Due to protracted commodity price declines, the UAE has been reducing overspending, which has been slowing down economic activity. How can the UAE find the right balance between holding back public spending and maintaining healthy economic activity?
The UAE is facing a similar challenge as other states in the region: maintaining economic activity at a time when spending needs to be adjusted to reduced oil revenues. That being said, the UAE is in a better position than many other countries because here you already have a more diversified economy. The non-oil economy is driven by factors like trade, tourism, and finance. In Dubai, for example, there is more or less the same level of economic activity, with a little softening, but much less than other parts of the country. Dubai is also at the beginning of a process that will, over the next four years, lead to Expo 2020. This will also support activity. The UAE has to continue with the strategy of relying primarily on the private sector to drive growth at a time when the government is going to have to scale back big construction and other projects. The UAE growth rate for 2016 is estimated to be 2.5%, which is above the GCC average. However, there is a distinction within that between the parts that are driven by oil and the parts that are not.
Your growth projections for 2016 appear to be lower than that of the UAE government, which predicts 3.5%. Why is that?
Growth in the UAE is essentially a combination of the oil economy and the non-oil economy. The non-oil economy in Dubai is expected to grow at a stronger pace than in Abu Dhabi, reflecting a cut back on big projects in the latter. Overall, it would be fantastic if growth ended up closer to the government's forecast. However, I have seen a little softening in the economy, both in Abu Dhabi and in Dubai, so at this stage I feel comfortable with our latest growth projection of 2.3%.
Higher government revenue would create much-needed room for fiscal maneuvering. What are the correct steps the UAE should take toward tax revenues?
We have been of the view that the UAE, and GCC countries more generally, all need to begin to develop non-oil based revenue sources. Among the most important instruments is the introduction of a VAT, which could be put into place in a coordinated way throughout the GCC. This could generate about 1.5% of additional GDP, based on our experience in other countries. So that would be a positive step. It would also be useful to explore whether some sort of low rate of corporate tax can be introduced. There are two things you need to consider in the GCC and UAE; these countries have substantial buffers they can draw on and do not have to make dramatic adjustments in terms of cutting back spending, raising taxes, or trying to reach a balanced budget overnight. That's why we think it's a perfectly sensible approach for the UAE to run fiscal deficits as they try to adjust only gradually to the new realities of oil prices. In doing so, they have to be careful about how they finance those deficits, because if you finance the deficit disproportionately from the domestic banking system, you could create liquidity shortages in the banking system, which may then have a knock-on impact on credit availability for the private sector at a time when you want the private sector to be more active. So instead it may make sense to draw on your assets and also borrow internationally. These various financing options need to be balanced. The other thing to do is to find ways of protecting the more vulnerable in society during the adjustment. For example, if you raise electricity tariffs and rates, you need to consider making that increase proportional to energy use and income levels.
Earlier this year, IMF head Christine Lagarde stressed the importance of the financial services sector as a crucial component in the growth and diversification plans of the UAE. What do you think about this?
Financial services certainly are an important sector in the UAE's diversification strategy. Of course, the banking system will be facing a more challenging environment going forward, because banks won't be able to rely as much on government deposits and will have to mobilize their own deposits. Liquidity will be tighter because of that, and borrowing costs are going up as risk appetite goes down. US rates are also edging up. All of that will have an impact. But all in all, banks are starting from a strong place in terms of capital and liquidity, and they should be able to manage that. The UAE also has the Dubai International Financial Center (DIFC), which is a very good example of how you can create a hub inside the UAE or any GCC country that serves as a magnet to attract financial companies and also other companies that seek to establish themselves in the UAE and have a regional presence as well.