The United Arab Emirates, once seven independent states under British oversight, has emerged into a global economic powerhouse because of its abundant natural resources, successful financial investments, and extensive focus on real estate and tourism. Having the world’s sixth largest oil reserves and fifth largest natural gas reserves, the UAE is poised for year over year economic growth, which has allowed them to focus more heavily on economic diversification and political reform. As this desert country continues to grow, so does their reliance on energy, which has spurred a major governmental effort to identify renewable energy sources to offset consumption. Renewable energy initiatives that the UAE have pursued drove the investment recommendations made in this analysis.
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UAE’s economy has seen extreme growth in recent years, as seen by above average GDP and eight figure year-over-year trade surpluses since 2003. This economic boom is more impressive when considering the country’s strong push to alleviate its reliance on oil exports and diversify into other industries. Currently, profits from oil exports represent roughly 33% of the economy. Volatile oil prices, which heavily correlate to UAE profitability, are becoming less important to overall financial growth. Actions like this help to mitigate risk for potential investors and should make the UAE more attractive in the foreign investment arena.
Capital markets in the UAE are also modern and robust. They enjoy two stock exchanges, have implemented an extensive market oversight organization to protect the integrity of their markets, and have created several government-owned investment institutions to help foster investment diversification. The Emirates welcome new business, as they have established Free Trade Zones that offer many benefits to investors that set up operations within UAE borders. The UAE ranks number one among Arab countries in foreign investment and is considered a global business center for its constant pursuit of social, economic, and technological advancement.
Political reform has been prevalent in the UAE throughout history. The first federal constitution was established in 1971 that brought these seven Trucial States together to operate as one entity. Although the UAE has experienced some growing pains in transferring authority from individual states to a federal governing body, the political stability is high. The UAE has recently rolled out a detailed, objective action plan called “Vision 2021” to help them methodically reach their goal over having balanced power among state dictatorship and federal policy.
The UAE has seen massive growth in its economy, population, infrastructure, and energy consumption for many years. The citizens of the UAE emit more greenhouse gases per person than any other country, and because of its geographic location, nearly all of their buildings are air-conditioned and water is obtained through energy-intensive desalination plants. Because of the exponential increases in demand for electricity, the UAE has focused its efforts on developing renewable energy sources. Estimates currently project that the demand for domestic power will more than double by 2020, and the UAE is tackling these consumption hikes head-on. Abu Dhabi, the capital of the UAE, is aiming to obtain 7% of its energy from renewable sources by 2020 and is currently planning the construction of a zero-waste city that will rely solely on renewable energy sources. This renewable energy push poses significant foreign investment opportunities, as an already economically-thriving country aims to eliminate energy reliance in parallel with having world-leading economic growth.
United Arab Emirates
The United Arab Emirates (UAE) was established in 1971 and is comprised of seven independent emirates or states, Abu Dhabi, Dubai, Sharjah, Umm al-Qaiwain, Fujairah Ajman and Ra’s al-Khaimah. It is located on the Arabian Peninsula and occupies 32,000 square miles between Saudi Arabia and Oman on the Persian Gulf. The country is over 80% desert and has no natural water sources. (The UAE, 2010)
As the largest of the emirates, occupying more than 75% of the country (United Arab Emirates, 2011), Abu Dhabi is the country’s capital. Another major city is Dubai, which is considered to be a financial and commercial mecca for the country.
The UAE’s history dates back to the 18th and 19th centuries when the dominant tribe in the area was the Qawasim. The Qawasim’s control of the maritime trade routes in the lower Persian Gulf and much of the Indian Ocean eventually provoked the British into a naval attack in 1819. After defeating the Qawasim, the British signed a series of treaties with the sheikhs of each of the emirates to preserve a maritime truce. This eventually led to the area becoming known as the Trucial States. In the truce, the sheikhs agreed not to engage in foreign relations or to relinquish any of their territories without British consent. In exchange, they were promised protection against naval attack, and assistance in any land attacks.
