Public Information Notice No. 04/66

Public Information Notice: IMF Concludes 2004 Article IV Consultation with the United Arab Emirates

June 29, 2004

On May 28, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the United Arab Emirates.¹

Background

The pursuit of a highly liberal, business friendly and market-oriented growth strategy continues to guide the evolution of U.A.E.'s economic development. Consistent with this strategy, each emirate and the federal government conduct economic policies that reflect differences in their natural resource endowments and their respective role within the federation. Openness and a sound record in macroeconomic management have enhanced the role of the private sector and contributed to the diversification of the economy.

In 2003, reflecting favorable developments in the oil market, higher oil production and prices, the U.A.E.'s macroeconomic performance is estimated to have been strong. Non-hydrocarbon real GDP growth is estimated to have remained robust at about 5 percent, one of the highest in the Gulf Cooperation Council area. A number of projects were launched in 2003 in the areas of construction, upstream gas, and downstream oil services. Inflation remained stable at 2.8 percent. Both the external current account and consolidated fiscal balances are estimated to have recorded large surpluses, 8.5 percent and 13.7 percent of GDP, respectively. The non-hydrocarbon deficit (excluding investment income) remained constant as a fraction of non-hydrocarbon GDP, at about 37 percent. The stock market index, which has been rising since 2001, increased sharply in 2003, by about 32 percent, on account of strong economic conditions and optimism regarding the economic outlook. Foreign reserves of the central bank at end-2003 remained steady at about US$15.0 billion, equivalent to about 4.0 months of imports. The broad money stock increased by 16 percent, close to the rates of the previous two years, mainly on account of about 13.5 percent increase in private sector credit. Much of this credit was granted to wholesale trade, construction, and personnel loan sectors.

The financial sector continued to perform well. The U.A.E. banks remained well capitalized and profitable. While the gross nonperforming loan (NPL) ratio at end-2003 remained relatively high at 14 percent, though lower than 2001 and 2002, provisions are considerable, bringing the net NPL ratio below 2 percent. The U.A.E. authorities have undertaken a number of initiatives to improve financial sector supervision and efficiency. Several important steps have been taken to address money laundering and financing of terrorist activities. As a result, U.A.E. is being regarded as a best practice model in this area. Tighter regulations now apply across the entire financial sector. Many Hawala (informal money transfers) dealers have registered and been certified by the U.A.E. central bank and are required to report on a quarterly basis their transactions records on transactions exceeding AED 2,000. As of end-February 2004, the central bank has received 112 applications for registration and 89 certificates have been issued. Considerable progress was made in 2003 in implementing plans to set up the Dubai International Financial Center (DIFC)—a financial free zone—an initiative of the Government of Dubai, which will deliver a comprehensive set of international financial functions.

Progress in introducing structural reforms has varied among the emirates. Dubai has extended foreign ownership of land and properties to some real estate developments and has also announced the launch of several new free zones. Abu Dhabi is moving ahead with utility privatization, with the objective to privatize its entire water and electricity sector by 2006. Restrictions on foreign ownership of companies and properties, however, remain in place in Abu Dhabi. The federal government has been implementing a series of reforms that include a phased implementation of performance-based budgeting within a newly-introduced three-year medium-term budget framework and corporatization of various supporting services.

In the area of labor policies, to create employment opportunities for U.A.E. nationals in the private sector the authorities have developed at the emirates' level programs to encourage domestic entrepreneurship and small and medium enterprises (SMEs). Key benefits of these programs are simple and streamlined application process, competitive interest rates, and favorable repayment terms. Also, a National Human Resource Development and Employment Authority was created to train nationals to ensure that they have adequate skills to be hired by the private sector.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They commended the United Arab Emirates for pursuing prudent macroeconomic policies, the prudent management of oil resources, and an outward-oriented development strategy, which have resulted in low inflation and high growth, as well as sizable fiscal and external current account surpluses, a comfortable international reserve position, and the accumulation of foreign assets. Further, they noted that sound policies supported by structural reforms have enhanced the role of the private sector, contributed to growth of the nonhydrocarbon sector and diversification of the economy, and enhanced the economy's resilience to external shocks. Directors agreed that the U.A.E. is in a strong position to take advantage of the global recovery and that the macroeconomic outlook over the medium term remains strong.

