Abu Dhabi in a strong position from which to withstand slump in oil prices

As the Middle East’s second-biggest oil producer, the UAE has seen much attention directed to it over the past year regarding the effect of subdued oil prices on the economy. The emirate of Abu Dhabi is a key player in the response to this challenge. As home to the nation’s capital it hosts many institutions that oversee the UAE’s social and economic development.

The country has put the bounty of its hydrocarbons resources to good use, using the sizeable revenues to underpin a bold strategy of economic diversification. The results of this effort are apparent on Abu Dhabi’s balance sheet, where expansion of the non-oil sector outpaces oil sector growth and sizeable external buffers to a large extent protect both the emirate and the wider UAE from the vagaries of oil markets.

The economy has grown more resilient against shocks over time, as shown by the Economic Performance Index (EPI), an initiative targeted toward the private sector. According to the Abu Dhabi Chamber of Commerce and Industry (ADCCI), the EPI condenses headline growth, fiscal stance, price inflation and the unemployment rate into a single time series index. According to the EPI, Abu Dhabi has performed better than nearly all of its peers and key industrial countries, as well as major emerging markets, for all but two of the last seven years. “Companies enjoy a tax-free environment, low government fees and technologies that increase efficiency, but there is room for improvement in infrastructure,” Khalifa bin Salem Al Mansouri, undersecretary at Abu Dhabi Department of Economic Development (ADDED), told OBG.

Strategy

The federal nature of the UAE means that economic strategy in Abu Dhabi is a multi-layered endeavour. The national economic direction is broadly mapped out in the UAE Vision 2021, developed by over 300 officials from 90 federal and local entities. The document envisions the UAE’s transformation to a knowledge-based economy, driven by an entrepreneurial culture and private sector capital. The federal government also influences the economic development of the individual emirates, including Abu Dhabi, through its ability to introduce legislation. In 2015, for example, the UAE’s minister of economy, Sultan bin Saeed Al Mansouri, revealed that a much-anticipated investment law was in the final phases of drafting. When promulgated, the new legislation is expected to allow 100% ownership to foreign investors in certain sectors, a development which has the potential to boost the level of foreign direct investment (FDI) in the UAE.

The most detailed map charting Abu Dhabi’s future economic development is the Abu Dhabi Economic Vision 2030, a policy document which originated with a 2006 decision by the crown prince of Abu Dhabi, Mohammed bin Zayed bin Sultan Al Nahyan, to mandate the General Secretariat of the Executive Council, the Abu Dhabi Council for Economic Development (ADCED), and the Department of Planning and Economy to develop a long-term vision for the emirate. The Economic Vision 2030 details how Abu Dhabi is to diversify its economy away from an overreliance on hydrocarbons, with 2030 chosen as a target because baseline growth assumptions indicated that tangible levels of diversification could be achieved by then.

Goals

The plan identified sectors through which Abu Dhabi has the potential to boost its non-oil GDP, such as tourism, manufacturing, logistics, health care, education, financial services, aerospace and telecoms. It also established a number of macroeconomic and macro-fiscal goals, such as: building an open and globally integrated business environment; adopting a disciplined fiscal policy that is responsive to economic cycles; establishing a resilient monetary and financial market environment with manageable levels of inflation; improving the efficiency of the labour market; developing infrastructure capable of supporting economic growth; and enabling financial markets to become the key financiers of economic sectors and projects. “Private sector growth will provide the local population with varied career options and alleviate the burden on public institutions,” Rashid Ahmed Al Rumaithy, board member at Abu Dhabi Chamber and Al Rumaithy Investment Group, told OBG.

Five Star

The broad strategic path established by the Economic Vision 2030 is supplemented by five-year plans created by ADDED in cooperation with the General Secretariat of the Executive Council. These contain detailed schedules and targets for the growth of individual sectors, and are supplemented by regular 12-month action plans to ensure that momentum is maintained. The most recent five-year plan is for 2016-20. The Strategic Plan 2011-15 focused on developing the export capacity of Abu Dhabi’s industrial sector, particularly with regard to downstream petrochemicals, metals, mining, aviation, aerospace, pharmaceuticals and life sciences. Abu Dhabi has also recently sought to further refine its strategy regarding its emerging industrial sector through the creation in 2013 of the Industrial Development Bureau (IDB). Based in ADDED’s headquarters, the IDB is tasked with strategic and policy development, promotion of the industrial sector, and the provision of investor services (see Industry chapter).

