Oil price movements have repercussions for countries across the world, although varied. A fall in oil prices bodes well for importing countries like India, but not for oil exporters. In 2014, when oil prices fell sharply, oil exporting nations—primarily the Gulf Cooperation Council (GCC)—were all over the news.
The fall in oil prices brought about a contraction in their GDP. Fiscal break-even oil prices (prices at which crude oil revenues of a country enable a balanced government budget) were frequently doing rounds in the media. In the aftermath of low prices, many GCC nations sought to ration their expenses and reduce their dependence on oil. In matters of diversifying the economy, the UAE comes to the forefront with two of its emirates (Abu Dhabi and Dubai) being global marquees. The UAE serves as a role model in the GCC; even the GCC kingpin Saudi Arabia looks up to it for guidance and inspiration.
How not-dependent is the UAE on oil? Many analysts as well as the UAE government itself look at the structure of the economy when looking at diversification. In 1975, oil contributed around 60% to the UAE’s GDP. Oil’s share fell to 37% in 2005 and further down to 30% in 2017. The share of oil has been taken up by retail and trade, construction and real estate, and financial and businesses services. On the face of it, this looks good.
Manufacturing makes around 8% of the UAE’s GDP. Refining and petrochemicals make around 60% of the manufacturing GDP. The UAE has made significant investments in petrochemicals in recent years.
One might argue the investments are made in downstream industries, but still it is very much related to oil. A fall in the price of oil does not bode well even for refining and petrochemicals, given the fact that the input—crude oil—is a national resource, and more often than not revenues are linked to oil prices.
The other significant chunk in the non-oil economy is accounted for by the construction and real estate sector. The UAE, Dubai in particular, has always been in the limelight for its mega construction projects as well as the most outlandish buildings. Photos of the Sheikh Zayed Road from the 1990s and comparing them to the present are not uncommon. While the change is quite dramatic, one must remember that the investment was fuelled by inflow of foreign capital which was drawing to the tax-free haven, and oil revenues of the government. There is widespread oversupply in almost every sphere of the real estate market—housing (supply of affordable housing, though, remains tight), commercial office and retail space, hotels, etc. The phenomenon is also reflected in falling rentals, falling sales and falling room tariffs. In fact, many analysts believe that the recovery in the real estate market largely hinges on the recovery in oil prices.
In recent years, much of the frenzy in the UAE was also centred around the Expo 2020, scheduled to open in October 2020. There are a lot of expectations around the Expo and how it would give a boost to the economy. In the run up to the Expo, many infrastructure projects were undertaken across the UAE, especially in Dubai. Estimates suggest the Expo would cost $8-9 billion, and it might end up being like other global sports event, giving a one-time bump up to the economic activity. While around 80% of the site is planned to be reused in the legacy phase, there is no denying the fact that it will only add to the existing oversupply. Much of the steam around the Expo is already spent. The site will open for testing in 2019 and no new big investment is likely come in. Dubai is pushing for accelerated completion of projects with increased budgetary allocations this year. Interactions with analysts on a recent visit to Dubai also suggest that the government is pushing for the completion of hitherto uncompleted construction projects ahead of the Expo (whether viable or not) to avoid any eyesore in Dubai’s skyline.
Oil contributes around 35% to government revenues. Had it not been for the revenues from oil, fiscal deficit would have ballooned to 10.2% of GDP in 2017 from 0.2%. In a bid to rationalise government finances and create alternative sources of revenue, the UAE introduced VAT at the rate of 5% starting January 1, 2018. VAT, in its current form, does not cover all businesses and services. Estimates suggest that VAT could contribute $3.5 billion to the government kitty if properly implemented. However, there are challenges with its implementation. Adequate IT systems are not in place, leading to a delay in businesses getting on board VAT. Many industries are vying to get exclusions from VAT—fishing, wholesale gold, vessel charters, etc. VAT has increased the cost of doing business—many small businesses have shut shop owing to increased costs. At the same time, immigrants are feeling the pinch as taxation has increased the cost of living, while incomes have not grown much.
Latest official data suggests that the UAE economy grew by 0.8% in 2017 after registering a growth of 3% in 2016. The IMF forecast the economy to grow at 2% in 2018. While many analysts take this number with a cheer, this is a sharp downward revision from 2.4% growth forecast in November 2017. In fact, last year, major non-oil sectors, too, witnessed a slowdown.
The UAE has outlined its Vision 2021 with the aim of making it one of the best countries in the world. In the same stride, it seeks to diversify the economy by promoting new technologies. The UAE has recently made changes to its visa policy to attract talent. It is also planning to allow 100% foreign ownership of businesses in non-free zone areas. However, the increased cost of living (reduced subsidies and increased taxes) and low income growth take away the charm of doing business as well as working in the UAE. Moreover, the introduction of VAT and other taxes takes away the biggest draw for the UAE—being tax-free. How much of the vision and plan can be translated into reality remains to be seen. The GCC diplomatic crisis with Qatar last year further gives a blow to the UAE, which was once a leading trade partner of Iran. As result of this crisis, investments in the UAE, too, have taken a hit. Additionally, business environment in the GCC area is hugely dependent on the geopolitical scenario in the region.
Today, the UAE seems more like a destination to splurge one’s wealth rather than create wealth. Recovery in the economy is still dependent on oil. Most investments are being undertaken by state-owned enterprises, which again get ultimately funded by petrodollars. Major manufacturing base is oil dependent. Oil is vital to government finances.
So, is the UAE moving away from oil? Maybe not any time soon.
-Anuj Agarwal & Prithvi Sehgal. Authors are Mumbai-based economists. Views are personal