Public revenue in Sharjah set to benefit from new value-added tax

The economy of Sharjah is highly diversified by regional standards, with oil and gas contributing less than 6% to GDP, and no individual sector accounting for more than 20%. The emirate has had particular success in developing its industrial and manufacturing sector through a network of free zones and industrial zones that continues to develop and expand, and it is one of the main industrial bases of the UAE. The authorities have also been taking a range of measures to boost foreign investment flows, supported by an attractive national business environment and competitive advantages, such as Sharjah’s comparatively low operating costs. “The cities of the UAE complement each other in terms of economic structures and investment opportunities, and Sharjah benefits from being one of the most diversified markets in the region and a stable investment environment,” Abdulla Al Dhawi, chairman of Al Dhawi Investments, told OBG.

GDP

The emirate’s GDP stood at Dh88.5bn ($24.1bn) in 2016 at current prices and an estimated Dh92.7bn ($25.2bn) in 2017, according to the Federal Competitiveness and Statistics Authority (FCSA). This meant that Sharjah accounted for around 7% of the UAE’s GDP in 2016 and had the third-largest economy of the federation. The largest component of Sharjah’s GDP according to the 2017 data was manufacturing, worth Dh15.7bn ($4.3bn), or 16.9% of the total. This was followed by real estate at Dh12.1bn ($3.3bn), or 13% of emirate-level GDP. Wholesale and retail trade, and repair of motor vehicles were next with an output of Dh11.8bn ($3bn), or 12.1% of the total.

Real GDP expanded by 3.1% in 2016, according to estimates from international ratings agency Moody’s, up from flat growth the previous year, when expansion was constrained by a fall in global oil prices. This was in line with federal GDP growth of 3%, according to IMF figures. In December 2017 Moody’s estimated Sharjah’s annual growth was 2.5%, and forecast it would rise to 2.7% in 2018 and 2019, with expansion to be driven primarily by increases in trade and tourism. The IMF estimated that national GDP growth was 0.5% in 2017, but had a more optimistic growth outlook of 2% in 2018 and 3% in 2019.

Based on the emirate’s estimated 1.41m inhabitants, as per Department of Statistics and Community Development (DSCD) figures, GDP per capita stood at Dh60,675 ($16,500) in 2015. This compared to a national average of Dh140,500 ($38,200), boosted by Abu Dhabi’s substantial oil and gas wealth. Sharjah’s 2016 GDP per capita was $32,684 in purchasing power parity terms, compared to $113,688 for Abu Dhabi and $81,420 for Dubai, according to Moody’s.

Hydrocarbons

The hydrocarbons sector – which is dominated by oil and gas production – contributed Dh5.1bn ($1.4bn), or 5.8%, to the emirate’s GDP in 2016. The figure was down substantially on previous years due to the fall in the value of the global oil prices that began in mid-2014. Hydrocarbons GDP hit a peak in absolute value terms of Dh10.4bn ($2.8bn) in 2013, equivalent to 13.2% of GDP. According to estimates for 2017, the industry’s contribution was 6.8% of total GDP, or Dh6.3bn ($1.7bn).

Competitive Advantages

Sharjah benefits from a number of competitive advantages over other emirates and other countries in the region. It is adjacent to Dubai but offers a lower cost of living and of doing business, which is helping to attract residents, tourists and industries that want to take advantage of Dubai’s facilities and infrastructure – such as Dubai International Airport and Jebel Ali port, the largest air and sea facilities, respectively, in the region – without the expense of operating in Dubai. Sharjah also benefits from strong connectivity and infrastructure of its own, being the only member of the UAE to border all other emirates. In addition, it hosts its own airport and is home to several ports, including Khorfakkan, which is located on the Gulf of Oman and therefore has the advantage of being located outside the Straits of Hormuz, passage through which adds time and insurance costs for shipping.

Foreign Exchange

As with all GCC currencies – with the partial exception of the Kuwaiti dinar, which is pegged to a dollar-dominated basket of currencies – the UAE’s national currency, the Emirati dirham, is pegged to the US dollar. The dirham rate is set at $1:Dh3.6725. There was some speculation that central banks in the GCC would come under pressure to adjust currency pegs in the wake of the oil price slide, but such notions were explicitly rebuffed by authorities at the time and have now receded.