“Priority initiatives for ADDED will be efforts that contribute to growth and diversifying the economy, and enabling key factors that will attract FDI aligned with the emirate’s master plan. Abu Dhabi needs to portray itself as a top-tier destination in terms of ease of doing business,” Al Mansouri of ADDED told OBG.

While the Abu Dhabi Economic Vision 2030 plan still has many years to run, historic GDP data shows that significant progress towards increased diversification has been made: the oil and gas sector’s proportionate contribution to aggregate economic growth has declined steadily over the past decade, contributing 59.3% of GDP at constant prices (2007) in 2005, 51.8% in 2010 and 50.5% in 2014, according to Statistics Centre - Abu Dhabi (SCAD). This has been due mainly to an increase in non-hydrocarbons activities. “The rising influence of privately held holding companies should help the country in its diversification efforts,” Al Rumaithy told OBG.

Key Sectors

Thanks to its hydrocarbons reserves, Abu Dhabi’s oil and gas sectors will continue to play a major role in the economy for years to come. Mining and quarrying activity, which includes hydrocarbons extraction, accounted for Dh485.7bn ($132.2bn) of Abu Dhabi’s total GDP of Dh952.7bn ($259.3bn) in 2014, or 51%. The emirate has been a significant player in the global oil market since it became a member of the Organisation of Petroleum Exporting Countries in 1966, and with oil reserves of nearly 100bn barrels, according to the “BP Statistical Review of World Energy”, it will continue to be a major hydrocarbons player (see Energy chapter).

However, the variety of economic activity in the emirate has grown rapidly, driven by a number of key sectors. The government’s infrastructure programme, and the need to satisfy both residential and commercial demand for real estate, has helped establish the construction sector as the second-largest contributor to GDP. In 2014 it accounted for 9.6% of the total, and while much of this was derived from work taking place in the capital, the most recent SCAD data shows that the entire emirate is witnessing an elevated level of construction activity: in the third quarter of 2015 the Abu Dhabi region accounted for 62.2% of building completions, while Al Ain and Al Gharbia accounted for 34.4% and 3.5%, respectively.

Abu Dhabi is well known as a financial hub, and in 2014 its expanding financial and insurance sector accounted for 7.2% of GDP, according to SCAD. Lenders headquartered in Abu Dhabi play a leading role in the wider UAE banking sector, which at the close of 2014 had aggregate assets of Dh2.31trn ($628.8bn), according to the Central Bank of the UAE (CBU), making it the largest banking industry in the region (see Banking chapter). The emirate’s stock market, the Abu Dhabi Securities Exchange, is the largest in the UAE, with a total market capitalisation of Dh464bn ($126.3bn) at the end of 2014, while the development of Abu Dhabi Global Market, a new financial free zone on the capital’s Al Maryah Island, is set to further increase the scale and sophistication of the emirate’s capital markets (see Trade & Investment chapter).

Manufacturing is the fourth-largest economic sector in Abu Dhabi, accounting for 5.5% of total GDP and 12% of non-oil GDP in 2014, and has been identified as a key area of future growth by the emirate’s economic planners. The most significant manufacturing activity in terms of gross output is the chemicals and plastics segment, which in 2014 showed gross output of Dh109.9bn ($29.9bn), according to SCAD. The emirate’s expanding steel and aluminium operations are another indication of successful diversification, with the basic metals segment recording gross output of Dh26.2bn ($7.1bn) in 2014. Other significant manufacturing segments include machinery and equipment, with gross output of Dh9.6bn ($2.6bn); structural metal products, Dh9.3bn ($2.5bn); and food, beverages and tobacco, Dh9.1bn ($2.5bn).

