Abu Dhabi's economy remains strong due to solid economic foundation

Economies around the Gulf region have faced a challenging economic environment since the second half of 2014, but a more optimistic outlook for international oil prices in 2017 has offered some welcome relief. The process of fiscal reform that the oil price decline precipitated is, however, set to continue. The restructuring of Abu Dhabi’s public finances has taken into account the federal government’s decision to reduce subsides, as well as the introduction of new fees and taxes by the emirate, and their affects have been felt by nationals and expatriates alike. In the meantime, Abu Dhabi’s ambitious plans to broaden the range of economic activity in the emirate have been granted greater clarity with the publication of the latest iteration of its development strategy in 2016.

New Strategy

The publication of Abu Dhabi’s most recent five-year plan, known as the Abu Dhabi Plan, in June 2016, has provided useful insight into the emirate’s economic direction over the medium term. The strategy includes 83 separate programmes over the coming period that are divided among five sectors of interest: social development; economic development; infrastructure and environment; security, justice and safety; and government affairs.

Given the broad scope of the plan, its targets are necessarily diverse. For example, unemployment of citizens is to be reduced, literacy rates improved and the rate of vaccination against communicable diseases increased. A key focus of the plan is the continued development of the emirate’s infrastructure, such as the important deepwater Khalifa Port and the expansion at Abu Dhabi International Airport (AUH), known as the Midfield Terminal Building, as well as boosting the capacity of the emirate’s utilities providers – an effort that follows on the success of the Abu Dhabi Water and Electricity Authority in harnessing private sector capital and expertise to guarantee stable supplies for a growing population. The business sector is also addressed directly in the plan, which calls for the emirate to maintain its strong position in global ease of doing business indices, Customs reform, new initiatives on consumer protection, and continued support for small and medium-sized enterprises (SMEs) and entrepreneurs (see analysis).

Looking to the longer term, the blueprint for future economic and social development in Abu Dhabi is to be found in Abu Dhabi Economic Vision 2030, which was published in 2008 and forms the conceptual and analytical framework around which the Abu Dhabi Department of Economic Development (ADDED) produces its five-year plans in cooperation with the General Secretariat of the Executive Council.

The Economic Vision 2030 strategy identifies a range of sectors that the emirate intends to develop in a bid to increase its non-oil GDP, such as tourism, manufacturing, logistics, health care, education, financial services, aerospace and telecommunications. It also sets out several 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; improving the efficiency of the labour market; developing infrastructure to support economic growth; cultivating a highly skilled, productive workforce; and enabling financial markets to become the key financiers of economic sectors and projects.

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Abu Dhabi has in some cases refined its strategic approach to crucial sectors through the development of specialised bodies, most notably with the establishment of the Industrial Development Bureau (IDB) in 2013. Based within 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). Given the federal nature of the UAE, taking stock of Abu Dhabi’s economic and social development also requires cognisance of the national-level strategic framework, the UAE Vision 2021, developed by over 300 officials from 90 federal and local entities. This comprehensive document aims, in broad terms, to move the UAE’s economy from its government-led, oil-dependent beginnings to one that is knowledge-based and driven by an entrepreneurial culture and private sector capital. Therefore, the authorities in Abu Dhabi work closely with the federal government as they pursue both their local and national objectives, and the decisions made at the federal level have considerable bearing on local conditions.

This is most conspicuous in the area of legislation, where the ability of the federal authorities to create and pass laws is of great significance to the business environment of the emirate. For example, the implementation of the newly adopted bankruptcy law is expected to boost business confidence, particularly for SMEs, as they will be able to take more risks and restructure when needed. Moreover, a new investment law that the Federal National Council is expected to approve sometime in 2017 will have ramifications for foreign investors who are considering Abu Dhabi as an investment destination, as it promises to open up several economic sectors to 100% foreign ownership.

Zoom In

At the national level, the UAE has made considerable progress towards meeting its ambition of an economically diverse economy. The IMF’s 2016 Article IV consultation for the UAE found that the country had seen a “remarkable transformation already” regarding this issue, and that its diversification to date compares favourably with other GCC countries. The IMF added that the increase in the level of sophistication of the UAE’s exports is comparable to economies that have successfully weaned themselves off of a reliance on commodities, such as Chile and Indonesia. In May 2017, ahead of the release of the 2017 Article IV report, the IMF mission noted the UAE’s “large financial buffers, diversified economy and the authorities’ robust policy responses” were continuing to facilitate adjustment to new oil market realities. Moreover, at a ministerial retreat in January 2017 the government charted a roadmap, titled “UAE After Oil”, which aims to enhance the country’s transition towards a more innovative and knowledge-based economy.

