The UAE needs to exercise more joined-up fiscal policy to guard against a risk of the economy overheating, the IMF says.
IMF sounds alarm on overheating
The UAE Government must be ready to cut back spending when the economy shows signs of overheating, the IMF says.
Its warning comes as oil prices hit post-downturn peaks and inflationary pressures edge higher.
More co-ordinated fiscal policy between each emirate was important, said an IMF adviser to the country.
"This is an important macroeconomic policy challenge for the UAE," said Taline Koranchelian, who led an IMF mission to the country this week.
"The high dependency on volatile hydrocarbon revenues underscores the need for strong demand management over the economic cycle."
Higher oil prices were a positive for the UAE by helping to bolster government reserves, said Ms Koranchelian after the conclusion of the annual mission.
But if prices remained high for a sustained period they risked smothering the economic recovery by impeding global growth, she said.
North Sea Brent crude briefly dipped below US$113 a barrel yesterday but had been rising in recent weeks because of unrest in parts of the Mena region.
Increasing inflationary pressures caused by higher commodity prices and rapid economic growth are stoking concerns about some emerging market economies overheating. Some economists have warned China, Russia and other economies risk a slowdown once governments start to raise interest rates.
High oil prices and a credit-fuelled property bubble led to accelerated growth in the UAE, especially Dubai, in the period up to 2008. The global credit crunch and a steep drop in oil prices put the brakes on expansion and caused a contraction in Dubai's economy.
The IMF says a contributing factor to the overheating and subsequent crisis was high government spending during the boom times.
Dubai, in particular, rolled out ambitious expenditure plans.
Instead of pro-cyclical fiscal policy - essentially spending during healthy economic times - the IMF supports a counter-cyclical fiscal stance. Such a policy encourages spending during downturns and a tightening of credit during inflationary periods.
The Federal Government has already made progress towards co-ordinating on spending with the establishment of a fiscal committee with representatives from each emirate.
It is also establishing a federal public debt unit to better regulate government debt. Until now, most borrowing has been undertaken at an emirate level. As a result, sovereign debt levels vary between each emirate.
But more could still be done, the IMF says.
"When you set up fiscal policy you determine your overall fiscal objective and this implies a certain amount of spending, which needs to be co-ordinated across the federal and emirate governments," Ms Koranchelian said.
The IMF raised its consumer price inflation forecast for this year to 4 per cent due to rising international food prices. But it said inflation was expected to remain moderate as housing rents continued to decline. Ms Koranchelian does not see any need to change the fixed exchange rate regime as the economy is in a low inflationary period and the US dollar peg has served the economy well.