By Tadeus Dobrovolskij and Sophia Freynhofer
Grasping the economic environment of a country is important to businesses and organizations for several reasons, such as the timing and nature of decisions regarding investment and market expansion, or, conversely, divestment and downsizing. Here are three examples: delayed investment decisions during periods of overall economic expansion could mean a loss of market share that is difficult to redeem. Choosing the right kind of financing of strategic investments anticipating deflationary or inflationary tendencies may considerably reduce the real cost of funds. Recognizing structural economic changes early on can guide investment and provide an early mover advantage in expanding industries and segments.
With this economic and country analysis we aim to deepen the understanding of current conditions, underlying factors and choices that have created them, and future perspectives for the United Arab Emirates (UAE) Government, and, most importantly, for companies and organizations operating in or with – or planning to operate in or with – the UAE.
The UAE has developed from a juxtaposition of Bedouin tribes to one of the world’s most modern and wealthy States in only about 50 years. This is not only thanks to the country’s oil reserves, which are the world’s seventh largest, but also thanks to a capable leadership making continued circumspect investments and a wide-ranging economic liberalization strategy combined with strong Government control. The UAE works as a modern State, grounded in tribal loyalties and Islamic values. UAE rulers are supreme in their decision-making power, so that policies can be implemented swiftly and with little bureaucratic delay. The Government operates guided by strategic plans that aim at balanced and durable development and prosperity for the country’s citizens; it has been able to achieve evident progress towards most of its strategic goals.
Economic growth has been impressive and steady throughout the history of this young confederation of emirates with brief periods of recessions only, e.g. in the global financial and economic crisis years 2008-09, and a couple of more mixed years starting in 2015 and persisting until 2019. Between 2000 and 2018, average real Gross Domestic Product (GDP) growth was at close to 4%. The UAE leadership has driven forward economic diversification efforts already before the oil price crash in the 1980s, and the UAE is nowadays the most diversified economy in the Middle East and North Africa (MENA) region. Although the oil and gas sector does still play an important role in the UAE economy, these efforts have paid off in terms of great resilience during periods of oil price fluctuations and economic turbulence. Unless global economic disruptions and regional tensions escalate, we expect growth to pick up again in the UAE in 2020-21, supported by expansionary fiscal policy interventions and new investor friendly laws.
As impressive as economic growth has been population growth in the UAE: the total population has increased from just about 550,000 in 1975 to close to 10 million in 2018. This growth is mainly due to the influx of foreign workers into the country, making the national population a minority. We expect population growth to gradually slowdown in the coming years. This is, on the one hand, due to a shift towards a knowledge-based economy and lower demand for labor in lower productivity sectors such as construction (also due to an asset bubble that has built up over the last years). On the other hand, this is also due to the effect of the country’s Emiratization policy, which will bring more nationals, Emiratis, into the labor force and private sector employment in higher productivity sectors, reducing demand for highly skilled foreign labor.
The UAE features a unique labor market system, in which residence in the UAE is conditional on stringent visa rules. This system is a major advantage in terms of macroeconomic stability, as labor supply adjusts quickly to demand throughout economic business cycles. This allows the Government to keep unemployment in the country on a very low level of less than 3%, and it also gives the Government more leeway in terms of macroeconomic policies – where other governments often need to make trade-offs between fighting unemployment and fighting inflation.
Inflation has been picking up in 2017 and 18. Contributing factors were the introduction of a value added tax (VAT) of 5% in 2018 as well as higher commodity prices. Despite the Government’s expansionary fiscal policy and a growing economy in 2018 and at the beginning of 2019, prices have been dropping in late 2018 and 2019 owing to oversupply in some sectors of importance to consumer prices. We expect inflation in 2019 to remain below 1%, but to pick up again in 2020, as the Government will stay on its current course and growth will pick up.
