## ENHANCING MEDIUM-TERM FISCAL POLICY FRAMEWORK: KEY IMPERATIVE FOR THE UAE

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### A. Introduction and Rationale
- UAE structure and fiscal decentralization
  - The UAE is a federation of seven emirates; each emirate maintains autonomy over its oil resources, fiscal policy, and debt issuance.
  - Emirates government spending accounts for 88.5 percent of total government spending.
  - No emirate has an obligation to contribute to the budget of any other emirate.
  - In terms of the share of sub-national government spending, the extent of fiscal decentralization in the UAE is the highest in the world.
- Federal funding and revenue composition
  - The federal government is partially funded by transfers from Abu Dhabi and Dubai.
  - The federal government’s own resources, based on fees and other revenue (including royalties and dividends from Etisalat, a public company) amount to about 75 percent of its total revenue.
- Progress and reforms to date
  - Federal government introduced a medium-term budget cycle (five-year budgeting cycle for 2017–21).
  - Abu Dhabi produces an internal medium-term fiscal outlook based on realistic oil price assumptions.
  - Dubai has a medium-term fiscal framework with three-year budget targets (targets are not published).
- Rationale for strengthening MTFFs
  - The UAE is adjusting to the new “lower-for-longer” oil environment.
  - Consolidated MTFF could set a clear direction for fiscal policy for the country as a whole and better align resource allocation with Vision 2021 and emirates’ development plans.
  - High quality of public financial management systems is a key ingredient of an appropriate MTFF.
  - Monitoring of contingent liabilities needs to be strengthened, including PPPs and GREs including their global subsidiaries.
  - Data-sharing across all levels of governments, including the central bank, could be strengthened.

### B. Current MTFFs in the UAE
- Federal government MTFF
  - Adopted a five-year budgeting cycle for 2017–21.
  - MTFF is anchored by the goal of achieving a balanced budget on a consistent basis.
  - Expenditure caps set top-down and presented on a sectoral basis with associated performance indicators.
  - All federal ministries and agencies prepare budgets using the zero-based budget principle.
  - Detailed annual budgets and quarterly execution are regularly published on the UAE Ministry of Finance website.
  - A draft federal law enabling the federal government to issue debt is under preparation.
- Abu Dhabi MTFF
  - Develops annual budget in line with ceilings derived from an internal five-year fiscal framework.
  - Department of Finance prepares an MTFF where growth projections are derived from an underlying macroeconomic model that captures fiscal feedback effects on growth.
  - MTFF uses a medium-term balanced budget target as an anchor, guided by a Permanent Income Hypothesis (PIH) framework.
  - MTFF includes revenue forecasts and an expenditure path that guide indicative aggregate expenditure ceilings; approved by Abu Dhabi’s Executive Council.
  - The MTFF examines key fiscal risks and delineates transfers between GREs and SWFs.
  - A new law aiming at establishing a more unified legal framework for managing public financial resources was issued in 2017.
  - The annual budget and MTFF are not published.
- Dubai MTFF
  - Uses a three-year MTFF to guide the annual budget process.
  - Department of Finance prepares a “Budget Strategy Paper” with three-year projections for revenue, expenditure and debt, and discussion of fiscal space and fiscal risks.
  - The medium-term framework aims to maintain annual deficits under 3 percent and public debt under 30 percent of GDP (non-binding limits).
  - The annual budget is presented to Dubai’s Supreme Fiscal Committee and approved by the Ruler of Dubai.
  - Main expenditure and revenue items are usually published.
- Institutional capacity and coordination
  - Macro-fiscal units created in the Departments of Finance of Abu Dhabi and Dubai and at the UAE Ministry of Finance.
  - A fiscal policy coordination unit established at the UAE Ministry of Finance to enhance data sharing and policy coordination at the consolidated level.
  - Past fiscal data available following the Government Financial Statistics (GFS) presentation at consolidated general government level and separately for the federal government and combined subnational governments.

### C. Key Findings and Fiscal Metrics
- Recent fiscal outcomes and implications
  - Consolidated fiscal balances have turned from sizeable surpluses into deficits.
  - The medium-term fiscal balance falls 8 percentage points of GDP short of the level needed to ensure that an adequate portion of income from exhaustible oil resources is saved for future generations.
  - A sustained fiscal adjustment effort would be needed to ensure intergenerational equity; large fiscal buffers allow fiscal consolidation to proceed gradually.
  - Pace and composition of fiscal consolidation should be chosen to alleviate dampening effects on non-oil economic growth.
- Fiscal heterogeneity across emirates and implications
  - Emirates’ fiscal policy autonomy and differences in fiscal positions, debt levels and contingent liabilities require strong emirate-level MTFFs.
  - Abu Dhabi: more dependent on oil revenues and low debt — needs to consolidate to adjust to the lower-for-longer oil price environment.
  - Dubai: more diversified, higher debt (especially if GRE contingent liabilities included), faces increased investment needs in the runup to Expo 2020.
  - In 2015, Abu Dhabi generated about 77.5 percent of the UAE oil revenues.
- Selected consolidated and emirate fiscal statistics (2014–16)
  - Consolidated Government — Overall Fiscal Balance: 2014 = 1.9; 2015 = -3.4; 2016 = -4.3.
  - Consolidated Government — Debt: 2014 = 14.2; 2015 = 17.1; 2016 = 20.2.
  - Central Government — Overall Fiscal Balance: 2014 = -0.1; 2015 = -0.5; 2016 = -0.4.
  - Central Government — Debt: 2014 = 0.0; 2015 = 0.0; 2016 = 0.0.
  - Abu Dhabi Government — Overall Fiscal Balance: 2014 = 2.4; 2015 = -5.9; 2016 = -6.7.
  - Abu Dhabi Government — Debt: 2014 = 1.9; 2015 = 2.0; 2016 = 4.5.
  - Dubai Government — Overall Fiscal Balance: 2014 = 1.8; 2015 = 2.6; 2016 = 0.3.
  - Dubai Government — Debt: 2014 = 32.0; 2015 = 31.3; 2016 = 30.6.
- Fiscal risks and coordination needs
  - Increased importance of economic diversification with the decline in oil prices; aligning fiscal spending with the 2021 National Agenda and emirates’ agendas is crucial.
  - Need for enhanced coordination between governments and GREs on investment and borrowing plans, and between SWFs and the CBU to facilitate cash management and liquidity forecasting.
  - Fiscal vulnerabilities have risen with the decline in oil prices, requiring strengthened analysis of fiscal risks from a further decline in oil prices, higher financing costs, and unexpected increases in contingent liabilities from GREs and PPP investment.

### D. Strengthening and Consolidating MTFFs — Options and Policy Directions
- Objectives for a consolidated MTFF
  - A consolidated, comprehensive, and forward-looking MTFF at the country-wide level, integrated with emirates’ MTFFs, can help address fiscal risks and align fiscal policy with national objectives.
  - MTFF can:
    - (i) improve macroeconomic management by delinking expenditure from short-term volatile oil revenues;
    - (ii) anchor medium-term fiscal policy on intergenerational equity and/or fiscal sustainability;
    - (iii) integrate medium-term fiscal policy with the diversification agenda;
    - (iv) facilitate risk analysis and decision-making.
- Design elements and operational guidance
  - Translate long-term objectives for the use of volatile resource revenues into operational guidance for the annual budget through a clear linkage between near/medium- and long-term objectives and regular reassessment mechanisms.
  - MTFF could set non-oil growth objectives and identify targets for non-oil revenue and public expenditure to attain these goals.
  - MTFF could include discussion of expenditure needs associated with the National Strategy in critical areas such as education and health care (Annex I).
  - MTFF should discuss plans to diversify non-oil revenues while considering effects on competitiveness and inclusiveness.
  - Include alternative macro-fiscal scenarios presenting fiscal implications of different key macroeconomic assumptions, including price and production scenarios and contingent liabilities (including PPPs, Annex II).
  - Make budgets more comprehensive by clearly identifying transfers to and from GREs and SWFs to provide clarity on fiscal strategy.
  - Commit to transparency to allow informed understanding and external scrutiny, supporting resource allocation aligned with national objectives and attracting foreign investors.
  - Consider numerical fiscal rules based on fiscal anchors to discipline policies while providing flexibility to respond to shocks.
- Institutional and technical steps
  - Integrate existing fiscal frameworks and expand their coverage.
  - Strengthen intergovernmental coordination and fiscal transparency.
  - Strengthen monitoring of contingent liabilities, including coverage of PPPs and GREs and their global subsidiaries.
  - Strengthen data-sharing across all levels of government, including the central bank.
  - Use risk-based, comprehensive framework with fiscal indicators, targets, and rules adapted to UAE-specific circumstances to guide projections and policy.

