Outlook for UAE economy remains mixed

The UAE economy is likely to take much longer to find its feet though financial conditions have stabilised, confidence has improved and some sectors – notably trade and tourism – seem well placed to benefit from a pick-up in global growth, according a report released yesterday.

Heading into the second half of 2010, the outlook for the UAE economy remains mixed. With large parts of the corporate sector stuck in restructuring mode, short on finance and burdened with high levels of debt, it is most likely that economic growth will remain sub-par for at least the next two years.

In the long-term, however, there is scope for a reformed corporate sector to emerge stronger than before, National Bank of Kuwait said in its country report.

Uncertainty over outstanding exposures to Dubai World and other government-related entities (GREs) has been one factor inhibiting lending by banks. Growth in bank claims on the private sector collapsed to almost zero in 2009 as banks suffered a funding squeeze and sought to rebuild their balance sheets by limiting new loans, increasing reserves and boosting holdings of 'safe' government assets.

Claims on the private sector rose by just four per cent in the year to March. Since bank credit was the cornerstone of Dubai's rapid economic expansion in earlier years, the business environment for local firms has now radically changed.

The property sector also shows little meaningful signs of revival. Weak lending, job insecurity and fewer speculative purchases have undermined demand for residential property, especially in Dubai. Although by the first quarter, prices had risen some 11 per cent from their low of the second quarter of 2009, they are still some 45 per cent lower than at their peak in the third quarter of 2008.

Moreover, new supply continues to pressure the already oversupplied market. Property consultants Colliers project that the number of residential units in Dubai will increase 12 per cent this year, thereby exacerbating the imbalance and limiting further price gains.

The construction sector – which contributed around one-fifth of non-oil GDP growth between 2002 and 2008 – continues to struggle, owing to a combination of cash flow problems, restricted access to project finance and uncertainty over project viability.

Citing Meed figures, it said civil projects with a budget value of $1.3 trillion had been planned, but close to $0.5 trillion of these have been either put on hold or cancelled. For sure, many of these were in the very early stages of planning, and their loss will have a minimal impact on GDP. However, the sheer size of the 'on hold' segment highlights the scale of the sector's problems. In addition, many of those schemes underway have been subject to delay.

Drags on economy

"We suspect that weaknesses in the finance, property and construction sectors will persist, providing a major drag on economic growth over the next couple of years. This will limit the UAE's ability to benefit from stronger growth in the world economy," NBK analysts said.

"After contracting 2.7 per cent in 2009, we expect real GDP to expand by 1.7 per cent this year and by a further 2.6 per cent in 2011. Growth will be led by the hydrocarbon sector, which will gradually revive as some of the exceptional Opec-driven cuts in crude output of the past two years are reversed. We assume that real hydrocarbon sector output (excluding refining and gas processing) rises by two per cent this year and three per cent in 2011. The sector accounts for around one-third of real GDP," it added.

Meanwhile, real growth in the non-oil sector is likely to remain subdued, at 1.5 per cent in 2010 and 2.5 per cent in 2011. Within this overall total, it seems possible that Abu Dhabi will expand at a fairly robust rate of 4-5 per cent per year, boosted by its relatively solid fundamentals and its expansionary fiscal policy. Dubai, on the other hand, could see output contract this year and expand only modestly in 2011, as the local corporate sector consolidates further. Dubai also faces restricted access to capital and spending cuts in its public sector in order to help service its debts. 2012 may be better, however, it added.

Internal, external balances

In its outlook for the UAE's internal and external balances, it said the fiscal position remains fairly comfortable, with high oil revenues allowing the Abu Dhabi government to accumulate massive net external assets, far in excess of the debt owed by Dubai GREs.

At face value, however, last year may have seen the UAE record its first budget deficit since 2003, at seven per cent of GDP, driven by a huge 45 per cent drop in hydrocarbon revenues and a 15 per cent increase in spending, including a 20 per cent rise in capital outlays. But these figures exclude both the income received on the government's vast overseas assets and profits from the Abu Dhabi government-owned oil company, Adnoc. Including these, the budget is likely to have been more or less in balance.

Forecasts of the UAE's public finances are subject to a wide margin of error, not only because of the volatility of oil prices, but because the expenditure plans of Abu Dhabi are not published in advance. But based upon reasonable assumptions, higher oil revenues (thanks to higher oil prices) and a slight drop in expenditures will reduce the deficit to around five per cent of GDP this year and three per cent next year. Including the 'off-balance sheet' revenue items described above, however, we expect the budget to record surpluses of 3-5 per cent of GDP per year. If oil prices turn out higher than the $70 per barrel we assume, the surpluses would be larger.

Along similar lines, the current account surplus is estimated to have dipped last year to one per cent of GDP from 8.8 per cent of GDP in 2008. The fall was less pronounced than for the fiscal balance because of a slump in imports. But higher oil prices could push it back up to five per cent of GDP in 2010 and 2011.

Consumer price inflation fell to an average of 1.6 per cent in 2009 – its lowest in nearly a decade – thanks to especially sharp decelerations in the food and housing rent components.

REvamp to boost confidence

The final debt restructuring deal between Dubai World and its creditors will provide a shot-in-the-arm to confidence in Dubai, and offer a short-term lift to stocks, but may not trigger a revival in the local economy, NBK analysts said in the study.

The $24 billion (Dh88bn) debt restructuring deal between state-owned Dubai World and its creditors appears to be inching towards a conclusion.

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