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29 March 2024

UAE's credit quality continues to be high

Global economic recovery would have a positive impact on the UAE, says Nomura. (PATRICK CASTILLO)

Published
By Shveta Pathak

The UAE's credit quality remains high and there is a renewed appetite for quasi-sovereign risk in Dubai, investment bank Nomura said.

"The successful Dubai Water and Electricity Authority [Dewa] new issue should help sentiment, indicating a renewed appetite for quasi-sovereign risk in Dubai," Nomura said in its latest report on the region.

Recovery in the UAE is under way and a 2.1 per cent expansion in economic activity is expected this year.

Nomura said it sees value in both Dubai's government bonds and credit default swaps (CDS). "External debt spreads have narrowed on most of the region's sovereign debt, while they remain wide for Dubai. We continue to see value in both Dubai government bonds and CDS, particularly in the wake of the announced restructuring proposal for Dubai World and recent indications of renewed market appetite for quasi-sovereign issuers."

Taking stock of economy in the region, Nomura said even as future economic performance is strongly connected to outlook for oil prices, its high per capita GDP of more than $35,000 (Dh128,553), extensive hydrocarbon reserves and plentiful offshore financial assets all provide a considerable buffer.

According to the report, recovery in the UAE is under way inspite of current economic challenges. It must still work through further deleveraging of its economy, but the announced proposal of the Dubai World restructuring , it said, is an important step forward in this process. Standing strong with high oil price environment and a fiscal stimulus, Saudi Arabia continues to remain a regional power house. There already are signs of increased private sector economic activity, and some tentative signs of renewed bank lending have appeared, the report said.

The region attended effectively to risks to the banking sector during the crisis. "However, some concerns about asset quality remain, keeping lending growth sluggish and providing some drag on non-oil growth."

For the UAE, which was not immune to economic crisis, Nomura said it expected GDP growth to return to positive territory in 2010.

The UAE is one of the economic powerhouses and it is emerging from the crisis in a stronger position to put in place the elements needed for a healthier and more sustainable growth path.

Implementation of measures, including stronger regulation and supervision, increased transparency, improved coordination among states and clarification of explicit public sector obligations, would be a key determinant of future success.

Ann Wyman, Managing Director and Head of Emerging Market Research, Europe, said: "The UAE remains one of the region's powerhouses. Its plentiful hydrocarbon resources and successful diversification drive have combined to create an economy with strong medium-term prospects."

Global economic recovery, led by Asia, would have a positive impact on the UAE, according to the report.

Crude oil production, which declined by about 10 per cent in 2009 on low prices and sluggish global demand, is expected to recover in 2010, though it is unlikely to be at its previous output level, it said.

Apart from increase in demand for commodities, the country's logistics and services sectors could benefit from Asia's strong recovery, it added.

Nomura said there is a return in consumer confidence in the region.

"The proposed Dubai World restructuring has been an important step in the process of reviving business and consumer confidence, which recent local survey data indicate is on the mend. The process of improvement will take time, particularly as an assessment of the impact on the banking sector is not yet complete. The recent successful return to the capital markets by Dewa should provide some additional important support to confidence."

Property

The property sector might take some time to recover, but the restructuring of debt, which would settle many outstanding liabilities to contractors, said the report, would contribute to a revival in activity "since many construction projects have been stalled by a lack of liquidity".

The government's response to the global financial crisis was swift and strong. Emergency liquidity measures, deposit guarantees, capital injections and an evaluation of prudential regulations all helped maintain confidence in the banking sector, which had experienced extremely rapid credit growth in the run-up to the crisis. Capital adequacy ratios were increased to 19 per cent system-wide at the end of 2009, which appeared sufficient to maintain confidence during the crisis.

Nomura said while government stimulus will remain important in future, it is expected to decline from 2009 levels. "This, combined with the recovery in oil prices, should see a return to a double-digit surplus as a percentage of GDP as early as this year," it estimated.

Monetary policy

Analysing monetary policy impact, the report said the government remains in favour of maintaining the currency peg to the dollar, and recent deflationary pressures are unlikely to lead to market pressure for a change. As such, interest rate policy should remain tied to that of the US for the foreseeable future, it said.

