## _cr16251 ## Source details **Canonical URL:** [_cr16251](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16251.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16251.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16251.pdf.json) --- ### Economic outlook and growth projections - Economic activity expected to moderate further in 2016, before improving over the medium term. - Nonhydrocarbon growth: - Projected to slow to 2.4 percent in 2016. - Forecast to increase to above 4 percent over the medium term. - Drivers and headwinds: - Near-term drag: fiscal consolidation, the stronger dollar, tighter monetary and financial conditions. - Medium-term support: rising oil prices, private investment pickup ahead of Expo 2020, strengthened external demand. - Real sector projections (annual percent): - Real GDP growth: 4.7 (2013), 3.1 (2014), 4.0 (2015), 2.3 (2016 proj.), 2.5 (2017 proj.), 3.1 (2018 proj.), 3.4 (2019 proj.), 3.7 (2020 proj.), 3.4 (2021 proj.) - Real hydrocarbon GDP: 2.9 (2013), 0.8 (2014), 4.6 (2015), 2.0 (2016 proj.), 2.0 (2017 proj.), 2.0 (2018 proj.), 2.1 (2019 proj.), 2.1 (2020 proj.), 2.1 (2021 proj.) - Real nonhydrocarbon GDP: 5.6 (2013), 4.1 (2014), 3.7 (2015), 2.4 (2016 proj.), 2.7 (2017 proj.), 3.5 (2018 proj.), 4.0 (2019 proj.), 4.4 (2020 proj.), 4.0 (2021 proj.) - Inflation: - CPI inflation (average): 1.1 (2013), 2.3 (2014), 4.1 (2015), 3.3 (2016 proj.), 2.8 (2017 proj.), 3.1 (2018 proj.), 3.3 (2019 proj.), 3.5 (2020 proj.), 3.6 (2021 proj.) ### Fiscal policy, consolidation, and recommendations - 2015 consolidation and outcomes: - Frontloaded fiscal consolidation in 2015 narrowed adjusted non-hydrocarbon deficit by 8½ percentage points to 29 percent of non-hydrocarbon GDP in 2015. - Fiscal break-even oil price reduced to about $60 in 2015 from $79 in 2014. - Composition: scaled back capital transfers to GREs, cut government investment, raised electricity and water tariffs, removed fuel subsidies. - Overall fiscal balance: deficit of 2.1 percent of GDP in 2015; deficit mainly financed by drawing down government deposits. - Selected fiscal indicators (percent of GDP): - Revenue: 28.5 (2015), 26.4 (2016), 27.0 (2017) - Taxes: 11.9 (2015), 11.1 (2016), 12.6 (2017) - Other revenue 1/: 16.2 (2015), 15.0 (2016), 14.1 (2017) - Expenditures: 30.6 (2015), 29.9 (2016), 28.3 (2017) - Expense 2/: 28.1 (2015), 27.3 (2016), 25.6 (2017) - Net acquisition of nonfinancial assets: 2.5 (2015), 2.6 (2016), 2.6 (2017) - Net lending(+)/borrowing(-): -2.1 (2015), -3.5 (2016), -1.3 (2017) - Adjusted non-hydrocarbon primary balance 3/: -29.0 (2015), -26.0 (2016), -24.5 (2017) - Gross central government debt: 16.6 (2015), 18.3 (2016), 17.8 (2017) - Net of government deposits in the banking system: 1.4 (2015), 2.6 (2016), 1.4 (2017) - Staff and Directors’ guidance: - Near-term: ease pace of consolidation to reduce growth impact given ample buffers. - Medium-term: strengthen consolidation to ensure intergenerational equity. - Diversify revenues (VAT, excises, potential corporate tax) and rationalize current spending. - Phase out remaining energy subsidies while protecting the vulnerable. - Prioritize curbing current spending, preserve public investment, and enhance investment efficiency. - Develop a consolidated forward-looking medium-term fiscal framework aligned with UAE 2021 vision. - Strengthen debt management to better account for contingent liabilities from GREs and PPPs. - Authorities’ baseline and staff-suggested illustrative adjustments (percent of non-hydrocarbon GDP): - Authorities’ intended adjustment by 2021: 8.6 (total). - Staff-suggested additional adjustment (total additional adjustment 3/4) sequence 2016–2021: -1.5, 0.5, 0.5, 0.5, 0.6, 1.5, 2.1 (total 2.1). - Additional revenues sequence: 0, 0.3, 0.3, 0.3, 0.3, 1.5, 2.7 (total 2.7). - Reduction in budgeted subsidies sequence: 0, 0.2, 0.2, 0.2, 0.3, 0, 0.9 (total 0.9). - Additional investment (front-loaded easing) sequence: -1.5, 0, 0, 0, 0, 0, -1.5 (total -1.5). - Deviation between projected non-hydrocarbon primary deficit and intergenerational equity level (2016–2021): 6.6, 4.9, 4.1, 3.4, 2.4, 1.3. - Gap breakeven to market prices (U.S.$, 2016–2021): 18.9, 9.6, 2.7, -3.2, -8.2, -15.7. - Cumulative fiscal deficits forecast: U.S $18.4 billion over 2016-21. - Financing recommendations: - Tap sovereign wealth funds and international capital markets rather than drawing down government deposits or incurring payment arrears. - Increase domestic sovereign issuance to deepen domestic debt markets; substitute part of CBU certificates of deposits (about $31.4 billion by end-March). - Approve Public Debt Law and the Trust law to allow federal issuance. - Abu Dhabi Eurobond issuance of $5 billion welcomed; further external bond issuance encouraged. ### Public financial management and debt frameworks - PFM recommendations: - Develop a consolidated forward-looking medium-term fiscal framework for federal and local alignment with 2021 vision. - Approve five-year federal fiscal framework, consolidate medium-term budgets for education and healthcare. - Abu Dhabi to adopt the multiyear performance-based budgeting framework and approve budgets ahead of the fiscal year. - Strengthen local PFM to increase budget credibility and comprehensiveness, avoid earmarking, and control expenditures. - Broaden coverage of fiscal accounts to include GREs and of monetary and financial statistics to non-bank financial institutions. - Public debt metrics and projections: - Gross public debt-to-GDP: 16.6 percent (2015); projected pick up to 17.0 percent in 2016, then decrease over medium term. - Under severe stress scenario with lower oil prices and higher GRE defaults, ratio could double. - Gross debt-to-GDP could double to 31 percent by 2021 under combined lower oil prices with 20 percent of GRE debt taken over by government. ### Financial sector soundness, monetary framework, and recommendations - Monetary anchor: - Dirham peg to the U.S. dollar (3.67) remains appropriate anchor for price and financial stability. - Support to enhance monetary framework, notably liquidity management. - Banking sector indicators and developments: - Banks remained well capitalized and liquid; regulatory capital to risk-weighted assets: 19.3 (2013), 18.1 (2014), 18.3 (2015), 18.0 (2016q1). - Non-performing loans to total gross loans: 6.7 (2013), 5.6 (2014), 5.2 (2015), 5.3 (2016q1). - NPLs rose slightly to 5.3 percent by end-March 2016; NPL coverage by provisions: 108 percent. - Domestic deposit growth slowed to 1.8 percent y-o-y at end–March 2016. - Wholesale foreign funding: 11.8 percent of banks’ liabilities by end–March 2016 (from 10.4 a year ago); average maturity about 2.6 years. - Domestic credit growth: 7.6 percent y-o-y at end-March 2016; credit to non-oil GDP to remain stable at 143.5 percent. - Overall liquid asset ratio: 20.7 percent by end-March 2016. - Return on Assets: 1.6 (2013), 1.7 (2014), 1.5 (2015), 1.5 (2016q1). - Return on Equity: 11.1 (2013), 13.9 (2014), 11.8 (2015), 12.0 (2016q1). - Real estate and loan quality: - Dubai average residential prices fell by 11 percent in 2015; Abu Dhabi residential prices fell by 0.8 percent in 2015. - NPLs for construction and real estate development declined from 12.3 percent in 2013 to 7.5 percent by end-March 2016. - NPLs for household loans declined from 10 percent in 2013 to 4.9 percent by end-March 2016. - Monetary and prudential reforms recommended: - Swift approval and implementation of the new central bank and banking law to enhance independence, governance, macroprudential framework, supervision, safety nets, and resolution framework. - Phase in Basel III capital framework and ensure new additional Tier 1 and Tier 2 issuances align with Basel III. - Introduce capital charges for systemically important banks, counter-cyclical capital buffers, dynamic provisioning. - Enforce loan concentration limits, set limits to open FX positions, strengthen corporate governance, move toward risk-based supervision, maintain loan-to-value and debt service-to-income measures. - Continue strengthening AML/CFT framework and address de-risking. ### Stress testing and resilience (Box 1 and Appendices) - Credit risk stress test assumptions: - Exposure-at-default as of end-2015; 60 percent LGD; PDs proxied by NPLs net of write-offs; banks assumed to continue lending with credit growing at 2 percent; net income before provisions evolves with non-oil GDP. - Downturn scenario assumptions: - GDP contraction: 3.5 and 1.6 percent in 2016 and 2017 respectively; no growth in 2018 (vs baseline growth of 2.3, 2.5, 3.1). - Real estate prices fall by 28.1 percent in 2016, 6 percent in 2017, and 5.3 percent in 2018. - Total increase in PDs by 3.8 times at end-2018. - Credit stress outcomes: - Average CAR declines from 17.8 percent to 15.7 percent under the downturn scenario. - Two small and three medium banks (5 total) would be below the 12 percent CAR minimum by 2018; aggregate capital shortfall: AED 7.3 billion (0.4 percent of 2018 GDP). - CAR pre- and post-stress by size (percent): - Aggregate CAR pre-stress: 17.8 (all local banks) - CAR post stress: 15.7 (all local banks) - Pre/post by size: Less than AED 30 billion: 19.8 → 16.6; Between AED 30 and 120 billion: 17.5 → 12.4; Larger than AED 120 billion: 18.1 → 15.3. - Aggregate capital (AED billion) pre-stress and shortfalls: - Pre-stress capital: 292.7 (all local banks); by size: 21.2 (Less than AED 30 billion), 86.6 (Between AED 30 and 120 billion), 184.9 (Larger than AED 120 billion). - Aggregate capital shortfall (AED billion): 7.3 (all local banks); 1.7 (Less than AED 30 billion); 5.6 (Between AED 30 and 120 billion); 0 (Larger than AED 120 billion). - Liquidity stress outcomes (LCR methodology, end-March 2016 data): - Baseline average LCR: 140 percent. - Adverse scenario average LCR: 128 percent (includes additional 5-10 percent haircut on HQLA and additional 5 percent run-off on stable deposits). - All banks would have LCRs above 100 percent under adverse scenario; one medium bank slightly below 100 percent under both baseline and adverse scenarios. - Phase-in schedule gives banks until 2019 to reach 100 percent LCR. - Appendix stress-test macro assumptions (Appendix V): - Oil shock: sudden permanent $10 reduction in oil prices through 2021; cumulative 1.7 percent decline in nonoil GDP over 2016-21. - Interest rate shock: increase of 100 bps in the EIBOR in 2016 and 2017. ### External sector, reserves, and current account - Current account and external figures: - Hydrocarbon exports (U.S.$ billions): 61.5 (2015), 54.5 (2016 proj.), 64.8 (2017 proj.) - Average crude oil export price (U.S.$ per barrel): 52.4 (2015), 45.3 (2016 proj.), 52.6 (2017 proj.) - Crude oil production (millions of barrels per day): 3.0 (2015), 3.0 (2016 proj.), 3.1 (2017 proj.) - Current account balance (U.S.$ billions): 12.3 (2015), 5.3 (2016 proj.), 12.2 (2017 proj.) - Current account balance (percent of GDP): 3.3 (2015), 1.4 (2016 proj.), 3.0 (2017 proj.) - External debt (percent of GDP): 60.2 (2015), 60.1 (2016 proj.), 56.3 (2017 proj.) - Gross official reserves: 94.0 (2015), 95.1 (2016 proj.), 100.9 (2017 proj.) - Reserves in months of next year's imports net of re-exports: 6.9 (2015), 6.6 (2016 proj.), 6.5 (2017 proj.) - Recent developments: - Current account surplus declined to 3.3 percent of GDP in 2015 from 10 percent in 2014 due to lower oil and gas prices. - Gross international reserves at the CBU increased to USD 94 billion in 2015 from 78.5 billion in 2014. - REER appreciated by 9.5 percent in 2015; edged down 1.5 percent year-to-date by end-March 2016. - 3-month forward implied yield at 0.78 bps on April 29 (lowest in GCC region). - External assessment (Appendix III): - NIIP estimated at 181 percent of GDP at end-2015. - Central bank international reserves estimated at 25 percent of GDP by end-2015 or 6.9 months of imports. - EBA-lite: current account gap in 2015 of 3.3 percent; macro balance approach indicates required CA of 4.4 percent of GDP in 2015 implying CA gap of 1.1 percent. - Staff assesses 2015 average REER as moderately overvalued within 2 to 10 percent. ### Government-Related Entities (GREs): risks and recommendations - GREs’ debt and vulnerabilities: - Total public debt in Dubai: 126.2 percent of Dubai GDP in 2015; Dubai GREs debt estimated at 66.6 percent of Dubai GDP in 2015. - In Abu Dhabi, GRE debt reached 27.4 percent of Abu Dhabi GDP in 2015. - Maturities due in 2016-18 total about US$80.5 billion: US$51.6 billion for Dubai and over US$28.9 billion for Abu Dhabi. - Net debt of GREs with ICR lower than 1.5 estimated at about U.S. $20 billion at end-June 2015. - GREs’ ICR about 2 as of end-June 2015. - Staff recommendations: - Strengthen GRE risk management, reporting, transparency, and governance. - Develop contingency plans (Dubai) and federal-level