The strength of the dollar against other currencies in 2015 and 2016 put export-oriented industries in dollar-pegged countries under threat, and may have played a role in the decline in tourism activity in Sharjah in 2015. However, an economic slowdown in hydrocarbons-dependent tourism source markets and the sharp fall in the value of the Russian rouble also played a major role (see Tourism chapter). Meanwhile, the dollar has lost ground against other major international currencies such as the euro and UK pound since early 2017, which is likely to support non-oil exports and tourism in various territories and nations operating with such pegs.

International Trade

The most-recent trade data available from the DSCD was published in 2013. Total exports for that year were worth Dh42.2bn ($11.5bn), including Dh37.8bn ($10.3bn) of re-exports and Dh4.4bn ($1.2bn) of original exports. The largest category of re-exports was pearls, stones and precious metals, worth Dh16.4bn ($4.5bn), while the largest category of exports by value was electrical machinery and equipment parts, worth Dh1.41bn ($383.8m). Asia was the main destination for re-exports and exports, worth Dh29.3bn ($8bn) and Dh1.95bn ($530.8m), respectively.

More recent figures are available from the FCSA for the UAE as a whole. The value of non-oil foreign trade for the country stood at Dh1.08trn ($294bn) in 2016, up from Dh1.06trn ($288.5bn) in the previous year. Non-oil exports rose 4.6% that year to Dh169bn ($46bn), while re-exports fell from Dh221bn ($60.2bn) to Dh215bn ($58.5bn). In the first half of 2017 total non-oil trade was worth Dh536bn ($145.9bn) in the UAE, down from Dh553bn ($150.5bn) during the same period a year earlier, a drop of 3.2% year-on-year. Imports, non-oil exports, and re-exports had all eased over the first half of 2017, led by non-oil exports with a decline of 11.1%.

Investment

The emirate attracted Dh912m ($248.2m) worth of foreign direct investment (FDI) in 2016 – a record amount, according to its investment promotion agency the Sharjah FDI Office, also known as Invest in Sharjah. In April 2018, however, Invest in Sharjah announced that the emirate had registered Dh5.97bn ($1.63bn) of FDI in 2017, representing a significant increase on the previous year.

The UAE attracted $8.99bn worth of FDI in 2016, according to figures from the UN Conference on Trade and Investment, the most of any GCC country. This was an increase from $8.8bn in 2015, though it was less than FDI inflows in the years preceding the oil crisis. Investment flows are supported by the improving business environment: the UAE placed 21st out of 190 countries in the World Bank’s “Doing Business 2018” report, up from 26th in 2017, and it was the highest-ranked in the MENA region.

The emirate is working to attract more foreign investment, including through the launch of Invest in Sharjah in September 2016. Investment promotion was previously carried out by the Sharjah Investment and Development Authority (Shurooq), of which Invest in Sharjah is a semi-autonomous arm. Shurooq is also an active investor, developer and operator of businesses in its own right – particularly in the tourism and real estate segments – which led to the establishment of Invest in Sharjah.

The body promotes FDI inflows through investment roadshows and other activities abroad, with a particular focus on India, Russia, China, GCC countries, the US and several European nations, including Italy and France. The body also had promotional events in late 2017 and early 2018 in Malaysia, Singapore, the Netherlands and Japan. Mohammed Juma Al Musharrakh, CEO of Invest in Sharjah, told OBG that investors from different countries tend to participate in specialised sectors in the emirate. “Chinese investment, for example, is mainly focused on manufacturing, while German investors are especially active in areas including renewable energy,” he told OBG. “The most promising source market for tourism investment is the GCC, as they benefit from fewer restrictions on ownership of hotels.”

Invest in Sharjah also holds an annual event to promote FDI, the Sharjah FDI Forum, which hosts discussions on trends within the investment sector. Al Musharrakh told OBG that in 2018 the office is emphasising developing Sharjah as a centre for entrepreneurship and start-ups. Observers say that the emirate’s business environment benefits from various advantages in this respect. “Sharjah offers a low cost base by regional standards, proximity to Dubai and access to talent and research and development (R&D) through some of the top universities in the region,” Samer Choucair, vice-president of CE-Ventures – a proprietary start-up unit of Sharjah-based conglomerate Crescent Enterprises – told OBG. Choucair outlined some of its advantages as a base for entrepreneurship, but added that the emirate’s operating environment was somewhat expensive for start-ups compared to some mature markets. Furthermore, operations are subject to regulatory constraints, such as strict and relatively costly employment visa requirements (see analysis).

