Growth under pressure in the UAE

The UAE economy is in healthy shape after a period of low growth, but problems in international markets could yet undermine progress. Published in MEED, 4 November 2011

After a period of low or no growth, the UAE economy appears to be building up some decent momentum at last. The Washington-headquartered World Bank says it expects the federation’s gross domestic product (GDP) to expand by 3.3 per cent this year and by a further 3.8 per cent next year. That is in line with statements by Sultan bin Saeed al-Mansouri, the UAE’s Economy Minister, who has suggested a growth rate of 3-3.5 per cent for this year.

The UK-based bank HSBC is even more bullish for this year, predicting that GDP will grow by 3.9 per cent in 2011, but easing off to 3.6 per cent next year. Despite the problems in some key international markets such as Europe and the US, it seems economists are confident that the UAE is fairly well-placed to deal with any problems that may emerge.

Positive scenario for UAE

“It’s reasonably positive,” says Liz Martins, senior economist at HSBC. “We think the UAE and the Middle East in general are stronger going into 2012 than they were going into [the downturn in] 2008.”

Such predictions are welcome news for the country after its GDP contracted by about 3 per cent in 2009 and grew only modestly in 2010. The country had the worst performance of any major Arab economy over those two years, according to HSBC.

The UAE is helped by the fact that it has one of the most open economies in the region. The latest World Bank Doing Business report, published on 20 October, ranks it at 33 out of 183 economies in terms of the ease of doing business. Only Saudi Arabia, with a ranking of 12, does better among Arab countries. The UAE is also ranked as the fifth best in the world when it comes to trading across borders, behind Singapore, Hong Kong, Estonia and South Korea.

Just as important is the fact that the UAE’s most important trading partners are in the fast-growing economies of Asia. While the economies of Europe and the US are stuttering, the likes of India and China remain buoyant. In addition, Abu Dhabi has vast oil reserves which earned some $78bn in export revenues last year and are expected to bring in a similar amount this year.

Meanwhile, Dubai has one of the most diversified economies in the Gulf and has been able to cement its position as the preeminent financial hub as a result of the problems in Bahrain and elsewhere this year.

Yet alongside all these positives, there are also a number of risks in the international economy, which could undermine the UAE’s position. While the projections are healthy for now, the momentum could quickly dissipate if the situation deteriorates elsewhere.

One key area of risk is oil prices – a vital issue given that the country’s hydrocarbons earnings account for 82 per cent of government revenue. The price of oil has been above $100 a barrel for most of this year, but there has been some easing off in the price since April, when it was trading at more than $120 a barrel. If Europe or the US fall back into recession that price fall is likely to continue or even accelerate, although it would take a very large drop for the country’s budget to fall into deficit – the breakeven price for the budget is closer to $60 a barrel, according to economists’ estimates.

The economy of Dubai has a different area of weakness in the shape of its large debts. According to IMF statistics published in May, Dubai’s total debt is close to $113bn, or 103 per cent of its GDP. In comparison Abu Dhabi, which has a far greater ability to pay due to its oil revenues, has total debts of $104bn, equal to around 55 per cent of its GDP.

Any sign that the problems in the European banking industry might prompt another global credit crunch would be a serious cause for concern in Dubai as much of its debt will need refinancing in the coming years. About $15bn is due next year, followed by $8bn in 2013 and $29bn in 2014.

“Abu Dhabi is fine. It has huge resources to draw on. It has deep pockets and will be able to weather any large downturn from Europe,” says Andrew Gilmour, a senior economist at Saudi bank Samba.

Dubai vulnerable to markets

“The main issue is Dubai. If the markets around the world and banks in Europe in particular become much more risk averse, it will be harder and much more costly to raise funds. Then Dubai could be in a bit of trouble.

“They’ve already had to turn to Abu Dhabi once, during the original credit crunch. It’s uncertain to what extent they’d be able to call on them again. If you had another credit crunch precipitated by events in Europe, then Dubai could slip back into recession itself.”