### E. Building Blocks and Fiscal Rules — Emirate-Specific Guidance
- Elements included in an MTFF
  - Use realistic macroeconomic assumptions consistently across local and federal governments:
    - Include realistic oil prices, production, and nonoil economic growth targets.
    - Recognize higher volatility of economic variables in oil-exporting countries and the need for strong analytical capacity, good national accounts and international investment position statistics, reliable methodologies, and well-qualified staff.
  - Expenditure and revenue forecasting:
    - Developing forecasting capacity requires time, technical capacity building, staff, and examination of past forecasting errors.
    - Robust estimates need a sound understanding of how parameters drive annual expenditure and revenues and repeated comparisons between the budget and actual budget execution outturns.
    - Include different contingent scenarios to calibrate prudential contingency reserves.
  - Reliable statistics are crucial to enable good policy analysis, decision-making, and to enhance MTFF credibility.
- Disaggregated, coordinated MTFF appropriate for the UAE
  - Maintain a disaggregated MTFF approach given high fiscal decentralization and differences in resource dependence among emirates, while strengthening coordination among federal and emirate governments.
  - Fiscal anchors should reflect long-term fiscal objectives of each emirate; each emirate should design and calibrate fiscal rules to align policies with goals and targets.
  - Integrate UAE-wide economic goals (growth and diversification) with emirate goals via reinforced intergovernmental coordination mechanisms.
- Key analytical elements to consider at the UAE level for designing disaggregated fiscal rules:
  - nonoil growth objectives
  - consolidated government spending targets
  - fiscal breakeven price
  - allocations for priority spending
  - debt objectives and financing options
- Abu Dhabi: intergenerational equity and PIH-based rules
  - In Abu Dhabi, where government debt is low and precautionary buffers are large, long-term fiscal policy goals should center on intergenerational equity.
  - The permanent income framework (PIH) aims to ensure equal share of assets across generations and maintain constant real consumption each year.
  - The nonoil primary deficit is estimated to be 8 percentage points of GDP higher than its PIH-based benchmark at end-2016 (see Annex I of the accompanying Staff Report).
    - This suggests Abu Dhabi needs to gradually reduce government spending or raise nonoil revenue to achieve intergenerational equity, while maintaining priority spending.
  - Three alternative PIH-based rules simulated:
    1. PIH perpetuity — nonoil primary balance remains constant over time.
    2. Modified PIH — allows an increase in the nonoil primary balance to maintain public investment at a high level.
    3. Fiscal Sustainability Framework (FSF) — incorporates the impact of higher public investment on economic growth and nonoil revenues.
  - As the nonoil economy expands and the country becomes more independent from oil short-term vulnerabilities, a move toward structural balances is appropriate to choose the most suitable rule depending on investment needs and projected medium-term impact on nonoil growth.
- Dubai: debt ceiling and deficit rules
  - In diversified Dubai:
    - Public debt stands at about 30 percent of Dubai’s GDP (115 percent if GRE debt is included).
  - A debt ceiling operationalized by an overall deficit rule is appropriate; ensure consistency between a target debt ceiling and a deficit rule.
  - Staff simulations:
    - A binding deficit rule of 3 percent of GDP over ten years implies a rising debt trajectory with government debt reaching 45 percent of GDP in ten years.
    - To maintain a stable debt trajectory at 30 percent of GDP (Dubai government’s indicative target), an overall deficit of 1 percent of GDP at most could be sustained.

### F. Information-Sharing, Cash Management, and Fiscal Coordination
- Information-sharing, cash management, and transfers
  - Strengthen information-sharing and establish rules for transfers among public entities (governments, GREs, SWFs) to facilitate MTFF design.
  - Improve cash management:
    - Expand coverage of Treasury Single Accounts (TSA).
    - Improve liquidity forecasting for entities outside TSAs.
    - Enhance information-sharing on cash management among fiscal and monetary authorities, GREs, and SWFs to improve predictability of financing flows, calibrate SWF liquidity buffers, and aid liquidity forecasting by the central bank (CBU).
  - Share information on budget preparation and MTFF at the country level to clarify contributions of different institutions to national goals.
- Fiscal coordination mechanisms and expenditure benchmarks
  - Enhance fiscal policy coordination mechanisms, including intergovernmental committees, to better align fiscal responsibilities with country goals.
    - Choice of mechanism depends on constitutional and institutional feasibility; cooperative approaches are most appropriate given high autonomy of Emirates governments.
    - Role of capital markets and rating agencies in enforcing fiscal discipline is important.
  - Consider establishing national expenditure benchmarks to ensure local budgets align with national objectives:
    - The EU example: an expenditure rule caps annual growth of primary expenditure at long-term nominal GDP growth and includes a correction for revenue measures so spending growth does not exceed medium-term economic growth unless matched by discretionary revenue measures.
- Monitoring contingent liabilities and managing PPPs
  - Strengthen monitoring and control of contingent liabilities, including PPPs, to prevent undue buildup of risks.
  - Review and vet GRE investment plans to balance GRE flexibility with consistency with fiscal and development goals.
  - PPPs can mobilize financing and support infrastructure provision but must realize efficiency gains while mitigating fiscal risks.
  - Dubai’s PPP law establishes a framework to reduce fiscal risks; supporting regulations should further strengthen PPP legal frameworks in Dubai and other governments should align PPP legal frameworks with best international practices.

### G. Integrating Annual and Medium-Term Budget Management; Transparency
- Integration and operational linkage
  - An official medium-term fiscal strategy should serve as the basis for annual budget preparation and can be based on a top-down resource envelope (macroeconomic model estimating revenues, expenditure, nonoil balances, and a fiscal anchor).
  - Fiscal risks analysis should calculate sensitivity of fiscal plans to macroeconomic and oil sector assumptions.
  - Match a top-down resource envelope with bottom-up cost estimates of existing policies; integrate sector policy scrutiny with the resource envelope and annual budget process.
  - Turn the medium-term budget framework into a performance-based expenditure framework to link funding to results and shift focus from inputs to outcomes.
  - Enhance timeliness and frequency of fiscal reporting on within-year budget outturns to improve monitoring and forecasting.
- Transparency, data, and institutional capacity
  - Improve fiscal data and transparency across all government levels:
    - Enhance availability, quality, and timeliness of consolidated and Emirates government data.
    - Generalize accrual accounting.
    - Strengthen capacity of macro-fiscal units at all government levels.
    - Improve national accounts and IIP statistics.
    - Increase transparency on annual budgets’ approval, implementation, and medium-term forecasts to strengthen monitoring and credibility.
  - Foster fiscal coordination across government levels:
    - Consider a common and consistent macroeconomic framework across emirates coordinated by the federal government with input from Emirates governments.
    - Share fiscal frameworks and produce one national document with a coherent fiscal strategy considering regional asymmetries.
    - Improve information-sharing and establish explicit rules for transfers among SWFs, GREs, and local and federal governments to facilitate cash management and liquidity forecasting.
    - Strengthen intergovernmental coordination mechanisms to integrate local and national objectives.
  - Enhance the role of institutions:
    - Fiscal responsibility laws and independent intergovernmental fiscal agencies may complement fiscal rules.
    - Enhance public financial management systems and ensure credible political commitment to annual and medium-term fiscal targets to support sound fiscal policies at local, federal, and consolidated levels.