Foreign Investment

A development that is set to boost foreign investment and project activity further is work by the government to encourage companies to invest in foreign export finance insurance. In early 2017 export credit agency UK Export Finance agreed to support a contract through its direct lending programme to construct the new headquarters of Sharjah’s environment and waste management firm Bee’ah. Tom Koczwara, director of the Debt Management Office at Sharjah’s Department of Finance, told OBG that this was the first major export finance deal for the emirate. A major new power station being built in Sharjah under an independent power project model is also likely to benefit from the support of a foreign export credit agency. “It helps a lot to already have one or two export finance deals under your belt when seeking to persuade other agencies to start working in a country or territory, so export finance activity is likely to increase and to support economic growth Sharjah in the coming years,” Koczwara told OBG.

Another development that could bolster investment, in particular outside of the free zones, is a planned revision of the UAE’s federal investment regime. Currently, foreign firms are limited to owning a maximum of a 49% stake in onshore companies, with some exceptions. However, Sultan bin Saeed Al Mansoori, the federal minister of economy said in April 2018 that changes to the Commercial Companies Law relaxing the requirement in some unspecified sectors were close to being finalised and would be implemented by the final quarter of that year.

Special Zones

A key component of Sharjah’s economy is its network of free zones and industrial zones. Two major free zones – which offer advantages such as 100% foreign ownership – are the Hamriyah Free Zone (HFZ), adjacent to Hamriyah Port, and the Sharjah Airport International Free Zone (SAIF Zone), next to the airport. The main focus in both zones is industry, with more of a concentration of medium-to-heavy industry in the HFZ. The emirate is also home to a network of 19 onshore industrial zones that do not benefit from free zone advantages (see Industry and Energy chapters).

Sharjah is also developing new free zones with non-industrial focuses to further support the growth and diversification of its economy. October 2017 saw the opening of Sharjah Publishing City, a 40,000-sq-metre, publishing business-focused zone for which 150 firms had signed up prior to its opening. A large printing facility is due to open in 2018, to be followed by a second phase the following year. Sharjah is already an important destination for the publishing industry, given its hosting of the annual Sharjah International Book Fair, the 36th edition of which took place in 2017. UNESCO has also designated the emirate as the 2019 World Book Capital.

In January 2017 the authorities launched development plans for another free zone, Sharjah Media City, which will focus on the media and creative industries, as well as innovation more generally. Construction work on the zone’s first and second phases is due to begin in early and mid-2018, respectively.

Sharjah Healthcare City, which was announced in 2010, will also operate as a free zone, allowing 100% foreign ownership. The government approved a master plan for the 2.4m-sq-metre zone in January 2017. The city will host not only hospitals, clinics and wellness centres, but also health care-related warehousing, equipment, light assembly plants, and retail and accommodation facilities.

In November 2016 the authorities also announced plans to establish another free zone, the Sharjah Research, Technology and Innovation Park, which will be developed by AUS Enterprises and adjacent to the emirate’s University City. The zone will seek to leverage research activities at nearby universities, hosting a range of R&D-oriented start-ups and businesses. The first elements of the first phase, including the central building, are due for completion by early 2019 (see analysis). The development of such new zones is part of a wider approach to build more specialised free zones. “We have two general free zones, and we are now looking to create ecosystems for specific sectors,” Al Musharrakh told OBG.

Public Finances

The value of Sharjah’s government debt was equivalent to 16.7% of GDP in 2016, according to Moody’s, up from 13% in 2015 and 1.6% in 2008. While debt levels are rising, they remain low in relative terms – the median figure for the MENA region is 61.9% – with plenty of room to grow before approaching a sustainability threshold. Moody’s forecast the figure to rise slightly in 2018 and hit 20.9% by 2019. Debt-to-government revenue is higher compared to peers, but in line with the median figure for MENA countries, with Moody’s reporting this to be 199.3% in 2016. However, this was a reduction on 2015, when this rate was 263.4%.

