Public Information Notice No. 07/125

Public Information Notice: IMF Executive Board Concludes 2007 Article IV Consultation with the United Arab Emirates

October 9, 2007

On September 21, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the United Arab Emirates.¹

Background

The U.A.E.'s economic performance remains very strong. Real GDP growth was in excess of 9 percent in 2006, with oil production rising by 8 percent and non-oil sectors growing at double-digit growth rates. The rapid expansion is supported by an outward-oriented development strategy, a favorable business climate, and sustained high oil prices. Strong domestic demand and housing shortages have led to sharp increases in rents and contributed to upward pressure on other prices. As a result, the consumer price index inflation exceeded 9 percent in 2006. Reflecting record high oil prices, the overall fiscal and external current account surpluses remained large in 2006, and have allowed further accumulation of official foreign assets.

The medium-term outlook is very positive with real GDP growth projected to remain strong in 2007, and slightly decelerating thereafter due to temporary capacity constraints. The fiscal and external accounts are projected to remain in large surplus.

Prudent government spending at the federal and emirate levels has led to a decline in the non-oil fiscal deficit (excluding investment income). At the same time, however, a number of large investment projects are being undertaken by public and quasi-public entities outside the budget, including in the hydrocarbon sector, infrastructure, real estate, and tourism. External borrowing to finance these investment projects has also picked up significantly.

The financial system is sound and has not been affected by the correction of the U.A.E. stock markets in 2005-06. The growth of private sector credit remains high and banks' exposure to the real estate sector has increased recently. Reforms are underway to strengthen the prudential and regulatory oversight of the banking system and the capital markets; open the banking sector to greater competition; and strengthen the legal framework for the financial sector.

The authorities are committed to the U.S. dollar peg in the period leading up to the establishment of the monetary union among the members of the Gulf Cooperation Council (GCC). They also remain committed to achieving the monetary union by 2010. On the back of higher inflation in the U.A.E. than in partner countries, the exchange rate of the dirham has appreciated in real effective terms by about 6 percent since 2004.

The authorities announced a major reform plan that sets the U.A.E.'s strategy for the next three years. A key focus of the strategy will be to improve government efficiency and strengthen the cooperation between the federal and emirate governments. Progress is also being made to improve the business climate, through updates of key legislation, such as the labor, company, and competition laws.

Efforts to address the weaknesses of economic statistics at the national level have intensified. Work is underway to improve consumer price data, including with Fund technical assistance, and to establish a National Bureau of Statistics by end-2007.

Executive Board Assessment

Executive Directors commended the U.A.E's impressive growth performance over the past few years, stemming from the authorities' successful outward-oriented development strategy, the use of oil resources to achieve economic diversification, and the pursuit of prudent macroeconomic policies. The medium-term prospects look bright, supported by a continued favorable outlook for energy prices given sustained global demand, a strong investment momentum, and an improved domestic business climate. Directors agreed that the key challenges will be to ensure sustained noninflationary growth and further diversification of the economy.

Directors observed that although the assessment of inflation is complicated by data weaknesses, the rate of price increases, driven mainly by strong demand for housing, is too high. They acknowledged, however, that the anticipated reduction of capacity constraints--especially in the housing market--is likely to reduce inflation pressures over the medium term. Directors considered that fiscal policy could play a greater role in regulating domestic demand. In particular, expenditure increases-including by public and quasi-public entities-should be consistent with the country's absorptive capacity. This, together with efforts to alleviate capacity constraints, would help subdue inflation and support a continued economic expansion with macroeconomic stability.

Directors supported the authorities' prudent fiscal policy, with the non-oil deficit declining substantially as a proportion of non-oil GDP, and the overall fiscal position expected to remain in surplus over the medium term. They commended the authorities' fiscal reforms, which are aimed at modernizing the fiscal system and improving efficiency. They welcomed the preparations to introduce a Value Added Tax system at the federal level. Directors called for greater fiscal coordination between the emirates and the federal government. They therefore welcomed the authorities' intention to establish a macro-fiscal unit at the federal government level. The phasing and monitoring of large investment projects carried out by government and quasi-public entities outside the budget should also be intensified.

Directors agreed that the current peg of the dirham to the U.S. dollar has served the U.A.E. well. They considered that the exchange rate of the dirham is in line with fundamentals, and noted that further structural reforms would help to sustain the U.A.E.'s competitiveness. Directors noted the authorities' commitment to work closely with other GCC member countries to reach consensus on the appropriate future exchange rate regime to be adopted as part of the GCC currency union. Looking forward, a few Directors saw value in some flexibility.

Directors noted the strength and resiliency of the U.A.E. financial system, as evidenced by the high capitalization and profitability of financial institutions. They encouraged the authorities to further strengthen prudential regulations and bank supervision, especially in the context of the current rapid credit growth and buoyant real estate market. Directors welcomed the authorities' intention to establish a federal credit bureau to help improve the reporting and monitoring of credit data. At the same time, they called for a strengthening of the supervision of financial services groups comprising banks, insurance companies, and securities firms.

Directors welcomed steps to enhance the supervision of capital markets and efforts to update the banking law and the company law, consistent with the recent Financial Sector Assessment Program update proposals. These steps would, inter alia, remove barriers to foreign participation in U.A.E. markets and help protect shareholder rights. Directors called on the authorities to move ahead to enact the draft securities law, encourage the listing on the equity market of large quasi-public enterprises, and promote an increased role for institutional investors in the markets. Such measures would strengthen investor confidence, reduce market volatility, and deepen the U.A.E.'s capital markets.

Directors welcomed the important steps taken to improve the U.A.E.'s statistical systems in the next few years. They looked forward to the establishment of a National Bureau of Statistics, and the launching of several statistical surveys currently under preparation. They encouraged the authorities to follow up on the Fund's technical assistance recommendations to improve the quality and timeliness of consumer price data, and fiscal data at the federal and emirates levels. Directors welcomed the authorities' intention to expedite the U.A.E.'s participation in the Fund's General Data Dissemination Standard.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.