### H. Annex I — Education and Healthcare: Key Findings and Policy Priorities
- Education — key findings
  - Public education spending is estimated at 1.6 percent of GDP per year.
  - In the UAE, 80 percent of primary and secondary students are enrolled in private institutions compared to 31 percent in the OECD.
  - In the UAE, the school-age population is 17 percent of the working age population compared to 29 percent in the OECD.
  - Expenditure per student:
    - UAE: $22,055
    - OECD average: $9,052
  - Inputs and resource indicators (table values)
    - Public education in percent of GDP: UAE 1.6; OECD average 4.5.
    - Percent of students in private education: UAE 69; OECD average 16.
    - School-age population to population 20-64: UAE 17; OECD average 29.
    - Students per teaching staff and PISA scores: UAE PISA scores are at the bottom of those in the OECD economies; in all subjects over 40 percent of students are at or below level 2.
- Education — policy recommendations and priorities
  - Increase the efficiency of education spending through new quality standards for teachers and schools, curriculum development, a common framework for school evaluation, and promotion of STEM and innovation.
  - Consider granting greater autonomy to schools as performance monitoring is enhanced.
  - Address fragmentation by provider type and curriculum; monitor disparities (e.g., performance differences across curricula and across emirates).
  - Strengthen monitoring via a national exam (piloted in 2017 and planned to be adopted in 2018).
- Healthcare — key findings
  - Public healthcare expenditure in general government increased by over 0.5 pp of GDP in 2011-16, largely reflecting Abu Dhabi efforts to improve healthcare infrastructure.
  - World Health Organization estimate: public health expenditure at 2.6 percent of GDP in the UAE.
  - Total health expenditure per capita:
    - UAE: nearly $1,500 per year (table: $1,478)
    - OECD average: $3,800 (about $2,200 adjusted for demographics)
  - Health system inputs and indicators (table values)
    - Share of population age 0-4: UAE 5.4; OECD 6.8.
    - Share of population age 60 and older: UAE 2.3; OECD 22.1.
    - Adjusted public health spending (percent of GDP): UAE 2.6; OECD 3.9.
    - Total health expenditure per capita ($): UAE 1,478; OECD 3,779.
    - Doctors (per 100,000 population): UAE 253; OECD 329.
    - Nurses (per 100,000 population): UAE 316; OECD 841.
    - Healthy life expectancy (years): UAE 68.3; OECD 71.6.
    - Infant mortality (per 100,000 births): UAE 5.9; OECD 4.8.
- Healthcare — fiscal pressures and reform recommendations
  - To approach OECD levels in health inputs would cost as much as 1.3 pp of GDP over the next few years; a gradual approach is warranted and healthcare expenditure should be protected during fiscal consolidation.
  - Move toward greater integration across healthcare models and consider a national insurance market over time.
  - Separate regulatory and service provision arms of the Ministry of Health.
  - Enhance regulation, price transparency, bundled payments, health information technology, and move public providers toward performance-linked allocations.
  - Exercise care with PPPs; Ministries of Finance and Health should develop an inventory of existing PPPs to identify commitments and government exposure.

### I. Macro-Financial Context, Banking System, and Liquidity Management
- Macro-financial context and key message
  - Oil prices have stabilized at around half of their 2014 peak and are expected to stay broadly stable at this level over the medium term.
  - With lower oil revenues:
    - current account surpluses have declined, and fiscal surpluses have turned into deficits;
    - the public sector’s propensity to accumulate deposits in the banking system has weakened.
  - Normalization of U.S. interest rates and recent banking regulatory changes in the UAE are creating new challenges for banks’ management of liquidity.
  - Ensuring healthy liquidity conditions and promoting financial market development is important for supporting robust credit and economic growth and diversification goals.
- Overview of the UAE banking system and financial markets
  - Banking system size and concentration:
    - total assets amounting to AED 2.6 trillion or 204 percent of GDP at end-March 2017.
    - the largest three banks hold over 50 percent of total assets of the banking system.
  - Financial soundness indicators (end-March 2017 unless otherwise stated)
    - Regulatory Capital to Risk-Weighted Assets: 18.6 (2017q1 series).
    - Regulatory Tier 1 Capital to Risk-Weighted Assets: 17.3, 17.2, 16.6 (series for prior years).
    - Non-performing Loans to Total Gross Loans: 5.3 percent.
    - Return on Equity: 11.7 percent at end-March 2017.
    - Non-interest Expenses to Gross Income (cost-to-income): below 38 percent.
    - Liquid Assets to Total Assets (Liquid Asset Ratio): 21.2–22.9.
    - Liquid Assets to Short Term Liabilities: 27.7–30.3.
  - Islamic banking:
    - Islamic banks had assets of AED 522 billion or 20 percent of total bank assets at end-March 2017.
  - Credit allocation and market development:
    - private credit-to-non-oil GDP ratio reached beyond 100 percent at end-2016.
    - outstanding loans to governments and GREs accounted for 23 percent of total loans at end-March 2017.
    - stock market capitalization (June 2017): Abu Dhabi Securities Exchange $120 billion (32 percent of projected 2017 GDP), Dubai Financial Market $84 billion (22 percent of projected 2017 GDP).
    - domestic government debt market does not exist; during 2001–15, $53.8 billion or 36 percent of all global sukuk issuances originated in the UAE.
  - Money and FX markets:
    - 36 percent of deposits and 23 percent of loans are in foreign currencies.
    - interbank liquidity is thin, traded only between a few banks with maturities up to one month.
- The CBU’s liquidity management framework (structure and instruments)
  - Liquidity drivers:
    - liquidity in the UAE’s banking system is driven by oil prices via governments’ and GREs’ deposits (about a quarter of total bank deposits).
    - in the absence of domestic debt markets, banks held liquidity at the CBU in remunerated CDs, required and excess reserves, and/or foreign assets.
  - Reserve requirements:
    - required reserves ratio: 14 percent on current, savings, and demand accounts; 1 percent on time deposits (maturity from 7 days onward).
    - ratios are the same for dirham and foreign currency deposits.
    - reserve requirements calculated using a bank’s balance sheet as of the fifteenth day of each month, with a time lag of 6 weeks between that day and the reserve maintenance period.
    - deviation from required daily reserves subject to a fee ranging from 150 to 300 basis points over the CBU repo rate.
  - Certificates of Deposit (CDs):
    - issued daily at a fixed rate on full allotment basis.
    - available maturities: one week, 1 month, 2 months, 3 months, 6 months, 9 months, and 12 months (most popular: 1 week, 1 month, 12 months).
    - the one-week CD rate is the policy rate adjusted following changes in the U.S. Federal Funds rate under the peg arrangement.
    - both Islamic and conventional CDs are available; the CBU also issues U.S. dollar-denominated CDs.
    - CDs are non-transferrable, redeemable upon banks’ request, and issued as accounting records at the CBU (CBU is the only counterparty to banks for CD trading).
  - Role of reserve requirements and CDs:
    - together they absorbed a structural liquidity surplus; constituted 77 percent of banks’ assets held with the CBU at end-2016.
    - remainder held primarily in banks’ excess reserves and current accounts.
  - CBU standing facilities (introduced in/after 2008 crisis; many remain unused except for test transactions):
    - Repo (liquidity up to three months against CDs): cost CDs 50 basis points over the one-week CD rate.
    - Interim Marginal Lending Facility (IMLF) — overnight liquidity against generally rated and tradeable securities: 100 basis points over the repo rate.
    - Borrowing Against Reserves Facility (BAR) — emergency liquidity support against reserve requirements: 300 basis points over the repo rate.
    - Foreign Exchange Swaps — U.S. dollar to dirham swaps up to one year: FX Currency Fixed implied swap rates.
  - Redemption option:
    - banks can redeem their CD holdings at any time at market price; introduced in 2008 and remains. This eases liquidity management for banks but creates potential moral hazard by discouraging active bank liquidity management.

### J. New Challenges and Need for Market Development
- New challenges from the lower-for-longer oil price environment and regulatory changes
  - Government and GRE deposit volatility:
    - oil revenues declined and became more uncertain; in 2015 government mobilized deposits to fund expenses, tightening banking system liquidity; in 2016 government increased deposits but GRE deposits decreased.
    - banks must account for new risks related to governments’ and GREs’ deposits when managing liquidity.
  - Interest rate environment:
    - expected increases in U.S. interest rates will increase the cost of funding for UAE banks as domestic deposit rates rise in tandem under the peg; cost of external funding will also rise.
  - Basel III liquidity requirements introduced by the CBU:
    - Liquidity Coverage Ratio (LCR): already applied to the three largest banks at 80 percent with full phase-in by 2019.
    - Net Stable Funding Ratio (NSFR): planned with 100 percent phase-in by 2018.
    - Both ratios require a significant amount of high quality liquid assets (HQLA); currently the only major securities that qualify are the CBU’s CDs.
  - Need for financial market development:
    - development of capital markets and Islamic finance is important to allow companies, governments, and GREs to reduce reliance on bank financing.

### K. Benefits of Developing a Domestic Debt Market
- Identified benefits
  - Governments would have a domestic funding source to tap if needed, diversifying funding and reducing reliance on bank financing, external borrowing or withdrawals from SWFs.
  - The CBU would obtain an additional instrument for managing liquidity by conducting open market operations in the context of the peg.
  - Issuing domestic securities would make the supply of liquid assets less dependent on oil prices and the peg; increase the pool of domestic securities that qualify as HQLA for Basel III liquidity requirements.
  - Provide banks with collateral usable for interbank operations and borrowing from the CBU, including emergency liquidity provision.
  - Help create a yield curve at long-term tenors to provide a benchmark for bank lending.
  - Support development of a domestic corporate bond market and interbank repo market by providing a pricing benchmark, enabling firms to diversify funding, and potentially attracting foreign investors.

