Report Series UAE: Update Executive Summary Economics Department Samba Financial Group P.O. Box 833, Riyadh 11241 Saudi Arabia ChiefEconomist@samba.com +44 207659-8200 (London) This and other publications can be Downloaded from www.samba.com Oil prices are back trading under $50/b, with little prospect for an improvement until 2017 at the earliest. Despite the relative diversification of the UAE economy and its large external savings, the weak outlook for oil prices and fears about global growth prospects, have dragged down sentiment, tightened liquidity, and are accelerating moves towards fiscal consolidation, while also depressing activity in regional markets. In this environment real GDP growth is forecast to slow to around 3 percent p.a. While the UAE, and Abu Dhabi in particular, has large external savings which it can draw on, the authorities will look to consolidate spending in the face of slumping oil revenues. Already there have been moves to reduce subsidies and curb capital transfers to GRE s, while non-priority projects are being scaled back or delayed. Despite this, the UAE s consolidated fiscal balance is projected to move into a deficit of around 4 percent of GDP this year, easing to 1.8 percent in 2016. Recent data confirm a slowdown in inflation as the impact of various measures (i.e. increased water and electricity charges and the removal of the rent cap in Abu Dhabi) affecting the heavily weighted housing and utilities component begin to wane. Average inflation will still probably come in around 4 percent this year, but we expect it to fall back under 3 percent during 2016-17. Available data confirm that the residential real estate sector is undergoing another price correction, particularly in Dubai. With large new supply coming to the market over the next couple of years, prices are expected to remain depressed. The expected lifting of Iranian sanctions next year should provide a boost as investment from this source increases, but this may not be enough to prevent further declines as the economy slows. As expected, liquidity in the banking system has tightened as deposit growth slows in the face of reduced public sector deposits, while loan growth, although also slowing, has remained solid. The loan to deposit ratio has ticked back up to 103 percent, and interbank rates have been steadily increasing since March. Although much of this has been in line with increases in US LIBOR, there has also been a widening in the spread of around 10 bps for 3 month rates. Markets have so far not been too spooked by the fall in oil prices, leading to only a modest increase in CDS spreads on UAE sovereigns. That said, UAE stock markets are down; the cost of raising funds in international markets has risen, and concerns over GCC exchange rate pegs have been reflected in the AED forwards market.
Continued oil price slump a headwind to growth Having posted a rally to $70/b earlier in the year, oil prices have taken a step down to trade at under $50/b, with little prospect for a strong improvement until 2017 at the earliest. Despite the relative diversification of the UAE economy and its large external savings, the weak outlook for oil prices and fears about global growth prospects, have dragged down sentiment, tightened liquidity, and are accelerating moves towards fiscal consolidation which were already underway, while also depressing activity in regional markets. All of this has been reflected in a slowdown in the broad PMI which came in at 54 in October, the lowest reading in two and a half years. Recent survey data still point to solid non-oil sector growth However, the PMI survey data is still consistent with solid growth in the non-oil sector. Encouragingly, the employment sub-component of the survey is still in positive territory, suggesting that new jobs are still being created, albeit at a much slower rate. The new orders index is also still relatively strong at 57.6, while export orders have picked up again after a dip in September. High frequency data from Dubai airport reinforce the view of continued expansion in the non-oil sector, with the volume of cargo handled growing by 2.7 percent in the first half after a contraction in 2014, while passenger traffic was up 13 percent. Total passenger traffic through Abu Dhabi was also up 18 percent year-on-year in September. Construction sector still steady In addition, the construction sector continues to perform reasonably well as there has not yet been a major retrenchment in public infrastructure spending, despite emerging fiscal deficits, and GRE s have pushed ahead with real estate projects. Available data show that building completions in Abu Dhabi were up 8.4 percent in first half of this year compared with 2014. Bank lending for construction and real estate has also continued to grow, albeit modestly at 5.7 percent y-o-y in September. That said, the correction in the real estate market (see below) will likely have a dampening influence next year, and the prolonged slump in oil prices will mean project delays and cancellation of nonessential capital spending. Offsetting this will be continued preparations for Dubai Expo 2020, with implementation of some projects possibly brought forward to benefit from potential reductions in project costs. Total spending related to the Expo, including private sector projects, is currently 2
