UNITED ARAB EMIRATES
The Financial Hub

The economy’s size has doubled in the past five years, and many analysts expect it to double again within in the next five years.

While the past few years have seen the rest of the world sit up and take notice of the Gulf countries, it is probably the UAE that is primarily responsible for such attention. Dubai’s seductive glamour and Abu Dhabi’s deep pockets are a hard combination to beat.

The latest example of this international prestige came in November, when Abu Dhabi’s sovereign-wealth management arm announced a massive cash investment in Citibank, the world’s biggest financial-services provider. The deal with Citi showed that Abu Dhabi’s investment whizzes have muscles to flex; instead of buying shares in the banking empire, it negotiated a deal that is more lucrative than just buying shares.

The UAE’s added prestige has made it the least dependent on oil among all its peers in the Gulf. Its economy has doubled in the past five years, and many analysts expect it to double again in the next five years. The coming year should see some specific accomplishments to push the country closer to a truly diversified economy: the development of increasingly sophisticated financial instruments, major privatisation sales, a long line of IPOs on the stock markets, and increased specialisation among the country’s seven emirates. Abu Dhabi has the oil; Dubai the growing international clout and markets. The smaller emirates, such as Ras al Khaimah and Sharjah, look set to capitalise on lower cost structures to carve out their own niches – as outsourcing locations for the back-office functions of Dubai’s and Abu Dhabi’s conglomerates and as affordable places to buy real estate.

Inflation tops concerns
The risks are straightforward: a US recession could drive oil prices lower, therefore chopping government revenue, particularly in Abu Dhabi. The overheated real-estate sector could slump, leaving banks exposed to loan losses. Standard & Poor’s, the global debt ratings company, has estimated that bailing out banks could force the UAE to take on liabilities that amount to a quarter of its GDP.

Analysts also worry that growing inflation could crimp economic growth. Housing shortages could continue due to a lack of labour and supplies to build more. Some worry about a real-estate bubble, but that would be far off, if at all.

Another concern, in the background now but perhaps significant in the future, is rising government debt. Domestic debt rose 11 per cent in 2007 after a 38 per cent surge in 2006.

While that is one way to spin debt, analysts also note that debt as a percentage of the GDP was at a manageable 47 per cent in 2006. Another debt story is a very positive one: the Emirates’ central bank in November began selling certificates of deposit in dirhams, dollars and euros, and at interest rates that will establish a standardised cost of funds in the country. This will make it easier for local companies to borrow money because it establishes a yield curve – a graph showing the interest rates of bonds with the same credit quality but different maturity dates. The yield curve is useful to help set interest rates on commercial bonds and to predict economic trends such as business cycles of growth and retrenchment. A yield curve for the UAE would make it easier to invest in the country’s assets because it provides clarity about the future.

The deposit certificates will also add to the number and sophistication of securities available on the bourses in Dubai and Abu Dhabi. The move has been hailed by foreign banks such as the UK’s Standard Chartered Bank, who said it would aid Dubai’s quest to become an international financial centre and the country’s quest as a whole to lessen dependence on oil.

Overall, the government figures seem encouraging. The current account is ballooning, a trend set to continue. It was at US$35.9 billion in 2006, and some forecasts see it expanding to US$56.6 billion by 2009, even with import spending growing at a rate around 7 per cent or 8 per cent.

Investment deals
The international investment community is noticing these developments and applauding. Major money managers such as Citibank, Credit Suisse, Deutsche Bank and Morgan Stanley have all recently praised the investment environment in the UAE. Morgan Stanley recently launched a new “Frontier” index of developing market stocks. The presence of UAE shares will add index-based investors, who buy all the shares in a particular index to mimic its performance, to the Abu Dhabi and Dubai bourses.

IPOs will serve as another attraction for outside investors, as they will for the larger GCC region. More than 80 IPOs are expected, with the bulk of them in Saudi Arabia and the UAE. One of the first, in January, could be Emirates Airlines, the largest Arab carrier. Media reports in late November had the company selling 20 to 30 per cent share to finance a US$60-billion fleet expansion plan. Emirates Chairman Ahmed bin Saeed al-Maktoum would not confirm that timeline, but has told local media the company want to sell shares publicly.

Privatisation looks to be a theme for 2008. The country’s leadership in late 2007 approved a plan to sell all electricity and water plants, which are now owned by the Federal Electricity and Water Authority. They supply utilities to parts of the Northern Emirates. A decision has not been made yet on whether the government would sell the plants in an IPO or through private sales.

A key concern for Abu Dhabi will be the continued access its sovereign-wealth fund, the Abu Dhabi Investment Authority (ADIA), has to world markets. It may be the largest such fund in the world, though its net worth is unknown. Estimates in late 2007 were a conservative US$200 billion to up to $900 billion. That combination of size and the lack of transparency about the fund has some investors alarmed.

The deal with Citibank saw the ADIA sending US$7.5 billion in cash to the bank for convertible securities. This means the bank will accept the money as a loan and pay an 11 per cent interest rate for three or four years. ADIA will then have the option to convert the investment into shares at a set price, which, if Citi’s operations stabilise, will certainly be below the stock price at that time. ADIA would then become the largest single shareholder in the company. The deal was welcomed in late November as a saviour for the struggling bank, but it did raise eyebrows among regulators. For the year, sovereign funds invested some US$37 billion in banks. Neither the US Securities and Exchange Commission nor the European Commission advocated acting to limit sovereign funds, but the regulators expressed a concern over their size and lack of disclosure habits.

While ADIA’s profit does not end up padding the UAE’s budget, the added wealth cycles through the country and enriches it indirectly. If the EU or US were to limit ADIA’s access, it could shrink the fund’s growth potential.

Overall, while the UAE could suffer a slight drop in demand for oil if the US economy struggles, internal developments are expected to more than compensate for that. The maturing financial market will continue to attract foreign money, along with IPOs and privatisations. That should help Dubai’s quest to establish itself as a global financial-services hub, and attract more capital to further diversify an economy that is not only growing but also branching out.

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