### L. Policy Recommendations and Operational Reforms (Liquidity and Markets)
- Upgrade the CBU’s liquidity management framework and develop domestic money and debt markets to encourage banks to manage liquidity more actively and to develop money markets.
- Streamline and possibly consolidate the CBU’s liquidity management instruments to:
  - encourage banks to manage their own liquidity better;
  - complement implementation of Basel III-compliant liquidity requirements.
- Start issuance of domestic government bonds to provide another liquid asset in addition to the CBU’s CDs, supporting CBU and bank liquidity management and facilitating pricing and integration of markets.
- Specific operational measures toward more active liquidity management:
  - Create a well-defined interest rate corridor:
    - unify standing facilities into one overnight lending rate to serve as a ceiling for the corridor.
    - introduce an overnight deposit rate (remunerated deposit facility) to serve as a floor for the policy rate corridor (currently bank balances with the CBU are not remunerated).
    - use the deposit and lending rates to help the CBU steer short-term interest rates under the peg.
  - Strengthen the CBU’s liquidity forecasting capacity.
  - Strengthen cooperation and information-sharing between the CBU, governments, and SWFs to ensure the CBU is well informed about expected cash management operations, both short-term and in the context of a medium-term fiscal framework.

### M. Reforming the CD Program, Liquidity Regulation, and Debt Issuance
- Reforming the CD program (paragraph 22)
  - "CDs could be offered at regularly scheduled auctions rather than as a daily tap facility."
  - "Such auctions could be held weekly with the results published to facilitate price discovery by market participants."
  - "The auctions would be calendarized with CD maturity profile to match maturing tranches."
  - "CDs should be traded at fixed volume variable rate auctions to provide a price signal to the CBU and banks."
  - "CDs would be issued as transferrable securities, which banks could trade with each other."
  - "Once CD auctions are well established, the early redemption feature could be removed from new CD issuances."
  - Expected effects: "This would incentivize banks to trade CDs with each other, fostering interbank market development, and to plan their liquidity needs better."
  - Operational note: "Proper sequencing of the CD program reforms would be important to avoid disruptions to the financial system."
- Liquidity regulation and bank incentives (paragraph 23)
  - Objective: "Ensuring that the application of liquidity regulations supports incentives for banks to actively manage liquidity and participate in liquidity markets."
  - Required actions:
    - "continued efforts to apply risk management standards to all banks,"
    - "develop additional guidance to complement the recently issued liquidity regulations and integrate the new liquidity ratios into regulatory reporting."
    - "The CBU could also make active use of the Pillar 2 of the Basel Accord to supervise and facilitate the development of liquidity risk management in banks."
- Initiating domestic government debt issuance (paragraphs 24–26)
  - Complementarity: "Starting issuance of domestic government debt could usefully complement the CBU’s steps towards more active liquidity management."
  - Legislative step: "A draft debt law is under consideration by the government and its speedy ratification could pave the way for a first domestic sovereign issuance."
  - Instrument mix and institutions:
    - "Governments could issue dirham-denominated debt at medium to long-term maturities."
    - "Over time, governments may consider creating debt management offices to oversee the issuance and monitoring of debt."
    - "Sukuk issuance could be usefully incorporated in the calendar of debt issuance, deepening Islamic markets."
  - Operational role of the CBU: "The CBU could take operational responsibility for government debt issuance, i.e., serve as the fiscal agent, to facilitate market creation."
  - Coordination and sequencing:
    - "Close coordination between fiscal and monetary authorities on cash flow management would be needed."
    - "As the domestic debt market takes off, the CBU’s CD issuance could be limited to short-term tenors only."
    - "Eventually, the development of a domestic debt market would enable the CBU to conduct open market operations and influence liquidity supply directly."
- Market infrastructure and broader financial-market development (paragraphs 27–28)
  - Central securities depository (CSD):
    - "A key element in this regard is creating a single central securities depository (CSD)."
    - Options: "a new body could be established or one of the existing CSDs on the UAE’s stock exchanges would need to be strengthened."
    - Practical consideration: "If an international CSD is to be used, its working hours should be aligned with the working week in the UAE."
    - Role: "Such CSD would facilitate trading of government bonds and CDs between banks and other market participants to ensure liquidity and reduce transaction costs."
  - Broader market-development measures:
    - "More active liquidity management by the CBU and banks, creation of the government debt market, as well as ongoing improvements in infrastructure and regulation of other markets, would facilitate financial market development in the UAE."
    - Elements of development:
      - "broadening the set of traded instruments (e.g., treasury bills and bonds, bills of exchange, promissory notes, etc.) and remittance facilities (e.g., through exchange houses),"
      - "ensuring that each market has healthy competition (borrowers, lenders and dealers, including from other countries),"
      - "fostering integration among different markets that allows funds to flow easily from one market to another, as well as integration of the interest rate structure."
    - Institutional actions noted:
      - "The Securities and Commodities Authority is taking steps to further improve the infrastructure of securities markets, while enhancing their supervision and corporate governance."
      - "The CBU is doing the same, in its role as the regulator and supervisor of exchange houses."
      - "In particular, it is taking steps to reduce the risk of withdrawal of correspondent banking relationships and prevent migration of remittances to informal channels (see the accompanying Staff Report)."

### N. Conclusion and Implementation Imperatives
- Assessment and urgency (paragraph 29)
  - "The CBU’s and governments’ plans regarding market development and liquidity management need to be accelerated."
  - The CBU’s current liquidity management framework has served the country well, but new challenges posed by the lower-for-longer oil prices and expected increases in U.S. interest rates call for moving towards more active management of liquidity.
- Expected benefits
  - Upgrading the CBU’s liquidity management framework, together with governments’ initiatives to develop domestic debt markets, would expand the range of liquid assets available to banks and the CBU, enabling them to manage liquidity better, consistent with the Basel III requirements.
  - More active liquidity management by banks would increase their resilience to unexpected shocks.
  - A more robust banking system would support healthy credit growth and contribute to further diversification of the UAE economy.

*Source: June 21, 2017, UNITED ARAB EMIRATES — INTERNATIONAL MONETARY FUND (cr17219)*

### References _______________________________________________________________________________ 20

### ENHANCING MEDIUM-TERM FISCAL POLICY FRAMEWORK: KEY IMPERATIVE FOR THE UAE

### A. Introduction
- UAE structure and fiscal decentralization
  - The UAE is a federation of seven emirates; each emirate maintains autonomy over its oil resources, fiscal policy, and debt issuance.
  - Emirates government spending accounts for 88.5 percent of total government spending.
  - No emirate has an obligation to contribute to the budget of any other emirate.
  - In terms of the share of sub-national government spending, the extent of fiscal decentralization in the UAE is the highest in the world.
- Federal funding and revenue composition
  - The federal government is partially funded by transfers from Abu Dhabi and Dubai.
  - The federal government’s own resources, based on fees and other revenue (including royalties and dividends from Etisalat, a public company) amount to about 75 percent of its total revenue.
- Progress and reforms to date
  - Federal government introduced a medium-term budget cycle (five-year budgeting cycle for 2017–21).
  - Abu Dhabi produces an internal medium-term fiscal outlook based on realistic oil price assumptions.
  - Dubai has a medium-term fiscal framework with three-year budget targets (targets are not published).
- Rationale for strengthening MTFFs
  - The UAE is adjusting to the new “lower-for-longer” oil environment.
  - Consolidated MTFF could set a clear direction for fiscal policy for the country as a whole and better align resource allocation with Vision 2021 and emirates’ development plans.
  - High quality of public financial management systems is a key ingredient of an appropriate MTFF.
  - Monitoring of contingent liabilities needs to be strengthened, including PPPs and GREs including their global subsidiaries.
  - Data-sharing across all levels of governments, including the central bank, could be strengthened.

