UAE: Investments to drive growth and diversification (page 1 of 2)

The strong oil price and higher investment levels are continuing to drive growth. According to IMF data, nominal GDP growth increased by 28.4% in 2005, to USD 133.8bn; this is similar to the Abu Dhabi Chamber of Commerce's estimate of 2005 GDP USD 135bn. Real GDP growth stood at 12.0%. The figures highlight that the economic performance was exceptionally strong last year. The IMF also indicated that the UAE's federal budget posted a surplus equivalent of 24.9% of GDP; the surplus is forecast to surge to 28.4% of GDP in 2006.

Recently, the IMF increased its real GDP growth forecast for 2006 to 10.5% in 2006, up from 7%. This will be partly driven by 11% growth in the oil sector, due to the completion of several significant oil production facilities and higher oil prices. Furthermore, government's diversification plans will continue to promote strong growth going forward. Dubai will continue to focus on expanding the tourism, media, commercial and service sectors. Abu Dhabi is also increasingly looking to diversify into the service sectors. In May, Abu Dhabi announced plans to invest more than USD 100bn over the next 4 to 5 years. Areas will include tourism, a new airport to handle up to 20m passengers and a new world scale port. In addition, Abu Dhabi plans to build on its comparative advantage and is also planning to make major investments in its energy and industrial sectors. This will include expanding crude oil production to 3.5m bpd from the current 2.5m bpd, and building of refineries, gas processing plants and petrochemical complexes. Gross fixed capital formation will be the main positive contributor to real GDP growth.

Although there have been large corrections in the local stock markets, these losses will not lead to wider contagion in the economy. At the time of writing, the Abu Dhabi Stock Market has fallen by 31.5% year to date, while the Dubai Financial Market has dropped by 54.5%. These are two of the worst performing stock markets globally. Nevertheless, investment and private consumption remain buoyant. Strong oil prices and negative real interest rates will sustain the strong growth momentum. In addition, business sentiment remains high.

Furthermore, the impact of the stock market correction on private consumption and investment will be partly mitigated by the higher government spending, which will keep domestic demand high. The Federal budget for 2006 has been approved and although it only counts for around 25-30% of total expenditure (with the majority of spending taking place on the individual emirate level) it is a proxy indication of the scale of spending increases. The 2006 federal budget sees government expenditure increasing markedly by 20%. This will be partly due to the absorption of the sharp increase in wages and salaries in mid-2005. The wage increases helped to offset the increase in the CPI for locals as well as spreading the oil wealth; many nationals work in the public sector.

With regards to the banking sector, banks remain highly capitalised and the fundamentals remain strong. Although the fall in the stock markets is likely to affect profitability for some banks in Q2 (especially those with strong brokerage businesses), overall the sector will remain healthy. Importantly the Central Bank is looking to introduce measures to improve the UAE's securities rules. Meanwhile, the Emirates Securities and Commodities Authority is keen to enforce the regulations, having penalised 74 companies or their representatives for alleged 'irregularities'.