The introduction of the VAT has provided the Government with an additional source of income – approximately 6% of the total revenue in 2018, or 27 billion United Arab Emirates Dirham (AED) – affording its fiscal policy more independence from oil and gas-related revenue, which constitutes about 36% of the total Government revenue. While the Government may still adjust the exact arrangement of the VAT, we do not expect any new taxes in the foreseeable future. Additional taxes would destroy one of the UAE’s main enticements for businesses to operate in the country and put a heavy burden on the economy.
The UAE’s monetary policy is in the service of stability and predictability, as the Central Bank of the UAE (CBUAE) keeps a peg to the US Dollar (USD) and moves interest rates close to the Federal Funds Rate. This policy makes sense in the current situation of global and regional economic and geopolitical uncertainty. Also considering the fact that exports have become the main driver of the UAE’s economic growth (the contribution of international trade to GDP grew from 31% in 2017 to 33.5% in 2018, outpacing overall GDP growth for the period), and the fact that the AED is currently undervalued, a departure from this policy – and particularly the peg – would negatively affect this important part of the UAE economy in the short term.
In the mid- to long term, however, we expect the UAE leadership to give up the peg. The peg will become less important, as the UAE transitions to a knowledge-based economy – and becomes yet more independent from the oil and gas sector (oil is currently still being traded not in AED, but in USD). On the contrary, it will become more and more important for the Government to have monetary policy at its free disposal to target inflation, shun too heavy reliance on taxes, and avoid situations where decisions on exchange rates and interest rates contradict fiscal policy measures – as has been the case in recent years, where monetary policy has limited fiscal policy effects on economic expansion. We expect that the UAE will take such a step-in coordination with other Gulf Cooperation Council (GCC) countries, in order to prevent a negative impact on exports.
Slower economic growth between 2015 and 2019 can be attributed to several factors affecting both demand and supply. The share of trade with Qatar is not big enough for the blockade to have had a significant impact in that context. Nevertheless, removing the blockade would lead to an expected output growth of 0.7% of GDP.
Within the UAE, prosperity is highly unequally distributed along geographic, national and gender factors, as well as skills levels. Nevertheless, inequalities do not show in the form of any remarkable social tensions, which is thanks to – among other factors – the leadership’s strong legitimacy, and cultural norms that tend to accept inequality. On the contrary, the UAE population ranks among the happiest globally. We do not expect this environment to change in any significant way, also because population growth should slow down a bit, reducing social pressure. It is important for businesses to consider such social and cultural factors, in order to successfully hire and manage people.
Proactive and farsighted leadership makes a difference in terms of laying the foundations for a country’s long- term development. The UAE offers businesses a strong enabling environment: stable political and macroeconomic conditions, a future-oriented Government, good general infrastructure and ICT infrastructure. Moreover, the country has made continuous and convincing improvements to its regulatory environment and is generally a top country for doing business.
The weaker points remain the level of education across the UAE population, limitations in the financial and labor markets, barriers to trade and some regulations that hinder business dynamism. The major challenge for the country, though, remains translating investments and strong enabling conditions into knowledge, innovation and creative outputs. To do so, the UAE Government should continue removing obstacles to collaboration and trade, continue its strong and proactive course on educational and innovation policy and pursue further reforms in the labor market so that all available talent, including women, flows where it can add most value. As for businesses, they need to reckon with some constraints to getting highly qualified employees for the time being, which can make “importing” such employees necessary.
Considering their position in a natural-resources dependent region, characterized by perennial political and societal divides, the UAE finds itself in an intricate global, regional and local risk landscape. Major risks include the deteriorating international economic environment, with potential impacts on trade, and climate-inaction as well as climate-action. Additional challenges include a younger population, the expanding role of women, and the large expatriate population. The UAE has been taking credible steps internationally, regionally and nationally to enhance resilience, economy and governance and has shown a capacity to evolve in order to meet present and future demands. We give the country good chances that it will be able to continue its current path of success.
Where the Government’s effectiveness has been more mixed is in the area of environmental and climate- related policies. Nevertheless, sustainability is a priority for the UAE Government, backed by substantive funding and a number of initiatives, giving business a particular opening here to come in with environmental technologies and solutions.