Other sectors of the economy that are playing an important part in the diversification of Abu Dhabi’s economy include: real estate, which contributed 4.6% of GDP in 2014, and has been significantly buoyed by the emirate’s status as a safe haven in a troubled region; wholesale and retail, representing 4.4% of GDP and thriving on the back of an expanding and wealthy population; transport and storage, which accounted for 4.3% of GDP, the continued growth of which is underwritten by the expansion of Abu Dhabi International Airport and the development of the Etihad Railway; and information and communication, which in 2014 accounted for 2.1% of GDP.

Fiscal Scenario

The federal budget issued by the UAE’s Ministry of Finance only accounts for 14% of total fiscal spending in the country, and each emirate is free to set its own fiscal budget. Some degree of oversight of this process is provided by the Fiscal Policy Coordination Council, which, supported by the Ministry of Finance, prepares backwards-looking fiscal data for the nation as a whole. Another level of fiscal coordination, meanwhile, is provided by a self-financed programme of IMF technical assistance.

At the national level, between 2010 and 2014 the UAE posted successive fiscal surpluses, thanks to stable hydrocarbons revenues coupled with moderate rises in expenditure. A planned national fiscal consolidation for 2014 did not materialise due to higher-than-expected Abu Dhabi government spending, according to the IMF. While this may have increased the fiscal break-even oil price to $78, up from $69 the previous year, the UAE’s overall fiscal surplus remained in place, running at 5% for 2014.

However, the sustained drop in oil prices since late 2014 means that the UAE is expected to show a fiscal deficit for 2015 when the data is collated. Estimates as to its size vary. Ratings agency Moody’s expects to see a deficit of 2.9% for 2015. While the nation has ample capital buffers to maintain its spending programmes in the face of fiscal deficits, the altered trend and the prospect of a prolonged oil price dip has focused attention on the issue of fiscal reform.

Surpluses are the norm for Abu Dhabi, despite a high subsidy bill and the cost of a lifelong health and welfare system for nationals. Forecasting surpluses accurately is challenging due to the frequency of budget reviews, by which spending plans are often altered mid-year, and the large component of hydrocarbons revenue on the emirate’s balance sheet. However, other than an anticipated Dh16.4bn ($4.5bn) shortfall in its net operating balance ( revenue minus expenditures) in 2015, the IMF foresees successive local government surpluses up to 2020. It is also worth noting that Abu Dhabi’s public finances are more robust than is apparent from available data: the emirate pays a portion of its oil revenue directly into reserve accounts, not reporting them as current revenue, while the public accounts do not include the significant income derived from the emirate’s portfolio of publicly owned foreign assets. This reserve liquidity grants Abu Dhabi considerable flexibility to deal with exogenous shocks, an ability which helped it attain an “AA2” sovereign rating from Moody’s, and “AA” from Standard and Poor’s and Fitch, in 2015. Fitch reported on February 3, 2016 that Abu Dhabi’s key credit strengths are its exceptionally strong fiscal and external metrics, and high GDP per capita.

Sovereign Wealth

According to the IMF, the UAE has sufficient external reserves to sustain it for more than 20 years, and the nation’s foreign investments have established it as a globally significant sovereign investor. Each year around 70% of any budget surplus is diverted to the Abu Dhabi Investment Authority (ADIA), the world’s second-largest sovereign wealth fund (SWF), holding $773bn of assets as of 2015, according to the Sovereign Wealth Fund Institute (SWFI). The fund maintains interests across a broad range of asset classes and markets, with an investment policy weighted towards North American equities. Recent years, however, have seen it concentrate more on Eastern markets, and in 2015 it received approval from the Chinese regulator to increase its allocation of Chinese “A” shares (see analysis).

While ADIA remains Abu Dhabi’s most visible instrument of sovereign investment, around 30% of budget surpluses are granted to the Abu Dhabi Investment Council (ADIC), which was spun off from ADIA in 2007. The vehicle took over ADIA’s domestic subsidiaries, which include systemically vital institutions such as Abu Dhabi Commercial Bank, National Bank of Abu Dhabi (NBAD) and Abu Dhabi Investment Company. ADIC has retained its local focus, but today its remit goes beyond the emirate’s borders to allow for a globally diversified investment strategy across a range of asset classes, including equities and fixed income, infrastructure, real estate and direct investments.