In January 1968 the British announced that they would be withdrawing from the Persian Gulf. Over the next three years, the emirates that made up the Trucial States worked to form their own federation. Agreement was finally reached between Abu Dhabi, Dubai, Sharjah, Umm al-Qaiwain, Fujairah and Ajman on December 2, 1971, and the United Arab Emirates was formed. On February 10, 1972 the seventh and final emirate, Ra’s al-Khaimah, joined the federation. (United Arab Emirates, 2011)
Currency & Exchange Rate Arrangements
After federation of the UAE in 1973, a new national currency was created, the Emirati Dirham (AED). In 1997 the AED was fixed and pegged to the US Dollar (USD). Currently pegged at a rate of 3.673 (The World Factbook: United Arab Emirates, 2011), this remains the country’s currency arrangement today. However, prior to the implementation of the AED in 1973, a host of different currency arrangements were used throughout the region.
Prior to 1966, the Persian Gulf rupee was the currency utilized in the Arabian Peninsula, which was pegged to the British pound (GPD) at a rate of 13.33. (Symes) Due to a devaluation of this currency in June 1966, the Bahraini dinar and the Qatar-Dubai riyal were adopted by the emirates.
The Bahraini dinar (BHD) debuted in 1965 in Bahrain, an island nation located north of the UAE in the Persian Gulf. The BHD was adopted by Abu Dhabi in 1966 and was used until 1973 when it was replaced by the Emirati Dirham. (Symes) It is currently pegged to the US Dollar at a rate of 0.377.
The Qatar-Dubai riyal was introduced in 1966 as a result of the Qatar-Dubai Currency Agreement. This agreement was reached between the countries of Qatar and Dubai because of a push by Britain for the Trucial States to take responsibility for their economic future. The Qatar-Dubai riyal was used by all of the emirates except Abu Dhabi from 1966 until 1973. Its value was equal to that of the Persian Gulf rupee prior to its devaluation. (Symes)
The formation of UAE meant significant changes to the overarching political structure. The creation of the constitution of the United Arab Emirates in 1971 established some formality within the conglomerate, although individual states still maintained significant power to control finances and natural resources. Since much disparity exists between the size, maturation, and political complexity within each emirate, the political environment is much different as well. The most developed emirates, Abu Dhabi and Dubai, have fairly sophisticated governments comprised of multiple hierarchical levels, while more remote settlements typically have only one ruler and several local representatives who are appointed solely by the ruler.
The UAE constitution established executive, legislative and judicial branches of government, and called for the formation of a number of fundamental councils to sustain these branches. The Federal Supreme Council has both legislative and executive powers, and is comprised of each emirate’s ruler and a separate President and Vice President who are elected by the Council every five years. All general policy, enactment or ratification of federal laws, overarching financial decisions, and international relations strategies are made by the Federal Supreme Council. The Federal National Council, UAE’s version of a Parliament and main legislative entity, is a 40-member body that represents the voice of the UAE constitution. Fifty percent of these members are chosen by an Electoral College, while the remaining twenty members are chosen by emirate rulers. The FNC has the authority to amend federal legislation and, amongst other duties, is responsible for reviewing the federal budget and managing international activities. The UAE constitution also formed the Federal Judiciary, which consists of five appointed judges. These judges have the authority to try cases involving senior officials, and often rules on disputes between emirate entities.
The biggest barrier that the UAE government has faced since its inception is the lack of cohesion between local policy and federal oversight. The UAE is growing and developing rapidly, and it is imperative to tailor the political systems to make them more responsive to the country’s needs as it faces the challenges of this development. Much emphasis has been placed on formalizing the local political environment to provide more stability and consistency from emirate to emirate, as well as ensuring that local government policy is representative of the federal political strategy and values. The first major breakthrough occurred in 2007, when the UAE launched the “UAE Government Strategy”. This strategy outlined a number of initiatives aimed at enhancing the six UAE government strategy sectors: social development, economic development, public sector development, justice and safety, infrastructure, and rural development. This initial reform strategy was undoubtedly a success, as the UAE has made significant strides towards unifying political efforts and operating within a common framework.
