IMF Executive Board Concludes 2015 Article IV Consultation with UAE
Lower oil prices are eroding long-standing fiscal and external surpluses, but the UAE has continued to benefit from its perceived safe haven status and large fiscal and external buffers that have helped limit negative spillovers from lower oil prices, sluggish global growth, and volatility in emerging market economies.
Nonoil growth remained robust at 4.8 percent in 2014, driven by construction, notably owing to capital spending in Abu Dhabi, and services underpinned by Dubai’s transportation and hospitality sectors. Real estate market prices have edged down since mid-2014. With past increases in rents only feeding gradually into consumer prices, inflation increased to 4.3 percent year-on-year in May 2015, also reflecting upward adjustments of electricity and water tariffs in Abu Dhabi. Credit to the private sector has picked up. GREs have continued to strengthen their finances.
The economic outlook is expected to moderate amid lower oil prices. Nonoil growth is projected to slow to 3.4 percent in 2015, before increasing to 4.6 percent by 2020, supported by the implementation of megaprojects and private investment in the run-up to Expo 2020. Growth in oil production will likely to moderate given the global supply glut. Annual inflation is projected to pick up to 3.8 percent in 2015. The overall fiscal balance this year is expected to turn negative for the first time since 2009 to record a deficit of 2.9 percent of GDP, but is expected to return to surpluses from 2016. The current account surplus is also projected to decline substantially, to 5 percent of GDP and will slowly increase with the projected gradual recovery in oil prices. Credit growth is expected to remain supportive of the activity.
Executive Board Assessment2
In concluding the 2015 Article IV consultation with the United Arab Emirates, Executive Directors endorsed staff’s appraisal, as follows:
Lower oil prices have increased macro-financial stability risks. Prudent economic policies, progress in economic diversification, and the safe-haven status of the UAE have helped build large fiscal and external buffers and strengthen the resilience of the economy. Also, the implementation of megaprojects and private investment in the run-up to Expo 2020 are expected to support activity over the medium term. However, lower oil prices are eroding fiscal and external surpluses, and going forward a hike in the US interest rate could lead to a tightening of financial conditions. These risks could be exacerbated by high volatility in stock markets, high NPLs, and low banking system liquidity if government and GREs withdraw deposits.
The macroeconomic policy mix should focus on gradual fiscal consolidation, while maintaining the peg and easing liquidity management if needed. The authorities’ plan to consolidate the fiscal position is appropriate, and would reduce fiscal vulnerability and ensure intergenerational equity. Fiscal consolidation will also help bring the external position closer to the level consistent with medium-term fundamentals. However, its pace should take into account the available fiscal buffers and the impact on the broad economy. The authorities’ monetary policy framework which aims to maintain the peg while strengthening liquidity management and deepening money markets, is appropriate. In an adverse scenario with a decline in deposits, liquidity management could be eased to support credit growth. Government deficit financing should avoid a tightening in liquidity in the banking system.
Fiscal consolidation requires rationalization of spending, but the quality of spending cuts is crucial to avoid damaging the country’s competitiveness and long-term growth prospects. Government investments should be preserved relative to nonhydrocarbon GDP to support infrastructure, while the implementation of GRE megaprojects should be gradual, in line with the expected demand. Public sector wage bill growth should be controlled while energy subsidies and capital and other transfers should be reduced. Raising more nonhydrocarbon revenues through new tax measures should also be considered. Fiscal policy implementation requires further strengthening annual budget processes, including strong Public Finance Management Systems, and integrating and operationalizing medium-term budget frameworks. Close oversight and continued strengthening of debt management frameworks are crucial.
Plans to strengthen the banking regulatory and supervisory framework by the CBU, with no exemptions in holding banks accountable, are welcome. The banking sector is resilient and has enough capital and liquidity buffers to withstand an adverse shock. The CBU plans to phase in Basel III capital and liquidity standards over 2015–19 and to strengthen its risk-based supervision are welcome and should be timely implemented. As the corporate sector structure in the UAE is characterized by large GREs and family groups, compliance by banks with the loan concentration limits for GREs and local governments is challenging and should be monitored, including the planned transition paths for banks exceeding the limits with no-exemption. Developing domestic debt markets would reduce the reliance on external funding and bank lending, helping banks comply with loan concentration limits. Over the medium term, the authorities should consider developing resolution frameworks, and establishing deposit insurance mechanisms. Efforts on strengthening the AML/CFT framework should continue.
Authorities should strengthen their macroprudential framework, building on their successful implementation of real estate-specific measures. Macroprudential policies such as maximum LTVs for mortgages and DSTI limits help reduce excessive exposures by the banking system associated with systemic risk. However, the current macroprudential policy framework needs to be strengthened in line with best practices such as formalizing a financial stability mandate in the central bank law, establishing a Financial Stability Committee at the central bank level, and institutionalizing coordination with the Ministry of Finance and other relevance agencies. Continued strengthening of GREs balance sheets and active management of their upcoming debt repayments, while raising risk-weights of bank lending to GREs if needed, will be important in reducing macro-financial vulnerabilities.
Structural reforms should aim at further diversifying the economy and accelerating private sector-led job creation for nationals. These could include: further opening up foreign direct investment, improving selected areas of business environment, transitioning toward a knowledge-based economy, easing access to finance for startups and SMEs, and creating the right incentives for entrepreneurship and job creation.
Staff encourages the authorities to build on recent progress in improving statistics. Staff welcomes efforts in implementing an inter-agency project to compile the International Investment Position, which will close an important statistical gap, including for the reporting of foreign assets and debt. It will be important to press ahead with this project and provide adequate resources for improving the quality of overall balance of payments statistics. It will also be essential to develop more comprehensive demographic and labor markets statistics, while disseminating complete data on Dubai GRE debt.
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