debt management functions; require assent of emirate finance department for emirate borrowing. - Avoid transfer of maturing GRE debt to domestic banks; consider raising risk-weights on lending to GREs to deter transfers. - Improve disclosure and delineation of commercial vs noncommercial GRE operations. ### Risks and downside scenarios - Risks tilted to the downside. - External risks: - Further sustained drop in oil prices: main external risk. - A $10 drop in oil prices would worsen fiscal and external balances by 4 and 3½ percentage points of GDP respectively assuming no policy response. - A permanent $10 drop could reduce UAE GDP level by 2½ percentage points after five years assuming revenue losses are fully offset with expenditure cuts. - Falling government deposits could reduce banking liquidity; rising NPLs could weaken credit and non-oil GDP growth. - Higher U.S. interest rates and volatile global financial conditions could trigger rollover risks for banks and GREs and intensify liquidity strains. - Slowdowns in other GCC countries and Brexit-related shocks could reduce FDI and tourism. - Domestic risks: - Dubai megaprojects, if imprudently implemented, may create additional macro-financial risks to GREs, banks, and fiscal position. - GREs’ leverage increases and historical bailout precedent present contingent fiscal risks. ### Debt sustainability analyses and stress-test outcomes (Appendix II) - UAE public debt: - Gross debt-to-GDP: 16.6 percent (2015); projected 17.0 percent (2016 projection) in one table. - Effective interest rate projections: 4.5 percent (2016), 5.6 percent (2017), 4.9 percent (2018), 6.1 percent (2019), 6.2 percent (2021). - Primary Balance (percent of GDP baseline): -2.8 (2016), -0.2 (2017), 1.2 (2018), 2.2 (2019), 3.2 (2021). - Stress-test scenarios (selected exact outcomes): - Oil price shock (lower by $10 in 2017-21): primary balance deteriorates to 0.9 percent of GDP in 2021; government debt rises to 26.1 percent of GDP in 2021; gross financing needs rise to 7.4 percent of GDP in 2021. - GRE contingent liability (20 percent of GRE debt taken over by government in 2017-21): primary balance deteriorates to 2.2 percent of GDP in 2021; government debt increases to 20.1 percent of GDP in 2021; gross financing needs increase to 3.6 percent of GDP in 2021. - Combined scenario (oil price shock + GRE contingent liability): primary balance deteriorates to -0.1 percent of GDP in 2021; government debt rises to 32.1 percent of GDP in 2021; gross financing needs rise to 10.9 percent of GDP in 2021. - Dubai-specific outcomes: - Dubai government debt (percent of Dubai GDP): 34.5 (2013), 31.3 (2014), 30.2 (2015), 28.2 (2016 baseline proj.), 19.5 (2021 baseline proj.) - Alternative 2021 outcomes: A1. Real GDP growth shock: 28.3; A2. Global downturn: 32.2; A3. Real estate shock with global downturn: 59.6. ### Structural reforms, competitiveness, and diversification - Reform priorities: - Raise productivity and competitiveness; pursue private sector-led diversification and a knowledge-driven economy. - Ease restrictions on foreign ownership outside free zones; improve access to international markets and global supply chains. - Support SMEs and startups: approve bankruptcy law quickly, broaden credit bureau coverage, focus public funds on guarantees rather than direct lending, promote capital market financing. - Promote innovation financing: innovation fund welcome; complement with venture capital and crowd-funding. - Labor market reforms: control size and wages of civil service; improve skills-job match; promote entrepreneurship; increase women’s participation. - Diversification goals: - Authorities plan to reduce oil share in GDP by a third over the next decade. - Non-oil economy growth in 2015: 3¾ percent; non-oil activities contribute more than two thirds of GDP. - Competitiveness metrics and concerns: - UAE compares favorably in infrastructure, macroeconomic environment; lags in innovation, higher education, and business sophistication versus advanced economies. - National accounts base year: 2007 (outdated) — statistical improvements recommended. ### Statistics, data, AML/CFT and correspondent banking - Statistics improvements needed: - Continue progress on fiscal, monetary, and financial sector statistics. - Improve national accounts, external sector statistics, compile international investment position, and labor market statistics. - Strengthen coordination between federal and local statistical agencies; broaden coverage to GREs and non-bank financial institutions. - AML/CFT and de-risking: - Recent steps: adoption of by-laws in 2015, national risk assessment launched, inclusion of AML/CFT in risk-based supervision. - Further actions: timely conduct national risk assessment, enhance monitoring of domestic and cross-border flows, upgrade regulatory requirements for banks and exchange houses, improve beneficial ownership information, harmonize free zone legal person procedures. - Survey: some UAE banks had one or more correspondent relationships terminated; most able to use alternatives. - Authorities remain concerned about de-risking and continue dialogue with foreign regulators; Anti-Money Laundering and Suspicious Cases Unit capacity building underway. ### Staff appraisal and policy guidance (summary) - Persistently lower oil prices increased macro-financial stability risks; large buffers have limited inward spillovers. - Recommended macroeconomic policy mix: - Gradual fiscal consolidation while maintaining the peg. - Use financing strategy that supports private credit growth: tap sovereign wealth funds and international capital markets rather than drawing down deposits. - Enhance liquidity management, develop domestic debt markets, reduce FX exposure of banks and firms. - CBU should stand ready to use instruments to support healthy liquidity. - Given large buffers, ease pace of consolidation in 2016; accelerate consolidation over medium term to close gap to non-oil fiscal balance consistent with intergenerational equity. *Source: UNITED ARAB EMIRATES — STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION (July 5, 2016). ### 3.3 percent of GDP. Banks remained well capitalized and liquid, though pressures on ### _cr16251 - 3.3 percent of GDP. Banks remained well capitalized and liquid, though pressures on ### Economic outlook and growth projections - Economic activity is expected to moderate further in 2016, before improving over the medium term. - Nonhydrocarbon growth projections: - Nonhydrocarbon growth is projected to slow to 2.4 percent in 2016. - Over the medium-term, nonhydrocarbon growth is forecast to increase to above 4 percent. - Drivers and headwinds: - Near-term drag from fiscal consolidation, the stronger dollar, and tighter monetary and financial conditions. - Medium-term improvement as oil prices rise, private investment picks up in the run-up to the Expo 2020, and external demand strengthens. ### Executive Board Assessment and strategic priorities - Directors’ overall assessment: - Welcome the UAE’s resilience to the oil price shock and commended prudent policies that built large fiscal and external buffers. - Noted persistent lower oil prices continue to pose challenges and underscored the need for sustained sound macroeconomic policies to reduce fiscal vulnerabilities, safeguard financial stability, and promote long-term growth. - Fiscal consolidation stance: - Near-term: Given ample buffers, a gradual adjustment effort is generally considered appropriate to minimize negative growth impact. - Medium-term: Stronger fiscal consolidation will be needed to ensure intergenerational equity. - Revenue and spending policy recommendations: - Diversify revenues and rationalize current spending. - Welcome plans to introduce a VAT and increase excise taxes, which could be followed by a corporate income tax. - Phase out remaining energy subsidies while protecting the vulnerable. - Prioritize curbing other current spending, preserve public investment, and enhance investment efficiency. - Develop a consolidated forward-looking medium-term fiscal framework aligned with the UAE 2021 vision. - Strengthen the debt management framework to better account for contingent liabilities from Government Related Entities (GREs) and Public-Private Partnerships (PPPs). ### Financial sector and monetary framework - Monetary anchor and policy framework: - The peg remains an appropriate anchor for price and financial stability. - Support for continued efforts to enhance the monetary framework, particularly by improving liquidity management. - Domestic debt and financing: - Encourage development of domestic debt markets and reduction of private sector foreign exchange exposure. - Authorities encouraged to tap sovereign wealth funds and international capital markets to finance the deficit. - Banking sector soundness and regulatory reform: - Banks remained well capitalized and liquid. - Emerging pressures on profitability and asset quality as economic slowdown and rising funding costs unfold. - Ongoing revision of the central bank and banking law should: - Further enhance central bank independence and governance. - Align the macroprudential institutional framework with best practices. - Upgrade banking sector regulation and supervision in line with global standards. - Strengthen safety nets and improve the resolution framework. - Specific supervisory and prudential recommendations: - Phase in the Basel III capital framework. - Enforce loan concentration limits. - Strengthen corporate governance. - Move toward risk-based supervision. - Continue efforts to strengthen the AML/CFT framework and address de-risking. ### Fiscal and public finance indicators (selected figures) - Aggregate fiscal and public finance metrics (annual percent of GDP unless otherwise indicated): - Revenue: 28.5 (2015), 26.4 (2016), 27.0 (2017) - Taxes: 11.9 (2015), 11.1 (2016), 12.6 (2017) - Other revenue 1/: 16.2 (2015), 15.0 (2016), 14.1 (2017) - Expenditures: 30.6 (2015), 29.9 (2016), 28.3 (2017) - Expense 2/: 28.1 (2015), 27.3 (2016), 25.6 (2017) - Net acquisition of nonfinancial assets: 2.5 (2015), 2.6 (2016), 2.6 (2017) - Net lending(+)/borrowing(-) (Revenue minus expenditures): -2.1 (2015), -3.5 (2016), -1.3 (2017) - Adjusted non-hydrocarbon primary balance 3/: -29.0 (2015), -26.0 (2016), -24.5 (2017) - Gross central government debt: 16.6 (2015), 18.3 (2016), 17.8 (2017) - Net of government deposits in the banking system: 1.4 (2015), 2.6 (2016), 1.4 (2017) - Fiscal developments and actions: - Frontloaded fiscal consolidation in 2015 narrowed the adjusted non-hydrocarbon deficit by 8½ percentage points to 29 percent of non-hydrocarbon GDP in 2015. - Fiscal break-even oil price reduced to about $60 in 2015 from $79 in 2014. - Composition of consolidation in 2015: scaled back capital transfers to GREs, cut government investment, raised electricity and water tariffs, removed fuel subsidies. - Despite consolidation, overall fiscal balance turned to a deficit of 2.1 percent of GDP in 2015 due to lower oil prices; deficit mainly financed by drawing down government deposits. ### External sector and reserves (selected figures) - Hydrocarbon exports (in billions of U.S. dollars): 61.5 (2015), 54.5 (2016), 64.8 (2017) - Average crude oil export price (in U.S. dollar per barrel): 52.4 (2015), 45.3 (2016), 52.6 (2017) - Crude oil production (in millions of barrels per day): 3.0 (2015), 3.0 (2016), 3.1 (2017) - Current account balance (in billions of U.S. dollars): 12.3 (2015), 5.3 (2016), 12.2 (2017) - Current account balance (in percent of GDP): 3.3 (2015), 1.4 (2016), 3.0 (2017) - External debt (in percent of GDP): 60.2 (2015), 60.1 (2016), 56.3 (2017) - Gross official reserves 5/: 94.0 (2015), 95.1 (2016), 100.9 (2017) - Reserves in months of next year's imports of goods & services, net of re-exports: 6.9 (2015), 6.6 (2016), 6.5 (2017) ### Recent macro-financial developments and risks - Non-oil activity and inflation: - Non-hydrocarbon growth slowed to 3.7 percent in 2015. - Inflation eased to 1.4 percent year-over-year by end-March 2016. - Tighter conditions and credit risk: - Sizable fiscal consolidation and a real effective exchange rate appreciation have dampened non-oil growth and increased credit risk. - Deficit financing in 2015 contributed to liquidity pressures and tightening of monetary and financial conditions. - Macro-financial buffer assessment: - Large fiscal and external buffers and safe-haven status have helped limit negative inward spillovers and maintain robust risk appetite. ### Policy recommendations and structural reforms - Near-term fiscal policy: - Ease the pace of consolidation in the near-term to reduce its growth impact given headwinds from lower oil prices. - Ensure deficit financing strategy avoids tightening banking system liquidity and crowding out private sector credit. - Medium-term fiscal and structural measures: - Diversify revenue sources (VAT, excises, potential corporate tax). - Phase out subsidies and protect vulnerable groups. - Strengthen public financial management and debt management framework to address GRE and PPP contingent liabilities. - Financial sector reforms: - Implement pending central bank and banking law reforms to build a full macroprudential framework, strengthen supervision, upgrade safety nets, and improve resolution. - Continue phasing in Basel III standards and move toward risk-based supervision. - Economic diversification and competitiveness: - Continue structural reforms to raise productivity and competitiveness. - Improve the business environment and ease restrictions on foreign ownership in the new investment law. - Spur competition, upgrade education quality, promote innovation and entrepreneurship. - Facilitate SMEs’ and startups’ access to finance (approve the bankruptcy law, broaden credit bureau coverage). *Source: UNITED ARAB EMIRATES — STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION (July 5, 2016).