The third crucial arm of Abu Dhabi’s sovereign investment is Mubadala Development Company, the Abu Dhabi-based investment and development company. Established in 2002, it differs from traditional SWFs in that it is partly self-financing through a debt issuance programme, and is therefore classified by the SWFI as a “strategic development SWF”. Mubadala has been involved in some of the largest and most strategically important developments in Abu Dhabi, including the landmark Cleveland Clinic, Emirates Aluminium, aerospace manufacturer Strata, Dolphin Gas and Paris Sorbonne University. More recently, it has begun to seek more investment opportunities in overseas markets across four broad areas: technology and industry; aerospace and engineering services; energy; and emerging sectors, including health care, real estate, infrastructure and capital investments. One of its most visible contributions to the economic landscape of the emirate in recent years is Abu Dhabi Global Market, a 450,000-sq-metre financial free zone on Al Maryah Island, the development of which is destined to be one of the nation’s major financial stories over the coming months and years (see Trade & Investment chapter).

Balancing The Books

The UAE’s external buffers mean that a prolonged dip in oil prices poses no threat to its economic wellbeing. Nevertheless, lower oil revenues over the past year have made alternative sources of government funding of increased interest at both national and emirate level. “Abu Dhabi has been one of the most proactive in the GCC in implementing fiscal reforms, despite its strong fiscal buffers. We see this as highly positive for fiscal sustainability, especially given the medium-term oil price outlook. The earlier start in fiscal reforms supports a more gradual approach,” Monica Malik, chief economist at Abu Dhabi Commercial Bank, told OBG.

Taxation and subsidies are the two main fronts of this process, and both come with their own challenges. The lack of personal income and corporate taxes in the UAE is one of the country’s chief competitive advantages, which makes a unilateral move to introduce them a difficult proposition. A proposed tax on the sizeable flow of remittances from the country, which reached Dh29bn ($7.9bn) in 2014, may provide another route to revenue for the government, although critics argue that it would be easily avoided and may damage a highly competitive exchange and remittance industry that is currently adjusting to new capital requirements introduced by the CBU.

According to the World Bank, in 2014 total global remittances were $583bn. It estimates that GCC countries transferred $102bn in 2014, mostly to south Asian nations India, Bangladesh, the Philippines, Pakistan, Sri Lanka and Nepal. “The utilisation of advanced technologies and innovative platforms to easily transfer funds internationally and in a cost-efficient manner will be vital in terms of attracting new clients and remaining competitive,” Promoth Manghat, CEO of UAE Exchange, told OBG.

The appreciation of the US dollar against Asian currencies, the growing influx of expatriates seeking job opportunities in the Gulf and the relatively low cost of sending money from the UAE may impact the level of remittances in the future. With over 200 nationalities living in the UAE, eight countries account for the vast majority of remittances, with India the largest, representing over half the total. “Despite lower oil prices, major infrastructure projects in the UAE continue to be developed, resulting in an increase in the number of migrant workers, so we anticipate remittances to remain robust in 2016,” Manghat told OBG.

VAT

The most promising area of tax reform, given the challenges associated with the other proposals, is value-added tax (VAT). VAT has been successfully introduced in more than 150 countries, according to the IMF, which consistently encourages its adoption by emerging economies. Given the lack of a sales tax, however, the introduction of any VAT structure would have to be incremental in order to avoid an unwelcome spike in inflation (see analysis).

As well as investigating ways to boost revenue, the government is taking steps to cut its expenditure. In this respect, the UAE joins a regional trend: oil-based economies around the Gulf are assessing their generous subsidy levels and low-tax regimes, an endeavour which is consistently encouraged by the IMF in its annual reviews of regional economies.