There are some signs of softening demand already in Dubai. HSBC’s purchasing managers index (PMI), for example, shows the emirate’s economy is still growing, but more slowly than earlier in the year when it benefitted from being seen as a safe haven.

Any figure in the PMI above 50 indicates growth and in April and May, the index was at a healthy 57.5 and 56 points respectively. By August, the figure had slipped back to 50.9, although it recovered slightly to 52.1 in September. “Our PMI survey does indicate that the private sector is losing some momentum,” says Martins. “There was a lot of positive sentiment towards the UAE for a couple of months in the second quarter with the safe haven impact following all the unrest. Dubai had a lot of tourists that would otherwise have gone to Bahrain or Egypt.”

Private credit

In addition, the financial services industry is struggling to recover the momentum it had before the crisis in 2008. Private sector credit is barely growing and has been falling as a percentage of GDP for the past two years. The country’s largest bank, Emirates NBD, increased its provision for bad debts by a further AED1.5bn ($408m) in its most recent quarterly results, with chief executive officer Rick Pudner saying “the outlook has become more cautious and uncertain”.

Trading volumes on the local stock market are also low and few new companies are coming to list their shares. So far this year, the only IPOs in the UAE have been Insurance House, National Takaful Company (Watania) and Eshraq Properties, all of which have listed on the Abu Dhabi Securities Exchange.

“The economy in Dubai is somewhat recovering, but financial services is not,” says one investment banker based in the city. “The global economic situation is definitely affecting them. The only IPOs we’ve seen in the market in the UAE are two insurance companies and one real-estate company and as a foreign or local investor I don’t want to have exposure to these sectors right now.”

The other five emirates that make up the UAE contribute little to the overall economy, but they may become more important in terms of government spending plans in the future. The UAE has avoided the large political protests seen in other countries around the Middle East, but there is significant disparity in fortunes of the major cities of Abu Dhabi and Dubai on the one hand, and the rest of the federation. The northern emirates account for about 80 per cent of unemployment among nationals, despite being home to just 40 per cent of the population. Closing that gap through more investment in infrastructure and jobs will be important if the country is to maintain its reputation for stability.

The government can certainly afford to boost spending without much difficulty, although the state of public finances is not as healthy now as it was before the crisis in 2008 and 2009. Public debt, for example, is running at about 26 per cent of GDP, compared to around 16 per cent in the years before the crisis. The budget is expected to show a surplus of about 10 per cent of GDP this year, but the surplus was above 20 per cent of GDP before the downturn struck.

But the country has vast resources in its various sovereign wealth funds which it can draw upon if needed. According to Samba’s estimates, the three emirates of Abu Dhabi, Dubai and Ras al Khaimah have between them almost $720bn in assets under management, with the Abu Dhabi Investment Authority alone accounting for $627bn.

The value of some investments are liable to be marked down this year, particularly those made in Europe, but not to the extent that it will cause any real concerns.

As a result, even if oil prices do slip, government spending is likely to remain robust which should, in turn, help to boost the overall economy.

Strong position

“We think government spending will continue,” says Martins. “The unrest [around the region] in the first quarter of the year provided an illustration of how urgent it is to keep spending. The argument is not that oil prices will definitely stay very high, it is that even if they fall we think that governments will keep spending. Vulnerable public finances is not a concern for the UAE.”

Gilmour agrees, saying the UAE like the rest of the GCC is in a reasonably strong economic position, despite the ongoing problems in international markets.

“The UAE and the other GCC countries have strong public finances, large external assets and large hydrocarbon resources,” he says. “They’ve got large foreign savings and governments committed to spending those savings, and the earnings that are coming in from oil, on developing and diversifying their economies. That spending will trickle down throughout the economy. So the economies will continue to grow, although perhaps not as fast as they would without a European crisis and a weak US economy.”