Fast Tracking Reforms in the UAE through Spending Cuts

A report released by the UAE central bank towards the end of July 2015 indicated that the government is likely to cut spending by 4.2% in the fiscal year of 2015. According to the report, consolidated government spending is expected to decline to Dh460.6bn ($125.5 bn), from Dh480.8bn ($131 bn) in 2014. It is notable that the projected spending cut is the first such instance in 13 years. Many analysts pin the reason for the spending cut on the recent decline in oil prices. The reduction is a reversal in the trend of growing state spending in the UAE, which grew at an average rate of 12%, every year, since 2004.

Also, the UAE’s spending on subsidies is projected to fall by 34.3% to Dh13bn in 2015, a reduction of Dh6.8bn over the previous year. The fiscal conservatism on the part of the UAE is seen as a reflection of the announcement from the International Monetary Fund (IMF) that the UAE will register its first fiscal deficit in 2015, since 2009. In July 2015, the UAE also announced that, effective from August 1, 2015, it was moving from a system of fixed and subsidized fuel prices to a system of adjusting prices monthly, in line with global price trends. Though the exact details of the pricing formula were not released, it was made clear that the prices would be based on the average global prices, along with the addition of operating costs.

Table: Fuel Price Deregulation in the UAE: Petrol and Diesel Prices Revision (as announced on July 28, 2015)

Source: UAE Ministry of Energy; *The subsidized diesel rates of diesel: Dh2.90/l in Dubai and the northern emirates (including Sharjah, Ajman, Umm Al Quwain, Ras Al Khaimah and Fujairah); and Dh2.35/l in Abu Dhabi.

The pursuit of reformsis causing investors and analysts to look upon the UAE more favourably.  The feeling has been expressed by investors that diminishing the fuel subsidies will enhance the credit profile of the country. Moody’s expects that “[…] removing fuel subsidies will reduce the UAE’s consolidated fiscal deficit by 0.4% of GDP this year and contribute another 0.6% of GDP to the fiscal balance in 2016, […].” A strong push for reforms in the UAE, according to the media in other GCC countries, has placed the UAE “[…] at the forefront among Gulf states in pushing through reforms to curb spending and raise new revenue in an era of cheap oil.”

The savings from the cut backs in spending are expected to further strengthen the UAE’s infrastructure and competitiveness, as more money will become available for strategic investments that can bring in more foreign investments. For instance, the government of Abu Dhabi is accelerating investment efforts in terms of large-scale infrastructure efforts such as the Khalifa Industrial Zone and the Masdar city. The UAE government’s spending on new projects across multiple parts of the country would support non-oil growth, including services, transport, tourism, construction, etc.

Moreover, the cut backs can support a programme of sustainable economic development. For instance, with three million cars on the streets of the UAE, which are growing at about 9% per annum, removal of fuel subsidies is likely to encourage a greater uptake for public transportation. This will have a direct impact on the environment in terms of reduced pollution due to diminished emission levels. By adopting a programme of intelligent cost cutting, the UAE appears to be leading the way in terms of the realization that countries that move towards sustainable growth models rather than hinging on highly regulated subsidized economic frameworks are more likely to thrive and compete better into the future.

Traditionally, in the UAE, Dubai has been considered to be in the forefront in terms of diversification efforts. Increasingly, other centers such as Abu Dhabi have been able to find their own competitive niches in various segments. It is notable that the Abu Dhabi’s manufacturing industries sector accounted for 12.6% of the emirate’s non-oil GDP in 2013. Petrochemicals and plastics are the top manufacturing sectors, accounting for around 50% of the manufacturing industries’ production and about 73% of the fixed capital formation. However, basic metal industries, like aluminium and iron, are rising in prominence as well, accounting for 11% of the production value of manufacturing industries sector in 2013. Savings from government spending can also be moved into other visionary programmes like the UAE’s space programme, which is expected to “[…] underpin an industrial base that will support research and development between companies and enhance technical skills of the workforce.”

As the government saves more money, it will be able to channel more resources into essential areas such as healthcare and education, too. As reforms continue to gather pace in the UAE, it can provide synergies to strengths built over the last few decades. Over 25% of the world’s 500 largest companies have based their operational headquarters for the Mena region in the UAE. The volume of foreign investments that has entered the country over the past decade has exceeded $100 billion. Looking into the future, the UAE’s Vision 2021 plan targets FDI equivalent of about 5% of what will be the nation’s total GDP in 2021 (from 2.66% in 2014). Pursuit of effective reforms in a coordinated and clinical manner can significantly increase the UAE’s profile, and thus, the chances of achieving such ambitious goals.