At the emirate level, GDP data shows that significant progress towards increased sectoral diversification has been made since the turn of the century: the oil and gas sector’s contribution to aggregate economic growth has declined steadily over the past decade, accounting for 59.3% of GDP at constant prices (2007) in 2005, 51.8% in 2010 and 50.5% in 2014, according to the Statistics Centre - Abu Dhabi (SCAD). Nevertheless, as Abu Dhabi controls the majority of the UAE’s combined oil reserves of 97.8bn barrels, according to the 2016 “BP Statistical Review of World Energy”, the hydrocarbons sector will be a major component of its economic life for decades to come.

A large number of the sectors that have historically contributed to economic diversification have derived their expansion from the economic growth that the emirate’s hydrocarbons resources have enabled. The construction sector, which is the second-largest component of the economy, is a case in point. According to SCAD’s “Statistical Yearbook of Abu Dhabi 2016”, construction accounts for approximately 9.6% of the emirate’s total GDP, although the past two years have been challenging ones for the sector, largely as a result of the decline in oil prices.

Building completions in the Abu Dhabi region were down approximately 9.4% year-on-year (y-o-y) in the third quarter of 2016, according to data from SCAD, although this trend was mitigated by a more than 100% rise in completions in the Al Ain region. In addition, while new building might have slowed, a 2016 report released by the global real estate consultancy JLL pointed out that a significant number of newly tendered contracts are likely to require refurbishments and extensions, as developers seek to generate more revenue from existing assets.

Financial Services

The financial sector is one of the most dynamic areas of economic activity in Abu Dhabi, and in 2017 the recently launched Abu Dhabi Global Market (ADGM) is likely to be a focus of regional and international attention (see Trade & Investment chapter). ADGM is a broad-based financial hub that is currently licensing local, regional and international institutions to establish operations within its prime real estate on Abu Dhabi’s Al Maryah Island.

The new zone has its own regulatory structure, legal system and independent companies registrar. It has established its core functions as wealth and asset management, as well as related activities such as its innovative approach to fintech development. In March 2017 ADGM and the Monetary Authority of Singapore (MAS) signed a cooperation agreement in order to foster closer cooperation on developments and initiatives that nurture fintech entrepreneurship and support innovation in financial services in both Singapore and Abu Dhabi. On the mainland, the Abu Dhabi Securities Exchange (ADX) has been the centre of equities trading in the capital since its establishment in 2000. With a total market capitalisation of Dh475bn ($129.3bn) at the end of 2016, the ADX is the largest exchange in the country, compared to the Dh337.41bn ($91.9bn) capitalisation of the Dubai Financial Market and the Nasdaq Dubai’s approximately $17.5bn for the same period.

The emirate’s banking institutions, meanwhile, play a leading role in the wider UAE banking sector. As of the third quarter of 2016, the aggregate assets of the nation’s banking industry stood at $662bn, according to National Bank of Abu Dhabi (NBAD), making it the largest banking industry in the region (see Banking chapter). Combined with insurance, Abu Dhabi’s vibrant financial sector accounts for approximately 7% of the emirate’s GDP, according to SCAD.

A landmark moment in the banking sector’s history occurred in April 2017, with the legal completion of a merger between NBAD and First Gulf Bank, the emirate’s two largest banks. The new combined institution – First Abu Dhabi Bank – has assets totalling Dh670bn ($182.4bn) and a market capitalisation of approximately Dh111bn ($30.2bn), making it a regional leader capable of playing a key supportive role in the federation’s future economic development. Consolidation in Abu Dhabi’s highly competitive banking sector has long been anticipated, and this merger could be a signal of others to follow in the short- to medium term (see Banking chapter).

Industry

Abu Dhabi’s access to low-cost feedstock means that manufacturing represents a promising route to economic diversification, and according to SCAD’s most recent figures, it is the emirate’s third-largest non-hydrocarbons economic sector, accounting for 5.7% of GDP. Chemicals and plastics is the largest segment in manufacturing, showing gross output of Dh109.9bn ($29.9bn) in 2014, with the emirate’s basic metals industry representing the second-most-promising manufacturing segment.