In 2010, the UAE announced its “Vision 2021”, which vowed to steer the country through upcoming challenges by operating efficiently and responsibly, displaying determination and innovation, and by being proactive in all governmental matters. The UAE is driving towards their vision very methodically, as the government recently released its “Government Strategy 2011-2013” as the first step to achieving the goals outlined in Vision 2021. This Government Strategy outlines seven general principles, seven strategic priorities, and seven strategic enablers that will be used when developing strategic and operational plans and will push the country closer to its vision (See Exhibit 1).
The political environment of the UAE is changing rapidly. The balance of power is slowly shifting from individual states to a central government entity through the establishment of an overarching constitution and the creation of formal federal councils. Individual emirate states have been slow to embrace this cohesion. Inter-state relationships have historically been relatively unstable in the UAE, which was highlighted in 2009 when Abu Dhabi provided Dubai with a $10B bailout when they could not repay a $4.1B Islamic bond and was in financial turmoil with creditors. This bailout caused strife between the two largest and most powerful UAE entities, and questions still linger as to whether Dubai will be able to meet its financial commitments.
Despite these recent events and overall political reform, the UAE political system is relatively stable. World Bank currently ranks the political stability of UAE in the 74th percentile of countries, while all Middle Eastern countries have a combined rating in the 37th percentile. Government effectiveness is also rated exceptionally high: in the 77th percentile (Middle Eastern countries combined are rated in the 48th percentile). Business Monitor International ranks UAE political stability at 82.1 (of 100). BMI uses specific objective data to analyze political risks, including distribution of wealth, policy stability, foreign relations, etc. These political risk ratings highlight the effectiveness of UAE’s government reform efforts. Despite residing in a hostile region, having individual states that control almost all local governmental matters, and the presence of rivalries within the states, UAE is viewed as having a stable political environment (See Exhibit 2).
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Over the past forty years, the UAE has transformed from a relatively unknown country into a thriving economic force. The UAE economy is the third largest in the Middle East behind Saudi Arabia and Iran. Their financial success started with the exportation of oil, an abundant resource in the UAE, and since then their economy has grown into other industries such as financial services, trade, retail sale, real estate, and tourism. The following discusses the UAE economy in detail.
Foundations of Economy
Oil was discovered in the lands of what is now the UAE in the early 1930’s. Once discovered, oil exportation began, and oil sales continued to grow, especially throughout the 1960’s. In 1971, the seven emirates formed the UAE, becoming the only Arab federation in the world. As the oil business continued to grow and prosper, the UAE used its financial success to develop the country and expand their economic goals. The UAE has since grown exponentially as an economy, due to success in areas such as natural gas exportation, foreign investment, trade, financial services, real estate, and tourism. Its government policies have also helped to spur this rapid growth. The UAE promotes a free market through its free trade zones created to attract foreign investment.
As much of the world faced financial struggles in the past few years, Dubai was hit especially hard. Similar to the real estate problems recently faced by the U.S., Dubai real estate prices rose constantly due to over-speculation on the assumed future value of property. When demand for real estate did not meet investors’ high expectations, Dubai was left owing billions in debt it could not pay. The Central Bank of the UAE provided Dubai a $10 billion loan to pay off its debt obligations. As a result of these recent financial difficulties, growth in the short term appears to be slower than recent years as the country recovers from its financial downturn. The UAE economy grew at a rate of 2.5 % in 2010. However, the economy should rebound in time. Its projected growth rate in 2011 is 3% and targets a 5% rate in 2012 and beyond. In the long term, the UAE will more than likely return to the fast-paced economic growth it enjoyed in previous years.
Current Analysis of UAE Economy
As discussed above, the country has faced extreme financial growth in the early 2000’s, but has dropped significantly in growth through 2008, 2009, and 2010. We will now analyze the performance of UAE’s economy by examining the gross domestic product, economic performance indicators, international trade, and resources and infrastructure.
