Of the UAE’s seven emirates, only Abu Dhabi and Dubai are economically significant. Thanks to its large oil and gas reserves, Abu Dhabi is the richest, accounting for 60% of GDP.
Both Dubai and Abu Dhabi are pursuing a state-led, if still capitalistic, development strategy. A large network of public and quasi-public companies, with strong links to the UAE’s ruling families, have been investing heavily in infrastructure, real estate, tourism, manufacturing and financial services.
Thanks to strong oil and gas export revenues and overseas investor appetite, the economy prospered during 2002 08: GDP grew strongly; foreign reserves climbed; and sizeable current account surpluses were achieved (Chart 3 and Chart 4).
But this development model came under pressure during the recent crisis, and Dubai’s debt crisis has been a severe setback to the overall UAE economy and banking system. The construction sector, one of the main growth drivers, was hit particularly hard; in the wake of the downturn, builders delayed or cancelled projects worth about US$330 billion mostly in Dubai. As a result, the economy contracted by 3.2% in 2009 and the banking sector, which was heavily exposed to construction and real estate, required state capital injections of about US$16 billion as well as central bank liquidity support.
The crisis also exposed a large build up of public (and quasi-public) debt in Dubai equivalent to 140% of the emirate’s GDP, well above normally accepted sustainability thresholds.
Dubai has managed to stave off default thanks to support from Abu Dhabi. But many companies are having to renegotiate their debts with creditors and will probably have to grind through an extended repayment process. As a result, investment spending will be kept to a bare minimum. Thus it could be several years before projects completed at the height of the boom generate substantial positive cash flow.
The economy recovered through 2010, recording GDP growth of 3.2% and the IMF foresees growth of 3.3% in 2011. Dubai’s debt and property market problems will probably continue to constrain its pace of expansion, as they did in 2010, while Abu Dhabi should experience stronger growth on the back of oil exports and public investment spending.
Longer term uncertainties loom, notably the sustainability of the state led development and economic diversification initiatives. Significant oil and gas reserves means that Abu Dhabi is in a better position if the diversification strategy underperforms. In contrast, Dubai’s reliance on non petroleum economic activity and heavy debt load means it has less of a cushion and is more vulnerable to shifting risk perceptions.