estimated at around $18 billion, although the official Master Plan has not yet been approved. This should take place by the end of the year. But residential real estate prices are falling Available data from various sources confirm that the residential real estate sector is undergoing another price correction, particularly in Dubai. With large new supply coming to the market over the next couple of years, prices are expected to remain depressed, especially in the Villa market where tough Federal Mortgage Caps and increased fees have also impacted affordability. The expected lifting of Iranian sanctions next year should provide a boost as investment from this source increases, but this may not be enough to prevent further declines as the economy slows in the face of sustained weakness in oil prices. Subsidy reforms should have only modest impact on aggregate demand World Economic Outlook 2013 2014 2015f 2016f 2017f Real GDP growth (percent change) World 3.0 3.0 2.9 2.9 3.0 US 2.2 2.4 2.5 2.7 2.8 Japan 1.5-0.1 0.5 1.1 1.2 Euro area -0.4 0.9 1.5 1.6 1.6 China 7.7 7.3 6.8 6.2 6.0 Emerging Markets 4.0 3.9 3.2 3.3 3.7 Saudi Arabia 2.7 3.5 3.1 0.6 2.5 Official policy rate (end period) US 0.25 0.25 0.50 1.00 2.00 Japan 0.10 0.10 0.10 0.10 0.10 Euro area 0.25 0.15 0.05 0.05 0.05 Oil Price ($/b period average) Brent 107.0 100.0 58.0 55.0 70.0 Samba estimates and forecasts The recent moves to raise water and electricity charges in Abu Dhabi (170 and 40 percent respectively), and the UAE wide fuel subsidy reforms, will have some adverse impact on consumer disposable incomes, although this is likely to be modest. In fact, given the slump in international oil prices, the impact on lifting fuel subsidies has turned out to be positive since deregulation was introduced in August this year. Diesel prices fell from the start while, after an initial 23 percent increase, gasoline prices have also now fallen (see charts). Prices are adjusted on a monthly basis and when international oil prices eventually rise again, UAE retail prices will follow suit. But given that gasoline costs represent only 3-4 percent of average UAE income, the adverse impact on household living expenses should be small. Global Growth Outlook Global growth prospects are mixed as many Emerging Markets (EMs) continue to struggle, and fears mount over a sharp slowdown in China, and the authorities ability to smoothly unwind imbalances built up in the economy, particularly the credit boom. While risks are elevated, we do not think China is headed for a hard landing, and instead will maintain growth at around 6-6.5 percent. This should help commodities find a floor, and ensure EM s do not deteriorate further, although their growth prospects remain variable and relatively weak. Meanwhile, advanced 3
economies are generally performing as expected. Growth is accelerating in the Eurozone, the UK remains solid, Japan is recovering after a contraction last year, and the US economy continues to grow strongly. That said, financial market strains and weak EMs will present headwinds and, with inflation still low, likely lead to cautious rate hike cycles in the US and UK, while prompting more easing from the ECB and Bank of Japan. Overall growth will probably do no more than hold at around 3 percent a year through 2017 (for more detailed analysis see our forthcoming December Economic Monitor). Oil Market Outlook Lower oil prices were supposed to bring a supply response from non-opec producers, but this is happening more slowly than expected, and has been offset by surging OPEC supply as members pursue the new market share strategy. As a result, projections that physical markets would start to rebalance during 2015 have been pushed into late 2016 (at the earliest). In recognition of this, the rebound in prices to $70/b in May could not be sustained, and Brent has subsequently dropped back below $50/b, resulting in an estimated average for 2015 of around $58/b. However, there is mounting evidence that non- OPEC production is now starting to decline, particularly in the USA. As long as global oil demand holds up as we expect, this should allow for a rebalancing of market fundamentals next year that will set the stage for a price recovery in 2017. The need to work down the large stock overhang and absorb new Iranian supply will keep prices suppressed in 2016, when we project Brent will average $55/b. But by 2017 we think prices will be back near $70/b. This projection is relatively bullish, particularly compared with futures markets, and we recognise that there are large downside risks in the short-term, especially on the demand side. However, current prices appear too low for medium or long-term market equilibrium, and unless there is a pick-up reasonably soon, the large scale curtailment in traditional oil sector investment may be setting the stage for an uncontrollable price surge further down the line (for more detailed analysis see our Oil Market Outlook Report published in October). 4
