Source: CIA
July 2009
Economy
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. Abu Dhabi has the world’s sixth largest oil reserves and fifth largest natural gas reserves. The oil is cheap to extract and at current production rates should last for more than 100 years. Dubai, accounting for 25% of GDP, has no oil, but has become the Gulf’s No 1 trading, financial, and tourist centre – the favoured base for many foreign companies operating in the Gulf and also the funnel for a lot of Iran’s foreign trade and external investment. Dubai is Iran’s largest trading partner, with bilateral trade worth US$14 billion annually. Iranians reportedly have US$300 billion worth of investments in Dubai.
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 (chiefly downstream oil processing, petrochemicals and aluminium smelting) and financial services.
Over the past 15 years, this strategy has been successful. GDP growth has averaged 6.6% a year, well above the regional average, while per capita income has doubled to US$54,000 (see chart). By per capita income, the UAE is the eighth richest country in the world. Undoubtedly the rise in the oil prices has been a big wealth accumulator, but the non-hydrocarbon sector has also been expanding rapidly and now accounts for 75% of real GDP, up from 25% in the early 1980s. Unlike many countries with big oil endowments, the UAE has been able to ward off the ‘Resource Curse’, a plight that has befallen many other countries which have allowed their petrodollars to unbalance the economy and fuel corruption and rent seeking.
The economy is very open to foreign trade and foreign investment. Trade constituted 175% of GDP in 2008. Oil accounts for 40% of exports; other exports include gas, petrochemicals, building materials, ships and substantial re-exports through Dubai. Though the Emirates are net capital exporters, foreign direct investment represented a sizeable 27% of investment in 2007. Dubai alone was attracting an estimated US$3 billion annually in inward direct investment before the global financial crisis hit. The UN ranks Dubai as the world's 17th most attractive investment destination. There is growing acceptance among the Emirates’ authorities that foreign companies can support development of the non-oil sector.
The global financial crisis and recession is hitting the UAE hard. The IMF expects real GDP to contract by 0.6% in 2009. Oil output has fallen by 10% in response to OPEC production cuts. More significantly, the construction sector, one of the main growth drivers, has slumped, with the Institute of International Finance (IIF) estimating that US$400 billion worth of public and quasi-public sector projects have been cancelled or delayed, the majority in Dubai. These include the US$95 billion Jumeirah Gardens and Dubailand – the emirate's much-publicised Disney-like theme park. From their mid-2008 highs, real estate prices have fallen by 50% in Dubai and 20% in Abu Dhabi. The downturn is being amplified by a reversal of migration flows, as expatriates leave due to declining job prospects.
The business cycle is especially volatile in Dubai. An overreliance on foreign debt to fund its diversification strategy, together with an unsustainable pace of development, has left the emirate very exposed. Foreign debt reportedly reached over 100% of GDP in 2008, well above normally accepted sustainability thresholds. A mix of refinancing difficulties, the sharp fall in real estate prices and a slump in world trade and finance have caused widespread liquidity, if not solvency, difficulties. Financial support from Abu Dhabi has reduced the risk of default. The central bank — in which Abu Dhabi is the major stakeholder — bought a US$10 billion bond issue by the Dubai government in February. A further US$10 billion is expected to be raised shortly. Even so, the economy is still forecast to contract by a whopping 10% this year, with the population falling by up to a 20% as expatriates return home.
Abu Dhabi is faring better thanks to its substantial fiscal resources and lower debt. Fitch estimates that Abu Dhabi’s breakeven oil price — at which, all else equal, its budget balances — is a low US$40 a barrel in 2009, despite cuts to oil production and higher spending. Infrastructure projects are proceeding, particularly in the hydrocarbons sector. The state-owned oil company ADNOC (Abu Dhabi National Oil Company) plans to invest US$50 billion over the next few years to expand oil, gas and refining capacity. Oil production capacity is expected to rise by 1 million b/d to 3.5 million b/d by 2012.
Overall, and with some important qualifications, national creditworthiness is strong. The IIF estimates that the UAE’s net external assets were US$300 billion at end-2008, equivalent to 1.4 times GDP. The majority of these assets are held by Abu Dhabi, specifically in its main sovereign wealth fund, ADIA (Abu Dhabi Investment Authority), which has around US$300 billion worth of assets. Abu Dhabi has a high investment grade sovereign risk rating. For long-term foreign currency bond risk, both Standard & Poor’s and Fitch rate it AA-; Moody’s rates the whole UAE Aa2. However, some caution is warranted.
- Since Abu Dhabi owns the majority of the wealth, the creditworthiness of the other emirates is related to the solidarity that exists within the federation. The recent bailout of Dubai suggests such solidarity is real.
- Creditworthiness may not stretch to paying bills to suppliers or contractors, as opposed to bondholders. Many Dubai-based state-owned enterprises have run up significant payment arrears with contractors through the current downturn.