The fiscal deficit also appears to be on a downward trend, which should help to slow debt growth in the coming years. The figure rose in the early years of the 2010s, peaking at 4.2% in 2015, but eased to 2.8% in 2016. In December 2017 Moody’s expected it to fall further to 2.3% for the year as a whole, and to decline moderately in subsequent years.

2018 Budget

In December 2017 the authorities approved a general budget for 2018, comprising Dh22.1bn ($6bn) of public expenditure, an increase of 6% over the previous year’s outlays. Approximately 44% of expenditure will be devoted to economic development, up from 41% the previous year; 23% will go to social development, up from 20% in 2017; 24% is allocated to investment in infrastructure, down from 31%; and 9% is set aside for government administration, security and safety, up from 8%.

Revenue

Under the 2017 budget, 74% of public revenue was operating revenue from central government departments, 17.5% was from capital income, 7% from Customs duties and 1% from hydrocarbons. Central government revenue comes primarily from local service fees, such as business licensing fees, and from sales of government land. Revenue has been growing in recent years: Moody’s forecast that government income would stand equivalent to 9.2% of GDP in 2018, up from 9% in 2017 and 8.4% in 2016.

Rising land sales have helped to bolster revenues in recent times: Koczwara told OBG that the value of land sales in 2017 hit its highest level since the 2008-09 international financial crisis.

This has been further bolstered by a number of major real estate projects, such as the Aljada project, which is a Dh24bn ($6.5bn) mixed-use development by UAE-based real estate developer ARADA that will eventually house approximately 70,000 people. Thaddeus Best, an analyst at Moody’s, told OBG that a potential risk to this source of government revenue was the recent fall in rental prices across the country, which, if sustained or worsened, could result in a cooling of real estate activities and hence reduced land sales for Sharjah’s government.

VAT

Government income is set to be bolstered by a significant new revenue stream, a 5% value-added tax (VAT) on consumer items, which has been in place in the UAE since January 1, 2018. The move was part of a wider plan to introduce consumer tax across the GCC from 2018 onwards; however, of the other member states only Saudi Arabia also launched the tax at the beginning of the year, with the remaining countries planning to follow suit later in the year or in 2019.

Essential items – including basic foodstuffs, medicine, residential rent, and school and health care fees – are exempt, and companies with sales of taxable goods or services worth less than Dh375,000 ($102,000) will not be obliged to register with the VAT authorities. The tax is also not applicable in free zones, such as the SAIF Zone or the HFZ.

The impact of the tax on Sharjah’s revenue appears set to exceed earlier expectations: in February 2018 Best told OBG that it appeared that emirate-level governments would receive 70% of VAT receipts raised in the country, up from previous expectations of a 50:50 split between the federal government and emirate-level authorities, though it remained unclear what formula would be used to decide how this would be divided between each of the individual emirates.

Koczwara told OBG that there was significant upside potential to the Sharjah government’s forecasts for the impact of VAT on its finances, as it has not budgeted any VAT revenue receipts for 2018. The Ministry of Finance has estimated that income from VAT across the UAE would be Dh12bn ($3.3bn) in 2018, rising to Dh20bn ($5.4bn) from 2019 onwards.

The implementation of VAT has led to some speculation that the UAE could introduce other taxes, particularly on corporate profits. “The fact that the government managed to introduce VAT on time indicates that it has the technical capacity to introduce new taxes,” Best told OBG. “However, the authorities are likely wary of putting too much pressure on the country’s competitive advantages, and we haven’t incorporated any expectations of new taxes beyond VAT into our ratings or outlook for Sharjah.”

Government Borrowing

In order to finance expansionary budget policies and the concomitant fiscal deficit – which has been steadily falling since 2015 – Sharjah’s government has stepped up borrowing in recent years, and has committed to a number of measures to facilitate this decision and reduce debt-servicing costs.

