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Middle EastFebruary 1 2019

UAE faces headwinds undaunted thanks to reform agenda

The UAE’s reform timetable is providing the country with some breathing space in addressing problems with a declining real estate market and stagnant job creation rates. James King reports. 
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UAE reforms

As the most diversified market in the Gulf Co-operation Council, the United Arab Emirates has fared relatively well in the lower oil price environment of recent years. Though gross domestic product (GDP) growth has fallen from highs of 5.1% in 2013 to lows of 0.8% in 2017, expectations for the economy are more buoyant over the medium term. In 2018 it is estimated to have expanded by 2.5%, while in 2019 this number should increase to 2.7%, according to research from Abu Dhabi Commercial Bank (ADCB). This performance comes at a time when the UAE’s economy is undergoing a profound shift away from oil dependence.

“The UAE economy is in one of the best positions in the Gulf to deal with the lower oil price and any global volatility, thanks to its structural strengths including high foreign exchange reserves and low debt levels. The government has also been very proactive in terms of its fiscal reforms over the past three years,” says Monica Malik, chief economist at ADCB.

A partial recovery

Despite this strength, however, few observers expect the UAE’s economic growth to return to the peaks of the recent past. For one, external factors are exerting downward pressure on the country. These include trade tensions between the US and China, regional political and economic instability and weaknesses in the global oil market. In addition – and despite impressive government efforts to diversify the economy – overall economic activity is still linked to the oil sector.

Together, these dynamics are creating challenges for both the UAE’s oil and non-oil economies. “The non-oil economy is to a large degree externally facing. With slowing global growth and a strong US dollar, a number of key sectors have been affected,” says Ms Malik.

ADCB research indicates that non-oil growth in the UAE will be close to 3% in 2019, up from 2.6% in 2018. This will largely be driven by increased government spending in the form of oil project outlays in Abu Dhabi (providing a small multiplier effect to non-oil activity) and investments in Expo 2020 preparations in Dubai. Nevertheless, these figures are far lower than recent historical norms: in 2013 the non-oil economy expanded by 5.9% while in 2014 it grew by 6.4%.

Crude pressure

The oil economy, meanwhile, is expected to see only moderate growth in 2019, hitting about 1.3%. “Oil sector growth will be limited [this year],” says Mohamed Bardastani, senior Middle East economist with Oxford Economics in Dubai.

Though the UAE’s average daily oil production is likely to increase over the next 12 months, the outlook for global oil prices has been revised downwards by most analysts. ADCB forecasts a Brent crude price of $66.8 per barrel, for example, down from its previous prediction of $73.8 per barrel. This revision comes after concerns arose regarding US waivers for Iranian oil exports, increased US oil output and weaker global demand.

This pressure on oil prices will contribute to the expected deterioration of the UAE’s fiscal position. As a percentage of GDP, the budget balance is estimated to have reached positive territory in 2018 at 2.9%, following three years of deficit. In 2019 this figure is expected to remain positive, though falling to 0.5%, before the fiscal balance is projected to slip to a minor deficit of 1.1% in 2020, according to ADCB.

Though lower oil prices will play a part here, this decline also mirrors a more expansionary fiscal stance adopted by the authorities. “The federal government is expected to raise spending this year so I think this increase will support growth in the non-oil sector,” says Mr Bardastani.

The UAE’s 2019 federal budget outlines planned spending growth of 17.3% in 2019, up from the 5.5% planned growth for 2018. As a result, the 2019 budget amounts to $16.3bn, the highest of its kind in the country’s history. Close to 60% of the total figure will be allocated to education and social development, according to a number of local media sources.

Fiscal reform

The budget’s emphasis, therefore, reflects the government’s wider priorities around socio-economic development and the growth of a private sector-driven knowledge economy. To get there, the government has been enacting a number of fiscal reforms to diversify its revenue base away from oil, alongside other measures designed to stimulate private sector activity. On the fiscal side, this includes the introduction of value-added tax (VAT) in 2018, a move that is likely to be a game-changer for government finances over the long term.

“The implementation of VAT in the UAE marks a positive step towards revenue diversification” says Thaddeus Best, a Moody’s analyst. He expects that an additional Dh24bn ($6.54bn) in revenue could eventually be raised for the country each year, equivalent to about 1.7% of GDP. Under the terms of the VAT scheme, the federal government will keep 30% of the revenue, with the remainder to be allocated to the individual emirates under a sharing formula.

Nevertheless, some fiscal reform measures, including changes to the fuel subsidy regime, have had a knock-on affect in terms of the cost of doing business. According to Emirates NBD’s December 2018 purchasing managers index report, input prices rose at their fastest rate in nearly a year as output prices fell from a few months earlier.

“Input costs are increasing for the non-oil private sector. This is partly a result of fiscal consolidation measures, including fuel subsidy reforms, increasing costs for businesses,” says Mr Bardastani. “On the other hand, output prices have not been increasing much. So there is this mismatch between input and output prices which is putting pressure on profitability. As a result, job creation isn’t as strong as it could be.”

Weak job creation is, in turn, putting pressure on the UAE’s real estate market through a significant drop-off in demand. Given that the real estate sector is somewhat over-represented on the country’s second largest stock exchange, the Dubai Financial Market, the bourse registered a 25% annual loss in 2018. This was its worst performance since the global financial crisis. It also stood out as one of the worst-performing Gulf Arab exchanges over the course of the year.

Betting on business

Beyond changes to the country’s fiscal stance, the UAE authorities have also worked hard to improve the business operating environment. This includes the introduction of 10-year residency visas for expats and, eventually, up to 100% foreign ownership of companies operating onshore in certain sectors.

Along similar lines, in late 2018 the authorities announced plans to streamline applications for investment fund licences operating either onshore or offshore. This will replace the previous system, in which a fund licensed in one of three jurisdictions (the Dubai International Financial Centre, Abu Dhabi Global Market, or the onshore UAE) were subject to limitations and restrictions on how their funds could be marketed or sold in the other two jurisdictions.

“I think generally speaking the government here in the UAE is always actively seeking out pro-business policies. It is always willing and actively trying to ease restrictions around doing business. And it has achieved considerable success,” says Mr Bardastani.

Though the UAE’s economy faces a number of pressing challenges, including its cooling real estate market and sluggish job growth, it is in a better position than many of its peers to weather the years of transition that lie ahead. The authorities have, for example, moved more quickly to address issues of fiscal consolidation while adopting a suite of open and pro-business legislative and regulatory changes to encourage a new wave of foreign investment. This is taking place in a market that is already known for its progressive stance towards overseas investors.

Nevertheless, 2019’s economic prospects are likely to be a good marker of what lies in store for the next few years: steady yet sub-optimal growth, accompanied by the teething pains of reform. Though good news is on the horizon in the form of the World Expo in Dubai in 2020, it is unclear to what extent this will boost economic output. For now, however, the UAE authorities must continue with the job of economic transformation.

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Read more about:  Middle East , United Arab Emirates