### B. Current MTFFs in the UAE
- Federal government MTFF
  - Adopted a five-year budgeting cycle for 2017–21.
  - MTFF is anchored by the goal of achieving a balanced budget on a consistent basis.
  - Expenditure caps set top-down and presented on a sectoral basis with associated performance indicators.
  - All federal ministries and agencies prepare budgets using the zero-based budget principle.
  - Detailed annual budgets and quarterly execution are regularly published on the UAE Ministry of Finance website.
  - A draft federal law enabling the federal government to issue debt is under preparation.
- Abu Dhabi MTFF
  - Develops annual budget in line with ceilings derived from an internal five-year fiscal framework.
  - Department of Finance prepares an MTFF where growth projections are derived from an underlying macroeconomic model that captures fiscal feedback effects on growth.
  - MTFF uses a medium-term balanced budget target as an anchor, guided by a Permanent Income Hypothesis (PIH) framework.
  - MTFF includes revenue forecasts and an expenditure path that guide indicative aggregate expenditure ceilings; approved by Abu Dhabi’s Executive Council.
  - The MTFF examines key fiscal risks and delineates transfers between GREs and SWFs.
  - A new law aiming at establishing a more unified legal framework for managing public financial resources was issued in 2017.
  - The annual budget and MTFF are not published.
- Dubai MTFF
  - Uses a three-year MTFF to guide the annual budget process.
  - Department of Finance prepares a “Budget Strategy Paper” with three-year projections for revenue, expenditure and debt, and discussion of fiscal space and fiscal risks.
  - The medium-term framework aims to maintain annual deficits under 3 percent and public debt under 30 percent of GDP (non-binding limits).
  - The annual budget is presented to Dubai’s Supreme Fiscal Committee and approved by the Ruler of Dubai.
  - Main expenditure and revenue items are usually published.
- Institutional capacity and coordination
  - Macro-fiscal units created in the Departments of Finance of Abu Dhabi and Dubai and at the UAE Ministry of Finance.
  - A fiscal policy coordination unit established at the UAE Ministry of Finance to enhance data sharing and policy coordination at the consolidated level.
  - Past fiscal data available following the Government Financial Statistics (GFS) presentation at consolidated general government level and separately for the federal government and combined subnational governments.

### C. Key Findings and Fiscal Metrics
- Recent fiscal outcomes and implications
  - Consolidated fiscal balances have turned from sizeable surpluses into deficits.
  - The medium-term fiscal balance falls 8 percentage points of GDP short of the level needed to ensure that an adequate portion of income from exhaustible oil resources is saved for future generations.
  - A sustained fiscal adjustment effort would be needed to ensure intergenerational equity; large fiscal buffers allow fiscal consolidation to proceed gradually.
  - Pace and composition of fiscal consolidation should be chosen to alleviate dampening effects on non-oil economic growth.
- Fiscal heterogeneity across emirates and implications
  - Emirates’ fiscal policy autonomy and differences in fiscal positions, debt levels and contingent liabilities require strong emirate-level MTFFs.
  - Abu Dhabi: more dependent on oil revenues and low debt — needs to consolidate to adjust to the lower-for-longer oil price environment.
  - Dubai: more diversified, higher debt (especially if GRE contingent liabilities included), faces increased investment needs in the runup to Expo 2020.
  - In 2015, Abu Dhabi generated about 77.5 percent of the UAE oil revenues.
- Selected consolidated and emirate fiscal statistics (2014–16)
  - Consolidated Government — Overall Fiscal Balance: 2014 = 1.9; 2015 = -3.4; 2016 = -4.3.
  - Consolidated Government — Debt: 2014 = 14.2; 2015 = 17.1; 2016 = 20.2.
  - Central Government — Overall Fiscal Balance: 2014 = -0.1; 2015 = -0.5; 2016 = -0.4.
  - Central Government — Debt: 2014 = 0.0; 2015 = 0.0; 2016 = 0.0.
  - Abu Dhabi Government — Overall Fiscal Balance: 2014 = 2.4; 2015 = -5.9; 2016 = -6.7.
  - Abu Dhabi Government — Debt: 2014 = 1.9; 2015 = 2.0; 2016 = 4.5.
  - Dubai Government — Overall Fiscal Balance: 2014 = 1.8; 2015 = 2.6; 2016 = 0.3.
  - Dubai Government — Debt: 2014 = 32.0; 2015 = 31.3; 2016 = 30.6.
- Fiscal risks and coordination needs
  - Increased importance of economic diversification with the decline in oil prices; aligning fiscal spending with the 2021 National Agenda and emirates’ agendas is crucial.
  - Need for enhanced coordination between governments and GREs on investment and borrowing plans, and between SWFs and the CBU to facilitate cash management and liquidity forecasting.
  - Fiscal vulnerabilities have risen with the decline in oil prices, requiring strengthened analysis of fiscal risks from a further decline in oil prices, higher financing costs, and unexpected increases in contingent liabilities from GREs and PPP investment.

### D. Strengthening and Consolidating MTFFs — Options and Policy Directions
- Objectives for a consolidated MTFF
  - A consolidated, comprehensive, and forward-looking MTFF at the country-wide level, integrated with emirates’ MTFFs, can help address fiscal risks and align fiscal policy with national objectives.
  - MTFF can: (i) improve macroeconomic management by delinking expenditure from short-term volatile oil revenues; (ii) anchor medium-term fiscal policy on intergenerational equity and/or fiscal sustainability; (iii) integrate medium-term fiscal policy with the diversification agenda; (iv) facilitate risk analysis and decision-making.
- Design elements and operational guidance
  - Translate long-term objectives for the use of volatile resource revenues into operational guidance for the annual budget through a clear linkage between near/medium- and long-term objectives and regular reassessment mechanisms.
  - MTFF could set non-oil growth objectives and identify targets for non-oil revenue and public expenditure to attain these goals.
  - MTFF could include discussion of expenditure needs associated with the National Strategy in critical areas such as education and health care (Annex I).
  - MTFF should discuss plans to diversify non-oil revenues while considering effects on competitiveness and inclusiveness.
  - Include alternative macro-fiscal scenarios presenting fiscal implications of different key macroeconomic assumptions, including price and production scenarios and contingent liabilities (including PPPs, Annex II).
  - Make budgets more comprehensive by clearly identifying transfers to and from GREs and SWFs to provide clarity on fiscal strategy.
  - Commit to transparency to allow informed understanding and external scrutiny, supporting resource allocation aligned with national objectives and attracting foreign investors.
  - Consider numerical fiscal rules based on fiscal anchors to discipline policies while providing flexibility to respond to shocks.
- Institutional and technical steps
  - Integrate existing fiscal frameworks and expand their coverage.
  - Strengthen intergovernmental coordination and fiscal transparency.
  - Strengthen monitoring of contingent liabilities, including coverage of PPPs and GREs and their global subsidiaries.
  - Strengthen data-sharing across all levels of government, including the central bank.
  - Use risk-based, comprehensive framework with fiscal indicators, targets, and rules adapted to UAE-specific circumstances to guide projections and policy.

_Source: June 21, 2017, UNITED ARAB EMIRATES — INTERNATIONAL MONETARY FUND_

### 12.      In sum, the main building blocks of an MTFF for the UAE are as follows:

### 12.      In sum, the main building blocks of an MTFF for the UAE are as follows:

### Elements included in an MTFF
- Use realistic macroeconomic assumptions consistently across local and federal governments:
  - Include realistic oil prices, production, and nonoil economic growth targets.
  - Recognize higher volatility of economic variables in oil-exporting countries and the need for strong analytical capacity, good national accounts and international investment position statistics, reliable methodologies, and well-qualified staff.
- Expenditure and revenue forecasting:
  - Developing forecasting capacity requires time, technical capacity building, staff, and examination of past forecasting errors.
  - Robust estimates need a sound understanding of how parameters drive annual expenditure and revenues and repeated comparisons between the budget and actual budget execution outturns.
  - Include different contingent scenarios to calibrate prudential contingency reserves.
- Reliable statistics are crucial to enable good policy analysis, decision-making, and to enhance MTFF credibility.

### Disaggregated, coordinated MTFF appropriate for the UAE
- Maintain a disaggregated MTFF approach given high fiscal decentralization and differences in resource dependence among emirates, while strengthening coordination among federal and emirate governments.
- Fiscal anchors should reflect long-term fiscal objectives of each emirate; each emirate should design and calibrate fiscal rules to align policies with goals and targets.
- Integrate UAE-wide economic goals (growth and diversification) with emirate goals via reinforced intergovernmental coordination mechanisms.

