The UAE leads the GCC in efforts to prepare for lower oil prices. Subsidy reform is the most recent and arguably most important example. Now a country that already boasts the world’s busiest airport and one of its biggest sovereign wealth funds could blaze a trail in tax too
With the precipitous drop in oil prices, much of the Middle East — and especially the Arab Gulf — could be entering a very different world. However, economists argue cheaper oil could bring benefits, particularly if governments reduce hugely costly and wasteful fuel and utility subsidies, while global prices mitigate short term political costs.
Mohieddine Kronfol, Middle East and North Africa fixed income and global sukuk chief investment officer at Franklin Templeton Investments, notes the region pays about 10% of its collective GDP on subsidies. “Lower oil prices could have a silver lining for some sovereigns in the Middle East,” he says. “We could see some structural changes in the region taking place as a result of cyclical changes in global commodity prices.”
As such, the UAE’s shift on August 1 to a new framework, in which it adjusts gasoline and diesel prices on a monthly basis according to international prices, is a positive precedent for other states, as Fitch said in a report shortly after the federal cabinet ratified the move. Other sources tell a similar story. Philippe Dauba-Pantanacce, senior Middle East economist at Standard Chartered, says the UAE has been “best in class” in the GCC (Gulf Co-operation Council) in adjusting its framework and preparing for weaker oil revenues. “Lower oil prices should be an opportunity for the GCC to reform subsidies,” he says.
But while other states in the GCC have talked about or even taken some steps in this direction, none have done so in such a tangible, unequivocal manner as the UAE. Fitch notes, for example, that Kuwait backed down on fuel price increases after consumers protested against the measures.
Action to adjust subsidies or cut back current spending in the region’s biggest economy, Saudi Arabia, has been even more disappointing. Saudi Arabia will see a deficit of around 13% of GDP in 2015, according to Fitch. It has eased the transition to a new ruler with more cash handouts, financed largely by drawing down reserves (though it has also announced a local bond programme).
In the UAE, on the other hand, subsidy reform has not been the only step the federation has taken to improve its standing. Potentially just as revolutionary both locally and regionally could be the introduction of federal VAT and corporate tax, preparation for which appears to be gaining momentum, according to a KPMG review in July, which noted UAE finance ministry reports of progress in talks between levels of government and in drafting the legislation.
“You’re beginning to see more of a federal structure in the UAE,” says Kronfol, who also points to work towards issuing federal bonds, crucial for improving local banks’ liquidity management options. “The new tax measures and preparations to issue federal bonds are part of a shift taking place in the country.”
George Abed, regional director at the Institute of International Finance, says a lean central government has contributed to a situation in which a relatively high proportion of Emiratis are employed in the private sector. “Fuel reform in the UAE caps efforts over a much longer period to diversify away from oil,” he says.
Indeed, this award also recognises the regional leadership carried out by the emirates themselves. Abu Dhabi and Dubai — whose deputy ruler Hamdan bin Rashid Al Maktoum is UAE finance minister — both have good examples to show other states in the region. Dauba-Pantanacce notes Dubai’s outstanding success in diversifying away from oil (its airport recently overtook London Heathrow to become the world’s busiest).
Meanwhile, Abu Dhabi, the capital of the UAE, has taken steps to reduce water and electricity subsidies, increasing prices on those utilities earlier this year by 170% and 40%, respectively, according to the IMF. In addition, Abu Dhabi has a sovereign wealth fund of global standing in the Abu Dhabi Investment Authority — an institution that could see the country’s vast wealth endure far longer than the most recent downturn in oil prices.
DRIVE FOR EFFICIENCY
UAE finance minister Hamdan bin Rashid al Maktoum says an expected budget deficit in 2015 as a result of low oil prices is temporary and a surplus is expected from 2016. “The government is working to consolidate its fiscal position gradually, maintaining the exchange rate system and easing liquidity management to support credit growth, with the objective of enhancing stability, sustainability and intergenerational equity,” he says.
The minister is proud of the UAE’s high rank in international surveys of public sector efficiency and ease of doing business. But he says the government is keen to diversify its revenues, though avoiding adverse effects on competitiveness and growth. “Rationalisation of public spending and increasing return on government expenditure are on the top of our agenda,” he says.
Reforming energy subsidies, which were “not well targeted or cost-effective for social protection”, has helped fiscal consolidation efforts and could entice people to use smaller cars. He says: “The previous system was pressurising the public purse and distorting prices, leading to over-consumption and resulting in congestion and adverse impacts on environment and health.”
Meanwhile, al Maktoum describes continued diversification efforts, with new laws to help small business funding. Economic growth hit almost 5% in 2014, with construction, tourism and services contributing, despite lower oil prices. “The growth in the non-oil sector is expected to continue in 2015 and beyond, as groundwork for Expo 2020 [hosted in Dubai] gains momentum,” he says.