Oil production is rising Given the current market share strategy being pursued by OPEC, oil production in the UAE has continued to trend up, with positive implications for overall GDP growth. According to Bloomberg data, crude oil production hit a record high of 2.97mb/d in October, and annual average output was up 3 percent compared with 2014. We do not expect OPEC to change strategy at it December meeting, and thus expect the UAE to push ahead with planned expansion projects. Public spending to adjust to low oil price outlook While the UAE, and Abu Dhabi in particular, has large external savings which it can draw on, the various authorities are expected to proceed with some modest fiscal consolidation in the face of the prolonged slump in oil prices. Already there have been moves to reduce subsidies (water, electricity, fuel), and Abu Dhabi had already started to curtail capital transfers to GRE s. Non-priority projects are being scaled back or delayed, and on a consolidated basis overall fiscal spending is likely to be down over 4 percent this year. It should be recalled though, that plans were already underway to curtail spending which had surged in the wake of the global financial crisis. In addition, capital spending will remain large, and will be supported by greater private sector finance, spurred on by a new law covering public private partnerships (PPP). Estimates by the IMF suggest that, over time, moves to curtail spending will lead to a steady decline in the fiscal break-even price back towards $50/b, from near $80/b in 2014. But fiscal deficits are expected Under our oil price assumptions we project that the UAE s consolidated fiscal balance will move into a deficit of around 4 percent of GDP this year as revenues fall sharply. This should improve to 1.8 percent in 2016 as fiscal consolidation measure s bear fruit and revenues stabilise, and should return to surplus in 2017 as oil prices recover. If prices were to stay low for longer (say $55/b for 2017), then deficits would continue. These would be manageable at less than 2 percent of GDP, but would probably prompt additional moves to contain spending. Financing projected deficits will focus on drawing down external savings, and possibly raising debt in international markets, although government domestic bank deposits have also been drawn down. 5
GRE debts remain a burden Some GRE s remain highly indebted and face more challenging times as real estate prices fall, official support wanes, and financing costs rise as the US finally stars raising interest rates. Data published by the IMF show large repayments are due next year including $6.3 billion for Dubai Holdings and subsidiaries, $4.3 billion for the Investment Corporation of Dubai and subsidiaries, and over $1 billion each for Dubai World and Nakheel. Repayment obligations in Abu Dhabi are lower, but still some $6.4 billion falls due for various GREs, including $2.5 billion for the International Petroleum Investment Company. Roll over risks are probably highest for Dubai s GREs. Growth will moderate Economic growth is expected to slow in the new low oil price environment as reduced revenues impact public spending. However, robust macroeconomic fundamentals, large external savings, a resilient banking system, and relatively diversified economic activity should ensure growth holds at around 3 percent through 2016-17, before accelerating again as spending is stepped up on Expo 2020 and as oil prices recover. The lifting of sanctions on Iran which should take place early next year should also provide a boost. The UAE and Iran have a history of close trading relations, and from 2016 we should see an increase in demand from Iran for goods and services from the UAE, as well increased investment by Iranian s in UAE real estate. External balances to remain healthy Even with lower oil price projections, the current account is expected to remain in surplus. Although substantially down on the 18-20 percent of recent years, we forecast that the current account surplus will hold at between 3-4 percent of GDP this year and next, before rising back towards 8 percent. As such central bank foreign exchange reserves should continue to grow, although at a much slower pace. Data for October show that they currently stand at $77.7 billion, up from $70 billion at the start of the year. (AETRCBCA Bloomberg). The UAE also has large external savings, mainly in Abu Dhabi s Sovereign Wealth Funds (SWF) which were estimated at $773 billion in June by the SWF Institute, equivalent to almost two time overall UAE GDP. 6
Inflation begins to trend down September data confirm the expected slowdown in inflation as the impact of various measures - such as increased water and electricity charges and the removal of the rent cap in Abu Dhabi - in the heavily weighted housing and utilities component begin to wane. Overall inflation dipped to 4.3 percent y-o-y, while the housing and utilities component receded to 8.3 percent. Average inflation will still probably come in around 4 percent this year, but we expect it to fall back under 3 percent during 2016-17. Bank liquidity tightens As expected, liquidity in the banking system has tightened as deposit growth slows in the face of reduced public sector deposits, while loan growth, although also slowing, has remained solid. Central bank data through September show that public sector deposits have fallen by 16 percent y-o-y and, while total deposits have continued to grow, the rate of growth has fallen sharply to around 1.5 percent. With loan growth still at 7 percent y-o-y this has pushed the loan/deposit ratio to near 103 percent. Banks still have substantial holding of