- The size and type of assets held by ADIA is a closely held secret, so it is impossible to know the volume of liquid assets it could deploy in a crisis. The IIF puts the value of its assets at US$300 billion, but some analysts estimate that it may hold up to US$800 billion.
The UAE currency, the dirham, is pegged to the US dollar. There are no restrictions on profit remittance, loan repayment or capital repatriation. Before the global financial crisis, persistent US dollar weakness and an inflation spike raised speculation that the peg may be adjusted or removed. But more recently the authorities have reaffirmed their commitment to the peg and have ample reserves to defend it. A monetary union with other Gulf countries was planned by 2010, but the UAE withdrew in May 2009.
On paper the UAE banking system is profitable and well capitalised. But rapid debt accumulation in recent years, followed by the building slump and the large fall in asset prices, are causing significant strain. The government has moved quickly to support the sector by guaranteeing deposits and injecting US$33 billion of capital. Standard & Poor’s estimate that if worse comes to worst a bank bailout would cost 25% of GDP. While large, this would be well covered by the government’s assets. The UAE has gone through several banking crises over the past three decades and has never allowed a bank to default.
While diversification is reducing UAE’s dependence on oil and gas revenues, there are doubts about the sustainability of current development plans.
- Overinvestment. Dubai, Abu Dhabi and Sharjah, as well as other countries in the region, are pursuing similar diversification policies. Both Dubai and Abu Dhabi are vying for regional prominence as financial centres with Bahrain and Qatar. Yet it is unlikely that the region will be able to support four financial centres. In other industries such as petrochemicals and aluminium smelting there is also a risk of excess production capacity.
- Debt overhang. Dubai has a heavy debt load equivalent to 110% of GDP. While support from Abu Dhabi has staved off default, the corporate sector will for an extended time be repaying debt and doing only a bare minimum of investment. Many recently completed projects are unlikely to create positive cash flow for many years. Recently established debt limits, which limit the debt load of individual emirates’ to 15% of their GDP, will also be a constraint.
- Private sector restrictions. The government is at the heart of most economic activity, resulting in close links between business and politics and raising the risk of resource misallocation. In addition, some projects benefit from access to energy at below-market energy prices – energy that might otherwise be exported at world prices.
- Job creation. The investment boom has had only a small impact on employment patterns. The capital-intensive petrochemical sector requires minimal labour. New construction jobs are filled by imported labour. The supply of local Emirati labour is ill-matched to the labour requirements of employers. For all these reasons, the unemployment rate for Emiratis remains high at 13%.
- Worsening perceptions. During the boom, plentiful cash and credit, and rising asset values, lubricated potential friction points between Emiratis and foreigners. But now that the tide of credit has gone out, the friction is causing conflict. To their surprise, for instance, foreigners are being locked up without charge in debtors’ prison during contractual disputes. Whatever the reality, perceptions among foreigners, especially those in the professional, technical and entrepreneurial classes, appear to be shifting – for the worse. As a result, it may be difficult to attract these people, on whom so much of the UAE’s development has relied, back to the country once a recovery gets underway. For further detail, see the Society section below.
Politics
At the federal level, the UAE is a confederation of seven emirates, each with its own ruler. Since its inception in 1971, the ruler of Abu Dhabi has claimed the presidency, while the ruler of Dubai has occupied the vice-presidency. Each emirate reserves considerable powers, including control over mining rights and investment incentives.
Relations between the ruling families of Abu Dhabi and Dubai have been warm, though there are reports that Abu Dhabi may seek to rein in Dubai's autonomy following its bailout of Dubai, the closure earlier this year of Dubai's creek-side jetties, which service dhows laden with goods for Iran, has been interpreted as one concession by Dubai to Abu Dhabi, which has been working with Washington to isolate Iran.
Freedom House, the political and civil rights monitor, rates the Emirates as only ‘Not Free’. Unlike in some other Gulf states, high and rising living standards have so far restrained the demands of Emiratis for greater political representation. According to World Bank surveys, the UAE ranks in the second top quartile of countries for political stability (chart below).
Members of the ruling families dominate the state-owned and quasi-state-owned enterprises, blurring the boundary between the government and the corporate sector. In these circumstances, firms can be at a disadvantage if they lack high-level contacts within the government. Dispute resolution can be difficult. In the past, many investors have been unwilling to pursue dispute resolution with government-related firms, out of fear of jeopardising their other business.
Business
According to the World Bank, the investment climate is good (see chart). The UAE ranks in the top 35% of countries on five dimensions of governance: regulatory quality, rule of law, control of corruption, government effectiveness and political stability. This places it well above the regional average on all five indicators.
On another World Bank gauge – ease of doing business, which attempts to measure ‘regulation and red tape relevant to a domestic small to medium-size firm’ – the UAE ranks 46 out of 181 countries, between Bulgaria (45) and Romania (47).