* ### 5. The current account surplus declined sharply in 2015 to 3.3 percent of GDP from ### _cr16251 - 5. The current account surplus declined sharply in 2015 to 3.3 percent of GDP from ### External sector and reserves - Current account surplus declined sharply in 2015 to 3.3 percent of GDP from 10 percent in 2014, due to lower oil and gas prices. - Nonhydrocarbon exports remained resilient. - Tourism sector expanded in 2015, but at a slower pace. - Foreign direct investment remained steady and net foreign inflows increased significantly, driven by banks’ foreign borrowing. - Overall external balance improved. - Gross international reserves at the CBU increased to USD 94 billion in 2015 from 78.5 billion in 2014. - REER appreciated by 9.5 percent in 2015, due mainly to the stronger U.S. dollar (to which the Dirham is pegged), and higher relative price inflation in the UAE, before edging down 1.5 percent year-to-date by end-March 2016. - 3-month forward implied yield at 0.78 bps on April 29 (lowest in the GCC region). ### Banking sector: liquidity, funding, capitalization, asset quality - Domestic deposit growth slowed to 1.8 percent y-o-y at end–March 2016, reflecting lower government deposits. - Wholesale foreign funding increased to 11.8 percent of banks’ liabilities by end–March 2016 from 10.4 percent a year ago; mostly dollar-denominated with an average maturity of about 2.6 years. - Domestic credit growth at 7.6 percent y-o-y at end-March 2016. - Lending standards tightened, though to a lesser extent in Q1 2016. - Overall liquid asset ratio of 20.7 percent by end-March 2016. - NPLs rose slightly to 5.3 percent by end-March 2016, notably for SMEs. - NPL coverage by provisions remains at 108 percent. - Interbank rates increased in 2015 following the U.S. interest rate hike in December; higher costs of funding and weaker asset quality could weigh on profitability in 2016. - Financial risks in the banking sector assessed as moderate at end-Q1 2016; banks’ balance sheets remained strong and the credit to non-oil GDP gap estimated to have remained negative. ### Real estate sector and loan quality - Structural measures in 2014 (tightening industry self-regulation, higher real estate fees, tighter macroprudential regulation for mortgage lending) helped contain speculative demand and led to declining prices. - Dubai average residential prices fell by 11 percent in 2015 (reflecting oversupply and weak demand). - Abu Dhabi residential prices fell by 0.8 percent in 2015. - Nonperforming loans for construction and real estate development declined from 12.3 percent in 2013 to 7.5 percent by end-March 2016. - NPLs for household loans declined from 10 percent in 2013 to 4.9 percent by end-March 2016. - Developments do not appear to pose systemic risks for the financial sector. ### Government-related entities (GREs) and public debt - GREs continued to deleverage, making early repayments and lengthening maturities. - GREs debt servicing capacity remains limited with an average interest coverage ratio (ICR) of 2 as of end-June 2015. - Total public debt in Dubai at 126.2 percent of Dubai GDP in 2015; large maturities are due by 2018. - Net debt of GREs with an ICR lower than 1.5 estimated at about U.S. $20 billion at end-June 2015. - In Abu Dhabi, GREs have substantially reduced their debt. ### Macroeconomic outlook and key projections - Nonhydrocarbon growth projected to slow to 2.4 percent in 2016 due to fiscal consolidation, a stronger dollar, and tighter monetary and financial conditions; credit growth falling to 5 percent. - Over the medium term, nonhydrocarbon growth forecast to recover to above 4 percent supported by: - (i) expected improvement in oil prices and positive effects on confidence and financial conditions; - (ii) pickup in private investment in the run-up to Expo 2020 supported by robust private sector credit growth; - (iii) increased demand from Iran after easing of sanctions. - Growth in hydrocarbon production likely limited given global supply glut. - Inflation projected to decline to 3.3 percent in 2016. - Fiscal deficit expected to widen and current account surplus to decline in 2016 owing to lower oil prices, before improving over the medium term. - Credit to non-oil GDP gap forecast to remain negative over the medium term. - Credit to non-oil GDP to remain stable at 143.5 percent. ### Risks - Risks tilted to the downside. - External risks: - Further sustained drop in oil prices is the main external risk; transmission via export and fiscal revenue losses. - A $10 drop in oil prices would worsen fiscal and external balances by 4 and 3½ percentage points of GDP respectively assuming no policy response (see Risk Assessment Matrix). - A permanent $10 drop could reduce UAE GDP level by 2½ percentage points after five years assuming revenue losses are fully offset with expenditure cuts. - Falling government deposits could reduce banking liquidity; rising NPLs could weaken credit and non-oil GDP growth. - Higher U.S. interest rates and volatile global financial conditions could trigger rollover risks for banks and GREs, intensify liquidity strains, and further weaken confidence; additional appreciation of the dollar would weigh on competitiveness and external demand. - Slowdowns in other GCC countries could spill over via trade, tourism and asset prices; increased issuance to finance deficits in these countries could put pressure on liquidity and cost of funding. - Deterioration in the UK economy or large sustained depreciation of the pound following its decision to leave the EU would negatively impact UAE via FDI and tourism channels. - Possible rebalancing of oil markets or geopolitical tensions could raise global energy prices and support UAE fiscal and external positions. - Domestic risks: - Dubai megaprojects, if not implemented prudently, may create additional macro-financial risks to GREs and banks and to the fiscal position given the 2008/9 debt overhang. - Authorities reiterated commitment to strengthen GREs’ balance sheets. ### Policy recommendations and discussions - Gradual fiscal consolidation is key to reduce fiscal vulnerability and strengthen fiscal sustainability while cushioning growth. - 2015 non-hydrocarbon primary deficit exceeds level consistent with constant real per capita annuity for intergenerational equity by about 7.6 percent of non-oil GDP (Appendix I). - Authorities’ baseline plans: - Narrow nonhydrocarbon fiscal deficit by 8.6 percent of nonhydrocarbon GDP by 2021 (relative to 2015). - Balanced overall budget by 2018. - Planned measures: (i) implement VAT from 2018 at 5 percent; (ii) increase excise taxes on tobacco and alcohol and introduce on soft drinks from 2018; (iii) improve fees structure and collection; (iv) scale back grants and capital transfers to GREs; (v) stabilize public wage bill as a share of non-oil GDP and other expenses in real terms. - Staff view: pace of consolidation should be more gradual in near term and accelerated over medium term: - Lower near-term consolidation (notably in Abu Dhabi) by raising capital spending while improving efficiency. - Back-loaded additional consolidation of 2.1 percent of non-hydrocarbon GDP over medium term to further reduce gap to intergenerational equity level. - Suggested measures include: (i) gradually phasing out electricity, water and gas subsidies while protecting lower-tier consumers; (ii) introducing corporate income tax over the medium term at a low rate of 10 percent. - Illustrative fiscal scenarios and figures (in percent of non-hydrocarbon GDP unless otherwise indicated): - Authorities’ intended adjustment of the non-oil primary balance: 8.6 (total adjustment by 2021). - Staff-suggested additional adjustment (total additional adjustment 3/4): sequence by year (2016 to 2021): -1.5, 0.5, 0.5, 0.5, 0.6, 1.5, 2.1 (total 2.1). - a. Additional revenues: 0, 0.3, 0.3, 0.3, 0.3, 1.5, 2.7 (total 2.7). - b. Reduction in budgeted subsidies: 0, 0.2, 0.2, 0.2, 0.3, 0, 0.9 (total 0.9). - c. Additional investment (front-loaded easing): -1.5, 0, 0, 0, 0, 0, -1.5 (total -1.5). - Deviation between projected non-hydrocarbon primary deficit and level consistent with intergenerational equity: 6.6, 4.9, 4.1, 3.4, 2.4, 1.3 (2016–2021 sequence). - Gap breakeven to market prices (U.S.$): 18.9, 9.6, 2.7, -3.2, -8.2, -15.7 (2016–2021 sequence). - Cumulative fiscal deficits forecast at U.S $18.4 billion over 2016-21. - Financing recommendations: - Deficit financing should tap sovereign wealth funds or international capital markets instead of drawing down government deposits or incurring payment arrears to avoid crowding out private sector. - Abu Dhabi’s recent Eurobond issuance of $5 billion is welcome; further external bond issuance should be pursued. - Increased domestic sovereign issuance, including by Abu Dhabi, would deepen domestic debt markets, provide new funding sources and instruments for banks, and help substitute part of existing CBU certificates of deposits (about $31.4 billion by end-March). - To allow federal issuance, authorities should approve the Public Debt Law and the Trust law. - The CBU should use instruments as needed to support healthy liquidity and avoid unwarranted tightening of monetary conditions. - Exchange rate policy: - The longstanding peg should be maintained. - Given appreciation of the REER and deteriorated terms of trade, external position moderately weaker than level consistent with fundamentals; further fiscal adjustment needed to close the estimated current account gap. - Strengthen policy framework via enhanced liquidity forecasting and management, further development of money and debt markets, and reducing FX exposure of banks and corporates. *Source: IMF staff report (text unit provided).* ### 16. Fiscal policy should be supported by a stronger public financial management ### Fiscal policy should be supported by a stronger public financial management framework ### Public financial management (PFM) - Authorities should develop a consolidated forward-looking medium-term fiscal framework to set direction for fiscal policy in the UAE as a whole and align aggregate resource allocation with the 2021 vision. - The federal fiscal framework could be a benchmark for the local level; plans to introduce a five-year federal fiscal framework and to consolidate medium-term budgets for education and healthcare are welcome. - Abu Dhabi needs to adopt the prepared multiyear performance-based budgeting framework to provide clarity on fiscal strategy and strengthen the annual budget process, notably by approving budgets ahead of the fiscal year. - Strong PFM systems at the local level should: - increase budget credibility and comprehensiveness; - avoid earmarking of revenues; and - firmly control expenditures. - Authorities broadly concurred and indicated ongoing work to strengthen fiscal coordination and generalize accrual accounting. ### Public debt management and contingent liabilities - Gross public debt-to-GDP is projected to pick up to 17.0 percent in 2017, before decreasing over the medium term. - This ratio could double in a severe stress scenario with lower oil prices and higher default rate of GREs. - Staff analysis shows GREs’ leverage increased in the past with weaker fiscal positions and lower interest rates, which eventually necessitated large bailouts from local governments (see Appendix IV). - In the context of lower transfers to GREs and planned megaprojects, debt management frameworks should be strengthened to properly account for contingent liabilities from GREs and PPPs. - Dubai needs to develop contingency plans if a severe stress scenario materializes (Annex II). - Recent efforts by Dubai’s supreme fiscal council and Abu Dhabi’s debt management office to closely