CDs at the central bank, but these have started to be drawn down. Interbank rates have been steadily increasing since March, although much of this has been in line with increases in US LIBOR, there has also been a widening in the spread of around 10 bps for 3 month rates. And operating conditions deteriorate Slowing economic activity, reduced deposits, and deteriorating asset prices will present banks with a more challenging environment in which NPLs are likely to rise. Already there is anecdotal evidence that cash flow problems and slowing activity have prompted some expatriates running smaller companies to leave the country with debts unpaid rather than risk imprisonment for bounced checks. Central bank data also confirms that banks continue to raise provisions, and it seems likely that profits will begin to suffer as we move into 2016. However, banks remain well capitalised, generally sound, and resilient to a deterioration in credit quality (according to central bank stress tests), although some smaller and medium sized banks may struggle under liquidity stresses. Mindful of this, the authorities have stressed their intention to focus on maintaining healthy liquidity, particularly to support the expected pick up in lending from 2017 as Expo related activity accelerates. That said, it seems likely that credit growth will remain muted next year. 7
Stock-markets are struggling Inevitably the slump in oil prices with its adverse implications for State spending and bank liquidity has weighed heavily on UAE stock markets. As of mid-november the Dubai bourse was down near 14 percent, while the Abu Dhabi bourse was down around 5 percent. Company earnings have been mixed with Q3 earnings reports showing increasing pressure on profits, particularly in the real estate and construction sector. Banks have been doing better, and 6 out of 8 Dubai banks report 25 percent profit increases for the first 9 months of the year. However, the outlook is challenging as oil prices are expected to stay weak during 2016 and the economy is set to slow. Current trailing PE ratios stand at 10.4 and 9.7 percent for Abu Dhabi and Dubai respectively, compared with a GCC wide estimate of 12.4 percent as calculated by Zawya, suggesting UAE shares are now relatively cheap. Market risk perceptions see limited deterioration Markets have so far not been too spooked by the fall in oil prices, leading to only a modest increase in CDS spreads on UAE sovereigns. Spreads have widened from their year lows in the more oil dependent Abu Dhabi, but are more or less unchanged at 73 bps from where they started the year. Meanwhile Dubai CDS spreads have remained steady at under 200 bps. UAE banks and corporates have been active in international markets this year, with banks alone raising around $4 billion through November according to Zawya. However, the market for Gulf issues has tightened in recent weeks, and costs are expected to rise. Concern over GCC exchange rate pegs has also mounted as reflected in the AED forwards market, although depreciation pressures are much lower than during the global financial crisis. Main Economic Indicators 2013 2014 2015f 2016f 2017f Nominal GDP ($ bn) 388.9 408.2 358.0 382.1 416.5 GDP per capita ($ '000) 54,773 54,428 45,898 46,601 49,000 Real GDP (% change) 4.3 4.6 3.0 3.0 3.5 Hydrocarbon GDP 2.9 4.0 2.9 2.1 1.2 Non-hydrocarbon GDP 5.0 4.8 3.0 3.5 4.6 Nominal GDP (% change) 4.2 5.0-12.3 6.7 9.0 Hydrocarbon GDP 0.0 0.0-38.3-4.5 28.5 Non-hydrocarbon GDP 5.0 5.0 7.0 6.2 7.1 CPI inflation (% change) 1.5 2.3 4.0 2.7 2.5 Hydrocarbon exports ($ bn) 129.4 113.4 70.0 66.8 85.8 C/A balance ($ bn) 70.2 54.5 15.2 12.1 32.1 (% GDP) 18.1 13.4 4.2 3.2 7.7 External debt ($ bn) 175.0 200.0 210.0 220.0 230.0 (% GDP) 45.0 49.0 58.7 57.6 55.2 Fiscal balance ($ bn) 40.3 20.2-12.5-6.9 9.2 (% GDP) 10.4 4.9-3.5-1.8 2.2 International reserves ($ bn) 68 70 79 81 90 8 Crude oil prod (m b/d) 2730 2760 2852 2880 2890 Crude oil price ($/b) 108 100 58 55 70
James Reeve Deputy Chief Economist James.Reeve@samba.com Andrew Gilmour Deputy Chief Economist Andrew.Gilmour@samba.com Thomas Simmons Economist Thomas.Simmons@samba.com Disclaimer This publication is based on information generally available to the public from sources believed to be reliable and up to date at the time of publication. However, SAMBA is unable to accept any liability whatsoever for the accuracy or completeness of its contents or for the consequences of any reliance which may be place upon the information it contains. Additionally, the information and opinions contained herein: 1. Are not intended to be a complete or comprehensive study or to provide advice and should not be treated as a substitute for specific advice and due diligence concerning individual situations; 2. Are not intended to constitute any solicitation to buy or sell any instrument or engage in any trading strategy; and/or 3. Are not intended to constitute a guarantee of future performance. Accordingly, no representation or warranty is made or implied, in fact or in law, including but not limited to the implied warranties of merchantability and fitness for a particular purpose notwithstanding the form (e.g., contract, negligence or otherwise), in which any legal or equitable action may be brought against SAMBA. Samba Financial Group P.O. Box 833, Riyadh 11421 Saudi Arabia 9