Tuesday November 2, 2004 was an aberration in terms of the UAE’s social and economic development, in that it was a day of bad news. The cacophony of diverse languages and music babbling over the airwaves was silenced to make way for wall-to-wall Koranic readings. The message, though ultimately inevitable, was one that Emiratis had dreaded hearing. After 86 years of life and 30 years as president of the federation that he was instrumental in creating, Sheikh Zayed bin Sultan al Nahyan had died.
In so many parts of the Arab world, the death of a leader is a trigger for official mourning without much in the way of heartfelt sorrow. The thronging crowds on the streets of Abu Dhabi and the tributes that poured in from around the world gave clear indication that Sheikh Zayed left a very different legacy. His domestic and international philanthropy, his ability to walk the delicate tightrope between support for the US war on terror and Arab fury at the ongoing Israeli-Palestinian and Iraqi conflicts, his religious tolerance and his top-down support for a thriving private sector economy have all contributed to building a country that punches above the weight of its 4.3 million inhabitants.
True, export earnings from the world’s third largest oil reserves helped to fund the UAE’s stellar growth that has contributed to a liberal environment. And not everything is perfect. Conditions for the lowest paid labourers are often questionable, and democracy as the US defines it is still absent. But with a GDP per capita of $20,131 last year and a zero corporate and personal income tax regime, few locals or members of the expatriate majority are complaining too vociferously.
Despite doomsday predictions of tribal feuding issued by some international think-tanks, the succession to the presidency of Sheikh Zayed’s son, Sheikh Khalifa bin Zayed al Nahyan, was smooth and almost instantaneous. In the seven months that have followed his ascendancy, the good news machine has swung back into business.
Revenue boost
The fortuitous coincidence of a sustained period of high oil prices, combined with increasing production capacity, has given the UAE federal government the revenue to turn a trickle-down of capital into the economy into flows more akin to a deluge. In 2004, the country’s daily crude output, which predominantly comes from Abu Dhabi, reached 2.3 million barrels per day (mbpd). Investment should take sustainable output to about 3mbpd by the end of this decade.
Total fiscal earnings for the year are estimated to be $25.5bn, a record high. More of the same is expected in 2005, with increased output capacity easily offsetting any decline in crude prices. As a result, the federal government cleared a balanced budget in 2004 despite heavy investment in public infrastructure and social security, and is bullish about increasing spending by a further 5% this year.
Because the UAE dirham is pegged to the US dollar (Dh3.67 = $1), interest rates are expected gradually to track moves by the US Federal Reserve to increase rates. For some resident expatriates in particular, any efforts to cool the economy will probably come as welcome news. Although the central bank likes to claim that consumer price inflation is about 2%, these calculations are based on the experiences of Emiratis, who are heavily buffered from increasing living costs by a system of subsidies. A more realistic inflation figure for foreigners – who make up 82% of the population in the emirate of Dubai – is about 8%.
Beyond oil
While oil underpins economic life in Abu Dhabi, in Dubai, trade and real estate are the crucial sectors. Dubai began its economic life as a trading centre and still relies heavily on re-exportation income generated by ports in Bur Dubai and Jebel Ali. But, in search of economic diversification, the emirate’s government has also built a portfolio of 13 free zones hosting industries as diverse as information communications technology, media, healthcare, commodities trading (diamonds and precious metals), bio-chemicals, outsourcing, data hosting and financial services.
These initiatives have undoubtedly helped to make business headlines, but Dubai’s major self-promotion successes have been its ability to attract sun-loving tourists and launch a seemingly endless stream of bizarre real estate developments. Iconic developments being built by Nakheel Properties include three palm tree-shaped residential resorts jutting off the city’s coastline, a series of man-made private islands in the shape of the map of the world, and the Dubai Waterfront project – an 81 million square metre mixed-use development that will consume all of the emirate’s remaining coastline.
At the practical end of the scale, Emaar Properties has begun to deliver many thousands of villas and apartments in themed developments designed to appeal to expatriate residents and holiday home buyers. Fuelled by a local law permitting foreigners to own freehold – a law yet to be ratified at a federal level – and a continuing influx of foreign workers who are enlarging the UAE’s population by 7% annually, asset price escalation has been dramatic. About 70% of Dubai’s real estate buyers are still believed to be speculators seeking a quick resale buck from off-plan purchases, but estate agents report that rental prices are nonetheless increasing by as much as 30% annually.
Expansion plans
Foreign trade and domestic real estate growth plus a seemingly unlimited hunger for domestic equities have been music to the UAE financial services sector’s ears. Many players have begun expanding overseas and into Islamic financial services. Many are talking about developing asset management businesses, mortgage arms and occasionally consolidation. But, judging by the headline profits reported for last year, expansion is more about preparation for tomorrow than pressures that threaten today.
For the year 2004, the Central Bank of the UAE reports that the federation’s 47 banks grew total net profits by 18%. National Bank of Abu Dhabi (NBAD) stole the show by passing a record milestone – a net profit in excess of Dh1bn following annualised profit growth of 41%. The largest of its competitors were not far behind though: Dubai-based Emirates Bank International (EBI) and National Bank of Dubai (NBD) made Dh972m and Dh927m respectively.
A profit of Dh461m may have given Dubai Islamic Bank (DIB) only fifth position in the league table but, at 96% year-on-year growth, it sent out a clear signal that the complexities of Shariah-compliance need not preclude an Islamic bank from rivalling the most successful of its conventional peers. The fact that there are only four full service Islamic banks in a market that remains closed to new entrants doubtless helps.
