Public Information Notice No. 11/57

Public Information Notice: IMF Executive Board Concludes 2011 Article IV Consultation with United Arab Emirates

May 23, 2011

On April 21, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the United Arab Emirates (U.A.E.), and considered and endorsed the staff appraisal without a meeting.¹

Background

The economic recovery in the U.A.E. is gaining strength, supported by a favorable global environment but subject to increased regional uncertainty. Real nonhydrocarbon GDP growth is projected to accelerate to 3.3 percent in 2011 from 2.1 percent in 2010, reflecting stronger tourism, logistics, and trade in the emirate of Dubai; and large public investment spending in the emirate of Abu Dhabi, including through Government-Related Entities (GREs). Higher oil prices are also contributing to a marked improvement in the fiscal and external positions. Despite higher international food prices, the CPI inflation rate is expected to remain moderate at 4.5 percent, as property rents continue to decline. At 4.2 percent, the U.A.E’s unemployment rate is low, though unemployment among nationals remains high (at 14 percent), and concentrated in the northern emirates.

The Dubai World (DW) debt restructuring was completed, but other GREs entered in restructuring negotiations. Nevertheless, the successful restructuring of DW’s debt improved market confidence, allowing top-grade Dubai issuers to regain market access. However, Dubai spreads remain high reflecting the risks posed by further potential debt restructuring needs. Many Dubai GREs initiated DW-style debt restructuring talks with banks, while Abu Dhabi stepped up its support to some GREs.

The banking sector has high capital buffers—including from the government—and remained profitable in 2010, but nonperforming loans have doubled since the crisis. The Central Bank of the U.A.E. (CBU) has made important progress in strengthening its financial stability analysis, revamping the regulatory framework, and developing macroprudential policies, with the view to improve bank risk management practices.

Risks to the recovery remain, including from possible economic spillovers of regional events. In particular, the current re-pricing of geopolitical risk in the region could lead to more challenging market conditions, which may put pressure on the entities that need to roll over external borrowing. The excess supply of property in Dubai, and the uncertainty regarding the scale of oversupply in the emirate, will continue to weigh on growth in the U.A.E. At more than 100 percent of GDP, Dubai’s GRE debt is large and roll-over needs are expected to l remain substantial for the medium term, posing continued fiscal and financial risks to the U.A.E. overall.

Executive Board Assessment

In concluding the 2011 Article IV consultation with the United Arab Emirates, Executive Directors endorsed staff’s appraisal, as follows:

The U.A.E. economy is recovering in an increasingly uncertain regional environment. Benefiting from high oil prices and strong demand from traditional trading partners, nonhydrocarbon GDP growth is projected to accelerate from 2.1 percent in 2010 to 3.3 percent in 2011. The real estate overhang and short-term refinancing needs from overleveraged GREs continue to weigh on the near-term outlook. Downside risks to the recovery relate to possible economic spillovers of regional events, including the re-pricing of risk.

In light of the still fragile recovery, short-term policies should focus on supporting domestic demand, and adjust to the economic spillovers from the unfolding regional events. An overall neutral fiscal policy stance following last year’s fiscal contraction would support the economic recovery, while Dubai should consolidate. To ensure efficiency of spending, the government should undertake cost-benefit analyses and implement the projects that have high economic return. While the central bank will maintain its accommodative monetary policy stance, it should also stand ready to provide liquidity to the market in case the re-pricing of risk in the region triggers a reversal of the recent deposit inflows to the banking sector.

The authorities’ response to the unfolding events in the region is appropriate. Improved infrastructure in the northern emirates will help raise the standards of living in these areas. Staff also advises the authorities to consider replacing the subsidies on water and electricity with explicit cash transfers to lower-income households. The authorities’ active labor market policies will help create jobs for nationals, and should be complemented by strengthening the skills mix. Given the concentration of unemployment in the northern Emirates, the government could also consider locating some of its agencies/entities in the North to create further employment opportunities for nationals in these areas.

The exchange rate is broadly aligned with fundamentals, and the dollar peg continues to serve as an effective nominal anchor for the economy.

Mitigating GRE risks should remain a policy priority. In the short term, the authorities should complete the restructuring of GRE debt, ensure the viability of these entities through writing-off impaired assets, and communicate their strategy on GRE debt refinancing. Going forward, limiting overall GRE borrowing by emirate, developing a GRE risk management framework, and reporting contingent liabilities arising from GREs in the fiscal accounts will help reduce GRE risks. GRE governance also needs to be improved, including by clarifying ownership, government support strategy, and delineating commercial and noncommercial operations carried by the GREs. Finally, better information disclosure about GRE financial accounts would improve investor confidence and ultimately translate into lower funding costs.

The CBU should continue to prepare the banking system for further possible deterioration in asset quality and future risks. The central bank has taken a number of steps that would help improve the resilience of the banking sector to future shocks. Given the likelihood of further increase in NPLs, the central bank should continue to ensure that banks provision adequately, while monitoring the performance of restructured loans. Higher capital charges on risky GREs, and continued retained earnings by banks would also limit the potential financial risks posed by the GREs.

The recent boom-bust underscores the need for strong demand management over the cycle. Under a pegged exchange rate regime, this requires mutually-supportive countercyclical fiscal and macroprudential policies, and the federal structure of the U.A.E. makes a close coordination between various governments imperative. Staff is encouraged by the authorities’ decision to deepen further the intergovernmental cooperation, including the CBU.

Developing the domestic capital markets will reduce U.A.E.’s dependency on external markets. In this context, given the limited scope for federal securities in the short term, the authorities should explore stable funding from non-traditional sources, such as term deposits from government sources.

The progress made by the NBS in establishing macroeconomic statistics and the ministry of finance in preparing consolidated fiscal accounts is an important step towards developing statistical capacity. However, further efforts are needed for the timely compilation and dissemination of key statistics, including on national accounts, balance of payments, and fiscal accounts. This will also require harmonization of methodologies across emirates. Staff encourages the authorities to move ahead with further developing the capacity to produce leading indicators and to collect and disseminate data on U.A.E.’s International Investment Position.