In the early stages of 2016 the manufacturing sector received a timely fillip when details emerged of a new Dh440m ($119.8m) aluminium facility planned for Abu Dhabi. Once operational in late 2017, the new plant will provide more than 200 manufacturing jobs and add a total of 65,000 tonnes of aluminium coils annually to the UAE’s output, which in turn will feed into downstream manufacturing processes such as automotive body parts, cans and aerosols. The initiative provides a good example of how the emirate can leverage its hydrocarbons wealth to power energy-intensive processes, such as the refinement of aluminium from bauxite, in order to drive downstream economic diversification, or further the capacity development of locally produced steel.

Another area that is playing an important role in the diversification of Abu Dhabi’s economy is real estate, which accounts for approximately 5.1% of GDP and has been significantly buoyed by the emirate’s status as a safe haven in a troubled region. The wholesale and retail segment represents 4% of GDP and has been driven by the UAE’s high-income status, as defined by the World Bank. Meanwhile, transport and storage, which together account for a total of 3.2% of GDP, have seen continued growth, underwritten by the expansion of AUH, Khalifa Port and phase one of the development of a 1500-km railway network. The information and communications segment, for its part, delivers some 2.2% of the emirate’s GDP.

Fiscal Scenario

The decline in oil prices that began in the second half of 2014 has renewed a focus on the fiscal policies of economies around the Gulf region. Faced with falling oil revenues, governments from Kuwait City to Muscat have sought to trim expenditure in a bid to tackle budget deficits. However, the UAE is well defended against a sustained period of low oil prices thanks to its large net foreign asset holdings, which enable it to finance fiscal deficits for many years. Its strength in this regard has been noted by the IMF in its 2016 Article IV consultation, and in 2016 a membership survey by CFA Institute, a global organisation for investment professionals, found that the UAE was viewed as the GCC member state that will be least affected by this challenging period, due to its substantial capital buffers. Any assessment of Abu Dhabi’s fiscal scenario must be undertaken in the context of its membership in a federation that produces both federal budgets and emirate-level budgets. The federal budget set by the UAE’s Ministry of Finance only accounts for approximately 14% of total fiscal spending in the country. While it is an important indicator of the health of the national economy, there is no direct link between the strategies of the federal and emirate-level budgets, meaning that it is possible that an expansionary federal policy can coexist with a consolidation of the Abu Dhabi budget, or vice versa.

The Abu Dhabi government has achieved successive fiscal surpluses on the back of stable hydrocarbons revenues, allowing for a moderately expansionary fiscal policy. A planned fiscal consolidation for 2014 did not materialise due to higher-than-expected government spending by Abu Dhabi, according to the IMF. However, even without consolidation, the overall fiscal surplus ran at 5% of GDP for 2014. The streak of surpluses came to an end in 2015, as the effects of lower oil prices became apparent in government accounts. Credit ratings agency Moody’s estimated the UAE federal government ran a fiscal budget deficit of 13.2% of GDP in 2015, which deepened to 14% of GDP in 2016 as a recovery in oil prices failed to materialise.

At the emirate level, Abu Dhabi’s oil revenues historically allowed it to run consistent budget surpluses, despite a high level of expenditure in areas such as fuel subsidies and health care. Forecasting the emirate’s surpluses accurately is complicated by the frequency of budget reviews, with spending plans regularly altered mid-year, as well as the large component of volatile hydrocarbons revenue on the balance sheet.

However, the IMF reported in its most recent Article IV consultation that it expected a deficit in the 2016 and 2017 net operating balances (revenue minus expenses) of the emirate, followed by continuous operating surpluses from 2018 (Dh17.7bn, $4.8bn) to 2021 (Dh66.5bn, $18.1bn). Abu Dhabi’s public finances are, in fact, even more robust than is shown in its official accounts: the portion of its oil revenue that it has directed into reserve accounts for decades is not reported as current revenue, and the public accounts do not include the significant income derived from the emirate’s portfolio of publicly owned foreign assets.