review GREs’ debt issuances are welcome and should be pursued. ### Risks to banking system and financial stability - Sustained lower oil prices, subdued non-oil growth, and strong interconnectedness with GREs pose risks to the banking system. - Lower oil prices have pressured banks’ liquidity and profitability via declining government deposits, lower net interest margins, and possible deterioration of asset quality. - A bottom-up default analysis from an additional $10 decline in oil prices suggests corporate sector probabilities of default would increase to the highest levels since 2009, worsening banking asset quality (see Appendix V). - In a severe scenario (sharp contraction in non-oil GDP and fall in real estate prices), the CBU’s credit risk stress test indicates capital adequacy ratios of five small to medium sized banks out of 22 would fall below the 12 percent capital requirement by 2018 (see Box 1). - Banking liquidity is expected to remain comfortable: liquidity risk stress test indicates the banking system would have enough high-quality liquid assets to meet obligations for a 30-day period under a stress scenario. - Buffers in the banking system are determined by bank-specific and macro factors, including oil prices. - The central bank should encourage banks identified in stress tests to strengthen capital and liquidity positions. ### Stress testing—key assumptions and outcomes (Box 1) - Credit risk stress test assumptions: - Exposure-at-default as of end-2015. - 60 percent loss-given-default (LGD). - Probabilities of default (PD) proxied by nonperforming loans net of write-offs. - Banks assumed to continue lending with credit growing at 2 percent. - Net income before provisions evolves in line with non-oil GDP. - PDs are a function of real GDP, Dubai real estate prices, and lagged PDs. - Downturn scenario: - GDP contraction of 3.5 and 1.6 percent in 2016 and 2017 respectively, and no growth in 2018 (compared to growth of 2.3, 2.5 and 3.1 percent in the baseline). - Real estate prices fall by 28.1 percent in 2016, 6 percent in 2017, and 5.3 percent in 2018. - Total increase in PDs by 3.8 times at end-2018. - Credit stress outcomes: - Average CAR declines from 17.8 percent to 15.7 percent under the downturn scenario. - Two small and three medium banks would be below the 12 percent minimum CAR, with an aggregate capital shortfall of AED 7.3 billion (0.4 percent of 2018 GDP). - CAR post stress by bank size: - Aggregate CAR (in percent) pre-stress by size: 17.8 (all local banks), 19.8 (Less than AED 30 billion), 17.5 (Between AED 30 and 120 billion), 18.1 (Larger than AED 120 billion). - CAR post stress: 15.7 (all local banks), 16.6 (Less than AED 30 billion), 12.4 (Between AED 30 and 120 billion), 15.3 (Larger than AED 120 billion). - Number of banks below 12%: 5 total; 2 (Less than AED 30 billion); 3 (Between AED 30 and 120 billion); 0 (Larger than AED 120 billion). - Aggregate capital (in AED billion) pre-stress: 292.7 (all local banks), 21.2 (Less than AED 30 billion), 86.6 (Between AED 30 and 120 billion), 184.9 (Larger than AED 120 billion). - Aggregate capital shortfall in AED billion: 7.3 (all local banks), 1.7 (Less than AED 30 billion), 5.6 (Between AED 30 and 120 billion), 0 (Larger than AED 120 billion). - Liquidity stress outcomes (LCR methodology, end-March 2016 data): - Baseline average LCR: 140 percent. - Adverse scenario average LCR: 128 percent (adverse includes additional 5-10 percent haircut on high-quality liquid assets on average and additional 5 percent run-off on stable deposits). - Overall, all banks would have LCRs above 100 percent under the adverse scenario; one medium bank would be slightly below 100 percent under both baseline and adverse scenarios. - Phase-in schedule provides banks until 2019 to reach 100 percent LCR. ### Regulatory and supervisory recommendations for the central bank and banking sector - Swift approval and implementation of the new central bank and banking law to: - further enhance central bank independence and governance; - align the macroprudential institutional framework with best practices, including giving the central bank responsibility for supervising all systemically important financial institutions; - enhance regulation and supervision in line with Basel core principles for effective supervision; - strengthen safety nets; and - improve the resolution framework. - Strengthen central bank institutional capacity and macroprudential tools. - Do not relax lending to stable resources ratio; implement LCR and NSFR as planned in both foreign and domestic currencies. - Maintain loan-to-value and debt service-to-income macroprudential measures; better monitor real estate markets and mortgage lending. - Continue central bank action to ensure credit risks are well provisioned before any distribution of banks’ profits; pursue draft regulation to phase in Basel III capital standards and ensure new additional Tier 1 and Tier 2 issuances align with Basel III. - Introduce capital charges for systemically important banks, counter-cyclical capital buffers, and dynamic provisioning. - Set limits to banks’ open FX positions, especially in currencies other than the US dollar. - Strictly enforce loan concentration limits for GREs and local governments. - Strengthen banks’ corporate governance, risk management, and address related-party lending, especially with GREs. - Continue risk-based supervision improvements and better risk-based allocation of supervisory resources. - Centralized Shari’ah Board approval is a positive step for Islamic banks’ governance. ### Government-Related Entities (GREs) - GREs should proactively manage debt profiles and upcoming debt repayments, using timely communication to guide market expectations and contain financial stability risks. - Improvements needed in GRE risk management, reporting, transparency, and governance. - Avoid transfer of maturing GRE debt to domestic banks to preserve banking sector stability; raising risk-weights on lending to GREs could deter such transfers. - Amendments to governance rules of publicly listed companies to better protect minority shareholders in GREs will help limit excessive leverage and related-party transactions. - Authorities noted GREs have made progress in repaying debt ahead of schedules and are not cash-constrained; GREs are not a major concern per authorities. ### AML/CFT and correspondent banking (de-risking) - Recent efforts: adoption of by-laws in 2015, launching national risk assessment, inclusion of AML/CFT requirements into risk-based supervision. - Further recommended actions: - timely conduct the national risk assessment; - enhance monitoring of domestic and cross-border financial flows; - upgrade regulatory requirements for banks and exchange houses; - improve availability and use of beneficial ownership information on legal persons and trusts; - speed up development of risk-based tools for assessing ML/TF exposure of banking and remittance activities and enhance mitigation of corresponding risks; - harmonize procedures for creating legal persons in free zones and monitor their activities. - These measures would help ease de-risking practices by correspondent banks. - A survey by the Arab Monetary Fund and Central Bank of the UAE observed some UAE banks had one or more correspondent banking relationships terminated, though most were able to establish or use alternative relationships. - Authorities remain concerned about de-risking and will continue dialogue with foreign regulators and banks. ### Structural reforms and diversification - Pursue reforms to strengthen competitiveness; address lagging business environment areas: starting a business, getting credit, enforcing contracts, streamlining exports procedures, resolving insolvency. - Maintain efficient public investment in infrastructure, including PPPs; Dubai’s new PPP framework is welcome and should be accompanied by stronger monitoring of contingent liabilities by the department of finance. - Transition toward a knowledge-driven economy (UAE Vision 2021) to raise productivity, which has been a drag on non-oil growth (see Appendix VI). - Supportive policies include: - relax restrictions on foreign ownership outside free zone areas; - improve access to international markets and global supply chains; - ease migration policies for highly-skilled workers; - foster competition; - upgrade quality of education; - harness innovation and use of new information and communication technologies. - New investment law should further ease FDI restrictions and avoid capital thresholds that could reduce attractiveness for innovative SMEs and startups. - Priority to innovation financing: the envisaged innovation fund is a positive step; improve frameworks for venture capital and crowd-funding. - Objective to reduce the oil share in GDP by a third over the next decade. ### Labor market, public employment, and SMEs - Improve public employment and labor market policies to spur private sector-led job creation for nationals: - control size and wages of the civil service; - improve skills-job match via education-for-employment plans and integrate soft skills into curricula; - promote entrepreneurship through re-skilling, business incubation, and support services; - use quotas, flexible work arrangements, childcare services, and active labor market programs to increase women’s participation. - Securities and Commodities Authority regulation sets, on a “comply or explain” basis, a quota of 20 percent of women in boards of listed companies. - SME finance: - SME lending estimated at 4 percent of total lending. - More than 77 percent of SMEs are reported lacking access to finance. - Inadequacy of insolvency framework hurts SME access to finance; swift approval of the bankruptcy law is a high priority. - Public funds should focus on guarantees and support services rather than direct lending. - Strengthen financial infrastructure, broaden credit bureau coverage, promote capital market financing of SMEs (listing, securitization). ### Statistics and data - Further efforts required to strengthen the statistical system: - continue progress on fiscal, monetary, and financial sector statistics; - improve national accounts and external sector statistics, including compilation of an international investment position; - compile labor market statistics; - strengthen coordination and data-sharing between federal and local statistical agencies; - broaden coverage of government statistics to GREs and of monetary and financial statistics to non-bank financial institutions. ### Staff appraisal and macroeconomic policy guidance - Persistently lower oil prices have increased macro-financial stability risks: fiscal and external positions weakened, economic activity softened, and credit risks upticked despite fiscal consolidation. - Large buffers built over time have helped limit negative inward spillovers and contain softening of investor appetite. - Recommended macroeconomic policy mix: - focus on gradual fiscal consolidation while maintaining the peg and employing a financing strategy that supports private credit growth; - greater fiscal consolidation than planned will be needed over the medium term to close the gap to the non-oil fiscal balance consistent with intergenerational equity and to support external sustainability; - given large buffers, ease the pace of consolidation in 2016 to minimize impact on growth when sentiment is weak; - maintain the peg as an anchor for price and financial stability; - enhance liquidity management, develop domestic debt markets, and reduce foreign exchange exposure of banks and firms; - deficit financing should tap into sovereign wealth funds and international capital markets, instead of drawing down government deposits or incurring payment arrears; - the CBU should stand ready to use its instruments if needed to support healthy liquidity. *International Monetary Fund staff report excerpt.