Risk drivers and outlook

The steep fall of international oil prices in recent months is severely impacting the revenues of oil exporting   countries, including the United Arab Emirates (UAE). However, thanks to years of large fiscal and external surpluses, the UAE has been able to build up large external assets, mostly through its large sovereign wealth funds, in particular Abu Dhabi’s ADIA. As a result, the country’s net foreign assets are worth about 120% of GDP, despite a relatively high external debt (of around 45% of GDP) compared to other countries in the region. Moreover, thanks to increasing diversification, the UAE’s economy is now less dependent on oil and gas revenues than before, being successful in attracting capital and visitors to a haven of political stability in a turbulent region. Thanks to these buffers, both the  UAE’s short- and medium-long-term political risk classifications are in category 2 on a scale from 1 (best) to 7 (worst).

However, despite the diversification, the United Arab Emirates’ export revenues continue to depend for almost two thirds on oil and gas revenues – its proven oil reserves being the seventh largest in the world. Therefore, the recent steep fall in international oil prices is affecting the country’s economic performance. If the current low oil prices continue, the  public budget would fall into deficit and its large current account surpluses of the past years will erode. Moreover, the country’s economic growth is likely to fall, from a solid average of 5% in 2011-13, weighing on the business environment and commercial risk.

The most important risks to the outlook therefore concern the future level of international oil prices and the evolution of global financing conditions, which – while currently accommodative – remain uncertain in the medium term, when significant debt of government-related entities (which caused a crisis in 2009-10) will mature.

Facts & figures

Pros

  • High energy reserves and revenues
  • Large sovereign wealth fund
  • Favourable location (interregional trade hub)
  • Stability attracts investments and tourists

Cons

  • Oil price fallen below breakeven price
  • Dependency on energy revenues
  • Government-related entities face refinancing challenges
  • Limited financial transparency

Main export products

  • Oil & gas (63.6% of current account receipts, net of re-exports and free zone imports), investment income (9%), tourism (6%), base metals (2%)

Income group

  • High income

Per capita Income (USD)

  • 38,620 (2012)

Population

  • 9.3 M

Description of electoral system

  • President: elected by the Supreme Council of Rulers
  • Federal National Council: half of delegates are appointed by the constituent emirates’ government, other half is elected; last in September 2011

Head of government

  • Prime Minister Mohammed Bin Rashid Al Maktoum (since tourists 2006)

Head of State

  • President Khalifa Bin Zayed Al Nahyan, Ruler of Abu Dhabi (since 2004)

Country risk assessment

Political stability supports economic activity

Over the past years, the United Arab Emirates – which includes the emirates of Abu Dhabi, Dubai, Sharjah, Ajman, Umm al Qawain, Fujairah and Ras Al-Khaimah – has been a safe haven in an unstable region. While unrest has been witnessed in the Middle East and North Africa (MENA) since early 2011, political stability in the UAE remains largely unaffected. This stability led to an increasing interest in the country, attracting capital inflows and strongly supporting sectors such as tourism, real estate and the hospitality industry. As a result, in 2013 and 2014, non-oil economic activity has grown by around 5.5%, shrugging off the effects of the Dubai crisis that hit the country in 2009-10 – when economic activity in this emirate contracted by 5%.

Even though political freedom is almost non-existent in the UAE, political opposition does not get off the ground as a result of the popularity of the ruling families and the distribution of oil wealth among the population. The position of the emirs is further reinforced by the country’s demography, as only ten to twenty per cent of the total population are estimated to be UAE citizens.

Within the UAE, the emirate of Abu Dhabi holds the most important political authority, which is explained by its significant financial capacity, based on its important energy resources. Abu Dhabi holds the bulk of the UAE’s proven oil reserves (about 94%) and its revenues represent almost two thirds of consolidated government revenues. Moreover, after Abu Dhabi’s financial support to the emirate of Dubai in 2009-10, the former seized the opportunity to increase political control over Dubai via a gradual trend of administrative and regulatory centralisation.

Diversification efforts to reduce oil dependency

Economic activity in the UAE is mainly located in Abu Dhabi and Dubai. Oil and gas remain the UAE’s largest source of revenues (64% of current account receipts and 79% of government revenues) and the UAE’s proven oil reserves are the seventh largest in the world. Dubai’s economy is more diversified and the federation as a whole is further diversifying its economy, having evolved into an important regional services hub with activities in transportation and logistics, but also financial services and tourism. Thanks to continued diversification efforts (including the recent successful bid for the 2020 World Expo), hydrocarbon dependency is lower than in many other oil exporting countries in the MENA region.

GraphUAE1EN

However, the dependency on hydrocarbon revenues (particularly in public revenues) remains important and more revenue diversification is needed to reduce dependency on strongly fluctuating international oil markets. The recent drop in oil prices again demonstrates the erratic nature of world energy markets: despite the escalation of severe security issues in Libya and Iraq as well as the conflict between Russia and Ukraine, Brent crude oil  prices have fallen by about 50% since mid-June 2014, after years of relative price stability (see graph).

