Dubai and other emirates lead government expenditure

The UAE operates the most decentralised system of government finances in the world, according to the IMF. Under the fiscal model, the national government pays for federal infrastructure, including major roads passing through multiple emirates, as well as spending on social services such as health, education and housing, with emirate-level authorities responsible for nearly all other outlays. As such, the federal government accounts for only 11.5% of total public spending in the country, with most expenditure undertaken by the individual emirates. About three-quarters of federal government revenue is derived from the national authorities’ own revenue streams, with the remainder contributed by Abu Dhabi and Dubai in agreed amounts.

Budget

The Dubai government plans its annual budgets around a medium-term fiscal framework incorporating a variety of three-year targets. The framework generally seeks to limit annual deficits to a maximum of 3% of GDP and government debt to no more than 30% of GDP – targets that the authorities have been comfortably meeting.

In December 2017 an emirate-level budget was unveiled for 2018: Dubai’s largest ever, with Dh56.6bn ($15.4bn) marked for expenditure, a 19.5% increase on 2017, and in line with the targets of the Dubai 2021 strategic plan. Under the new budget 42% of outlays are to go to general and administrative expenses, subsidies, grants and support spending, an 11.5% increase on 2017; 30% to salaries for government employees, a 10% increase; and 21% to infrastructure investment, an increase of 46.5% on 2017. “We have been seeing strong counter-cyclical spending by the authorities who are willing to develop large construction and infrastructure projects at a time when most GCC governments have been reducing expenditure,” Mathias Angonin, sovereign risk group lead analyst at Moody’s Investors Service Middle East, told OBG. The significant increase in infrastructure spending is largely driven by Expo 2020-related projects, such as the main expo building, roads and bridges, and works for the Dubai Metro and Al Maktoum International Airport. “The expo presents challenges that require us to focus on availing construction expenses needed for the mega-infrastructure projects related to Expo 2020 Dubai”, Abdul Rahman Saleh Al Saleh, diretor-general of Dubai’s Department of Finance, said in a press statement in December 2017. In its July 2017 Article IV consultation on the UAE, the IMF said it expected the emirate to continue to run a deficit in the years running up to Expo 2020.

The government has a number of options for financing the deficit. Local banks are already large lenders to the emirate, as well as to government-related entities (GREs), though such exposures may need to be reduced under new concentrated lending rules (see Banking chapter). The federal and emirate-level governments have also issued bonds in the past, preferring to tap international markets to avoid crowding out local private sector borrowing. In February 2017 international press reported that the Dubai government was considering issuing foreign debt for the year, and the authorities decided to generate $500m by selling ten-year bonds in mid-2017. The sale of other bonds could be used to finance deficits exceeding this.

Revenues

Public revenues for the emirate are expected to climb to Dh50.4bn ($13.7bn) across 2018, a 12% increase on 2017 and dominated by fees, such as those levied on corporations, housing fees, visa fees and traffic fines. According to government figures, non-tax revenues will represent 71%, while tax revenues will represent 21% of the total estimate. Additionally, oil income is projected at 6% and returns on government investments at 2%.

The authorities have been moving to grow certain revenue streams in recent years. Steps to accomplish this have included a Dh35 ($9.53) fee imposed on passengers at the emirate’s airports in 2015, a new levy on hotel stays and increased parking fees. In April 2017 Dubai Police increased the amounts of various traffic fines, with several doubling and the penalty for using a phone while driving quadrupling. The new measures were accompanied by a sharpening of other penalties, such as having black points on one’s licence and driving bans of various lengths for some types of offences.

Government Debt

With the Dubai authorities having registered a balanced budget for the four years leading up to 2017, government debt remains low. According to Moody’s, the figure was equivalent to 25% of GDP in 2015, down from around 33% in 2010. “Since 2010 the authorities and government entities were able to replace short-term maturities with long-term profiles, which had a soothing effect on the liquidity position of the entities,” Angonin told OBG. This will change the repayment schedule for these debts, but not the debt-to-GDP ratio. However, government figures do not fully demonstrate the extent of public sector debt, as some GREs have large loans on their books that are not recorded as part of the central government total. The IMF estimated the value of such GRE debt at 60% of GDP in 2016. Additionally, under a reclassification initiative, which was undertaken in early 2017, some federal government spending now takes place outside the central budget via public entities that operate their own budgets. When all such GRE liabilities are taken into account – including those with less than 50% ownership by the government – public debt stands at around 117% of GDP, according to the IMF. The situation is further complicated by the fact that the government is also one of the main lenders to some GREs. “The fall in net present value of debt across all government entities since 2010 has not been that large, partly because the government was the main creditor to some of these entities, through [majority public-owned bank] Emirates NBD, for example,” Angonin told OBG.

A New Tax

The authorities will soon have a new revenue stream to underpin continued investment, in the form of a consumption tax. GCC countries have long been known for their low or non-existent levels of tax, facilitated by high oil revenues that obviate the need for governments to raise funds through fiscal measures. This has now changed, with the UAE and other Gulf countries having introduced value-added tax (VAT) on non-essential consumer items on January 1, 2018, at a rate of 5%. While a significant change in regional tax policy, the rate is low by international standards, compared to an average of 19% across OECD countries.

In late August 2017 the UAE issued a new law describing how the tax would be applied in the country, with executive regulations providing further details published through the end of the year. This announcement followed the establishment of a federal tax authority in March. The tax will not be applied to essential items such as food staples, pharmaceuticals, residential rent, the first sale of new properties, school fees, hospitalisation costs, and a number of other products and services, including local transport and life insurance.

Companies with sales of taxable goods or services (taxable supplies) and taxable imports in excess of Dh375,000 ($102,000) are obliged to register for VAT; those with taxable supplies between Dh187,500 ($51,000) and Dh375,000 ($102,000) have the choice of registering but are not required to do so.

The implementation of VAT is expected to generate fiscal revenues of approximately Dh12bn ($3.3bn) in 2018 and Dh20bn ($5.4bn) in 2019. The IMF has said the introduction of the tax will be a major achievement for the country in terms of diversifying its revenues away from oil and gas production, and the fund expects income from the measure to reach 1.5% of national GDP in the medium term.

It remains to be seen how such revenue will be shared among different levels of government, but Angonin believes it will likely be split between the federal and emirate-level authorities, and Moody’s is working on the assumption that revenue raised in a given emirate would be divided equally between its local government and the federal government.

This system should have a particularly positive impact on Dubai’s fiscal situation, given its large retail sector. Assuming revenue equivalent to 1.5% of GDP, such a 50:50 split between the federal and local authorities would be enough to wipe out Dubai’s anticipated 0.6% fiscal deficit in 2017. This would allow the emirate to either move out of deficit spending or further step up investment while maintaining overruns at a relatively low level. The latter seems the most likely, with the IMF expecting continued deficit spending leading up to Expo 2020 and Moody’s forecasting the value of central government debt would rise to 30% of GDP in 2018.