Near Term

In January 2017 credit ratings agency Fitch reaffirmed the emirate’s “AA” rating with a stable outlook, given its ample fiscal and financial buffers. According to figures from Fitch, Abu Dhabi’s sovereign net foreign assets were 282% of GDP in 2016, which is higher than the median of 61% of GDP for other “AA”- rated economies. The key drivers for the decisions included strong fiscal and external metrics and a high GDP per capita, balanced by a high dependence on hydrocarbons and a relatively weak economic policy framework. Fitch also stated that it expected a 5.9% deficit in 2017 and higher spending following two years of lower expenditure. The agency anticipates Abu Dhabi to post a 1.5% surplus, as oil prices are set to recover to around $55 per barrel, value-added tax (VAT) is introduced, and new utility prices and taxes on hotels and rents bring in more revenue. In addition, Fitch noted that despite major improvements, gaps in data availability were a weakness, particularly when it comes to standard international investments positions and balance of payments. This was attributed to a weak economic policy framework at the federal level.

Sovereign Wealth

These foreign assets, through which Abu Dhabi stores the fruits of its hydrocarbons profits for later decades, are significant from the perspective of generational equity. It has also established the sovereign as a high-profile investor in global markets. According to the Sovereign Wealth Fund Institute (SWFI) the emirate – after meeting all its budgetary commitments and other funding requirements – has traditionally diverted 70% of its budget surpluses to the Abu Dhabi Investment Authority (ADIA), which had its 40th anniversary in 2016. While estimates regarding ADIA’s total assets vary, in 2016 the SWFI ranked it the third-largest sovereign wealth fund (SWF) in the world, behind only Norway’s Government Pension Fund and the China Investment Corporation. ADIA’s investment strategy sees it maintain interests across a broad range of asset classes and markets, the single biggest of which is developed market equities, for which its published investment strategy has set a 32% minimum and a 42% maximum. This is followed by emerging market equities (10-20%) and government bonds (10-20%). ADIA has also established smaller holdings in areas such as real estate (5-10%); credit (5-10%); alternative investments, comprising hedge funds and managed futures (5-10%); infrastructure (1-5%); and small-cap equities (1-5%).

In terms of geography, ADIA’s investment policy is weighted towards North America, which it targets at 35-50% of its portfolio, followed by Europe (20-35%), emerging markets (15-25%) and developed economies in Asia (10-20%). The combined efforts of its in-house and external managers resulted in an annualised rate of return of 7.5% over the three decades to 2015, compared to the average US consumer price index rate of 2.7% for the same period, according to a March 2016 report from the Abu Dhabi-based daily The National. Perhaps just as important to the economic life of the emirate is ADIA’s function as an incubator for local talent, which has resulted in numerous UAE national alumni going on to perform key roles in Abu Dhabi and elsewhere across the nation, including as ministers and chairmen of government departments.

Broad Horizons

While ADIA remains the principal 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. ADIC’s first phase of development involved taking on ADIA’s domestic subsidiaries, which included prominent institutions such as Abu Dhabi Commercial Bank, NBAD and Abu Dhabi Investment Company. Its remit was subsequently extended to include interests beyond the emirate’s borders, and today it pursues a globally diversified investment strategy across a range of asset classes, including equities and fixed income, infrastructure, real estate and direct investments.

Mubadala

The Mubadala Investment Company represents another arm of the emirate’s investment activity. Established in 2002, it differs from traditional SWFs in that it is partly self-financed through a debt issuance programme, and is therefore classified by the SWFI as a “strategic development SWF”. Over the past 15 years it has played a central role in the diversification of the emirate’s economy away from hydrocarbons activity, making strategically important investments in projects such as Cleveland Clinic Abu Dhabi, Emirates Global Aluminium, aerospace manufacturer Strata, Dolphin Energy and the Paris-Sorbonne University Abu Dhabi. One of its most notable contributions to the emirate’s economic landscape in recent years has been its development of the ADGM, the financial freezone on the capital’s Al Maryah Island, which in October 2016 was accorded “The Financial Centre of the Year (MENA)” award by the magazine Global Investor/ISF (see Trade & Investment chapter).

Mubadala Investment Company named a new board and reorganised its assets in January 2017, following the $125bn merger between it and the International Petroleum Investment Company (IPIC). The crown prince of Abu Dhabi, Sheikh Mohamed bin Zayed bin Sultan Al Nahyan, was reaffirmed chairman of the new board. The new firm, which began operations on May 1, 2017, has set up four investment platforms to oversee its assets. Formerly, it focused on four broad areas: technology and industry; aerospace and engineering services; energy; and emerging sectors, which included health care, real estate, infrastructure and capital investments. The new organisation includes petroleum and petrochemicals, which will account for 31.1% of total assets; alternative investment and infrastructure (31%), which includes the former emerging sectors business units for segments such as health care and real estate; technology, manufacturing and mining (21.6%); and aerospace, ICT and renewables (10.6%). The remaining 5.7% of the group’s interest includes a variety of corporate assets, including cash. One of the more notable decisions was the creation of a new utilities business unit.