Key analytical elements to consider at the UAE level for designing disaggregated fiscal rules:
- nonoil growth objectives
- consolidated government spending targets
- fiscal breakeven price
- allocations for priority spending
- debt objectives and financing options

### Abu Dhabi: intergenerational equity and PIH-based rules
- In Abu Dhabi, where government debt is low and precautionary buffers are large, long-term fiscal policy goals should center on intergenerational equity.
- The permanent income framework (PIH) aims to ensure equal share of assets across generations and maintain constant real consumption each year.
- The nonoil primary deficit is estimated to be 8 percentage points of GDP higher than its PIH-based benchmark at end-2016 (see Annex I of the accompanying Staff Report).
  - This suggests Abu Dhabi needs to gradually reduce government spending or raise nonoil revenue to achieve intergenerational equity, while maintaining priority spending.
- Three alternative PIH-based rules simulated:
  1. PIH perpetuity — nonoil primary balance remains constant over time.
  2. Modified PIH — allows an increase in the nonoil primary balance to maintain public investment at a high level.
  3. Fiscal Sustainability Framework (FSF) — incorporates the impact of higher public investment on economic growth and nonoil revenues.
- As the nonoil economy expands and the country becomes more independent from oil short-term vulnerabilities, a move toward structural balances is appropriate to choose the most suitable rule depending on investment needs and projected medium-term impact on nonoil growth.

### Dubai: debt ceiling and deficit rules
- In diversified Dubai:
  - Public debt stands at about 30 percent of Dubai’s GDP (115 percent if GRE debt is included).
  - A debt ceiling operationalized by an overall deficit rule is appropriate; ensure consistency between a target debt ceiling and a deficit rule.
- Staff simulations:
  - A binding deficit rule of 3 percent of GDP over ten years implies a rising debt trajectory with government debt reaching 45 percent of GDP in ten years.
  - To maintain a stable debt trajectory at 30 percent of GDP (Dubai government’s indicative target), an overall deficit of 1 percent of GDP at most could be sustained.

### Information-sharing, cash management, and transfers
- Strengthen information-sharing and establish rules for transfers among public entities (governments, GREs, SWFs) to facilitate MTFF design.
- Improve cash management:
  - Expand coverage of Treasury Single Accounts (TSA).
  - Improve liquidity forecasting for entities outside TSAs.
  - Enhance information-sharing on cash management among fiscal and monetary authorities, GREs, and SWFs to improve predictability of financing flows, calibrate SWF liquidity buffers, and aid liquidity forecasting by the central bank (CBU).
- Share information on budget preparation and MTFF at the country level to clarify contributions of different institutions to national goals.

### Fiscal coordination mechanisms and expenditure benchmarks
- Enhance fiscal policy coordination mechanisms, including intergovernmental committees, to better align fiscal responsibilities with country goals.
  - Choice of mechanism depends on constitutional and institutional feasibility; cooperative approaches are most appropriate given high autonomy of Emirates governments.
  - Role of capital markets and rating agencies in enforcing fiscal discipline is important.
- Consider establishing national expenditure benchmarks to ensure local budgets align with national objectives:
  - The EU example: an expenditure rule caps annual growth of primary expenditure at long-term nominal GDP growth and includes a correction for revenue measures so spending growth does not exceed medium-term economic growth unless matched by discretionary revenue measures.

### Monitoring contingent liabilities and managing PPPs
- Strengthen monitoring and control of contingent liabilities, including PPPs, to prevent undue buildup of risks.
- Review and vet GRE investment plans to balance GRE flexibility with consistency with fiscal and development goals.
- PPPs can mobilize financing and support infrastructure provision but must realize efficiency gains while mitigating fiscal risks.
- Dubai’s PPP law establishes a framework to reduce fiscal risks; supporting regulations should further strengthen PPP legal frameworks in Dubai and other governments should align PPP legal frameworks with best international practices.

### Integrating annual and medium-term budget management; transparency
- Better integrate annual and medium-term budget management across federal and emirate levels and strengthen transparency and communication:
  - An official medium-term fiscal strategy should serve as the basis for annual budget preparation and can be based on a top-down resource envelope (macroeconomic model estimating revenues, expenditure, nonoil balances, and a fiscal anchor).
  - Fiscal risks analysis should calculate sensitivity of fiscal plans to macroeconomic and oil sector assumptions.
  - Match a top-down resource envelope with bottom-up cost estimates of existing policies; integrate sector policy scrutiny with the resource envelope and annual budget process.
  - Turn the medium-term budget framework into a performance-based expenditure framework to link funding to results and shift focus from inputs to outcomes.
  - Enhance timeliness and frequency of fiscal reporting on within-year budget outturns to improve monitoring and forecasting.

### Conclusions and policy recommendations
- MTFFs would help Emirate governments:
  - Use annual budgets to facilitate counter-cyclical spending within medium-term goals for diversification and nonoil growth.
  - Achieve better resource allocation by linking policy, planning, and budgeting for more efficient public finance use toward medium-term development goals.
  - Regularly update expenditure projections under development plans and link updates to annual budgets on a rolling basis.
- Improve fiscal data and transparency across all government levels:
  - Enhance availability, quality, and timeliness of consolidated and Emirates government data.
  - Generalize accrual accounting.
  - Strengthen capacity of macro-fiscal units at all government levels.
  - Improve national accounts and IIP statistics.
  - Increase transparency on annual budgets’ approval, implementation, and medium-term forecasts to strengthen monitoring and credibility.
- Foster fiscal coordination across government levels:
  - Consider a common and consistent macroeconomic framework across emirates coordinated by the federal government with input from Emirates governments.
  - Share fiscal frameworks and produce one national document with a coherent fiscal strategy considering regional asymmetries.
  - Improve information-sharing and establish explicit rules for transfers among SWFs, GREs, and local and federal governments to facilitate cash management and liquidity forecasting.
  - Strengthen intergovernmental coordination mechanisms to integrate local and national objectives.
- Enhance the role of institutions:
  - Fiscal responsibility laws and independent intergovernmental fiscal agencies may complement fiscal rules.
  - Enhance public financial management systems and ensure credible political commitment to annual and medium-term fiscal targets to support sound fiscal policies at local, federal, and consolidated levels.

*International Monetary Fund — UNITED ARAB EMIRATES*

### Annex I. Aiming for First-Rate Education and Healthcare

### Annex I. Aiming for First-Rate Education and Healthcare

### Education — key findings
- Public education spending is estimated at 1.6 percent of GDP per year.
- At first glance this compares with the OECD average of 4.5 percent of GDP, but comparisons require adjustments for private sector role and demographics:
  - In the UAE, 80 percent of primary and secondary students are enrolled in private institutions compared to 31 percent in the OECD.
  - In the UAE, the school-age population is 17 percent of the working age population compared to 29 percent in the OECD.
- After adjusting for private sector size and demographics, the UAE’s public education spending exceeds that in the OECD countries with the highest levels of public education spending (Norway, Denmark, Finland).
- Expenditure per student:
  - UAE: $22,055
  - OECD average: $9,052
  - Expenditure per student in the UAE is above $22,000, more than twice as in the average OECD economy.
- Inputs and resource indicators:
  - Public education in percent of GDP: UAE 1.6; OECD average 4.5.
  - Percent of students in private education: UAE 69; OECD average 16.
  - School-age population to population 20-64: UAE 17; OECD average 29.
  - Students per teaching staff and PISA scores: UAE PISA scores are at the bottom of those in the OECD economies; in all subjects over 40 percent of students are at or below level 2 (the proficiency level deemed by the OECD as necessary to participate fully in a globalized world).

### Education — policy recommendations and priorities
- Increase the efficiency of education spending:
  - Bridge the performance gap within the same resource envelope by implementing new quality standards for teachers and schools, developing curriculums, introducing a common framework for school evaluation, and promoting STEM and innovation.
  - As performance monitoring is enhanced, consider granting greater autonomy to schools.
- Ensure equitable outcomes:
  - Address fragmentation by provider type (public schools with 27 percent of students and private schools with the rest), curriculum (Ministry of Education or international), and jurisdiction (Abu Dhabi with 35 percent of the students and Dubai and Northern Emirates with the rest).
  - Monitor disparities: private schools following international curricula in Dubai perform better in PISA than private or public schools that follow MOE curricula.
  - Note intra-public-school disparities: average spending per student is estimated to be 50 percent higher in the ADEC public schools compared to other public schools.
  - Monitor gender outcomes among nationals: lower rates of secondary school graduation and tertiary enrollment for males.
  - Strengthen monitoring via a national exam (piloted in 2017 and planned to be adopted in 2018) to track performance across jurisdictions and systems.

