Introduction
The United Arab Emirate’s debt has been rising sharply in recent years, from around US$17 billion in 2003, almost 19 percent of GDP, to US$184 billion in 20092. Of the debt, only a significant proportion can be traced directly to the public sector.
A report by UBS bank notes that majority of the debt is attributed to the corporate sector. Most of the companies that owe the major section of the debt are financial institutions, and are partly owned by the public sector. Banks in the UAE have been growing their debt levels in the stated years, and could now account to 75 percent of the total foreign debt.
The discussion entails reasons as to why the debt level of the UAE has been increasing at an alarming rate. It also looks at the composition and structure of the debt, debt per capita and yearly rate of change. An important factor to consider is the influence of debt on the economic growth of the region, and if the current debt levels are sustainable in the long term. In so doing, the discussion looks at other alternatives that could have been implemented to solve for the debt, including possible debt restructuring solutions.
Literature review illustrates documentation on the topic of global debt, while the empirical background looks at the economic growth of the country, expansion policies and investments that have taken place.
Costs and benefits of using debt have also been illustrated. Several emirates will be evaluated on their contribution to the UAE debt, policies that have been employed in the past, and recommended solutions. Lastly, the discussion may seek to point out the appropriate debt levels depending on income levels as well as potential for growth. A summary has been provided, where critical discussion points have been highlighted and a brief conclusion.
Literature Review
A report by the institute of international finance (IIF) shows that United Arab Emirate’s debts have risen sharply since 2003. According to the IIF, debt levels increased to US$106 billion in 2007, from US$17 billion in 2003, an increase of more than 500 percent.
The country’s banking sector is the major external borrower of funds, as these institutions seek to expand the regions domestic credit growth. UAE banks have become more and more dependent on external debt since the domestic deposit growth has become increasingly constrained by interest rates and the high loan to deposit rate, estimated at 100 percent.
The international credit market has shrunk in recent years due to the declined support of UAE’s debt levels, coupled with the financial crisis of 2007-2010. Foreign financial institutions have been increasing their deposits in the UAE, as they try to profit from the potential revaluation of the dirham against major hard currencies, thereby increasing external debt for the country. In the non-financial sector, the rise in external debt could have been driven by the corporate expansion, notably in Dubai.
The IIF explains that majority of the debt is generated from private equity transactions and Islamic financing. The two elements are more difficult to track down than traditional banking, thus insufficient data fails to capture the full scope of the private sector’s debt build up.
A UBS report claims that although the government’s debt is low, indicators point towards continual increase in contingent liabilities. The IMF noted that the UAE’s government debt was 10 percent of GDP in year 20073, although IIF’s estimate is much higher, at 21 percent to GDP by accumulating off budget activities in central government accounts.
More than two thirds of UAE’s debt is owed to domestic institutions, especially banks, while the rest is foreign debt. The country’s external debt liabilities are smaller than the UAE’s central bank reserves, and Abu Dhabi investment agency’s foreign assets, indicating that in net terms, UAE is a significant international creditor.
A research conducted by Bank of America-Merrill Lynch, concluded that the UAE accounted for almost 50 percent of GCC (Gulf Cooperation Council) foreign debt repayable in 20094. Saudi Arabia and Kuwait made up most of the remaining proportion of debt. Government owned entities accounted for 61 percent of UAE’s outstanding debt in 2009.
According to Merrill Lynch, private sector debts have been raising sharply, especially in the UAE, and as then global economic outlook changes, GCC countries may face stiffer challenges. Recent fluctuations in oil prices have been dampening investor moods when it comes to investing in the country, thereby limiting credit growth.
As the energy sector becomes more unreliable, at least in the long term, the real estate sector faces increasing pressure to perform. The UAE government has been investing in the system, pouring money in a bid to ease short term liquidity restrictions though slower GDP growth levels are unavoidable.
Rising inflation in the UAE has increased to the cost of living, as per the Merrill Lynch report, which causes both households and businesses alike to borrow in order to deal with the surging prices. Loan advances and bank overdrafts in the country increased by over 35 percent from 2007 levels, to AED44 billion in 2008.
Empirical Background
The UAE, made up of seven emirates, has been involved in a rapid economic boom over past years, based on several socio-economic indicators. 2009 GDP levels estimated US$200 billion, of which industry and services sectors contribute significantly.
Investments in the country have resulted into low unemployment rates, at 12.8 percent (2008), as compared with other countries in the Middle East region. UAE ranks within top 20 countries globally in GDP per capita terms, at US$42,000, while the country ranks highest in daily per capita expenditure, averaging almost US$ 27.