Possible Synergies

In addition to the firms named above, companies or entities owned by Mubadala include Mubadala Petroleum and Masdar, while the firm is a stakeholder in Emirates Defence Industries Company, EMI Music Publishing and asset management firm The Carlyle Group. IPIC’s investments are more focused on energy and include Aabar Investments, and petrochemicals and oil firms Borealis, Compañía Española de Petróleos, Cosmo Oil, OMV and Arab Petroleum Pipelines, also known as SUMED.

With stakes in 18 companies, IPIC’s interests span oil and gas exploration and production, marketing, petrochemicals and power projects in locations ranging from Kazakhstan and Pakistan to Austria and Portugal. The most lucrative area of overlap is likely to be energy, as both firms worked on plans for the construction of the UAE’s first land-based liquefied natural gas plant. As the emirate works to cut spending, the consolidation of the two giants will not only lead to increased efficiency, but create a new entity with greater global reach.

Fund Performance

The breadth of Mubadala’s portfolio meant it was not as exposed to the downturn in the global energy markets as IPIC. According to the financial statements of the two funds at the end of 2015, Mubadala had assets of Dh246.4bn ($67.1bn), up from Dh243.6bn ($66.3bn) in 2014, while IPIC saw its total assets fall from $66.29bn in 2014 to $58bn at the end of 2015. This makes Mubadala the more valuable of the two funds. Combined, the companies’ assets were worth $125bn as of the end of 2015.

While Mubadala has seen its full-year revenues increase every year since 2012, with revenues in 2015 expanding by 4.3% to reach Dh34.1bn ($9.3bn), IPIC’s revenues have contracted due to the decline in oil prices – by 3% in 2014 and 30.1% in 2015 to stand at $35.8bn at the end of 2015. During 2015 IPIC saw its income decline from a profit of $1.5bn to a loss of $2.6bn, while Mubadala’s net profits grew from Dh1.2bn ($326.7m) to Dh1.4bn ($381.2m).

According to the companies’ financial results, in the first six months of 2016 Mubadala’s y-o-y income contracted, from Dh625m ($170.2m) in the first half of 2015 to a loss of Dh4.4bn ($1.2bn) in the first half 2016. While Mubadala’s revenues increased in this period, from Dh13.6bn ($3.7bn) to Dh14.3bn ($3.9bn), its cost of sales also increased, from Dh12.3bn ($3.3bn) to Dh15.6bn ($4.2bn). Looking at Mubadala’s various investments, its semiconductor business represented the largest share of overall revenues at 64%, increasing from Dh7.9bn ($2.2bn) in the first half of 2015 to Dh9bn ($2.5bn) in the same period of 2016, while income from its hydrocarbons investments, at 12.2% of the total, fell from Dh2.4bn ($653.4m) to Dh1.7bn ($462.8m). Income from its aerospace and technology operations, meanwhile, represented the third-largest revenue generator, at 10.6%. The company’s comprehensive income fell from a gain of Dh477m ($129.9m) in the first half of 2015 to a loss of some Dh4.9bn ($1.3bn), which it attributed to a higher cost of services, lower commodity prices and decreased gains from financial investments and impairments. The value of Mubadala’s total assets fell by 5% during the period to stand at Dh233bn ($63.4bn) as of the end of June 2016. According to IPIC’s results for the first half of 2016, its revenues contracted by 14% y-o-y, from $18.7bn to $16.1bn. While profits were still in the red at the end of the first half of 2016, at $90.7m, this is a significant improvement from the $1.3bn loss reported a year earlier. The company’s total assets, continued its downward trend during the first six months of 2016 falling from $58bn to $57.8bn.

Pension Fund

Both the federal General Pension and Social Security Authority and the local Abu Dhabi Retirement Pensions & Benefits Fund (ADRPBF) collect contributions from employees, employers and the state. Due to the nature of the UAE’s government, there is a distinction between the federal and local level. The federal pension contributes only on behalf of federal agencies and ministries, with Abu Dhabi effectively opting out of this federal system. Large international companies, such as HSBC, are considered to fall under the federal government, while entities such as NBAD – now First Abu Dhabi Bank – work closely with Abu Dhabi’s fund.