Prominent among these was a move in 2014 to obtain ratings from sovereign debt credit rating agencies Moody’s and Standard & Poor’s. “Obtaining the ratings had a revolutionary impact on Sharjah’s ability to raise funding,” Koczwara told OBG. The government spent the following two years restructuring the debt of public and government-related entities to reduce interest payment costs, a process that led to both renegotiation of terms with existing lenders and the issuing of sukuk (Islamic bonds) to repay some outstanding debt, much of which was more expensive bank debt. The process finished in 2016, bringing down debt-servicing costs by about 50%.

The emirate has issued three sukuk to date: a $750m instrument in September 2014, a $500m bond in January 2016 and a $1bn sukuk in March 2018. The most recent issue, which was by far the largest, was oversubscribed 2.35 times, indicating strong investor confidence and increasing momentum in Sharjah’s investment environment.

In February 2018 the authorities issued an RMB2bn ($297.8m) instrument into the Chinese market – a so-called Panda bond – making Sharjah the first Middle Eastern government to tap into this market. “The Chinese market represents a liquidity pool that is not correlated with the global US dollar market, and the pricing has been comparable to other options, so it is a valuable addition to our portfolio of options for raising debt,” Koczwara told OBG, adding that the move would help build and strengthen existing relationships with Chinese financial institutions.

Koczwara told OBG that the emirate has potential to become a regular issuer of debt in the coming years, having established a public sukuk programme of unlimited size. “The government has always been comfortable with borrowing to fund net capital investment, while debt remains at low levels compared to international norms,” he told OBG. “Increased economic pressures since 2015 have led to lower revenue and higher spending to support the economy, leading to some deterioration in the debt profile. However, we are returning to the previous balance in indicators such as the fiscal deficit, which will allow us to issue more debt.”

Ratings

As noted previously, Sharjah’s public debt has been rated by Moody’s and Standard & Poor’s since 2014. In January 2017 Standard & Poor’s downgraded its rating for the emirate, from “A/A-1” to “BBB+/A-2” with a stable outlook, where it remained at the time of publishing. This is one of a number of downgrades applied by Standard & Poor’s to GCC sovereigns in the past 3 years.

Despite the downgrade, the rating remains firmly within investment-grade territory. The agency reported that this decision was primarily a result of worse-than-expected fiscal performance and rising debt levels, which was mainly due to increased government capital spending on the construction of housing and infrastructure such as roads and government buildings. Moody’s has held the emirate’s debt rating as “A3” – also comfortably inside investment-grade parameters – since 2014. The agency reaffirmed the rating in December 2017 and maintained its outlook for Sharjah as stable.

Best told OBG that the agency’s decision to maintain its previous rating despite rising debt levels was based on expectations that the introduction of revenue-raising measures at both the federal and emirate level – and in particular the aforementioned arrival of a 5% VAT in the country – will stabilise debt levels. “Sharjah’s economy also weathered the oil price shock well, underscoring its resilience,” he told OBG. He also noted an improvement in finances at the Sharjah Electricity and Water Authority (SEWA), which is one of the few public sector entities for which the government has provided explicit guarantees for some of its debts.

One factor behind this includes the fall in oil prices since 2014, which have risen again since mid-2017 but remain well below 2013 highs.

A deal to source more electricity from the national grid and secure long-term gas supplies has also helped to bolster SEWA’s finances, as have efforts to step up revenue collection. Koczwara told OBG that the authority is now a net contributor to government finances, rather than running at a loss. The authorities have plans to further reduce costs at SEWA by investing in improving efficiency in the authority’s power generation infrastructure, which has been recorded as low at some key power stations. “Gas purchase is the largest component of SEWA’s cost base, so investing to increase efficiency makes strong financial sense,” Koczwara told OBG.

Outlook

While hydrocarbons production represents only a small proportion of Sharjah’s GDP, the partial recovery in international oil prices since mid-2017 is likely to boost economic growth in the emirate, given its impact on not only the federal budget, but also demand from other emirates and countries in the region, as well as leading tourism source markets such as Russia.

The decline in the value of the dollar, to which the dirham is pegged, against other major currencies should also strengthen tourism and the emirate’s export-oriented industries. Recent moves to strengthen public finances through the federal introduction of VAT and reforms at SEWA will also serve to further stabilise the economy, while the development of both new and existing free zones, and efforts to engage foreign export finance providers, are expected to further boost the environment for foreign investment, all indications suggesting a promising long-term outlook for Sharjah’s economy.