In his May report on the UAE banking sector, EFG-Hermes analyst Tammam Barbir cautiously welcomed institutions’ ability to drive double-digit loan growth on the back of both corporate and retail lending opportunities. Further robust economic growth and public spending this year should support corporate, treasury, trade finance and project finance desks, while the continuing influx of new residents will support expectations of growth in consumer credit, particularly credit cards and mortgages.
“Asset growth no longer seems to be the main driver for earnings growth at UAE banks,” wrote Mr Barbir. “Some banks are starting to resemble investment banks with commercial and retail banking arms. The high earnings generated from these activities that are not related to core banking are driving banks to further increase their exposure to both the equity and real estate markets.”
Here, Mr Barbir is sounding the early warning bell for “over-investment”. On the one hand, local banks are ramping up their fee income streams, particularly for project finance advisory mandates but, on the other, as new loan opportunities open up, the temptation is to chase them before the competition does – thus lowering margins and potentially damaging credit control processes.
Although credit extended for trade finance topped the central bank’s breakdown of where the banks’ money went last year, reaching a total of Dh69.5bn, personal loans for non-business purposes still accounted for Dh24bn. Thus far the central bank has not made any noises about tightening money supply, for example by setting loans/deposits ratios, mimicking Kuwait and Qatar, but a move of this kind would not come as an enormous surprise.
Credit control
There was a brief flurry of excitement in May, however, when four local banks were fined for extending credit to consumers to buy shares in IPOs, though the furore burnt itself out when the central bank governor, Sultan bin Nasser al Suwaidi, resolutely refused to release the names of the banks concerned. The problem had become apparent when subscriptions to the Dh497m IPO launched for Aabar Petroleum exceeded the value of the UAE’s GDP.
That these four banks had offered credit worth Dh229bn more than their combined capital, reserves and deposits was clearly cause for alarm, especially given strong interest being shown in the local equity markets. Investment bankers estimate that over 25 companies will launch IPOs in the UAE this year. In early July, the Emirates Securities and Commodities Authority issued regulations for the listing of conventional and Islamic bonds on domestic stock exchanges. Equities were so popular last year that the aggregate market capitalisation of companies listed in Abu Dhabi and Dubai rose by 98% to Dh355bn, almost $100bn.
Few would dispute that local banks’ ability to muscle into big tickets deals is a good thing for the industry’s development. The likes of HSBC and BNP Paribas show no signs of being cut out of the loop – indeed, Gulf banks’ balance sheets could not possibly handle the estimated $40bn of GCC project finance deals due to come to market in the next two years – but issuers are increasingly mindful of the benefits of local participation.
Last July, Abu Dhabi Commercial Bank (ADCB) and NBAD took the two largest portions of the $1.36bn five-year bridging loan required by Dolphin Energy – double the commitments of Barclays Capital and HSBC respectively. For the Taweelah IWPP refinancing, a separate $150m tranche was earmarked for Islamic finance and subsequently taken up by Abu Dhabi Islamic Bank.
Emirates Bank, NBAD and NBD joined HSBC as lead arrangers for Emirates airline’s $500m bond and, this June, Dubai Islamic Bank was the mandated lead arranger for the world’s first airline sukuk. The Islamic bond issue raised $550m for Emirates airline at 75bp over dollar Libor, and received 50% over-subscription in the process.
Centre of attention
Along with booming domestic equity markets, the new Dubai International Financial Centre (DIFC) has been receiving a lot of attention since it went live last September. That attention has not always been for the right reasons – the high profile sackings of the centre’s two top regulators in June 2004 caused a storm of negative publicity that the project could have done without. This May the voluntary defection of five more regulators to join a fledgling rival financial centre in neighbouring Qatar was also something of an embarrassment.
With the unbridled confidence so characteristic of Dubai, however, executives at the DIFC have no intention of allowing these upsets to break their stride. Thus far, the centre’s independent regulatory authority, the Dubai Financial Services Authority (DFSA), has licensed 13 financial institutions plus a host of ancillary service providers.
First through the doors were private banks and asset managers, attracted by a zero corporate tax regime, the prospect of access to an estimated $2000bn of Arab wealth and a legal framework based on English law. Swiss private bank Julius Baer took licence number one and was followed by the likes of Merrill Lynch Bank (Suisse), Franklin Templeton, Ansbacher and Mellon Global Investments. Credit Suisse has taken two floors in the DIFC’s flagship Gate building – somewhat resembling a futuristic Arc de Triomphe – and both Deutsche Bank and Citigroup have announced their intention to apply for licences in due course.
Litmus test
If the DIFC is to be more than just another offshore centre, however, the litmus test will be its ability to attract wholesale and investment banks. Standard Chartered did sign up early on, but it was not until June 30 that the centre scored the goal of a pure-play investment bank: Barclays Capital.
“There is a huge appetite for assets in the region,” says Nicholas Hegarty, BarCap’s managing director for the Middle East and North Africa. “There’s liquidity from the return of flight capital post-9/11 and liquidity from the high price of oil. The DIFC will provide us with a legal structure we’re comfortable with and a nexus of operations from which we can develop relationships in an increasingly aggressive market.”
The next test will be the DIFC’s own stock exchange, the DIFX, scheduled for launch on September 26. Again, the idea is that the wider Middle East needs a liquid capital market that will be open to issuers and investors of any nationality, and that offers automated trading facilities within an international regulatory framework.
Chief executive of DIFX Steffen Schubert expects it to take some time to generate significant derivatives listings, but has high hopes for equities, bonds and funds. He also claims to be in talks with around 80 intermediaries – including CSFB, HSBC and Deutsche Bank – plus 200 potential issuers spread from India to Africa.
As usual the sceptics are adopting a ‘wait and see’ approach, while those driving the UAE’s economic development forward do exactly the opposite.