* ### 30. In terms of composition, priority should be given to diversifying revenues and ### _cr16251 - 30. In terms of composition, priority should be given to diversifying revenues and ### Fiscal composition and current spending - Priority should be given to diversifying revenues and rationalizing current spending. - Authorities’ plans to introduce the VAT and increase excise taxes in 2018 are welcome, whose implementation should be followed by the introduction of a corporate income tax. - Remaining subsidies should be phased out while protecting lower-tier consumers. - Other current spending should continue to be curbed, while public investment should be preserved and its efficiency enhanced. ### Public financial management and debt frameworks - Public financial and debt management frameworks should continue to be strengthened. - Developing a consolidated forward-looking medium-term fiscal framework would assist the authorities in setting direction for fiscal policy in the UAE as a whole and aligning resource allocation with the 2021 vision. - Strong Public Finance Management systems at the local level are needed to increase budget credibility and comprehensiveness. - In the context of lower transfers by emirate governments to GREs and planned megaprojects, strengthening debt management frameworks is important to properly account for contingent liabilities from GREs as well as other Public-Private Partnerships (PPPs). ### Central bank and prudential framework reform - The ongoing revision of the central bank and banking law is an opportunity to strengthen prudential frameworks. - The new law should: - further enhance central bank independence and governance, - align the macroprudential institutional framework with best practices, - enhance regulation and supervision of the banking sector in line with global standards, - strengthen safety nets and improve the resolution framework. - In particular, the authorities should develop a fully-fledged macroprudential framework and, in the meantime, should not relax the existing measures aimed at containing systemic liquidity risks and vulnerabilities from the real estate sector. ### Banking regulation, supervision, and safety nets - CBU’s plans to strengthen regulation and supervision of the banking sector should be timely implemented. - Overall, the banking sector has enough capital and liquidity buffers to withstand an adverse shock. - Plans to encourage banks identified in the stress tests to strengthen their capital and liquidity positions are appropriate. - The CBU should continue to ensure adequate credit provisioning. - The CBU’s plans to phase in the Basel III capital framework, including capital surcharges for systemically important banks and counter-cyclical capital buffers, to strictly enforce loan concentration limits for GREs and local governments, to strengthen corporate governance, and to move toward risk-based supervision should be implemented as planned. - Ongoing efforts to strengthen the AML/CFT framework and address de-risking should also be pursued. ### Structural reforms to raise productivity and diversification - Structural reforms aimed at raising productivity, improving competitiveness and further diversifying the economy should be pursued. - Reforms should continue at the federal and local levels to improve lagging areas of business environment such as starting a business, obtaining credit, enforcing contracts, streamlining export procedures and resolving insolvency. - Transition towards a knowledge-driven economy should be accelerated; in this regard, the new investment law should ease restrictions on FDI. - Priority should be given to implementing the innovation strategy, notably by developing the policy framework for innovation financing such as venture capital and crowd-funding. - Private sector-led job creation for nationals would require: - controlling the size and wages of the civil service, - improving the skills-job match, and - promoting entrepreneurship. - To ease SMEs and startups’ access to finance, the bankruptcy law should be swiftly approved, public funds more focused on providing guarantees, the credit bureau coverage broadened, and market financing enabled. ### Statistics and data improvements - Further progress is needed in improving statistics. - Improvements in external sector, national accounts, trade and labor market statistics are needed. - Better coordination between the federal and the local levels is critical. - Building on significant progress made over the past year, the authorities should broaden the coverage of fiscal accounts and financial sector indicators. *International Monetary Fund* ### 36. It is recommended that the next Article IV consultation take place on the standard 12- ### _cr16251 - 36. It is recommended that the next Article IV consultation take place on the standard 12- ### Recommendation - It is recommended that the next Article IV consultation take place on the standard 12-month cycle. ### Real Sector Developments and Outlook - Overall growth slowed in 2015. - Growth is driven mostly by non-oil growth. - Transportation sector continued to expand (Traffic at Dubai International Airport, 2009–16: Passengers per month, cargo in tons per month, thousands, 3-month moving average). - Real GDP and components (Real GDP Growth, 2013−21 in annual percent change): - Real GDP growth: 4.7 (2013), 3.1 (2014), 4.0 (2015), 2.3 (2016 proj.), 2.5 (2017 proj.), 3.1 (2018 proj.), 3.4 (2019 proj.), 3.7 (2020 proj.), 3.4 (2021 proj.) - Real hydrocarbon GDP: 2.9 (2013), 0.8 (2014), 4.6 (2015), 2.0 (2016 proj.), 2.0 (2017 proj.), 2.0 (2018 proj.), 2.1 (2019 proj.), 2.1 (2020 proj.), 2.1 (2021 proj.) - Real nonhydrocarbon GDP: 5.6 (2013), 4.1 (2014), 3.7 (2015), 2.4 (2016 proj.), 2.7 (2017 proj.), 3.5 (2018 proj.), 4.0 (2019 proj.), 4.4 (2020 proj.), 4.0 (2021 proj.) - CPI inflation (average): 1.1 (2013), 2.3 (2014), 4.1 (2015), 3.3 (2016 proj.), 2.8 (2017 proj.), 3.1 (2018 proj.), 3.3 (2019 proj.), 3.5 (2020 proj.), 3.6 (2021 proj.) - Crude oil production (Thousand barrels per day / Millions of barrels per day as in tables and charts): - Crude oil production (Table 2, in millions of barrels per day): 2.8 (2013), 2.8 (2014), 3.0 (2015), 3.0 (2016 proj.), 3.1 (2017 proj.), 3.2 (2018 proj.), 3.3 (2019 proj.), 3.3 (2020 proj.), 3.4 (2021 proj.) - Real estate: Sales prices (Dubai, Abu Dhabi) and Rental prices (Dubai, Abu Dhabi) shown in Residential Real Estate Sales and Rental Price Index, 2009−16 (Index, Jan 2009=100); rents have shown a lagged response to declining real estate prices. ### Fiscal Developments and Outlook - The fiscal stance was contractionary, but the overall fiscal balance deteriorated in 2015. - Hydrocarbon-related revenues declined due to lower oil prices; government spending remained elevated. - Fiscal break-even oil prices and Brent/WEO comparisons indicate increased fiscal vulnerability; the gap between the break-even and the Brent prices has increased fiscal vulnerability. - Key consolidated general government finance indicators (Table 4, percent of GDP unless otherwise noted): - Total revenue: 40.8 (2013), 37.3 (2014), 28.5 (2015), 26.4 (2016 proj.), 27.0 (2017 proj.), 27.5 (2018 proj.), 27.5 (2019 proj.), 27.2 (2020 proj.), 27.0 (2021 proj.) - Expenditures: 30.4 (2013), 32.3 (2014), 30.6 (2015), 29.9 (2016 proj.), 28.3 (2017 proj.), 27.3 (2018 proj.), 26.3 (2019 proj.), 25.4 (2020 proj.), 24.7 (2021 proj.) - Net lending(+)/borrowing(-): 10.4 (2013), 5.0 (2014), -2.1 (2015), -3.5 (2016 proj.), -1.3 (2017 proj.), 0.2 (2018 proj.), 1.2 (2019 proj.), 1.8 (2020 proj.), 2.3 (2021 proj.) - Adjusted non-hydrocarbon primary balance (in percent of non-hydrocarbon GDP): -35.2 (2013), -37.6 (2014), -29.0 (2015), -26.0 (2016 proj.), -24.5 (2017 proj.), -23.5 (2018 proj.), -22.8 (2019 proj.), -21.6 (2020 proj.), -20.4 (2021 proj.) - Gross general government debt: 16.3 (2013), 14.2 (2014), 16.6 (2015), 18.3 (2016 proj.), 17.8 (2017 proj.), 17.2 (2018 proj.), 16.5 (2019 proj.), 15.8 (2020 proj.), 15.1 (2021 proj.) - Fiscal break-even oil price (US$ per barrel, Table 4, consolidated): - Fiscal break-even oil price: 69.4 (2013), 79.0 (2014), 60.1 (2015), 58.3 (2016 proj.), 57.4 (2017 proj.), 53.7 (2018 proj.), 51.6 (2019 proj.), 50.8 (2020 proj.), 49.9 (2021 proj.) - Dubai and Abu Dhabi government expenditure profiles and composition are shown (Figures and Tables 4b, 4c). ### Monetary and Financial Developments - Banking sector liquidity remains comfortable. - Debt issuance by banks has helped close funding gaps despite lower total debt issuance. - CDS spreads (Dubai, Abu Dhabi) were moderately higher. - Non-financial corporate debt continued to increase, as did debt-at-risk. - Monetary sector (Table 5, annual percent change unless otherwise indicated): - Credit to private sector: 3.5 (2013), 11.5 (2014), 8.7 (2015), 5.0 (2016 proj.), 6.1 (2017 proj.), 7.8 (2018 proj.), 8.7 (2019 proj.), 8.9 (2020 proj.), 8.7 (2021 proj.) - Broad money: 22.5 (2013), 8.0 (2014), 5.5 (2015), 5.6 (2016 proj.), 6.3 (2017 proj.), 6.4 (2018 proj.), 7.2 (2019 proj.), 7.8 (2020 proj.), 7.5 (2021 proj.) - Net foreign assets: 53.0 (2013), 16.2 (2014), -11.5 (2015), 2.2 (2016 proj.), 8.4 (2017 proj.), 3.9 (2018 proj.), -1.4 (2019 proj.), -5.1 (2020 proj.), -7.5 (2021 proj.) - Financial soundness (Table 7, percent): - Regulatory Capital to Risk-Weighted Assets: 19.3 (2013), 18.1 (2014), 18.3 (2015), 18.0 (2016q1), Conventional 18.7, Islamic 15.4 (as reported). - Non-performing Loans to Total Gross Loans 1/: 6.7 (2013), 5.6 (2014), 5.2 (2015), 5.3 (2016q1), Conventional 5.0, Islamic 6.8. - Return on Assets: 1.6 (2013), 1.7 (2014), 1.5 (2015), 1.5 (2016q1). - Return on Equity: 11.1 (2013), 13.9 (2014), 11.8 (2015), 12.0 (2016q1). ### External Sector Developments and Outlook - Current account surplus is declining amid lower oil prices. - Non-oil external deficits remain large. - Hydrocarbon exports are increasing as domestic consumption declines and production remains robust. - Diversification of export destinations is underway; Non-Oil Exports: Top partners include CHINA, HONG KONG, EGYPT, KUWAIT, SINGAPORE, OMAN, SWITZERLAND, SAUDI ARABIA, TURKEY, INDIA, REST OF WORLD (shares shown for 2007–14). - Foreign direct investment flows have increased steadily (FDI Inflows, FDI Abroad, Net FDI, 2005–15 in U.S. $ billions). - Key external statistics (Table 2 and Table 3): - Exports and re-exports of goods: 371 (2013), 343 (2014), 300 (2015), 304 (2016 proj.), 323 (2017 proj.), 338 (2018 proj.), 353 (2019 proj.), 368 (2020 proj.), 384 (2021 proj.) - Hydrocarbon exports (U.S.$ billions): 129.4 (2013), 101.9 (2014), 61.5 (2015), 54.5 (2016 proj.), 64.8 (2017 proj.), 68.7 (2018 proj.), 72.8 (2019 proj.), 76.9 (2020 proj.), 81.1 (2021 proj.) - Average crude oil export price (U.S. dollar per barrel): 110.0 (2013), 98.9 (2014), 52.4 (2015), 45.3 (2016 proj.), 52.6 (2017 proj.), 54.5 (2018 proj.), 56.5 (2019 proj.), 58.4 (2020 proj.), 60.1 (2021 proj.) - Current account balance (U.S.$ billions): 74.1 (2013), 40.3 (2014), 12.3 (2015), 5.3 (2016 proj.), 12.2 (2017 proj.), 11.0 (2018 proj.), 8.9 (2019 proj.), 9.5 (2020 proj.), 10.4 (2021 proj.) - Current account balance (percent of GDP): 19.1 (2013), 10.0 (2014), 3.3 (2015), 1.4 (2016 proj.), 3.0 (2017 proj.), 2.5 (2018 proj.), 1.9 (2019 proj.), 1.9 (2020 proj.), 2.0 (2021 proj.) - Gross official reserves (Table 2 / Table 3): 68.2 (2013), 78.5 (2014), 94.0 (2015), 95.1 (2016 proj.), 100.9 (2017 proj.), 104.0 (2018 proj.), 103.0 (2019 proj.), 99.1 (2020 proj.), 93.7 (2021 proj.) - External debt (percent of GDP): 44.3 (2013), 48.8 (2014), 60.2 (2015), 60.1 (2016 proj.), 56.3 (2017 proj.), 53.6 (2018 proj.), 50.8 (2019 proj.), 47.9 (2020 proj.), 45.4 (2021 proj.) - In months of next year's imports of goods & services, net of re-exports: 5.0 (2013), 6.0 (2014), 6.9 (2015), 6.6 (2016 proj.), 6.5 (2017 proj.), 6.2 (2018 proj.), 5.7 (2019 proj.), 5.2 (2020 proj.), 4.7 (2021 proj.) ### Business Environment and Government Indicators - UAE ranks favorably on a number of governance and competitiveness indicators, but there is scope for improvement. - Global Competitiveness Index Ranks by Category, 2015–16 (rank out of 140), examples: - Health and primary education: 38 - Higher education and training: 37 - Market size: 31 - Technological readiness: 30 - Innovation: 26 - Financial market development: 20 - World Governance Indicators, 2014 (0=minimum, 100=maximum) shown across Voice & Accountability, Political Stability, Government Effectiveness, Regulatory Quality, Rule of Law, Control of Corruption (comparisons with UAE, GCC, Singapore). - World Bank Doing Business, 2016 (rank out of 189) shows specific sub-indicators (Starting a business, Dealing with construction permits, Getting electricity, Registering property, Getting credit rights and information, Protecting investors, Paying taxes, Trading across borders, Enforcing contracts, Resolving insolvency) with UAE versus Advanced Economies and GCC. - Education and innovation policies need further improvement; school assessment comparisons include TIMSS and PISA scores (TIMSS 8th grade math; PISA 15-yr old science). ### Key Risks, Vulnerabilities, and Debt Profiles - Fiscal vulnerability increased due to a widened gap between fiscal break-even oil prices and market oil prices. - Non-hydrocarbon external deficits remain large, and diversification is ongoing but incomplete. - Non-financial corporate sector: rising debt and debt-at-risk (Debt-at-risk share indicators and ICR thresholds in Figure 4). - Dubai and Abu Dhabi maturing bonds and syndicated loans schedules show sizable debt service requirements across 2016–21 (Tables 6a and 6b), with total Dubai Debt and total Abu Dhabi debt presented in U.S. dollar millions. - Example aggregates (Table 6a): Total Dubai Debt across 2016–21: 61,312 (2016-21) with totals and beyond; Total, including GREs with minority ownership: 67,018 (2016-21) and overall totals in Table. - Example aggregates (Table 6b): Total Abu Dhabi Inc. across 2016–21: 28,178; Total Abu Dhabi debt: 32,195 (2016-21); Total Abu Dhabi debt, including banks: 43,028 (2016-21); totals including GREs with minority ownership shown. ### Selected Memorandum and Meta Indicators - Quota: SDR 752.5 million as of March 2016. - Population: 9.4 million, nationals: 1 million. - Per capita GDP-2014: $43,180; poverty rate: n.a.; unemployment rate: 4.2% (2009). - Local currency per U.S. dollar (period average): 3.67 (2013), 3.67 (2014), 3.67 (2015); thereafter shown as ".." in table. - Nominal GDP (in billions of U.S. dollars): 389 (2013), 402 (2014), 370 (2015), 376 (2016 proj.), 406 (2017 proj.), 431 (2018 proj.), 461 (2019 proj.), 494 (2020 proj.), 529 (2021 proj.) - Nominal GDP (in billions of UAE dirhams): 1,427 (2013), 1,476 (2014), 1,360 (2015), 1,380 (2016 proj.), 1,490 (2017 proj.), 1,584 (2018 proj.), 1,692 (2019 proj.), 1,815 (2020 proj.), 1,942 (2021 proj.) *Sources: Country authorities; Haver; Markit; HSBC; Reidin; Orbis; Bloomberg; Dealogic; NBS; World Bank; IMF staff estimates and calculations as presented in the source material.