While there are restrictions on fiscal flexibility, the Emirates should be able to maintain its growth outlook and continue on a recovery path.
UAE in strong place as world turns defensive
The UAE economy is today enjoying a period of stable growth, three years after the contraction it suffered during the peak of the global financial crisis.
Credit Suisse believes that over the next two years, the UAE will continue on a path of gradual recovery, with GDP growing at about 3 to 4 per cent year on year. Sustained high oil prices, domestic demand growth and prudent fiscal policies are critical factors in the country's ability to sustain growth.
Although the Emirates seems less oil-dominated than other GCC countries (with net oil exports accounting for 30 per cent of GDP compared with 50 to 60 per cent in Saudi Arabia, Qatar and Kuwait), net oil exports play a key role since they also are a major growth driver for other key sectors, especially banking and real estate.
Assuming that the global economy picks up later this year and oil prices recover some of their recent declines, the UAE should be able to maintain its growth outlook.
But a sharper-than-expected drop in oil prices over the short term and continued sluggishness in the property sector remain key risks to growth.
Domestic demand in the country seems to be recovering gradually, reflected by a strong surge in imports last year and a gradual pick-up in credit growth.
However, because of a rather restrictive fiscal policy and a slow recovery of the financial system, as well as continued downside risks from the property sector, domestic demand growth is likely to be more moderate than in other oil-exporting countries.
And although inflation remains low at about 1 per cent year-on-year because of the continued deflationary effect of house prices, inflation in food prices continues to rise.
The continuing consolidations in the property sector and ongoing debt restructuring have restricted the UAE's fiscal policy flexibility. The government continues to provide financial assistance to government related entities (GREs) through debt forgiveness and asset purchases.
While the funding needs of GREs seem manageable in the short term, Dubai's ability to tackle debt maturing in 2014 will be critical to its growth prospects.
The IMF estimates that the federal Government's expenditures as a percentage of GDP will not rise over the coming years because of the need to generate a fiscal surplus and stabilise gross government debt at about 20 per cent of GDP.
The Government's fiscal austerity has significantly improved the financial soundness of banks and GREs. We see these measures as extremely positive as it lowers the country's vulnerability to global risks.
One of the key positive impacts of the Government's fiscal austerity has been the significantly improved liquidity situation in the country's banking sector.
We also see a positive outlook for the UAE's equity markets.
Although frontier markets are traditionally high risk, Credit Suisse believes that by avoiding cyclicals (stocks affected by economic ups and downs) and heavily owned stocks, high-yielding stocks in the UAE offer scope not only for a relative outperformance versus emerging markets, but also a potential absolute return in United States dollars.
The UAE markets are currently trading on a 2012 price to earnings ratio of 4, which is a deep discount to GCC peers and the emerging market indexes.
We believe this discount is unjustified in view of our earnings growth forecast of 15 per cent this year. In addition, the currency peg that operates in the Emirates means the country has a defensive quality in a world facing a prolonged period of risk aversion.
Nora Wassermann is an emerging market economist, global research at Credit Suisse. Kamran Butt is the head of Middle East and India private bankingglobal research at Credit Suisse