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UAE Future Looks Bright, Despite Immediate Challenges

Monday, February 22, 2010

The International Monetary Fund’s (IMF's) Executive Board, in its Article IV consultation with the United Arab Emirates (UAE), has said that prospects remain bright for the region despite the numerous challenges the Emirates have faced since 2008, among them the real estate bubble in Dubai.

The UAE has been severely affected by the a series of external and domestic shocks in 2009, including the global economic slowdown, the shutdown of international capital markets, and the impact of the bursting of the Dubai property bubble in mid-2008. A second bout of disruption arose when Dubai World (DW) announced in late November 2009 that it would seek a debt standstill through May 2010, including on bonded debt owed by its Nakheel property subsidiary. Further, the IMF observed that the UAE’s tax-take will have been adversely affected by plummeting oil receipts, the fall in global trade, as well as the decline in property and construction activities.

Going forward, the IMF noted that market tensions have calmed since DW paid off the Nakheel bond on time in December, with financial support from Abu Dhabi, but the Fund has warned uncertainties remain. In particular, the IMF noted discussions on the restructuring of Dubai's debt, which are currently ongoing.

Overall real GDP is estimated to have contracted by about 0.5% in 2009. Hydrocarbon GDP declined by 6.25%, while non-hydrocarbon growth, which had averaged 8% in the three previous years, is estimated to have slowed to about 1%. This figure masks the diverging fortunes of Abu Dhabi (where growth was sustained by public sector investment spending) and the northern emirates (in particular Dubai and Sharjah), where economic activity dropped owing to the bursting property bubble and the contraction in world trade.

After peaking at about 12% in 2008, annual consumer inflation declined to about 1% in 2009. According to the IMF, this reflects lower import prices, and a reduction in rents arising from an increased supply of buildings as well as the renewal of contracts at deflated market prices.

The external current account balance is estimated to have shifted to a deficit of 2.7% of GDP in 2009, the first deficit in decades. As a result of OPEC-mandated production cuts and lower prices, hydrocarbon export revenues dropped by about 45% in 2009, while imports fell by 22% owing to a sharp contraction in consumer goods imports and despite the large public infrastructure projects in Abu Dhabi. The reopening of capital markets in the second quarter of 2009 and external borrowing particularly by Abu Dhabi entities helped stabilize the international reserves position by end-2009.

The IMF estimates that the consolidated fiscal position is at a virtual balance in 2009, following a surplus of 21% of GDP in 2008. Both oil and non-oil revenues fell owing to the decline in oil prices and the slowdown in economic activity, while spending increased by about 14% – a continuation of the expansionary fiscal stance adopted in 2008.

As the global crisis intensified, the authorities implemented measures to maintain confidence in the banking system, including recapitalization. As a result, the capital adequacy ratio of national banks increased from 13% to 18% in half a year. The authorities are currently working on tightening the regulatory framework by introducing a general provision for unclassified loans, standardizing loan classification, and enforcing provisioning standards uniformly.

In its recommendations, the IMF Executive Board observed that the global financial crisis, lower oil prices, and the bursting of the Dubai bubble, together with the recent announcement that DW would seek a six-month debt standstill, have raised important challenges for the UAE economy. The Board agreed that the prospects for the UAE economy, given its underlying strengths, remain favorable, but noted that it will be important for authorities to embark on a more balanced and sustainable growth path over the medium term.

Concluding, the Board underscored that, given the limitations of monetary policy, fiscal policy should continue to play an important role in supporting economic activity. Lastly, the Board stressed the need for increased transparency of economic and financial data, including financial accounts and business strategies for government-related entities.