* ### Appendix I. Long-Term Fiscal Sustainability Analysis ### Appendix I. Long-Term Fiscal Sustainability Analysis ### Key findings - Under conservative baseline assumptions and using the permanent income hypothesis, the non-oil primary balance is lower than the level consistent with intergenerational equity. - The gap between projected deficits and the deficits consistent with a constant real per capita annuity was about 7.6 percent of non-hydrocarbon GDP in 2015. - With the gradual fiscal consolidation assumed in the baseline, the gap is projected to shrink to about 2.5 percent of non-hydrocarbon GDP by 2021. - Favorable persistent shocks could imply a smaller gap. ### Baseline and post-2021 assumptions - Projections until 2021 are based on staff’s macro-framework, including the WEO assumptions about the oil price. - After 2021, baseline scenario assumes: - flat hydrocarbon production - annual oil price growth of 2 percent - inflation of 2 percent - population growth of 1.5 percent - real return on assets of 4 percent ### Alternative scenarios considered - (i) lower population growth by 0.5 percentage point - (ii) lower real return on assets by 1 percentage point - (iii) lower oil price by $10 in 2016-21 and to remain constant thereafter - (iv) higher oil price by $10 in 2016-21 and to increase by 2 percent per annum in nominal terms thereafter *Source: IMF staff calculations.* --- ### Appendix II. Debt Sustainability Analysis ### Overall assessment - The UAE public debt is sustainable and its net financial assets are large when including sovereign wealth funds’ assets. - Gross debt-to-GDP is estimated at 16.6 percent in 2015, below the 2005-2013 average of 18.5 percent. - This ratio is projected to pick up to 17.0 percent in 2016, and to decrease over the medium term as the primary balance turns to surplus and growth picks up. - This ratio could double under a severe scenario with lower oil prices and higher defaults by GREs. - In Dubai, the debt ratio could triple if there is a severe shock to the real estate sector compounded with a global downturn. - These risks can be mitigated by the large fiscal buffers. ### Baseline scenario assumptions (selected) - Growth: - oil sector growth expected to remain broadly constant - non-oil GDP growth projected to slow to 2.4 percent in 2016, before gradually increasing to 4 percent over the medium-term - overall GDP growth projected to range between 2.3 and 3.7 percent over the medium term - Interest rates: - Effective interest rates projected to increase from 4.5 percent in 2016 to 6.2 percent in 2021 - Fiscal adjustment: - Path of the cyclically adjusted primary balance (CAPB) reflects fiscal measures adopted and authorities’ plans to contain current spending and diversify revenue - Financing: - Primary deficit expected to widen in 2016 before improving and turning to a surplus by 2018 - Gross financing needs expected to increase to [7.8] percent of GDP and to decrease over the medium-term - Part of the financing needs in the first two years would be provided by the sovereign wealth funds - Growth picking up above the interest rate would help lower debt-to-GDP ratios ### Quantitative projections and indicators (selected exact figures) - Gross debt-to-GDP: - 2015: 16.6 percent - 2016 (projection): 17.0 percent - Effective interest rate (selected years): - 2016: 4.5 percent - 2017: 5.6 percent - 2018: 4.9 percent - 2019: 6.1 percent - 2021: 6.2 percent - Real GDP growth (selected years baseline): - 2016: 2.3 percent - 2017: 2.5 percent - 2018: 3.1 percent - 2019: 3.4 percent - 2021: 3.4 percent - Primary Balance (percent of GDP, baseline): - 2016: -2.8 - 2017: -0.2 - 2018: 1.2 - 2019: 2.2 - 2021: 3.2 - Primary (noninterest) revenue and grants (aggregate over projection horizon shown): 162.6 (percent of GDP, table aggregate) - Primary (noninterest) expenditure (aggregate over projection horizon shown): 156.3 (percent of GDP, table aggregate) ### Debt dynamics drivers (components, as presented) - Identified debt-creating flows and contributions include: - Primary deficit (explicit yearly values in table; e.g., 2015: -5.8 percent of GDP) - Automatic debt dynamics derived from interest rate/growth differentials - Residual, including asset changes and interest revenues (projections include exchange rate changes) - Residual contribution examples (table): - 2014: 15.0 (percent of GDP) - 2015: 3.4 - 2016: -1.0 - 2021: 4.4 --- ### Debt sensitivity and Stress Test Scenarios ### Stress-test results and scenarios (selected exact outcomes) - Combined lower oil prices with GREs defaults: - Assumes lower oil prices by $10 with 20 percent of GRE debt taken over by the government in 2017-21 - Total debt-to-GDP in the UAE will double to 31 percent by 2021 - Combined global downturn with a real estate shock (Dubai): - Combines a sharp decline in GDP growth with a real estate shock and government takeover of 20 percent of total GREs debt in 2017-21 - Total debt in Dubai would increase by about 40 percentage points of its GDP ### Alternative scenarios (baseline vs shocks, selected figures) - Oil price shock (oil price lower by $10 in 2017-21): - Primary balance deteriorates to 0.9 percent of GDP in 2021 - Government debt rises to 26.1 percent of GDP in 2021 - Gross financing needs rise to 7.4 percent of GDP in 2021 - GRE contingent liability (20 percent of GRE debt taken over by government in 2017-21): - Primary balance deteriorates to 2.2 percent of GDP in 2021 - Government debt increases to 20.1 percent of GDP in 2021 - Gross financing needs increase to 3.6 percent of GDP in 2021 - Combined scenario (oil price shock + GRE contingent liability): - Primary balance deteriorates to -0.1 percent of GDP in 2021 - Government debt rises to 32.1 percent of GDP in 2021 - Gross financing needs rise to 10.9 percent of GDP in 2021 --- ### Dubai Government Debt Sustainability ### Summary of risks and outcomes - Dubai’s government debt sustainability has improved but remains vulnerable to severe shocks. - Scenario outcomes (selected exact figures): - A sharp decline in GDP growth in 2016 (by ¾ standard deviation from the baseline) and gradual recovery in 2017–21 would raise the debt-to-GDP ratio by about 8.8 percentage points in 2021 compared to the baseline. - Under a severe global downturn scenario (real GDP shock, lower real interest rates, deterioration in primary balance), Dubai’s government debt would increase to about 32.2 percent of GDP in 2021. - A scenario combining a global downturn with a real estate shock, where the government takes over 20 percent of GREs’ total debt in the medium term, would imply a government debt-to-GDP ratio of 59.6 percent in 2021 (three times the baseline). ### Dubai numerical path (selected table entries) - Dubai government debt (percent of Dubai GDP, historical and projected): - 2013: 34.5 - 2014: 31.3 - 2015: 30.2 - 2016 (baseline projection): 28.2 - 2021 (baseline projection): 19.5 - Alternative scenario outcomes for 2021: - A1. Real GDP growth shock: 28.3 percent of GDP - A2. Global downturn scenario: 32.2 percent of GDP - A3. Real estate shock with global downturn: 59.6 percent of GDP --- ### External Debt Sustainability Framework (selected metrics) ### Baseline external debt path (percent of GDP) - External debt-to-GDP: - 2014: 48.8 - 2015: 60.2 - 2016 (projection): 60.1 - 2017: 56.3 - 2018: 53.6 - 2019: 50.8 - 2020: 47.9 - 2021: 45.4 - Change in external debt (selected years): - 2015: 11.4 - 2016: -0.1 - 2017: -3.8 - 2021: -2.6 ### Identified external debt-creating flows (selected contributions, percent of GDP) - Current account deficit, excluding interest payments: - 2015: -5.4 - 2016: -3.8 - 2017: -5.6 - 2021: -4.9 - Automatic debt dynamics (2015): 6.3 (percent of GDP) - Contribution from nominal interest rate (2015): 2.1 - Contribution from real GDP growth (2015): -2.1 - Contribution from price and exchange rate changes (2015): 6.3 ### Gross external financing need (selected) - Gross external financing need (in billions of US dollars): - 2011: 34.4 - 2015: 85.9 - 2016 (projection): 99.8 - 2017 (projection): 95.4 - 2021 (projection): 107.3 - In percent of GDP (selected): - 2011: 9.9 - 2015: 23.2 ### External debt vulnerability tests (Figure highlights) - Bound tests include interest rate shock, current account shock, growth shock, combined shock, real depreciation shock (one-time real depreciation of 30 percent in 2010 is noted as historical shock). - Example baseline and scenario averages shown in figures (exact averages embedded in charts for respective variables). --- *Italic: Appendix I. Long-Term Fiscal Sustainability Analysis; Appendix II. Debt Sustainability Analysis — IMF staff, as presented in the source PDF.* ### Appendix III. United Arab Emirates: External Sector Assessment ### Appendix III. United Arab Emirates: External Sector Assessment ### Overall Assessment - The UAE’s external position is moderately weaker than suggested by fundamentals. - The peg to the US dollar continues to serve the UAE well. - Projections over the medium term show a current account gap that could be closed with fiscal policy adjustment. - The decline in the oil price reduced the current account surplus in 2015 and is expected to further reduce in 2016. - The projected upward trend in oil prices will improve the current account over the medium term. - EBA-lite approaches project a current account gap in 2016, but the very strong external balance sheet and access to capital markets are mitigating factors. - Given high import content (labor as well intermediate inputs) of non-oil exports, exchange rate adjustment would have only a limited impact on external competitiveness and would mainly affect the external position through its impact on the fiscal balance. - External adjustment should be driven by direct fiscal adjustment rather than fiscal adjustment via the exchange rate to maintain the peg as a credible anchor for prices and financial stability. ### I. Foreign Asset and Liability Position and Trajectory - NIIP is estimated at 181 percent of GDP at end-2015, mainly dominated by assets held in the Sovereign Wealth Funds (SWFs). - Central bank international reserves are estimated at 25 percent of GDP by end-2015 or 6.9 months of imports. - External liabilities were 52 percent of GDP (portfolio 3% and debt 49%). - Projections suggest the NIIP over GDP ratio will remain broadly stable over the medium term. - Assessment: external balance position is sustainable. - EBA-lite external sustainability (ES) approach: for 2015 there is a current account gap of 3.3 percent reflecting suboptimal savings. - Macro balance approach: current account balance required to preserve income constant on a real per capita basis is 4.4 percent of GDP in 2015, implying a current account gap of 1.1 percent of GDP. - Under the baseline, improvements in the current account balance are expected to marginally reduce some of the shortfall over the medium term, suggesting a need to save a bigger share of the oil wealth. - CA gap varies between about 0.2 and 8 percent of GDP for 2016 across scenarios. - The substantial assets held under the SWFs represent both savings for future generations and protection against oil price volatility. ### II. Current Account - Oil exports represented only 30 percent of exports of goods over 2013-15 (or 42 percent of exports excluding re-exports). - The current account surplus fell from 10 percent of GDP in 2014 to 3.3 percent in 2015 due to the sharp decline in oil prices. - Non-oil exports remained