In August 2015 the UAE took an important step towards reducing government spending, becoming the first country in the Gulf to remove transport fuel subsidies altogether, so that petrol prices are now linked to global markets. Given that subsidies are estimated to have cost state-owned energy companies around $1bn per year over the last decade, this area of the nation’s balance sheet is a high priority for further reform. Within the UAE, Abu Dhabi has pushed ahead in its efforts to pare back government spending via changes to water and electricity tariffs.

Under a system made effective on January 1, 2015, expatriates pay 170% more for their water than previously, with the tariff rising from Dh2.20 ($0.60) per thousand litres to Dh5.95 ($1.62) per thousand litres for up to 700 litres per day for an apartment and 5000 litres per day for villas. Usage above these levels is charged at higher rates. Nationals are now required to pay water rates for the first time, starting at Dh1.70 ($0.46) per thousand litres. Electricity will now be charged at Dh5 ($1.36) per KWh for nationals, while for foreign residents the tariff is Dh15 ($4.08) per KWh. A higher rate of Dh5.50 ($1.50) per KWh kicks in at between 30 and 400 KWh for nationals in flats and villas, respectively, while for expatriates it starts at between 20 and 200 KWh and costs between Dh21 ($5.72) and Dh29.30 ($7.98) per KWh.

Abu Dhabi’s overhaul of its utilities subsidies is a significant move, in that for the first time nationals as well as expatriates have been asked to contribute towards their provision. The new tariffs will bring both budget savings and changes in usage patterns: under the old tariff regime, according to the Federal Water and Electricity Authority, UAE residents consumed 550 litres of water and up to 30 KWh of electricity a day, compared with the international average of 170-300 litres and 15 KWh a day, respectively.

Inflation & Monetary Policy

The task of removing fuel subsidies in the UAE was made easier by the low oil prices seen over the past year. Despite subsidy removals, fuel prices edged downwards in the second half of 2015 due to a glut of cheap oil: in August the government was able to reduce the price for a litre of petrol by 8.5%, bringing it in line with average prices on the international market. Lower petrol and diesel prices have a sizeable effect on the UAE’s economy, not just because 11% of household budgets are accounted for by transportation costs, but also due to the fact that in the absence of a national rail network the sole means of transporting goods between urban centres is fuel-hungry road haulage.

Falling fuel costs, therefore, have helped keep inflation at a low level despite an 8.3% year-on-year rise in housing costs in November 2015. In December 2015 the Ministry of Finance announced that inflation for November had dipped to 3.5%, from 3.7% in October. The IMF foresees a relatively modest inflation rate of 2.6-3.3% from 2016-20 – a more manageable level than the double-digit rate seen in the run up to the global economic crisis of 2008. This is a welcome forecast for the CBU, which has limited scope to tackle wayward inflation through normal monetary policy measures. While the central bank sets interest rates at the federal level, the pegging of the UAE dirham to the US dollar means its capacity to address inflationary pressures through rate changes is circumscribed by the need to synchronise with the actions of the US Federal Reserve. In any case, inflation is mostly driven by developments in the housing market and fluctuations in the price of tradeables, with the exchange rate varying relative to other major trading partners with the US dollar. While the CBU faced calls to de-couple from the dollar link during the period of elevated inflation in 2008, more modest inflation rates since have allowed it to support the peg.

Trade & Investment

The stability of the UAE’s dollar peg has played an important role in its emergence as a trading centre. Foreign trade in goods through Abu Dhabi’s air and sea hubs is a central component of its economy, and in 2014 net trade in goods amounted to 25.8% of GDP, according to SCAD. The dominant role played by hydrocarbons means that the exportation of oil and gas products accounts for the vast majority of Abu Dhabi’s exports: in 2014 hydrocarbons products worth Dh309.5bn ($84.2bn) left the emirate for markets around the world, representing 87.5% of total exports. However, the emirate’s diversification strategy has helped boost non-oil exports in recent years. In 2014 Dh18.9bn ($5.1bn) of non-oil exports left the emirate, up from Dh15.9bn ($4.3bn) the previous year, the largest contributor to which was the manufactured goods category, which accounted for 65.7% of total non-oil exports.

