With a fragile economic recovery underway in the country, the International Monetary Fund (IMF) has suggested that the emirate of Dubai consolidate its debt ratios, which it believes will be aided by the introduction of GCC-wide value-added tax (VAT).
Dubai should undertake fiscal consolidation to achieve a comfortable debt-to-GDP ratio over the medium-term. The planned introduction of a GCC-wide VAT would enhance revenue mobilisation capabilities and facilitate such consolidation, the IMF said in a mission statement on the UAEs economy today.
After a 3.2 per cent decline in 2009, the UAEs economy returned to growth in 2010, with the momentum carrying into 2011, the IMF said, while cautioning that several factors, including the unrest in the Middle East and North Africa (MENA) region continue to pose downside risks to the countrys growth prospects.
Benefiting from high oil prices and strong demand from traditional trading partners, and despite fiscal contraction, the economy grew by an estimated 3.2 per cent in 2010, the IMF confirmed. The momentum is carrying into 2011 with non-oil GDP growth projected to accelerate from 2.1 per cent in 2010 to 3.3 per cent, reflecting strong tourism, logistics, and trade in Dubai; and large public investment spending in Abu Dhabi, including through GREs [government-related enterprises], the IMF statement said.
Higher oil prices are contributing to a marked improvement in the fiscal position and balance of payments. The successful restructuring of Dubai Worlds debt has improved market confidence, allowing top-grade Dubai issuers to regain market access, it added.
However, credit spreads remain high, reflecting uncertainty about debt restructuring needs of other GREs, and more recently a higher regional risk premium. The large overhang in the real estate market will also remain a drag on the economy, and the unrest in the MENA region poses downside risks.
The IMF mission visited the UAE from February 27 to March 7, to hold discussions for the UAEs 2011 Article IV consultation. Discussions focused on near-term economic policies; measures to maintain financial stability; and a medium-term strategy to mitigate risks posed by the highly-leveraged GREs and maintain macroeconomic stability over the business cycle.
The IMF statement noted that in 2009, despite the authorities supporting the banking sector through liquidity injection, recapitalisation, and deposit guarantees in the face of a decline in oil prices, the post-Lehman shut down of international capital markets, and the price correction in the property market, real GDP contracted by 3.2 per cent in that year.
The statement further added that the country needs to strengthen the economys resilience to shocks in the future. The recent episode of debt restructuring in Dubai and the ramp-up of GRE borrowings in other emirates underline the need to identify, assess, and mitigate the risks posed by these entities, the statement advised. The recent boom-bust experience highlights the challenge of macroeconomic management over the cycle, it said.
Given the pegged exchange rate regime, this requires mutually-supportive countercyclical fiscal and macro-prudential policies. Underpinning these reforms is the need to improve statistical capacity to inform policy decisions and disclosure, the IMF statement added.
However, the global agency noted that a recovery, though fragile, is gaining strength, benefiting from a favorable global environment. High oil prices, improved growth prospects in Asia, and low interest rates are contributing to the recovery in the UAE, the IMF noted. Real GDP is projected to continue to grow at 3.3 per cent in 2011, it said.
It also added that even though inflation will rise from the recent lows, it will remain firmly at moderate levels. Driven by higher food prices, consumer price inflation is expected to rise, but will remain moderate at 4.5 per cent in 2011, as rents continue to decline. Analysis of the real exchange rate suggests that the dirham is in line with fundamentals.
Moreover, the IMF noted that Dubai and Abu Dhabi, though following different growth trajectories, continue to benefit from recent global and regional developments. Higher oil production and increased infrastructure spending, including through GREs, are the main drivers of growth in Abu Dhabi, though its non-oil growth will continue to slow down partly due to last years fiscal contraction. Dubai is benefiting from its leading position as a regional hub, with growing links to Asia, and improved competitiveness thanks to the ongoing price correction in the real estate market, the statement said.
Nevertheless, the agency highlighted that several factors continue to pose a drag on the countrys economic prospects. One of the first factors the IMF mentions is [t]he large property overhang and uncertainty regarding its size. It said that [t]he excess supply of property in Dubai which will further increase in light of the expected completion of unfinished projects and uncertainty regarding its size will continue to weigh on property prices, investment, and growth.
To add to the woes is the potential risk of a property surplus in Abu Dhabi. There is also a risk that Abu Dhabis strategy to ramp up its housing supply, unless carefully managed, will put further pressure on the property market, it said.
Despite the successful debt restructuring exercise undertaken by Dubai World, the IMF believes that the impending debt servicing requirements could still pose a short-term challenge. With an estimated $31b of debt due in 2011-12, of which at least $5b in the real estate sector, Dubai continues to face significant rollover risks in the short term, it said.
Despite better communication, the absence of a well-defined, coherent, and transparent strategy to address GRE financing will translate into higher borrowing costs for Dubai (both sovereign and GREs) in an already difficult market. In addition, the government of Dubais strategy to use the earnings of the well-performing GREs to finance the underperforming entities may dampen investment and growth, it said.
Also adding to the woes could be international sanctions against Iran, which is a major trade partner of the UAE. The sanctions on Iran, one of the UAEs largest trading partners and a traditional source of demand for Dubai real estate, could undermine the recovery, it said. Furthermore, the unfolding turmoil in the region poses downside risks to the outlook. The re-pricing of risk in the region would result in more difficult market conditions. It added.
Nevertheless, the IMF acknowledged that higher oil prices and the UAEs safe haven status in the region could see it emerging a beneficiary of the recent political turmoil in MENA region. On the positive side, there are indications that the UAE may benefit from increased tourism and investments looking for diversification within the region. Higher oil prices are also benefiting the UAE as a hydrocarbon exporter, though if sustained, they may dampen the recovery in view of lower demand from Asia, it said.
The IMF also suggested that the country should continue to pull its weight behind developing a local debt market to enhance depth and liquidity. Developing a domestic debt market would help banks over time meet the Basel liquidity requirement. The CBU plans to introduce a short-term liquidity ratio along the lines of Basel III. A government securities market would help banks improve their liquidity buffers, it said, adding that the IMFs staff stands ready to provide technical assistance on market development.
The Fund also lauded the countrys recent announcement to invest in infrastructure upgrade in the Northern Emirates and job-creation policies for the nationals. The authorities plan to upgrade the infrastructure in the Northern Emirates is a step towards more inclusive economic development and should be expanded. The plan will help ease the electricity shortages in the northern emirates, it said.
It suggested removing water and energy subsidies, and instead a cash handout to the poorer segments of the economy. [R]eplacing the current mostly implicit subsidies on water and electriciy with explicit cash transfers to lower-income households would better target those in need, while reducing bottlenecks through more effective conservation, it said.
Although overall unemployment in the UAE is low, unemployment among nationals remains high and concentrated in the northern emirates. The federal and local governments are setting up employment programs to encourage the recruitment of nationals in the private sector. Local governments have also established SME funds and training programs. The mission encourages the government to consider launching its planned active labor-market policies in the Northern Emirates and locating some of its agencies/entities in the North to create jobs in these areas.