resilient. - Projected moderate pick-up in oil price over the medium term is expected to help maintain a current account surplus. - EBA-Lite CA model predicts a CAB of 4.1 percent of GDP for 2015 based on actual policies, and estimates a cyclically adjusted CA gap of [0.8] percent of GDP. - The 2015 cyclically-adjusted CA is broadly in line with the level implied by medium-term fundamentals and desirable policies (i.e., the gap would be removed if the desirable fiscal policy setting is achieved). - The 2015 current account gap was mostly driven by fiscal policy. ### III. Real Exchange Rate - Dirham pegged to the U.S. dollar at a rate of 3.67 since November 1997. - The REER appreciated by 9.5 percent over 2015 and by about 20 percent compared to a decade ago. - Recent REER appreciation driven mostly by the U.S. dollar nominal appreciation vis-à-vis trading partners’ exchange rate. - Indirect estimates of the REER (relying on the CA and ES approaches) suggest an overvaluation within 1 to 7 percent. - The REER index model suggests the exchange rate was overvalued by 26 percent in 2015, from 8 percent in 2014. - Staff assesses the 2015 average REER as moderately overvalued, within a range of 2 to 10 percent, compared to the level implied by medium-term fundamentals and desirable policies. - Exchange rate movements have limited impact on the current account; external current account adjustment will occur through further fiscal consolidation. ### IV. Capital and Financial Accounts: Flows and Policy Measures - Capital inflows are dominated by stable FDI, inflows to the banking sector, and external debt issuances; outflows are largely trade credits and portfolio investment. - Capital account is open and domestic capital markets are the most developed in the region with significant portfolio and investment inflows. - Steps to further attract FDI inflows are ongoing. - The overall external balance sheet remains very strong. - Assessment: There are no immediate risks or vulnerabilities associated with capital flows. ### V. FX Intervention and Reserves Level - External assets are composed of the CBU’s international reserves and assets held under the SWFs. - SWFs’ assets play a dual role: precautionary motives and savings for future generations. - Assessment: External assets are more than adequate for precautionary purposes (measured by the Fund’s metrics). - A larger current account surplus and resulting NIIP accumulation would be needed to ensure real per capita income can be maintained at a constant level when oil wealth is exhausted. - A gradual fiscal adjustment over the medium term would help attain this objective. ### Table Summary (External Stability Results) - CA gap (ES Approach): -4% - REER gap (ES Approach): 7% - CA Approach gap: -1% and 1% (two entries in table) - REER Index Approach: 26% --- ### Appendix IV. Performance and Risks Posed by Government Related Entities (GREs) ### Key Findings on GREs and Fiscal/Financial Risks - UAE’s balance sheet as a whole is strong, but GREs pose significant fiscal and financial stability risks. - Publicly-held government debt is small, while fiscal and external buffers are large; accounting for GREs' debt reveals the full scale of sovereign risk. - Rollover risks have increased with large fiscal financing needs and the lift-off of the US interest rate. - Worsening domestic and external conditions might increase GRE leverage and default probability, straining financial system and fiscal accounts. ### GREs History and Debt Dynamics - GREs strengthened their finances, especially in Abu Dhabi, after restructuring following the 2008-09 crisis. - GREs’ debt in relation to GDP decreased in both Abu Dhabi and Dubai over the past six years. - Total public debt (including GREs’ debt) in Dubai was 126.2 percent of Dubai’s GDP in 2015, with large maturities due by 2018. - Staff estimates: Dubai GREs debt amounted to 66.6 percent of Dubai GDP in 2015. - In 2015, Abu Dhabi GRE debt reached 27.4 percent of Abu Dhabi GDP. - Share of bonds in GRE debt increased from 39 percent in 2010 to 46 percent in 2015. - In Abu Dhabi, bonds increased from 32 percent of total Abu Dhabi GREs’ debt in 2010 to 67 percent in 2015. - By international comparison, GREs’ outstanding bond debt for the UAE is among the highest in the GCC region but much lower than in many developed European countries. ### Debt Servicing Capacity and Rollover Risks - GREs’ interest coverage ratio (ICR) about 2 in 2014 versus about 10.9 for the overall corporate sector in 2014. - “Debt-at-risk” (ICR < 1.5) has increased to about US$20.4 billion. - Low return on assets (below 5 percent) and high leverage underlie reduced servicing capacity. - Maturities due in 2016-18 total about US$80.5 billion: US$51.6 billion for Dubai and over US$28.9 billion for Abu Dhabi. - Risks: tightening domestic liquidity, competition from local governments to finance deficits, possible reversal of capital inflows, and most corporate debt being denominated in foreign currency could increase forward exchange rate premium. ### Contingent Fiscal and Financial Risk Scenario - A scenario where the government would take over 20 percent of GREs’ debt would raise the government debt-to-GDP ratio to 32.1 percent, versus 14.1 percent of GDP in 2016 under the baseline. - Loans to GREs increased by 6 percent so far in 2016 and correspond to about 7.6 percent of the assets of the banking sector. - Greater corporate leverage could reduce firms’ resilience and quickly spill over to the financial sector. ### Drivers of GRE Leverage and Policy Recommendations - Panel regression: change in GRE assets/equity depends on firm-specific factors (size, profitability, ICR, asset tangibility) and macro/financial factors (non-hydrocarbon primary government deficit, oil price, UAE interbank rate, US dollar index, VIX, corporate spreads). - Individual firm factors, especially profitability, are important; fiscal position and financial/monetary conditions also significantly impact leverage. - Containing GRE borrowing is a pre-condition for fiscal sustainability and financial stability at emirate level; requires strong institutional framework. - Recommendation: function of debt management office in Abu Dhabi is a good example to be undertaken at the federal level. - Any borrowing at the emirate level should require assent of the emirate finance department to signal market stability and debt sustainability. - Improved corporate governance and transparency needed: delineate commercial vs noncommercial GRE operations, clarify government support strategy, standardize accounting/auditing/financial reporting, increase information disclosure, improve risk management. --- ### Appendix V. Effect of Lower Oil Prices and Higher Short-Term Interest Rates on Default Risk and Liquidity Buffers ### Model and Scenarios - Probabilities of default (PDs) assessed using the National University of Singapore (NUS) forward intensity model. - Model calibrated with monthly data January 1990–December 2015 for 74 listed UAE firms: 17 banks and 57 other firms (47 private, 10 GREs). - PDs are functions of common and firm-specific risk factors (stock market index, short-term interest rate, distance-to-default, profitability, size, market-to-book value, idiosyncratic volatility) driven by macro factors (oil price changes, real nonoil GDP growth, consumer price inflation, changes in three-month EIBOR). - Scenarios: - Baseline consistent with 2016-21 macroeconomic framework. - Oil shock: sudden but permanent $10 reduction in oil prices throughout 2021 and a cumulative 1.7 percent decline in nonoil GDP (relative to baseline) over 2016-21 associated with gradual fiscal consolidation to eliminate additional fiscal deficit from lower oil revenues. Fiscal multiplier of 0.5. - Interest rate shock: increase of 100 bps in the EIBOR interbank rate both in 2016 and 2017. ### Probabilities of Default Results - PDs for the 74 listed firms are low but rising. - Under the adverse oil shock scenario, corporate sector PDs would increase to the highest levels since 2009. - During the financial crisis, average PD for the 17 UAE banks spiked to 100 bps while average PD for other UAE firms peaked at 38 bps. - Average PD for UAE banks declined to 7.2 bps in May 2013 but has since been higher than PD for other firms. - GREs’ PDs have been trending down on average, though sample is small and may understate risks. - Under both lower oil price and higher interest rate scenarios, PDs for UAE banks and other UAE firms are projected to significantly increase; under the adverse oil shock with economic slowdown, PDs are forecast to spike to the highest levels since the 2009 crisis. ### Bank Liquidity Buffers: Determinants and Effects - Liquidity buffers proxied by: - inverse of loan-to-deposit ratio, - interbank assets-to-interbank deposits ratio, - liquid assets-to-customer deposits and short-term funding ratio. - Explanatory variables include total assets (log), ROA, Tier 1 capital ratio, cost-to-income ratio, net loans-to-total assets ratio, net interest margin, change in Fed funds rate (percentage points), percentage change in Brent oil prices, government deposits, and non-oil GDP. - Sample: 17 domestic banks for 2005:Q1–2015:Q4 (unbalanced panel, fixed effects, clustered SEs, quarterly seasonality dummies). ### Estimation Findings and Policy Implications - Both bank-specific and macroeconomic factors play a role in determining liquidity buffers. - Liquid assets-to-customer deposits and short-term debt ratio appears affected by oil price changes: higher oil prices can lead to higher customer deposits and higher liquidity buffers. - Macroeconomic factors may affect deposits and loans simultaneously, reducing statistical significance for loan-to-deposit ratio dynamics. - Policy recommendations: - Strengthen liquidity and capital requirements in line with Basel III. - Strengthen banks’ corporate governance. - Ensure adequate provisioning and strengthened capital requirements for banks. - Enforce loan-concentration limits and tight control of related-party lending. - Encourage transparency on maturity mismatches in market disclosures. - Diversify funding sources, strengthen treasury function, and maintain a cushion of high-quality liquid assets. - Develop safety nets and resolution frameworks further, and continue strengthening the AML/CFT framework. - Observed disclosure gap: limited information on projected cash flows on a contractual basis indicates a short-term liquidity gap within the three-month maturity bucket in UAE banks and liquidity surpluses in longer maturity buckets. --- *Source: IMF staff estimates as presented in Appendix III–V, Appendix III. United Arab Emirates: External Sector Assessment.* ### Appendix VI. Competitiveness and Economic Diversification in the ### Appendix VI. Competitiveness and Economic Diversification in the Context of Fiscal Consolidation ### Overview: transformation and objectives - The UAE has seen remarkable transformation and authorities have ambitious goals for further economic diversification to position the country so that it can celebrate its last barrel of exported oil. - Diversification strategy emphasized: promote private sector-led, knowledge-driven, export-oriented growth. ### Output growth and volatility - Output growth volatility is still largely driven by oil. - Within the GCC, the UAE is the third fastest growing economy and its output has been the least volatile after Bahrain. - When compared to countries that managed to successfully diversify away from commodity exports such as Chile, Indonesia, Malaysia and Mexico (CIMM), the UAE’s average growth was favorable, but output volatility was significantly higher. - The non-oil economy grew by 3¾ percent in 2015. ### Status of economic diversification and export structure - Indicators of diversification: the UAE compares favorably with the GCC but lags behind CIMM on both diversity and level of sophistication of exported goods. - Export quality: the UAE compares favorably with the region, and Chile and Indonesia but lags Malaysia and Mexico. - Overall export quality in the UAE has increased over time but improvements have been uneven and concentrated in hydrocarbon and chemical products. - The quality of exported goods requiring higher labor skills (manufactured goods, machinery and transport equipment) declined. - The UAE produces very low levels of high technology goods when compared to CIMM. ### Where the UAE’s gaps are - Low and declining productivity has been a drag on non-oil growth. - Non-oil growth has been driven by capital accumulation financed from oil receipts, and a rapid expansion of imported foreign labor. - Competitiveness strengths: infrastructure and the quality of the macroeconomic environment compare very favorably with advanced economies. - Competitiveness weaknesses: innovation, financial