### Healthcare — key findings
- Public healthcare expenditure in general government increased by over 0.5 pp of GDP in 2011-16, largely reflecting Abu Dhabi efforts to improve healthcare infrastructure.
- World Health Organization estimate: public health expenditure at 2.6 percent of GDP in the UAE, substantially below OECD peers even after accounting for the younger population structure in the UAE.
- Total health expenditure per capita:
  - UAE: nearly $1,500 per year (table: $1,478)
  - OECD average: $3,800 (about $2,200 adjusted for demographics)
- Demographic adjustment example:
  - Using the UAE’s demographic profile would reduce average OECD public health spending from 6.8 to 3.9 percent of GDP (counterfactual interpretation).
- Health system inputs and indicators (table values):
  - Share of population age 0-4: UAE 5.4; OECD 6.8.
  - Share of population age 60 and older: UAE 2.3; OECD 22.1.
  - Adjusted public health spending (percent of GDP): UAE 2.6; OECD 3.9.
  - Total health expenditure per capita ($): UAE 1,478; OECD 3,779.
  - Doctors (per 100,000 population): UAE 253; OECD 329.
  - Nurses (per 100,000 population): UAE 316; OECD 841.
  - Healthy life expectancy (years): UAE 68.3; OECD 71.6.
  - Infant mortality (per 100,000 births): UAE 5.9; OECD 4.8.

### Healthcare — fiscal pressures and reform recommendations
- Fiscal pressure projection:
  - To approach OECD levels in health inputs (raising the number of doctors and nurses), this would cost as much as 1.3 pp of GDP over the next few years.
  - A gradual approach is warranted given fiscal and implementation constraints; protect healthcare expenditure during fiscal consolidation.
- Integration and system design:
  - Current system is a mix of a mandatory health insurance model (in Abu Dhabi and Dubai, including special insurance schemes for government employees and nationals) and a government-funded model (in the Northern Emirates).
  - Greater integration across healthcare models could prevent disparities and avoid duplication; consider better coordination by insurers and providers across regions and eventually a national insurance market.
  - Plans to separate regulatory and service provision arms of the Ministry of Health would align with practices in the education sector and international examples (Italy, Sweden, United Kingdom).
- Monitoring, oversight, and cost containment:
  - Enhance robust regulation to maintain standards across public and private providers.
  - Increase price transparency and implement payments by episode of care (bundled payments by medical conditions) to contain cost growth and increase efficiency.
  - Promote health information technology for data sharing across insurers and providers and benchmarking of costs.
  - Review incentive and payment structure for public providers: move from budget allocations for current and capital expenditure toward linking allocations to indicators of quantity and quality of care to place public providers on the same footing as private providers.
  - Exercise care with PPPs in healthcare financing; Ministries of Finance and Health could develop an inventory of existing PPPs to identify commitments and government exposure (for example, through demand guarantees).

### Education and health care adjustments — methodological identities and counterfactuals
- Public education spending as percent of GDP identity (equation 1):
  - Public education spending / GDP = (public education spending / public school enrollment) / GDP per population 20–64
    × public school enrollment / total enrollment
    × total enrollment / pop. 5–19
    × pop. 5–19 / pop. 20–64
- OECD adjusted public education expenditure example:
  - 4.5 percent of GDP × 30.7/84.4 × 16.5/28.8 = 0.9 percent of GDP (counterfactual: level of public education expenditure the average OECD country would have assuming UAE private school coverage and demographic profile).
- Public health spending identity (equation 2):
  - Public health spending / GDP = (health spending per capita (age 40–44) / GDP per capita pop. 40–44)
    × Σ over age groups [ population(age i)/total population × health spending(age i)/population(age i) ÷ health spending(age 40–44)/population(age 40–44) ]
- OECD adjusted public health expenditure example:
  - Using the UAE’s demographic profile reduces health spending from 6.8 to 3.9 percent of GDP (counterfactual: level the average OECD country would have assuming the UAE demographic profile).

*Source: IMF staff calculations and analysis (Annex I).*

### 1.      The UAE economy and banking system are facing new challenges. Oil prices have

### 1.      The UAE economy and banking system are facing new challenges. Oil prices have

### Macro-financial context and key message
- Oil prices have stabilized at around half of their 2014 peak and are expected to stay broadly stable at this level over the medium term.
- With lower oil revenues:
  - current account surpluses have declined, and fiscal surpluses have turned into deficits;
  - the public sector’s propensity to accumulate deposits in the banking system has weakened.
- Normalization of U.S. interest rates and recent banking regulatory changes in the UAE are creating new challenges for banks’ management of liquidity.
- Ensuring healthy liquidity conditions and promoting financial market development is important for supporting robust credit and economic growth and diversification goals.

### Overview of the UAE banking system and financial markets
- Banking system size and concentration:
  - total assets amounting to AED 2.6 trillion or 204 percent of GDP at end-March 2017.
  - the largest three banks hold over 50 percent of total assets of the banking system.
- Capitalization, asset quality, profitability, and efficiency (selected financial soundness indicators, end-March 2017 unless otherwise stated):
  - Regulatory Capital to Risk-Weighted Assets: 18.6 (2017q1 series).
  - Regulatory Tier 1 Capital to Risk-Weighted Assets: 17.3, 17.2, 16.6 (series for prior years).
  - Non-performing Loans to Total Gross Loans: 5.3 percent (stable at 5.3 percent over the past few years).
  - Return on Equity: 11.7 percent at end-March 2017.
  - Non-interest Expenses to Gross Income (cost-to-income): below 38 percent.
  - Liquid Assets to Total Assets (Liquid Asset Ratio): 21.2–22.9 (series shown).
  - Liquid Assets to Short Term Liabilities: 27.7–30.3 (series shown).
- Islamic banking:
  - Islamic banks had assets of AED 522 billion or 20 percent of total bank assets at end-March 2017.
- Credit allocation and market development:
  - private credit-to-non-oil GDP ratio reached beyond 100 percent at end-2016.
  - outstanding loans to governments and GREs accounted for 23 percent of total loans at end-March 2017.
  - stock market capitalization (June 2017): Abu Dhabi Securities Exchange $120 billion (32 percent of projected 2017 GDP), Dubai Financial Market $84 billion (22 percent of projected 2017 GDP).
  - domestic government debt market does not exist; during 2001–15, $53.8 billion or 36 percent of all global sukuk issuances originated in the UAE.
- Money and FX markets:
  - FX swap markets are actively used given the peg and significant dollarization: 36 percent of deposits and 23 percent of loans are in foreign currencies.
  - interbank liquidity is thin, traded only between a few banks with maturities up to one month.

### The CBU’s liquidity management framework (structure and instruments)
- Liquidity drivers:
  - liquidity in the UAE’s banking system is driven by oil prices via governments’ and GREs’ deposits (about a quarter of total bank deposits).
  - in the absence of domestic debt markets, banks held liquidity at the CBU in remunerated CDs, required and excess reserves, and/or foreign assets.
- Reserve requirements:
  - required reserves ratio: 14 percent on current, savings, and demand accounts; 1 percent on time deposits (maturity from 7 days onward).
  - ratios are the same for dirham and foreign currency deposits.
  - reserve requirements calculated using a bank’s balance sheet as of the fifteenth day of each month, with a time lag of 6 weeks between that day and the reserve maintenance period.
  - deviation from required daily reserves subject to a fee ranging from 150 to 300 basis points over the CBU repo rate.
- Certificates of Deposit (CDs):
  - issued daily at a fixed rate on full allotment basis.
  - available maturities: one week, 1 month, 2 months, 3 months, 6 months, 9 months, and 12 months (most popular: 1 week, 1 month, 12 months).
  - the one-week CD rate is the policy rate adjusted following changes in the U.S. Federal Funds rate under the peg arrangement.
  - both Islamic and conventional CDs are available; the CBU also issues U.S. dollar-denominated CDs.
  - CDs are non-transferrable, redeemable upon banks’ request, and issued as accounting records at the CBU (CBU is the only counterparty to banks for CD trading).
- Role of reserve requirements and CDs:
  - together they absorbed a structural liquidity surplus; constituted 77 percent of banks’ assets held with the CBU at end-2016.
  - remainder held primarily in banks’ excess reserves and current accounts.
- CBU standing facilities (introduced in/after 2008 crisis; many remain unused except for test transactions):
  - Repo (liquidity up to three months against CDs): cost CDs 50 basis points over the one-week CD rate.
  - Interim Marginal Lending Facility (IMLF) — overnight liquidity against generally rated and tradeable securities: 100 basis points over the repo rate.
  - Borrowing Against Reserves Facility (BAR) — emergency liquidity support against reserve requirements: 300 basis points over the repo rate.
  - Foreign Exchange Swaps — U.S. dollar to dirham swaps up to one year: FX Currency Fixed implied swap rates.
- Redemption option:
  - banks can redeem their CD holdings at any time at market price; introduced in 2008 and remains. This eases liquidity management for banks but creates potential moral hazard by discouraging active bank liquidity management.
- Historical role as lender of last resort:
  - during 2008-2009 crisis, the CBU introduced U.S. dollar swaps, borrowing against reserve requirements, and emergency liquidity support to alleviate stress.