The ADRPBF’s main priority is increasing sustainability, and therefore its approach is based on long-term programmes. Given the emirate’s relatively young population, the fund is much better placed than its counterparts in other parts of the globe that face the opposite problem of a small number of younger citizens supporting a much larger older population. According to the ADRPBF’s 2015 annual statistic book, the fund had 81,828 active members in 2015, who on average were 34 years old and had a pensionable salary of Dh23,562 ($6410). Most active members had put in five years of service at 57%. Only 7% of active members worked in the private sector in 2015, a slight drop from 8% in 2013, while 66% and 27% were in the government and semi-government segments, respectively. Conversely, most employers who contribute to the fund were from the private sector at 76%, compared to 15% and 9% in the government and semi-government sectors, respectively. This indicates the need for continued efforts by the ADRPBF to improve private participation among employees. Smaller firms were also the most common contributors, as employers with up to 100 workers accounted for approximately 90% of active employers in 2015.

Financial Stability

Abu Dhabi’s large hydrocarbons resources, coupled with external reserves that have been built up over decades, have resulted in a high degree of financial stability. In its 2016 Article IV consultation, the IMF noted that the UAE banking system is resilient and has sufficient liquidity and capital buffers to withstand adverse shocks. The effects of low oil prices since mid-2014 have therefore been most visible in terms of performance rather than stability. The UAE three-month interbank rate (the interest rate on short-term loans made between banks) rose during 2016, from 1.06% in January to 1.39% in December of the same year, with an average of 1.16% for 2016 as a whole, and in the first two months of 2017 remained on average at its December 2016 value. However, this represents a modest level compared to rates of 5% or higher seen in 2007 and 2008.

The national government’s efforts to stabilise the real estate market by tightening industry self-regulation, increasing real estate fees and introducing more stringent mortgage lending regulations have helped rein in speculative demand for real estate and contributed to a decline in prices, which started in 2015. In December 2016 the Department of Municipal Affairs and Transport once again capped rental increases in Abu Dhabi at 5%. Nevertheless, the quality of UAE banks’ real estate portfolios remains resilient, with non-performing loans for construction and real estate development falling from 12.4% of the total in 2013 to 7.5% by the end of March 2016, according to the IMF. Lastly, Abu Dhabi’s government-related entities (GREs) have continued to reduce their levels of debt. While Dubai’s debt burden, which was in excess of 125% of GDP in 2015, may pose a risk to stability at the national level, several Abu Dhabi GREs with high debt burdens have demonstrated their ability to actively manage their obligations, making early repayments in some cases and lengthening maturity profiles in others.

Balancing The Books

The gradual reduction of fiscal deficit in line with ensuring stability has been a common theme for GCC governments. Abu Dhabi has a broad range of options when it comes to making up any budgetary shortfall caused by low oil prices. Its most effective short-term measure is its ability to turn to its SWFs for budget support. In addition, the country’s SWFs have assets equivalent to around 400% of GDP – enough to prop up the budget for 23 years at current spending levels. The emirate, which is the largest contributor to the federal budget, has a longstanding mechanism by which it is able to withdraw funds from several of its SWFs in order to cover a fiscal deficit in extraordinary circumstances.

However, while this facility represents a useful short-term fiscal tool, liquidating ADIA’s foreign assets reduces its ability to earn income from its investments. The authorities have therefore explored other funding routes that would allow them to meet their spending commitments without depleting foreign holdings.

Abu Dhabi enjoys a low outstanding debt level, equivalent to about 4% of GDP, according to a February 2016 report from Moody’s; and therefore, raising debt on international markets has emerged as a viable option due to competitive market rates and Abu Dhabi’s solid sovereign rating. In 2016 the emirate staged its first sovereign bond sale in seven years, with the emirate’s Department of Finance raising $5bn through a pair of $2.5bn tranches: a five-year offering with a coupon rate of 2.125% and a 10-year instrument with a rate of 3.125%. The sale was made viable by the emirate’s strong credit ratings, with both Standard & Poor’s and Fitch granting the emirate an “AA” rating for its long-term debt, placing it firmly in the high-grade investment category.