market developments, higher education and training, and business sophistication compare less favorably with advanced economies, though favorably with peers including CIMM. - Business environment bottlenecks that could limit diversification prospects include the cost of starting a business and trading across borders. - National accounts and statistical issues: the base year for GDP estimates is 2007 and is therefore outdated; the practice of summing GVA compiled by three different agencies to derive national GDP is not advisable and should be discontinued. ### Policy recommendations and reform priorities - Reforms should focus on developing the private sector, transitioning toward a knowledge-driven economy, and expanding export industries. - Further developing the private sector: - Strengthen competitiveness to improve lagging areas of the business environment while preserving macroeconomic and financial stability and maintaining world-class infrastructure. - Ease SMEs’ and startups’ access to finance and provide targeted public support to incubate businesses, access markets and raise productivity. - Design incentives for nationals that favor entrepreneurship instead of public employment or rent-seeking. - Accelerating transition toward a knowledge-driven economy: - Facilitate technology transfer through further openness to foreign direct investment, trade and migration of highly skilled people. - Foster competition by lowering barriers to entry and reducing the public sector footprint to raise efficiency. - Boost innovation via higher R&D spending, better linkages between firms and universities, improved intellectual property rights framework, more integration into global supply chains, and adequate financing. - Authorities’ plans to set up an innovation fund are welcome to provide seed money, but need to be accompanied by private sector funding through venture capital and crowd-funding. - Continue enhancing the quality and relevance of education and training, and promote diffusion and use of information and communication technologies, including electronic and mobile government services. - Developing exporting industries: - Pursue a mix of vertical diversification in existing export industries and horizontal diversification through suppliers’ clusters into high-value-added and innovation sectors. - Policies include better access to international markets, incentives to make export sectors more attractive than non-tradables, tailored export promotion services (marketing, standardization, financing and guarantees), and creation of platforms for industrial clusters. ### Key statistics and fiscal/diversification context - Non-oil economy growth in 2015: 3¾ percent. - Non-oil activities contribution to GDP: more than two thirds. - Historical non-oil share (1980s): 20 percent. - National accounts base year: 2007 (described as outdated). *Appendix VI. Competitiveness and Economic Diversification in the Context of Fiscal Consolidation (from the provided IMF content)* ### 3. The growth outlook is expected to somewhat moderate in 2016 amid low oil prices ### 3. The growth outlook is expected to somewhat moderate in 2016 amid low oil prices ### Growth outlook and drivers - Growth is expected to somewhat moderate in 2016 amid low oil prices and a slowdown in investments due to the continued commitment for fiscal consolidation. - Investments related to Expo 2020 are expected to support higher growth from 2017 onwards, including: - expansion of the national network of airports and rail network, - air and maritime transport means, - roads, - tourism facilities, - real estate, - the knowledge based economy. - The authorities plan to further reduce the contribution of oil to GDP to less than 20 percent by 2021, as per the National Vision 2021. - Authorities are preparing to launch a post- oil strategy and “celebrate the country’s last barrel of exported oil.” ### Fiscal policy: adjustment, measures, and financing - The authorities undertook a significant fiscal adjustment in 2015 amounting to 8.5 percent of non-hydrocarbon GDP. - Measures implemented in 2015 included: - raised electricity and water tariffs, - removed fuel subsidies by moving to a market-based pricing of gasoline and diesel, - Abu Dhabi scaled back capital transfers to Government-Related Entities (GREs) and reduced investment. - Despite measures, an overall fiscal deficit emerged in 2015 equivalent to 2.1 percent of GDP. - Authorities’ fiscal target: reach a balanced budget by 2018 using conservative assumptions on oil prices. - Fiscal consolidation plans for 2016: - frontloaded adjustment in the Emirate of Abu Dhabi, - slight consolidation in the Emirate of Dubai and at the federal level. - Revenue and tax policy plans: - reduce dependence on hydrocarbon fiscal revenues and diversify non-oil revenues, - plans for a value-added tax in the context of a GCC-wide initiative at a rate of 5 percent are underway to be introduced in 2018, - increase in excise taxes on tobacco and alcohol and a tax on soft drinks. - Spending-side plans: - continue scaling back grants and capital transfers to GREs, - stabilize the wage bill as a share of non-oil GDP, - gradually phase out electricity, water, and gas subsidies (authorities agree with staff on this medium-term measure). - Corporate taxation: authorities have initiated a study to analyze the impact of the introduction of a corporate income tax to inform possible introduction, timeline, and rate. - Financing strategy for deficits: authorities agree with staff that financing should include tapping international capital markets or the sovereign wealth funds while limiting drawing down government deposits in domestic banks. - Example: in April 2016, the Abu Dhabi government issued US$5 billion in Eurobonds to finance its deficit, its first issuance since 2009. ### Fiscal coordination, transparency, and GREs - Progress made: - substantial progress in fiscal coordination and reporting, - development of a fiscal framework at the federal level, - plans to introduce a five- year federal fiscal framework and strengthen fiscal coordination at the local level. - Systems and institutional links: - Dubai’s fiscal system has been electronically linked to that of the federal government, - Government Financial Policy Coordination Council aims to complete electronic linking between federal and local systems. - Ministry of Finance signed a cooperation agreement with the UAE Central Bank to enhance cooperation in monetary statistics and government financial and banking information. - GREs: - GREs have made considerable progress in restructuring and financing their debts by making early repayments and lengthening maturity profiles, - GRE financial positions have strengthened and are not cash constrained, - authorities will continue to monitor GRE activities and aim to increase transparency and disclosure, - Dubai’s Supreme Fiscal Council and the Abu Dhabi Debt Management Office have closely reviewed GREs’ debt issuance, - bank exposure to GREs is bound by concentration risk limits set by the central bank. ### Monetary policy and financial stability - Exchange rate policy: - the exchange rate peg has served the UAE well and has been an important element of stability for decades, - authorities agreed with staff that planned fiscal consolidation would further bolster confidence in the stability of the exchange rate system. - Central bank role and banking sector soundness: - the CBUAE has been effective in preserving financial stability, - the banking sector remains highly capitalized and profitable, with a capital adequacy ratio largely exceeding the minimum requirement of 12 percent, - CBUAE will continue close monitoring of liquidity, which has been robust, and stands ready to provide liquidity support as necessary, - the central bank has ensured credit risks are well provisioned before any distribution of bank profits, contributing to strengthened capital buffers, - CBUAE will continue to monitor real estate markets and mortgage lending and stand ready to calibrate macro-prudential measures if needed. - Regulatory and macro-prudential reforms: - new central bank and banking law is under preparation to enhance central bank independence and governance and set up a sound institutional framework for financial stability oversight, - CBUAE is reviewing and updating regulations to strengthen the prudential framework in line with Basel III requirements: - issued in 2015 a regulation on liquidity requirements, - prepared a draft regulation to phase in Basel III capital standards from 2016 onwards, with the expectation to fully implement it by end-2018, - developed new regulations covering risk management (under discussion with the banking sector), - plan to review the regulatory framework for non-bank financial institutions and engage stakeholders by end-2016, - recent approval of a centralized Shari’ah Board to provide regulatory support to Islamic financial institutions on Shari’ah governance. - Stress testing and resilience: - staff analysis and CBUAE stress testing point to banking sector resiliency to severe shocks: - CBUAE top-down solvency stress test suggested few medium and small banks would be adversely affected, - all banks would have liquidity coverage ratios above 100 percent in liquidity risk stress testing, - CBUAE is working on establishing a financial stability stress index to identify vulnerabilities and monitor banking system risks. - Brexit and international linkages: - due to limited interconnectedness between the UAE and the UK financial systems, CBUAE does not expect a significant impact from the UK’s decision to leave the EU, - UAE banks do not depend on foreign interbank markets to fund their balance sheets and have a consolidated net foreign interbank position that is positive, - CBUAE will continue to monitor developments from the Brexit vote and implications for the UAE economy. - AML/CFT and de-risking: - authorities have strengthened the AML/CFT framework and addressed de-risking issues: - adopted the by-law, - upgraded regulatory requirements for banks and exchange houses, - improved availability and use of beneficial ownership information of legal persons established in the UAE, - enhanced monitoring of cross-border financial flows, - Anti- Money Laundering and Suspicious Cases Unit at the central bank will continue capacity building and bolster regional and international cooperation, - these efforts prepare for the next round of mutual evaluation of UAE’s AML/CFT framework scheduled for 2022, - authorities conducted the AML/CFT national risk assessment and have asked for the Fund’s technical assistance, - authorities seek Fund involvement to increase awareness of concerned regulators and ease capacity constraints on de-risking issues. ### National Vision 2021 and structural reforms - Vision 2021 objectives and status: - launched a national agenda in 2014 to ensure achievement of Vision 2021 by setting measurable objectives and monitoring progress, - vision aims to make the UAE among the best countries in the world in terms of global competitiveness and efficiency by the Golden Jubilee, - focus on transitioning to a knowledge-based economy promoting innovation, research, and development based on improvements in the business environment and attractiveness to foreign investment, - as of 2015, the country ranks in the first place in government efficiency and holds the 17th position for global competitiveness. - Industrial and energy plans: - initiative to double the manufacturing sector’s share of the economy from 11 percent to 20 percent by 2025 through improved innovation and energy-efficient manufacturing, - launch of a number of clean and renewable energy projects to enhance competitiveness and sustainability and preserve the environment. - Government modernization and governance: - Smart Government Initiative “24/7/365” launched successfully in 2015, - new regulation aims to increase women participation to 20 percent of members of the boards of listed companies, on a “comply or explain” basis. - SME and labor policy support: - continued support for small and medium enterprises (SMEs), which employ most of the labor force in the UAE: - central bank set up a work force for implementation of a strategy in support of SMEs in coordination with stakeholders as established by Law 2 of 2014, - Ministerial Development Council reviewed executive regulations for SMEs to enhance sector potential and support entrepreneurs in line with UAE Vision 2021, - central bank is planning to issue new regulations to mobilize credit to the SME sector to mitigate risks and increase SME share in banks’ lending, - labor policy will continue to focus on increasing employment of nationals in the private sector. *IMF staff report excerpt.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16251.pdf_