The currency peg to the dollar looks set to remain in place, said the report.

The GCC monetary union will not be an issue in the near term, Nomura said.

Giving details, the report said it was almost nine years ago that the six GCC countries agreed to establish a monetary union with a single currency by January 1, 2010. Such union would enhance intra-regional trade and financial activity and also the development of a common capital market, it was believed. Regional policymakers have also indicated their belief that such a union could offer better protection from external shocks and/or speculative attacks. "Although the process of moving towards monetary union has been delayed, and Oman and the UAE have withdrawn, the remaining countries have continued to push ahead with planning for the project," it said.

Noting that in December last year a monetary union agreement was signed between Saudi Arabia, Kuwait, Qatar and Bahrain, the report said in March this year, the Gulf Monetary Council, a precursor to a planned Gulf central bank, held its first meeting. "At the gathering, the policy-makers reiterated their commitment to push ahead, though without a deadline for the start of the single-currency area."

A statement from the meeting indicated a continued desire by the four countries to see both Oman and the UAE rejoin the discussions, it added.

A set of "convergence criteria" for the monetary union has been put forward which look similar to those used by the eurozone one, with added requirements that in the event that oil prices face a significant drop, the fiscal deficit ceiling may be raised to five per cent of GDP; and foreign exchange reserves (including sovereign wealth fund assets) should be maintained at a minimum of four months import cover.

"The council's next steps include fleshing out monetary rules and determining an appropriate exchange rate regime, among other aspects of monetary union. We continue to believe that GCC monetary union will not be an issue in the near term given the complexities of its establishment and the challenging political dimensions of leadership and governance. Moreover, recent experience in the euro area should spur considerable reflection about the most appropriate institutional arrangements [notably with respect to fiscal rules] to ensure the longevity of any such arrangement."

Credit risk

Analysing credit risk in the UAE, Nomura said markets clearly differentiated between different emirates, as can be seen in the CDS spreads of each.

"The government's fiscal stimulus during the global economic crisis facilitated infrastructure spending in the region, especially in Abu Dhabi, it noted. In addition, the Abu Dhabi Government provided support to quasi-sovereign entities through equity injections and lending as well as its contribution to the Dubai Financial Support Fund. This support, combined with weaker oil revenues, led to a large decline in the government's 2009 overall fiscal surplus leaving it with a very modest surplus of less than two per cent of GDP.

As the economy treads the path of recovery, inflation remains subdued, especially as the sharp decline in real estate prices is still stabilising, said the report.

Inflation, which was in double digits in 2007 and 2008, reduced significantly in 2009 to end the year with slight deflation of -0.3 per cent year-on-year, as rentals declined and import prices too saw a fall.

This year is likely to see a "subdued" inflation in the backdrop of a weaker growth environment even though price pressures may return with a stronger recovery in oil prices, a normalisation of the property market and increasing import prices by next year.

Saudi Arabia

On Saudi Arabia, Ann Wyman said: "Saudi Arabia, the Gulf's largest economy, is setting a course for continued strong economic performance. Its swift and pre-emptive actions to maintain confidence in the banking sector during the credit crisis, followed by a decisive and substantial fiscal response to the global economic slowdown, have helped it to weather the storm. While the country's medium-term growth prospects remain inextricably tied to hydrocarbon production, it is making strides toward economic diversification. Business and consumer confidence is returning, and bank lending looks to have resumed, albeit at a slower, and healthier, pace."

Nomura expects an economic growth of 3.7 per cent in Saudi Arabia, led by increased oil output, loose fiscal and monetary policy and an increase in bank lending to the private sector.

Bullish on Qatar

Equally bullish towards Qatar, Nomura said that as a result of vast hydrocarbon revenue and high levels of both public and private investment, the country remains one of the world's fastest-growing economies.

Regarding Kuwait, the report said: "Kuwait is the world's fourth largest oil exporter, and estimates its own reserves at 100 billion barrels, or more than 100 years of production. Endowed with plentiful hydrocarbon reserves and a small population, it remains one of the world's most affluent countries, with per capita GDP in excess of $50,000."