Revenue Base

Abu Dhabi has also sought to broaden government revenue. In April 2016 the emirate introduced and revised a number of new fees related to government services in order to manage costs and sustain quality. A 4% municipality fee, alongside a Dh15 ($4.08) per night charge on hotel bills, is now collected by the Abu Dhabi Tourism & Culture Authority and deposited into the government’s coffers. On the rental side, a 3% municipal fee is now charged on the annual value of expatriates’ lease contracts, with a minimum charge of Dh450 ($123) per year. In its assessment of the new measures, ADCB found them positive from a structural perspective in the context of the medium-term outlook for oil, and pointed out that similar levies in Dubai had not adversely affected performance. According to the central bank’s 2016 annual report, total government revenue improved during the first nine months of 2016 by 22%, largely due to a 163.7% spike in revenue from property incomes, sales of goods and services, and fines and penalties, not including profit transfers from the national oil company. At the national level, a more significant revenue boost will come in 2018, when the long-anticipated introduction of a GCC-wide VAT is expected to be implemented in the UAE. The proposed 5% levy offers the federal government significant gains, with the IMF estimating that new tax revenues could amount to 2% of GDP (see analysis).

On the other side of the ledger, cost-cutting provides another means of offsetting a reduction in oil revenue. Subsidies are estimated to have cost state- owned energy companies about $1bn per year over the decade to 2015, according to a July 2015 Bloomberg report, and this area of the nation’s balance sheet is thus a high priority for further reform. The UAE was the first country in the Gulf to remove transport fuel subsidies, so that deregulated petrol prices are now linked to global markets. “Abu Dhabi remains one of the most proactive countries in the region in terms of reforming its fiscal position, and in 2016 they announced a utility subsidy reduction for the third year in a row,” Monica Malik, chief economist at ADCB, told OBG. The emirate’s new electricity and water tariff framework also represents a significant change in that it requires Abu Dhabi nationals to pay for electricity and water usage for the first time, while expatriates have been asked to pay a higher rate than was previously the case. The new tariffs will bring both budget savings and changes in usage patterns, INFLATION & MONETARY POLICY: New utility tariffs, the removal of subsidies, and the introduction of new fees and charges in Abu Dhabi’s tourism and real estate sectors mean that the inflation rate has become one of the more keenly observed economic indicators of the past year. According to a January 2017 report by The National, ADCB foresees a countrywide rise of more than one percentage point in the inflation rate in 2017 to reach 2.8%, while Standard Chartered anticipates 3% inflation for that year. The Central Bank of the UAE (CBUAE) is expecting an inflation rate of 2.1% in 2017, with an end-of period prices increase of 2.6%. In its 2016 Article IV consultation, the IMF also forecast a relatively modest inflation rate for the UAE of 2.8% to 3.6% between 2017 and 2021 – a considerably more manageable level than the double-digit growth that was seen in the run-up to the global economic crisis of 2008.

This is a welcome forecast from the point of view of the CBUAE, which has only a limited ability to manage inflation through conventional monetary policy measures. The central bank sets interest rates at the federal level, but the pegging of the UAE dirham to the US dollar means that its capacity to address inflationary pressure through rate changes is circumscribed by the need to synchronise with the US Federal Reserve.

While the CBUAE faced calls to de-couple from the dollar during the period of elevated inflation in 2008, the more modest inflation seen since that time has allowed it to support the peg, with its policy rate falling in line with rate hikes by the US Federal Reserve in 2016 and 2017. The government of the UAE and the IMF concluded as part of the 2016 Article IV consultation that the peg has served the UAE well, and has been an important element of stability for decades.

Outlook

Despite Abu Dhabi’s progress to date in diversifying its economy, international oil prices remain a determining factor in its economic outlook. The World Bank anticipates a partial recovery in oil prices in 2017 to around $55 per barrel. Though a welcome improvement and one that the World Bank expects will result in a recovery for UAE GDP growth to 3% by 2018, this falls beneath most independent assessments of the country’s breakeven price. Therefore, fiscal reform is likely to remain a key issue in the medium term. However, a question remains as to the pace of fiscal consolidation.

Abu Dhabi’s return to the markets to raise debt in 2016 revived interest in the prospect of federal sovereign offerings. The issue has been on the agenda for some years, and in 2016 the federal Cabinet revealed it was establishing a suitable framework for national issuances of debt. Reaching a final agreement on debt ceilings and debt servicing has proved challenging in the past, and appeared to be the principal cause of the delays surrounding the draft law in 2016. However, the prospect of a new federal debt law and the subsequent attainment of a federal credit rating for the UAE remains a real one in 2017, and one which will significantly alter the manner in which the nation utilises the debt capital markets to fund national development.