To sustain these encouraging developments, Directors saw scope for further strengthening fiscal policy and the financial sector, and further strengthening of the economic structure. They called on the authorities to improve the structure of the budget over the medium term. In particular, they noted the importance of reducing the deficit in the nonhydrocarbon portion of the budget to ensure a measure of intergenerational equity. In this context, they recommended constraining government employment and establishing a system of civil service remuneration based on productivity and performance. Some Directors, however, noted that achieving intergenerational equity could also be accomplished through the accumulation of productive capital and improvement in labor productivity. Directors also supported reducing budgetary subsidies, and in this regard welcomed the reduction in agricultural subsidies in the Emirate of Abu Dhabi and recommended phasing out subsidies on water and electricity and replacing them with targeted payments to nationals whose incomes fall below an established threshold.

On the revenue side, Directors were of the view that the revenue base needs to be strengthened to reduce its reliance on oil and gas revenues, and recommended introducing a value added tax in coordination with other members of the Gulf Cooperation Council, expanding the base of the corporate income tax, and considering the introduction of a local property tax.

While noting the efforts of some emirates and the federal government to improve the efficiency of public administration, Directors also stressed the importance of improving fiscal data and transparency, and the use of medium-term budget frameworks. They also encouraged the authorities to improve fiscal policy coordination among the emirates.

Directors endorsed the pegged exchange rate arrangement. They noted that this policy has provided an anchor for price stability, and contributed to low inflation and market confidence. Directors agreed with the thrust of the authorities' monetary policy and supported strengthening the central bank's instruments for controlling liquidity and encouraged the authorities to move from tap sales of certificates of deposit to an auction system, in order to allow the development of a repurchase market in certificates of deposit.

Directors noted the progress achieved in improving financial sector supervision. They also highlighted the need to address a number of issues in financial regulation. In particular, they supported the authorities' intention to complete the rationalization of responsibilities for securities regulation and develop a mechanism for adjusting liquidity that is compatible with Islamic financial principles. Directors also agreed that there is a need to assess fully the regulatory arrangements for the Dubai International Financial Center. They commended the authorities for putting in place a comprehensive and modern AML/CFT regime, and looked forward to the adoption of the draft law on the financing of terrorism. They also welcomed the creation of a mechanism to monitor informal funds transfers and urged its vigorous implementation.

Directors commended the U.A.E.'s open-border foreign labor policy, which has enabled the private sector to recruit expatriate workers at internationally competitive wages, contributed to economic growth, and improved competitiveness of the nonhydrocarbon economy. They endorsed the authorities' long-term labor market strategy to increase employment opportunities for U.A.E. nationals. Directors stressed that such a strategy should continue to rely on raising the skills of nationals through better education and training programs to meet private sector labor demand, while avoiding mandatory measures such as quotas. Directors further noted that labor market reforms should increase flexibility in hiring and firing, and move towards equalizing benefits in the private and public sectors.

Directors encouraged the authorities to set up a transparent investment regime, and to improve ownership rights for foreigners. In this regard, they endorsed the proposed amendment to the Commercial Company law and a law to improve the resolution of commercial disputes. They also encouraged the privatization of public utilities.

Directors commended the authorities for the provision of data on the government's foreign assets. They also welcomed the renewed efforts of the Interministerial Statistical Committee and the authorities' intention to participate in the GDDS. However, they noted that improvements in the U.A.E.'s economic statistics, with regard to data quality, coverage, periodicity, timeliness, and consistency, depend on increased coordination between the federal and emirates' authorities and the training of staff. They endorsed providing the Ministry of Planning with sufficient resources to carry out its new mandate to improve the statistical data base.

It is expected that the next Article IV consultation with the U.A.E. will take place on the standard 12-month cycle.