Big Draw

Thanks to the lengthy list of trade agreements signed by the UAE, including its membership in the Greater Arab Free Trade Area and the World Trade Organisation, as well as free trade agreements with markets such as Singapore, the UAE has established itself as an attractive location for inward investment.

The total stock of FDI in Abu Dhabi has grown steadily in recent years, from Dh60.9bn ($16.6bn) in 2012 to Dh71.9bn ($19.6bn) in 2013 and Dh81.1bn ($22.1bn) in 2014, according to SCAD (see Trade & Investment chapter). The emirate has adopted a proactive stance in order to draw yet more investment. It has invested heavily in economic zones capable of attracting heavy and light industry and manufacturing concerns, while the ADCCI has been reinforcing links with some of the emirate’s most important investment partners. “The chamber has opened offices in Singapore and Korea, and it is now looking to open three more in China, India and Serbia,” Ohan Balian, chief economist at the ADCCI, told OBG. “If we are going to diversify the economy away from oil, then investment from abroad is one way of doing it.”

The stepping up of the ADCCI’s efforts with regard to inward investment is significant: in the past the government has been successful in attracting large-scale investment to Abu Dhabi, but many in the business community believe that the smaller concerns targeted by the chamber are just as important to the long-term goal of economic diversification. “The best way to achieve diversification is to promote inward investment, not just from larger corporates but from small and medium-sized enterprises (SMEs) as well,” Peter Michelmore, senior partner at Reed Smith, told OBG. “SMEs play a key part in the development of a sustainable growth model, and the financial sector should provide them with guidance. It will also be important to implement policies and procedures that contribute to the national economy while supporting local businesses,” Al Mansouri of ADDED told OBG.

In February 2016 the UAE’s prime minister, Sheikh Mohammed bin Rashid Al Maktoum, announced the country’s plans to cut the number of ministries. “We will have a road map to outsource government services to the private sector. The new government will have a smaller number of ministries and more ministers to deal with national and strategic issues,” said Al Maktoum. He announced the formation of a single Education Ministry and the fusing of several state bodies. No timescales were given for the changes.

Outlook

External factors are destined to play a large part in Abu Dhabi’s economic performance over the coming year, according to Sebastien Henin, head of asset management at The National Investor. “Oil prices and the global environment, such as the Chinese economy and the Federal Reserve’s decisions on interest rates, will dominate prospects,” he said.

Any prolonged period of low oil prices presents a number of downside risks, such as reduced liquidity in the banking sector (see Banking chapter), a slowdown in real estate and increasing volatility in securities markets. However, these are mitigated by Abu Dhabi’s strong external position. This has been recognised by the ratings agencies: when granting Abu Dhabi its “AA2” and “AA” ratings in 2015, Standard and Poor’s, Moody’s, and Fitch noted not just the size of the emirate’s external buffers but also the fact that GDP growth tends to exceed that of its peers, and non-oil GDP growth has averaged 7.3% over the past decade. While the IMF expects the data for 2015 to show that non-oil growth in the UAE slowed as a result of the oil price scenario, it anticipates a recovery to 4.6% by 2020, thanks largely to the implementation of mega-projects and private investment in the run up to World Expo 2020, to be held in Dubai. Many Abu Dhabi-based firms and institutions stand to benefit from the UAE’s hosting of this major event. “There is huge potential in Expo 2020. We have created a task force which meets in Dubai every 15 days to explore business opportunities. It is one of the major growth drivers here,” Arif Usmani, global head of wholesale banking at Abu Dhabi Islamic Bank, told OBG.

The economic stability of both Abu Dhabi and the UAE means that the government is well positioned to continue its fiscal reform process: alterations to the tax and subsidy environments are therefore likely to figure prominently in the coming months and years. In the longer term, the opening up of the Iranian economy with the easing of the international sanctions represents a further growth opportunity. “The UAE stands to benefit hugely from the sanctions removal. In 2008 Iran’s GDP was as big as that of Saudi Arabia. There is huge potential for it to grow again, in which case the UAE’s trade with Iran, which is already strong, will grow exponentially,” Alp Eke, senior economist at NBAD’s economics department, told OBG.