Corruption is not a systemic problem. Transparency International’s 2008 Corruption Perceptions Index ranks the UAE 35 out of 180 countries. The UAE ranks third in the Middle East behind Israel and Qatar (ranked 33 and 28 respectively). This index attempts to measure abuse of public office for private gain.
There is no national treatment for foreign investors and ownership levels are capped. Dubai is considered the most open to foreign direct investment, with a number of ‘free zones’. These areas allow 100% foreign ownership and are exempt from taxes, import duties and any currency restrictions. The largest is the Jebel Ali complex where more than 6000 foreign companies operate. Free zones also exist in Sharjah, Ajman, Fujairah and Ras al-Khaimah.
The slump has highlighted serious weaknesses in the legal system. According to the US Commerce Department, dispute resolution can be difficult and can favour locals over foreigners. Moreover, in some areas laws are not codified and there is no independent judiciary. Another major flaw is a lack of bankruptcy protection (business and personal) – meaning individuals are personally responsible for debt obligations.
- So far, the Abu Dhabi bailout funds have largely been used by Dubai’s state-linked companies to meet bond commitments, rather than to pay suppliers and contractors. There are many reports of payment delays, contract re negotiations and unfair calling of performance bonds. In May, Nakheel – Dubai’s largest government-linked property developer – reported that it had received some state funds to help pay contractors, but was also restructuring payment plans.
- Downpayments on some properties whose construction has been cancelled have not yet been repaid.
- Dishonouring cheques is a criminal offence in UAE and some debtors have been gaoled during debt recovery operations.
- Courts and arbitration centres are clogged. According to the Dubai International Arbitration Centre US$4.9 billion worth of construction claims are pending.
The slump has also highlighted shortcomings in contract and labour law potentially reducing the country’s attractiveness to expatriates. There is no bankruptcy protection, so individuals can be sent to debtors’ prison. Foreign executives have reportedly been arrested over alleged financial wrongdoing, but have remained uncharged for up to a year. Unclear redundancy laws have caused disputes over severance pay to surge. Labour mobility is hindered by the fact that work visas are removed with job loss and transferring to a new job requires a ‘no objection letter’ from the current employer. Reflecting these concerns, the country ranks poorly for protecting investors (113) and enforcing contracts (145) in the World Bank ease of doing business survey.
Widespread labour unrest in 2006 and 2007 caused some damage to offices and building sites. The unrest coincided with international pressure on the Emirates to change its restrictive labour laws. In response to criticism from the International Labour Organisation, and reportedly to clinch a trade deal with the United States, the authorities issued a new draft law in 2007, but the proposed legislation still bars workers from forming unions, striking and engaging in collective bargaining.. OPIC (the US government’s Overseas Private Insurance Corporation) does not provide insurance cover in the UAE because of the country’s failure to meet international labour standards.
The large number of jobs held by expatriates is causing discontent among local Emiratis, especially unemployed youth. To tackle these concerns, the authorities are carrying out a process of ‘Emirisation’. Employment quotas apply for firms operating in banking (4%), insurance (5%) and trade (2%). All secretaries and public relations officers must be Emiratis. There are also rules on redundancy — employers must apply to the labour ministry 30 days in advance before making an Emirati redundant and if an expatriate and an Emirati work similar jobs the expatriate must be laid off first. Firms who do not meet regulations can face fines or loss of visa renewal rights. Many firms note that meeting these regulations is hindered by a lack of employable UAE nationals.
The risk of outright expropriation is low. The UAE needs foreign investment to meet diversification aims. Nonetheless, it should be noted that there are no rules on compensation if expropriation ever did occur.
Society
Rapid modernisation and a large influx of expatriate workers mean that the UAE is more heterogeneous than it was even a decade ago. Foreigners account for 80% of the 4.8 million population and 99% of the private sector labour force. Apart from some highly-paid white-collar expatriates, the majority are lowly paid South Asians working in the construction and service sectors. This mix, coupled with the troubles the Emirates’ property, construction and financial sectors, is creating tensions, eg the labour unrest, youth discontent and contractual disputes noted above.
After a number of recent much-publicised arrests, there is also a rising perception that the social and cultural environment is becoming more conservative. Even Dubai, which has a reputation for openness and tolerance, has recently introduced a code of conduct on public behaviour, covering clothing, displays of affection, alcohol consumption and so on.
Security
Iran and the UAE have an unresolved territorial dispute over the Tunb and Abu Musa islands, but this is unlikely to lead to conflict.
Foreign embassies warn of a high terrorist threat. As a highly westernised Muslim society, with a large non-Muslim population, many of the trappings of ‘Western decadence’, and ‘a key partner in the War on Terror’ (in the words of the US State Department), the UAE makes a tempting target for jihadists. That said, the Emirates have not experienced a successful terrorist attack and the security services are ubiquitous and vigilant.
Occasional protests by foreign construction workers over pay and conditions have involved little bloodshed and property damage. The fact that foreigners can be deported at any time acts as a deterrent to labour militancy.
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