GraphUAE2EN

Meanwhile, there remains considerable uncertainty about international oil markets in the longer term, as demand and supply drivers in the market are changing. On the demand side, much will depend on future global economic activity (with an important role for emerging markets), the development of alternative energy sources (like the use of natural gas in transportation or progress in the renewable energy sector), improvements in energy efficiency and environmental concerns relating to greenhouse gas emission. On the supply side, both positive and negative shocks are likely in the coming years. Supply can increase – putting negative pressure on oil prices – as a result of further developments in shale oil extraction technologies (which could further increase production in the US  and in other countries – if the shale technology is successfully exported there) or thanks to new supply entering the markets (e.g. in case of the easing of sanctions against Iran). However, geopolitical tensions and unrest in oil producing countries could negatively affect oil production there and result in upward pressure on oil prices.
Finally, prices could be supported by lower production quota by OPEC. If that were to happen (during its November 2014 meeting, the OPEC decided to leave its oil output unchanged), price and quantity effects would partly offset each other in member countries, among which the UAE.

Oil prices have fallen below the UAE’s breakeven oil prices…

The UAE’s oil and gas reserves are far from exhausted. At its 2013 production rate, oil reserves are sufficient for another 74 years of production. However, as a result of the sustained fall in oil prices, current international oil prices have fallen below the UAE’s fiscal breakeven oil price (the oil price below which the government budget books a deficit), which the IMF estimates at around USD 74 per barrel. As a result, if oil prices remain around their current low levels, the UAE may soon book a public deficit, for the first time since 2010. Considering the country’s balance of payments position, oil prices are now close to the external breakeven oil price (the oil price that makes for a balanced current account), which is estimated at around USD 54 per barrel. That being said, it should be noted that the UAE’s fiscal and – especially – external breakeven oil prices stand to decrease in the years ahead, thus improving prospects.

GraphUAE3EN

… but large foreign assets mitigate impact of lower oil prices

Thanks to successive and extensive government budget and current account surpluses over the past years (in 2011-13 amounting to on average 8% and 16% of GDP respectively), the UAE as a whole has been able to build up large  foreign assets through its sovereign wealth funds (SWFs), particularly Abu Dhabi’s ADIA. The UAE is estimated to hold more than USD 600 billion in external assets. This is almost four times as much as the country’s gross external debt, which is estimated at around 45% of GDP. As a result, the UAE is a net foreign creditor, with a net foreign assets position of around 120% of its GDP. Moreover, the country’s liquidity is strong, with foreign exchange reserves amounting to approximately 6 months of imports, a safe buffer, though not exceptional among fellow oil exporting countries in the region.

There is, however, typically limited transparency about the assets (and their maturity profile) of the SWFs in the UAE (and the wider region). This makes it difficult to assess whether the large foreign assets can be made liquid (at a reasonable price) in case of sudden shocks. Nevertheless, taking into account the estimated size of these assets, they do represent an important financial buffer for the UAE when confronted with financing needs.

GraphUAE4EN

Dubai overcomes its debt problems

The debt restructuring of Dubai’s troubled government-related entities (GREs) is being finalised and the last major restructuring (of Dubai Group) was completed. The restructuring was required after the bust of Dubai’s booming business cycle in 2009, when its GREs (which are closely linked to the emir and so inspired confidence in  financial markets, even in absence of an explicit (sub-)sovereign guarantee) were confronted with severe liquidity problems. The UAE’s central bank and Abu Dhabi had to bail out Dubai’s GREs with a USD 20-billion loan – which was rolled over earlier this year, at reduced interest rates. Over the past year GREs have been able to find less stringent financing conditions to refinance their debt and last August, property developer Nakheel announced it had repaid all of its bank debt as much as four years ahead of schedule. Despite these positive developments, Dubai’s total government and GRE debt still amounts to around 140% of the emirate’s GDP with almost two thirds of this debt falling due before 2019. Thus, the emirate remains vulnerable in case of volatility in global financial markets in the coming years; particularly in case of strong market reactions to US Fed monetary tightening. Indeed, given its open capital account and its currency peg to the USD, the UAE’s monetary policy must follow the US Fed’s. Meanwhile, prices in the real estate sector (which was severely hit by the Dubai crisis) have rebounded. Some residential real estate prices in Dubai have even already reached previous peaks and the double-digit growth of real estate prices last year even started to raise questions of another boom-bust cycle. However, prices stabilised in recent months after authorities took measures, including tighter mortgage requirements and higher transaction taxes, reducing incentives for speculation in the real estate market.

Increasingly assertive foreign policy

Over the past year, the UAE’s foreign policy has become increasingly assertive. Its leadership perceives the regional influence of the Islamist Muslim Brotherhood (MB, which was founded in Egypt) as a threat to its domestic stability and in the past year, dozens of Emirati Islamists have been condemned. Moreover, relations with Egypt have intensified after the ouster of MB President Morsi. Together with Kuwait and Saudi Arabia, it has provided an estimated USD 20 billion in financial support to the new Egyptian regime. In early 2014, it also launched air strikes in Libya (together with Egypt) and in Iraq. The UAE’s aversion to the MB has also strained relations with fellow GCC state Qatar – which supports the MB – over the past years. However, tensions with Qatar have eased in recent months, after a number of senior Egyptian Muslim Brotherhood members left Qatar upon the request of the UAE and Saudi Arabia.

Analyst: Sebastian Vanderlinden, s.vanderlinden@credendogroup.com