### New challenges from the lower-for-longer oil price environment and regulatory changes
- Government and GRE deposit volatility:
  - oil revenues declined and became more uncertain; in 2015 government mobilized deposits to fund expenses, tightening banking system liquidity; in 2016 government increased deposits but GRE deposits decreased.
  - banks must account for new risks related to governments’ and GREs’ deposits when managing liquidity.
- Interest rate environment:
  - expected increases in U.S. interest rates will increase the cost of funding for UAE banks as domestic deposit rates rise in tandem under the peg; cost of external funding will also rise.
- Basel III liquidity requirements introduced by the CBU:
  - Liquidity Coverage Ratio (LCR): already applied to the three largest banks at 80 percent with full phase-in by 2019.
  - Net Stable Funding Ratio (NSFR): planned with 100 percent phase-in by 2018.
  - Both ratios require a significant amount of high quality liquid assets (HQLA); currently the only major securities that qualify are the CBU’s CDs.
- Need for financial market development:
  - lower oil revenues weaken medium-term prospects and underscore the need to diversify the economy away from reliance on oil.
  - development of capital markets and Islamic finance is important to allow companies, governments, and GREs to reduce reliance on bank financing.

### Benefits of developing a domestic debt market (as identified)
- Governments would have a domestic funding source to tap if needed, diversifying funding and reducing reliance on bank financing, external borrowing or withdrawals from SWFs.
- The CBU would obtain an additional instrument for managing liquidity by conducting open market operations in the context of the peg.
- Issuing domestic securities would make the supply of liquid assets less dependent on oil prices and the peg; increase the pool of domestic securities that qualify as HQLA for Basel III liquidity requirements.
- Provide banks with collateral usable for interbank operations and borrowing from the CBU, including emergency liquidity provision.
- Help create a yield curve at long-term tenors to provide a benchmark for bank lending.
- Support development of a domestic corporate bond market and interbank repo market by providing a pricing benchmark, enabling firms to diversify funding, and potentially attracting foreign investors.

### Policy recommendations and operational reforms proposed
- Upgrade the CBU’s liquidity management framework and develop domestic money and debt markets to encourage banks to manage liquidity more actively and to develop money markets.
- Streamline and possibly consolidate the CBU’s liquidity management instruments to:
  - encourage banks to manage their own liquidity better;
  - complement implementation of Basel III-compliant liquidity requirements.
- Start issuance of domestic government bonds to provide another liquid asset in addition to the CBU’s CDs, supporting CBU and bank liquidity management and facilitating pricing and integration of markets.
- Specific operational measures toward more active liquidity management:
  - Create a well-defined interest rate corridor:
    - unify standing facilities into one overnight lending rate to serve as a ceiling for the corridor.
    - introduce an overnight deposit rate (remunerated deposit facility) to serve as a floor for the policy rate corridor (currently bank balances with the CBU are not remunerated).
    - use the deposit and lending rates to help the CBU steer short-term interest rates under the peg.
  - Strengthen the CBU’s liquidity forecasting capacity.
  - Strengthen cooperation and information-sharing between the CBU, governments, and SWFs to ensure the CBU is well informed about expected cash management operations, both short-term and in the context of a medium-term fiscal framework.

*Source: cr17219 (IMF staff report excerpt).*

### 22.      Reforming the CD program to provide benchmark short-term instruments. CDs could be

### Reforming the CD program to provide benchmark short-term instruments.

### Reforming the CD program (paragraph 22)
- "CDs could be offered at regularly scheduled auctions rather than as a daily tap facility."
- "Such auctions could be held weekly with the results published to facilitate price discovery by market participants."
- "The auctions would be calendarized with CD maturity profile to match maturing tranches."
- "CDs should be traded at fixed volume variable rate auctions to provide a price signal to the CBU and banks."
- "CDs would be issued as transferrable securities, which banks could trade with each other."
- "Once CD auctions are well established, the early redemption feature could be removed from new CD issuances."
- Expected effects: "This would incentivize banks to trade CDs with each other, fostering interbank market development, and to plan their liquidity needs better."
- Operational note: "Proper sequencing of the CD program reforms would be important to avoid disruptions to the financial system."

### Liquidity regulation and bank incentives (paragraph 23)
- Objective: "Ensuring that the application of liquidity regulations supports incentives for banks to actively manage liquidity and participate in liquidity markets."
- Required actions:
  - "continued efforts to apply risk management standards to all banks,"
  - "develop additional guidance to complement the recently issued liquidity regulations and integrate the new liquidity ratios into regulatory reporting."
  - "The CBU could also make active use of the Pillar 2 of the Basel Accord to supervise and facilitate the development of liquidity risk management in banks."

### Initiating domestic government debt issuance (paragraphs 24–26)
- Complementarity: "Starting issuance of domestic government debt could usefully complement the CBU’s steps towards more active liquidity management."
- Legislative step: "A draft debt law is under consideration by the government and its speedy ratification could pave the way for a first domestic sovereign issuance."
- Instrument mix and institutions:
  - "Governments could issue dirham-denominated debt at medium to long-term maturities."
  - "Over time, governments may consider creating debt management offices to oversee the issuance and monitoring of debt."
  - "Sukuk issuance could be usefully incorporated in the calendar of debt issuance, deepening Islamic markets."
- Operational role of the CBU: "The CBU could take operational responsibility for government debt issuance, i.e., serve as the fiscal agent, to facilitate market creation."
- Coordination and sequencing:
  - "Close coordination between fiscal and monetary authorities on cash flow management would be needed."
  - "As the domestic debt market takes off, the CBU’s CD issuance could be limited to short-term tenors only."
  - "Eventually, the development of a domestic debt market would enable the CBU to conduct open market operations and influence liquidity supply directly."

### Market infrastructure and broader financial-market development (paragraphs 27–28)
- Central securities depository (CSD):
  - "A key element in this regard is creating a single central securities depository (CSD)."
  - Options: "a new body could be established or one of the existing CSDs on the UAE’s stock exchanges would need to be strengthened."
  - Practical consideration: "If an international CSD is to be used, its working hours should be aligned with the working week in the UAE."
  - Role: "Such CSD would facilitate trading of government bonds and CDs between banks and other market participants to ensure liquidity and reduce transaction costs."
- Broader market-development measures:
  - "More active liquidity management by the CBU and banks, creation of the government debt market, as well as ongoing improvements in infrastructure and regulation of other markets, would facilitate financial market development in the UAE."
  - Elements of development:
    - "broadening the set of traded instruments (e.g., treasury bills and bonds, bills of exchange, promissory notes, etc.) and remittance facilities (e.g., through exchange houses),"
    - "ensuring that each market has healthy competition (borrowers, lenders and dealers, including from other countries),"
    - "fostering integration among different markets that allows funds to flow easily from one market to another, as well as integration of the interest rate structure."
  - Institutional actions noted:
    - "The Securities and Commodities Authority is taking steps to further improve the infrastructure of securities markets, while enhancing their supervision and corporate governance."
    - "The CBU is doing the same, in its role as the regulator and supervisor of exchange houses."
    - "In particular, it is taking steps to reduce the risk of withdrawal of correspondent banking relationships and prevent migration of remittances to informal channels (see the accompanying Staff Report)."

### Conclusion (paragraph 29)
- Assessment: "The CBU’s and governments’ plans regarding market development and liquidity management need to be accelerated."
- Rationale: "The CBU’s current liquidity management framework has served the country well. However, the new challenges posed by the lower-for-longer oil prices and expected increases in U.S. interest rates call for moving towards more active management of liquidity."
- Expected benefits:
  - "Upgrading the CBU’s liquidity management framework, together with governments’ initiatives to develop domestic debt markets, would expand the range of liquid assets available to banks and the CBU, enabling them to manage liquidity better, consistent with the Basel III requirements."
  - "More active liquidity management by banks would increase their resilience to unexpected shocks."
  - "A more robust banking system would support healthy credit growth and contribute to further diversification of the UAE economy."

*Source: cr17219*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17219.pdf_