Based on the gradual withdrawal of monetary stimulus both regionally and globally, the UAE is set to gradually move from a stage of spare capacity and accelerating economic growth, to a stage of capacity constraints and steady-state growth, according to a report by EFG-Hermes, the region’s leading full service investment bank.
“The UAE economy has rapidly evolved from a youthful economy to one that is now showing signs of maturity. At present, oil production is running close to full capacity, the loan-to-stable resources ratio in the banking system is approaching its statutory limits, housing rents are becoming comparable to those in Europe and the US, and equity prices have more than kept pace with the rise in net earnings,” noted Hany Genena, Senior Economist at EFG-Hermes and author of the report.
He added, “As a result, we believe it is prudent to closely monitor investment expenditure at this stage of the cycle to avoid the build up of excess capacity. With financing sourced easily from the equity market, this risk will remain even if funding from the banking sector dries up.”
In 2004, the real GDP growth rate converged to 7.4%, down from a one-off jump of 11.9% in 2003, due to the diminishing marginal growth in crude oil production. At present, the UAE is producing at close-to-full capacity, with de-bottlenecking underway. Given that capacity additions will not come on stream until 2006, EFG-Hermes expects the marginal impact of higher crude production on real GDP growth to be negligible in 2005 and 2006, and probably well into the medium-term if capacity additions do not coincide with the current oil cycle.
However, the report also indicates that the prospect of high crude oil prices and production levels over the coming 12-18 months is continuing to bolster investor confidence as evidenced by the exuberant performance of the Abu Dhabi Securities Market (ADSM) and Dubai Financial Market (DFM): From end 2004 until 30 August 2005, the DFM and ADSM indices gained 143% and 71%, respectively, ranking the first and sixth best performers in the Middle East and North Africa (MENA) region.
Investor confidence is additionally demonstrated by the rising demand for the AED and the negligible spread between AED-denominated deposits and USD-denominated deposits.
The positive sentiment has also continued to fuel aggregate domestic demand, as manifested in strong double-digit acceleration in the year-on-year growth in credit to the private sector: As at March 2005, year-on-year growth accelerated to 35%; ranked the second highest in the GCC after Saudi Arabia.
“Almost 50% of the growth in gross loans to residents was attributed to the growth in demand for construction, trade, and personal loans – including margin financing. In 2006, we believe loan growth will decelerate to the mid teens as the Central Bank of the UAE is considering the tightening of reserve requirements and stiffening credit approval procedures to limit the build of systematic risks in the banking system as was the case in neighboring GCC states in 2004,” continues Genena.
As for the fiscal stimulus, the report indicates that stimulus from government expenditure was moderate in 2004, reflecting a prudent fiscal stance. The annual growth in total expenditures and grants, as recorded on the officially-reported consolidated budget, decelerated from 5.6% in 2003 to 4.2% in 2004, despite the tremendous growth in on-budget and off-budget revenues.
“It is interesting to note that the reported consolidated budget, which primarily excludes investment income generated by government and quasi-government entities, was close to balance in 2004 for the first time in 20 years, and is expected to post a surplus in 2005. The government is forecast to retain its net creditor position vis-à-vis the banking system over the medium term,” adds Genena.
In terms of inflation, the report indicates that the key driver of inflation remains the rise in housing rents. In 2004, housing and housing-related costs, which represent 36% of the CPI, rose 6.7% and pushed the rate of inflation to 4.6% up from 3.2% in 2003. The EFG-Hermes report forecasts the CPI rate of inflation to cross the 6.0% mark in 2005, particularly after the recent increase in fuel prices.