The region could be said to lack strict sector regulations, as most banks follow self-regulation policies. Banks have been seen promoting the use of debt among users in a bid to increase the size of their loan books, and ultimately maximize interest income.
While this process may derive short term profitability, it may not necessarily ensure sustainable and responsible consumer lending. Analysts point out that implementation of a consumer credit control policy in the country may lead to better and sustainable relationships between banks and their customers.
Most investments have been directed towards building infrastructure, inclusive of property development projects. Presently, there are some US$ 350 billion tied up in construction projects5. The average growth rate of trading activities, from 2004 to 2009, was 11 percent. Efficiency of operations around ports, airports and other outlets supported the high growth rate. Emirates such as Dubai and Abu Dhabi lead in investment programs, as they diversify their income generating sources.
Although growth of the emirates can be traced to the oil industry, the sector is no longer reliable in the long term as oil and gas reserves are predicted to decline in coming years. Still, oil and gas reserves continue to form a proportionate share of the country’s GDP, where natural resources contributed 85 percent of 2009 GDP.
The UAE was largely affected by the 2007 to 2009 global financial meltdown, particularly Dubai6, and the country’s economy resided by 4 percent. Dubai had engaged in massive construction projects, including the Burj Khalifa, now the world’s tallest building.
Other projects include Dubai World Central International Airport, the three Palm Islands, Dubai Mall, and The World, all of which are record breaking projects meant to boost Dubai’s growing tourism industry. All these projects came at a cost, indebting Dubai up to a tune of $US80 billion in 2009.
The Chamber of Commerce and Industry (DCCI) anticipates that foreign debt levels may reach 62.5 percent of GDP by the end of 2010. If the rise in debt levels goes on unchecked, then the government would be forced to intervene in the economy.
The government could raise tax levels to discourage consumption, implement fiscal contraction policies, or pump in more money in the economy so as to bail out ailing firms. Government involvement in the economy discourages the benefits of the free market model, where resources follow demand and supply patterns, which would influence investors to abandon the region for less regulated emerging markets.
Discussion
Downturns in UAE Markets
Oil Industry
Downturns in various markets have not helped UAE’s debt problems. Soaring oil prices in the first half of 2008 did not maintain their record high levels, as the markets corrected themselves. Oil price fluctuations were significant in 2008, peaking at US$147 and declining to below US$60 a barrel.
The fluctuations negated UAE’s economic outlooks, as the oil and gas sector accounted to about 35 percent of GDP. “Gulf news, a local newspaper, had estimated that oil revenues for Abu Dhabi, which contributes to almost 95 percent of the United Arab Emirate’s oil output, would reach US$100 billion should the prices remain fairly high, which was not the case.”7
Real Estate market
The UAE is experiencing misfortunes in the property market, in addition to oil prices woes. The real estate sector had been a bull market for six consecutive years, ever since the UAE government permitted overseas investors to purchase land on a freehold basis in 2002.
A correction in prices ensued in 2008, according to a HSBC report, where property prices declined by 4 percent in Abu Dhabi, and 5 percent in Dubai, for the first time since 2002. The current economic climate does not favor property projects in the region, due to the possible bear market. Further leveraged investments at this point in time would be un-advisable, given the fact
Stock Markets
The global fiscal crisis of 2007-2009 did not spare UAE stock markets, as well as some other emerging markets. During 2008, both the Dubai Financial Market (DFM) and the Abu Dhabi Securities Exchange (ADX) fell to their lowest levels, declining from their peak 2008 year levels by 68.51 percent and 46.48 percent respectively.
The combined losses of the two stock markets during the period amounted to 6.19 billion dirham (US$1.68 billion) in market value. The downturns in the markets contributed to negative GDP growths, whereby the UAE economy shrunk by almost 3 percent in 2008-2009.
Possible solutions
Proposed solutions should aim at both establishing protective mechanisms that would avert unsustainable debt levels, and the procedures that should be effected should the problems persist. One way to prevent a debt crisis would be via establishing a bailout fund among the members of the UAE.
Countries would contribute to this fund in pre-determined proportion. The bailout fund could come with stringent conditions for the parties involved, concerning debt loads for each member. For instance, such regulations could stipulate the maximum debt to GDP ratio, such as 60 percent.
Still in the formulation of prevention measures, regulations that concern penalties to members who break established conditions could be enacted. It is not sufficient for UAE members to bail out each other in debt crisis without establishing consequences for the bailed out members. It’s only recently that Abu Dhabi bought US$10 billion government bonds from Dubai so as to save it from its foreign creditors.
