UAE: Investments to drive growth and diversification (page 2 of 2)

Central bank measures include tackling the massive oversubscriptions for IPOs; the authorities are looking to move towards a more conventional method of pricing, with investment banks acting as book runners. Generally IPO valuations have been low, partly to encourage national investors to participate in the stock market.

However, the IMF has indicated that inflation is a major area of concern given the limited monetary tool available to the central bank. Companies as well as expatriates have expressed their concern over the rising cost of doing business in the country. A number of smaller companies have indicated that they are looking to move to cheaper regional countries due to the rising costs. Increasing rents continue to be the main factor behind this. Inflationary pressures are also increasing with the weakening of the US dollar. The IMF forecasts an inflation rate of 8.0% in 2005, although it noted that the CPI does not reflect true price increases as the basket of goods and services does not weight the housing costs and rents realistically.

We believe that greater foreign exchange flexibility, such as monitoring the dirham against a trade weighted basket would have a number of advantages, including greater monetary policy flexibility. Given high inflation levels, real interest rates have been negative. In order to dampen inflation, Dubai has capped annual rent increases to 15%. While, there is anecdotal evidence that a number of landlords are not adhering to this limit, this cap will result a lower inflation level in 2006. Residential rents in Dubai increased by an average of 17.1% in Q1 compared with 30.1% over the same period in the previous year. Furthermore, the rise in cost is transitory as rents are forecast to come down by the end of the year, with greater housing supply coming onto the market.

Despite the recent sharp increase in the cost of doing business, it is important to note that the UAE still remains the top destination for FDI in the region, with many companies basing their regional headquarters in the UAE given the investment-friendly environment. FDI inflow into the UAE was over USD 19.0bn in 2005, equivalent to 14.2% of GDP. Investment inflows are forecast
to remain at similar levels in 2006.

Moreover, the government will continue to promote reforming the business environment, which will further help to further attract FDI in to the UAE. The government has pledged to take prompt action to address a number of issues raised by the WTO during a round of trade policy review discussions held at the end of April. The Ministerial Legislative Committee has approved a federal draft law amending some provisions of the Commercial Companies Law. The draft law will be submitted for approval at the Cabinet's next meeting. Currently, the Commercial Companies Law restricts foreign ownership to 49%. Moreover, the agencies law had recently been amended to outlaw exclusive agency. With the continuation of strong FDI and the diversification of the economy, the UAE outlook will remain positive going forward.