UAE Economy: Impact of Dubai crisis
Introduction
In 2009, the U.A.E. witnessed a significant slowdown in growth and strains in the banking system as a result of the global financial crisis, the decline in oil prices, and the continuing fallout from the bursting of the Dubai property bubble. The ramifications of the DW debt event will depend on the scope and modalities of the debt restructuring, its impact on the financial sector, and the strategy being developed by the Government of Dubai (GD) to put Dubai World (DW) and possibly other corporate entities on a viable economic and financial footing.
Improved global conditions, especially out of Asia, will fuel Dubai’s logistics and service sector. However, the correction in the over-extended property and construction sector renders the overall outlook highly uncertain. With foreign investor confidence shaken and international capital markets less accessible, Abu Dhabi’s policy of selective support to Dubai will play an important role in limiting contagion to the U.A.E. economy and the banking system.
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Key issues
- The contrast between growth based on hydrocarbon resources and that based on non hydrocarbon diversification funded by maturity-mismatched leverage
- The spillover effects and financial support structures in the federation
- The volatility of markets in response to a lack of information disclosure and transparency
- In particular, the debt announcement undermined the widely held market perception of implicit government support, including from Abu Dhabi
Relook
The authorities responded to the global financial crisis in a comprehensive and prompt manner. Also, the increased spending on strategic infrastructure projects, mainly in Abu Dhabi, to reduce the contraction in construction activity, and provided support to quasi-public entities and national banks, has done a larger good for the UAE economy as a whole.
However, recent developments in Dubai, while material, should be viewed in the wider perspective of the U.A.E. as a whole. Although the need to roll over part of Dubai’s substantial external borrowing in the post-Lehman environment has highlighted the risk embedded in the financing strategy of some Dubai entities, the U.A.E. has a net external creditor position well in excess of 100 percent of GDP, among the largest in the Fund’s membership.
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Recent Economic Developments
After the Global downturn, it hit simultaneously all of the U.A.E.’s three growth engines in 2009; Oil receipts plummeted, global trade and logistics contracted, and property development all but ground to a halt as incomes fell and property prices plunged.
Actions taken by Abu Dhabi boosted the fiscal stance via equity injections and loans. The central bank deployed bank liquidity support facilities and lowered interest rates. The federal government rolled out large scale recapitalization measures and provided AED 50 billion term funding to the banks. Finally, the GD announced a support package of $20 billion (half provided by the central bank and the other half by Abu Dhabi) to finance the needs of Dubai’s GREs, and established the Dubai Financial Support Fund (DFSF) to manage the support program.
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UAE Economy (2009)
- Notwithstanding the compensatory measures adopted by the authorities, overall real GDP of Dubai is estimated to have contracted by about ½ percent in 2009.
- Hydrocarbon GDP declining by 6¼ percent. Crude oil production averaged only 2.4 million barrels per day in 2009 lower then a average of 2.6 million barrels per day in 2008.
- Non Hydrocarbon growth, which had averaged 8 percent in the three previous years, is estimated to have slowed to about 1 percent.
- Inflation declined to 1 percent in 2009, reflecting lower import prices (-10 percent in 2009) and a reduction in rents as an increased share of rental contracts got renewed at the deflated market prices and new buildings came on stream.
- The external current account balance is estimated to have shifted to a deficit of 2.7 percent of GDP in 2009, the first deficit in decades.
- New external borrowing, mainly by Abu Dhabi entities, helped stabilize the reserves by the end of 2009, which stood at central bank international reserves to $31 billion by year’s end.
- Broad money growth slowed from 19 percent in 2008 to 10 percent in 2009. The consolidated fiscal position is estimated at a virtual balance in 2009, following a surplus of 21 percent of GDP in 2008.
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Outlook for 2010 and the Medium term
The fiscal and monetary policy mix will need to show adaptability over the medium term in order to sustain a further diversification of the economy within a more uncertain environment.
- Given Dubai’s share in U.A.E.’s non-oil GDP (above 50 percent) real GDP growth for the U.A.E. as a whole will be low (about ½ percent), despite the authorities’ support packages and Abu Dhabi’s investment projects that will help offset the contraction in Dubai.
- Growth would recover starting in 2011 owing to higher activity in the oil and trade sectors in response to the recovery in Asia; and orderly restructuring of Dubai’s GREs.
- Medium-term non hydrocarbon growth is projected to average about 4½ percent a year over the medium term, or 4 percentage points lower than before the crisis, a reflection of less activity in Dubai’s property sector and higher costs to access international capital markets.
- CPI inflation is expected to reflect higher import prices and the impact of Abu Dhabi’s large investments in infrastructure.
- Based on the WEO’s oil price projections, the overall fiscal position is projected to return to a surplus of about 10 percent of GDP in 2010. Over the medium term, the overall surplus will increase to about 15 percent of GDP, mainly due to a gradual increase in non-oil revenues associated with the introduction of the VAT.
- In 2010, the non hydrocarbon deficit is projected to contract by about 4 percentage points, to 30 percent of NHGDP, owing mainly to a slowdown in project implementation in Abu Dhabi, and to improve over the medium term because Abu Dhabi is not expected to continue providing support to its GREs
- The external current account is expected to shift to a surplus of about 7 percent of GDP in 2010, and to increase gradually in subsequent years. In the financial account, capital outflows would resume, reflecting official outward investment, but the Central Bank of the United Arab Emirates’ (CBU) gross official reserves would increase steadily.
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Conclusion
The ramifications of the Dubai event are still unfolding, as it will take some time for the GD to develop a strategy to restructure its GREs. Downside risks could materialize if the Dubai debt restructuring were to generate additional uncertainty.
It is important that uncertainty be removed regarding the financial viability of DW entities, the extent of implicit government guarantees to GREs, and the insolvency regime. If uncertainties remain in these areas, ramifications could include sustained lack of market access for even stronger Dubai entities and a more permanent loss of confidence in Dubai as a reliable business location.
The Dubai authorities stressed that they were committed to working with creditors in achieving an orderly and cooperative debt restructuring. They also indicated that they were working on improving transparency and corporate governance. This was regarded as important for viable companies to maintain access to international capital markets. The scope of the corporate restructuring and the debt restructuring options were still being defined.
Restructuring would seek to ensure economic and financial viability while protecting systemically-important entities. So far the debt restructuring is limited to the announced $22 billion, but the authorities recognized that other property GREs may have to enter a similar process.
The spillover effects of the Dubai event on the GCC, the wider region, and advanced economies appear manageable. However, the event may have a lasting impact on the availability and cost of external capital as creditors likely will further discount notions of implicit guarantees in pricing quasi-sovereign and private risk.
Author name: Abhijeet Ahir, Economic Analyst, MBA Finance (SIIB)
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April 1, 2010 - 2:33 am
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