow them to absorb the recent uptick in nonperforming loans in the small and midsize enterprise and retail sectors,” the rating agency said.

Moody’s has kept its outlook on the UAE banking system at stable, which the rating agency says reflects the banks’ strong capital, resilient profitability and solid funding. “Loan performance will progressively stabilise, as the recovering economy and the resilience of large borrowers will offset ongoing problem loan formation among small and mid-sized businesses and individual borrowers,” said Mik Kabeya, Assistant Vice President at Moody’s.

Strong capital levels provide a large, loss-absorbing buffer for the UAE’s banks. Moody’s expects strengthening profitability to support capital levels, with sector-wide tangible common equity at 14 per cent to 15 per cent of risk-weighted assets over the next 12 to 18 months. Profitability will improve slightly as rising interest rates support net interest margins, the rating agency said. As banks raise their lending rates, their higher loan yields will moderately outweigh the higher rates they will need to pay on deposits.

In addition operating expenses will remain broadly stable, and loan-loss provisioning will gradually stabilise as the economy recovers. Higher oil prices will continue to support solid funding and liquidity. “UAE banks will remain primarily depositfunded, with only a moderate need to turn to confidence-sensitive capital markets,” said Kabeya.

“UAE banks have sufficient liquidity headroom to accommodate a pick-up in credit growth.” The UAE’s Islamic banks are also showing healthy growth. Assets of Islamic banks operating in the UAE amounted to AED 565 billion at the end of H1 2018, a 6.7 per cent growth from a year earlier, according to CBUAE figures.

UAE Islamic banking assets accounted for 20.55 per cent of total bank assets in the country valued at AED 2.749 trillion, at the end of June 2018. This is an encouraging sign in a country aiming to derive 10 per cent of its GDP from the Islamic economy by 2021. It isn’t far off. In 2018, the Islamic economy accounted for 8.3 per cent of Dubai’s GDP and the Halal industry accounted for 5.8 per cent of the total trade volume in Dubai, according to the Dubai Statistics Centre.

Worldly woes

However, in the absence of a fair wind blowing from the global market, the UAE will be navigating some fairly choppy waters in 2019. Dubai is very much a global city, and manufacturing, trade, transport and tourism dynamics will continue to be influenced by global and regional developments, which remain subject to uncertainty.

According to the World Bank, coping with these developments requires a combination of flexible markets, policies and fiscal buffers. Outbreaks of trade protectionism, headwinds to banking sector activities and regional instability all threaten to weaken trade and asset prices. These risks are particularly relevant for Dubai given its role as a major trade, financial, and logistics centre.

A faster rise in US interest rates or higher financial market volatility could increase borrowing costs for banks and Government Related Entities (GREs), while the Expo 2020 risks overcapacity, inflated property prices and debt, the World Bank warned. Large investment projects, if not implemented prudently, may create additional macro-financial risks for GREs and banks, most of which are government-owned.

However, according to the World Bank, the main economic challenge confronting the UAE relates to the country’s ability to adapt its successful diversification model to increasing competition among services hubs. The UAE’s private sector is still dominated by expats, despite exhaustive Emiratisation programmes.

Education and labour market reforms have only just scratched the surface, and there is still much work to be done. “Improving medium-term growth and job prospects and advancing to a competitive knowledge-based economy require deepening and broadening structural reforms aimed at increasing the role of the private sector and fostering talent and innovation,” agreed Tamirisa.

“Other reform priorities include promoting competition, privatising nonstrategic government-related enterprises (GREs), and improving the ecosystem for SME development and access to finance. “In particular, developing domestic government debt markets would catalyse financial market development and expand sources of financing for SMEs.

Enhancing the quality of education and healthcare and promoting gender equality would cultivate talent.” While higher oil prices have given the UAE’s economy some breathing room, it can’t afford to be complacent. The IMF has warned that tightening financial conditions and increased global and regional uncertainty call for continued vigilance in monitoring financial sector risks, including those from a downturn in real estate and concentrated loan portfolios.

“Continued improvement of economic policy frameworks and coordination, and enhancing statistics would help align policies with the Vision 2021 goals for non-oil growth and further diversification of the economy,” said Tamirisa. “Stronger fiscal anchors would help mitigate the impact of adverse shocks on the economy while ensuring long-term growth, debt sustainability and saving for future generations.

“Better monitoring and analysis of contingent fiscal liabilities stemming from GRE borrowing, delays in payments, and public-private partnerships, would help mitigate risks. Further improvements in the frequency and quality of economic statistics would support policy-making and inform business decisions.”

When the books were closed on 2018 it looked like a pretty good year for the global economy; however, the fault lines have been drawn and opinion is divided on when and where the cracks will show. What is known is that the UAE has the economic armoury needed to meet a new financial year, and all the risks that accompany it, with confidence.





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