UAE Macroeconomic Outlook


Investors should adopt realistic approach

World Economic Climate

Across the world investors’ belief that the worst of the financial crisis is behind us is gradually rebuilding and confidence is  improving.  Continuous financial stimulus have reduced banks’  interest rates to its lowest level in history. World economy seems to be recovering, and the rate of job losses is slowing down. Property markets world wide are showing signs of stabilization.  Loan and mortgage defaults are not scary anymore, because banks are able to liquidate properties in  timely  manner and recover their funds.

Deflation, once a threat to the economy,  is not on the cards any longer. On the contrary, the fear of inflation is spreading fast. Deflation causes the consumers to hold or delay spending .  As a result, all economic activities  will slow down,  which will prompt layoffs at large scale. Jobless people will not be able to provide for their needs, mortgage and car loans. In periods of deflation overall economy shrinks, causing more people to lose jobs and more businesses to close down - vicious circle, as described by Marc Faber!

Recently the IMF delegation, which held an annual round of meetings with UAE Minister of State for Financial Affairs Obaid Humaid Al Tayer, said it expected that inflation in the Emirates would shrink to 1 per cent in 2009 from 12.2 per cent in 2008. It foresaw that inflation would increase to 3 per cent in 2010 and 4 per cent in each of 2011 and 2012. Inflation erodes the value of money, and is also not regarded as positive to the economy. Cost of products and services rises too fast in a short period of time.

The main source of income for the Gulf countries is oil. When the world economic activities shrink, oil consumption drops. Hence, some oil producing countries reduce prices and export quotas to compete for a larger market share. Countries like Russia or Iran can’t afford any drop in oil income. If the oil price drops they would produce and sell more, unlike the countries from OPEC. Currently, oil price is holding value well  between  USD 75 and 80, while projected to reach over USD 85 in short term.

However, it takes 6 to 12 months for the oil returns to reach the economy. But once this happens, governments will begin announcing larger budgets, then launch and award new projects, companies will execute these projects and only then  the average consumers will benefit from the circulation of oil money in the system. This will result in companies hiring more expatriates, securing larger number of accommodations, health care and transport facilities. In short, growing economy will produce more consumers and establish consumer confidence.

GCC Economic Climate

In general, the Gulf countries are recovering  from the financial crisis at different pace.

Saudi Arabia leads on the recovery path. Real estate prices are soaring again, inflation is estimated at approximately 4%, and Inter-Bank lending rates are even lower than in 2007 (0.7% for 3 months). The banks in the kingdom have strong financial positions and are willingly lending to the real estate and construction industries.

UAE economy, and in particular Dubai, suffered more from the financial crisis than the rest of the Gulf countries, as the pace of development was faster. Prudent fiscal and monetary policies of the government had helped the nation to overcome the impact of the global financial crisis. In 2008, the real estate and construction industries contributed more than 30% or 1/3 to Dubai GDP. In 2009, 85% of the construction development was delayed due to various reason.

Despite the widely spread impact of the financial crisis, Abu Dhabi went ahead with many mega projects that absorbed good part of Dubai unemployed exapt population.

However, the worst economic hit was the sudden departure of hundreds of billions foreign investments from the UAE banks, right after the collapse of Lehman Brothers and later during the fourth quarter of 2008. The UAE government reacted fast by providing support packages of over 120 billions of dirhams to the financial system in order to restore liquidity in the markets. In result of the development of smart mechanism to reduce EIBOR, the current EIBOR rates are now less than half in comparison to the rates six months ago.

The UAE banks suffered at most, as in the beginning of 2009 were left with AED 120 billions gap between total bank loans and deposits. This huge exposure to the credit crunch caused the credit ratings of UAE banks to decline. Many investors withdrew their deposits, which lead to liquidity crunch. During the first quarter of 2009 the deposit rates soared briefly to 7.5% per month on annual basis. Banks became reluctant to offer mortgages, which in turn resulted to stagnation in the real estate markets across the country.

Gradually, banks are closing the gap between the loan and deposits. The deposit rates are now reduced to 3%, while mortgage rates to 6.5%, according an article in Gulf News.

Real Estate Sector

While many analysts think that property prices have reached the bottom between February and July this year, other real estate professionals still disagree and predict a second bottom next year. However, the correction in property prices prices is healthy in the long term, especially for young and flexible economy like the one of Dubai. In early 2009, the soaring cost of living was already driving out many new foreign investors out of the city. This departure would have been even more harmful to Dubai economy than the current real estate prices correction.

Analyses of real estate supply as a pipeline stretching between 5 to 10 years time frame from project announcement up to actual delivery suggest that real estate prices will stabilize due to accumulating of supply. Eventually this will lead to increasing appetite for more units and a wave of new development activity. At present, most of the projects announced since early 2008 are canceled or delayed. No new projects were announced in 2009. Most probably no new projects will be announced in 2010, other than infrastructure related. Funding off-plan buyers became a distant dream. Financing of projects is also extremely difficult, not to say impossible. The new RERA rules stating that developers can not start selling off plan until  they have paid 100% for the land and deposit 30% of project cost in ESCROW account, are contributing to the freeze of residential developments. The days of financing the whole real estate project out of buyers installments are gone for ever.

In 2010, according physical estimation of Dubai construction sites, approximately 34 000 residential units are going to be completed. Many projects are currently delayed due to renegotiation of construction cost. With the falling value of the US Dollar, we may expect the building materials and labor cost to soar in the coming few years. The current cost for building per sq. ft., which is now AED 320-450 will rise. Supply of cheap labor from Asia will cost much more for sure, specially with Asian currencies soaring against the US Dollar.

Conclusion

Banking system in UAE survived the financial crisis thanks to huge government interventions. The bank rates are dropping very quickly which is a clear sign of liquidity improvements and are expected to drop  even further, which will help economy to grow, stabilize the real estate market and fuel the stock market.

Stock market in UAE should continue to improve in slow uptrend, with corrections between rallies of 30% to 40%. Stocks from the banking sector offer risk/reward balance, and in particular the national banks. Even with huge provisions, UAE banks are still very profitable in comparison to banks around the world. The probability of a second bottom, or crash, in DFM is very low, although Dubai real estate prices may decline further.

In short term, investors should adopt realistic approach, but not optimistic.

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