Penalties should be imposed so as to discourage UAE members from pursuing high risk debt leveraged financial strategies. A model that measures accurate debt levels is also recommended. Improvement in reporting rules could help prevent members from accumulating unsustainable debt levels in their growth policies.
There are several ways of handling a debt crisis once it emerges. One method would be by use of grants and loans. Abu Dhabi bought US$10 billion government bonds from Dubai which would assist the emirate clear short term loans. This method however only transfers the debt burden into the future, at substantially higher cost.
Members of the UAE could also intervene by paying off the debt owed by individual emirates without placing conditions. While this solution may strengthen ties between member emirates, it creates moral hazard problems. External creditors may avoid transacting with the rescued emirate in the future as a result. Alternative solutions would lead to a cutback in government expenditure as discussed below.
Composition of Government expenditure cuts
Inevitably, the public sector is usually the first affected when a country’s government imposes expenditure cuts. Expenditure cuts could involve public sector layoffs, or suspension of investment in infrastructure. Independent UAE members could decrease their involvement in development projects.
Dubai could halt further spending in record breaking projects in the short term, as the emirate’s aggressive growth strategy is mostly to blame for its debt problems. Shrinking the size of the public sector may require efficiency in operations and implementation of government policies.
The UAE government could decrease the amount of subsidies paid to boost economic activities. The impact of this would be a slowdown in economic growth. Other sectors that could be affected include social benefits, government backed pension plans, and government consumption.
Research by Nichel, Rother and Zimmerman (24) indicates that cutbacks targeting social benefits and government payrolls have the biggest impact on debt reduction8. In the study, conclusions were drawn that significant reductions in government subsidies and government consumption do not necessarily contribute proportionally towards government debt reduction.
Conclusion
In summary, the United Arab Emirates promises further economic growth, possibly at an average annual rate of 6 percent in the short term. The region is expanding rapidly, notably in the real estate and financial services sector.
The reason for the aggressive growth came with the realization that overreliance on the oil sector was no longer feasible; hence the country had to diversify in other promising sectors. Much of the growth has been financed by debt, which meant that the region could not escape the clutches of the global credit crisis in recent years. The high debt levels, especially in Dubai, could trigger a financial crisis in the Gulf region.
Dubai still remains susceptible to future economic shocks, as the emirate still bears high debt levels. As a result of the debt levels, Dubai World has had to restructure its debt, while Dubai Holdings could follow the same direction. The debt restructuring only serves to decrease pressure in the short term, whereby the emirate has had to offer new government securities to repay previous loans.
Unsustainable debt levels negatively affect economic growth and investment in the country. This could explain the reason Dubai has experienced decreased investment activities, as investors and creditors become wary of investing in the emirate, a scenario explained as debt overhang.
Works Cited
Charter, David. “Storm over bailout of Greece, EU’s most ailing economy”. The Sunday Times. 2010: 8-15. Print.
Clement, Henry. et al. Globalization and the Politics of Development in the Middle East. New York: Cambridge University Press. 48-76. Print.
Greenaway, David. The World Economy: Global Trade Policy. 2009. New York: John Wiley and Sons. 64-89. Print
IMF. “Report for Selected Countries and Subjects”. Web.
Jian, Pan. “Global financial crisis takes toll on UAE.” China View. 02 Dec 2008: 14-15. Print.
Nickel, Christiane, Philipp Rother and Lilli Zimmermann. “Major Public Debt Reductions: Lessons from the past, lessons for the future”. Working Paper Series. No. 1241, Sept 2010: 26-35. Web.
World Bank. “Doing Business in the United Arab Emirates”. Web.
Footnotes
1 Charter, David. “Storm over bailout of Greece, EU’s most ailing economy”. The Sunday Times. 2010: 8-15. Print.
2 Greenaway, David. The World Economy: Global Trade Policy. 2009. New York: John Wiley and Sons. 64-89. Print
3 IMF. “Report for Selected Countries and Subjects” Web.
4 Clement, Henry. et al. Globalization and the Politics of Development in the Middle East. New York: Cambridge University Press. 48-76. Print.
5 World Bank. “Doing Business in the United Arab Emirates”. Web.
6 Jian, Pan. “Global financial crisis takes toll on UAE.” China View. 2008: 14-15. Print.
7 World Bank. “Doing Business in the United Arab Emirates”. Web.
8 Nickel, Christiane, Philipp Rother and Lilli Zimmermann. “Major Public Debt Reductions: Lessons from the past, lessons for the future”. Working Paper Series. No. 1241, 2010: 26-35. Web.