Gross Domestic Product
Since 2003, the UAE’s Gross Domestic Product (GDP) growth rate has exceeded the worlds GDP every year. In 2009, the GDP of both the UAE and the world declined, but the UAE’s growth rate of -0.7% was better than the world’s growth rate of -1.9% (Worldbank). According to the UAE government website, this decrease in GDP was based on a decrease in oil prices. The per barrel price dropped from $95 in 2008 to $60 in 2009. The government projected a real GDP growth of 2.5% for 2010. The UAE currently ranks 35th in the world in GDP at around $230 Billion (Worldbank). UAE’s per capita GDP rose steadily from $23,523 in 2003 to $58,272 in 2008, but fell to $50,070 in 2009. The overall world per capita GDP faced a decline in 2009 as well. The UAE ranks 7th in the world in per capita GDP. The GDP growth and GDP per capita indicators show that the UAE’s economy is growing at a high rate in comparison to the rest of the world.
The non-oil sector industries that contribute to UAE’s GDP (UAE Govt Website):
Manufacturing – 16.2%
Construction – 10.7 %
Wholesale and retail trade and repairing services – 9%
Real estate – 8.2 %
Government services – 8.0 %
Transportation, storage, and communication – 7.1 %
Financial services – 5.8 %
Hotels and restaurants – 1.8 %
Agriculture, livestock, and fishing – 1.7 %
Electricity, gas, and water – 1.6 %
Household services – 0.5 %
Economic Performance Indicators
The UAE faced double-digit inflation rates from 2005 through 2008, anywhere from 13-19% per year. In 2009, the UAE’s inflation rate dropped to -11.3% (Worldbank). These dramatic increases and decreases are substantially different from the 2-3% cost of living annual increase that most economies target. UAE officials project that inflation will remain around 2% this year (Khaleejtimes).UAE’s unemployment rate has slowly risen from 2.75% in 2004 to 4.25% in 2010 (Trading Economics). Although unemployment has risen, it is still low in comparison to many other countries around the world. UAE’s Growth Rate of Industrial Production was 3.2% in 2010 (estimate), ranking them 102nd in the world (CIA)(analysis). The current interest rate of the UAE, called the Emirates Interbank Offered Rate (EIBOR), is 2.5% for a one year loan (Worldbank). The EIBOR one year interest rate has remained at or near 2.5% since the end of 2009. The average overall interest rates have dropped in the past four years. In 2007, the average interest rate was 5.5% (Trading Economics). As of January 2011, the current average interest rate in the UAE was 1%. The UAE government spent around 32% of its GDP in 2010, and the UAE government will continue to operate in a budget surplus. The EIU forecasts that UAE’s budget surplus will continue to narrow in coming years, as the government budget will face deficits from 2013-2015 (EIU).
The UAE exported $192 Billion in 2009 and imported $150 Billion, resulting in a trade surplus of $42 Billion (Trading Economics). The UAE has enjoyed a trade surplus between $20 Billion and $62 Billion since 2004. The UAE’s top importing partners are China, India, US, Germany and Japan (UAE Embassy). The top five exporting partners of the UAE are Japan, South Korea, India, Iran, and Thailand. The major exports of the UAE are oil, natural gas, re-exports, dried fish, and dates. The major imports of the country are machinery, transport equipment, chemicals, food (UAE Embassy).
Resources and Infrastructure
UAE land is rich in natural resources. The UAE contains about 10% of the world’s oil reserves, and has the world’s seventh largest supply of natural gas (UAE Embassy)(See exhibits 4 and 5). The exportation of oil is the major source of revenue for the UAE, accounting for about 30% of its annual GDP (UAE Embassy). The UAE government has used this oil revenue to invest heavily in the country’s infrastructure. These investments in the country have promoted the rapid growth of other industries in the UAE including tourism, re-export commerce, and telecommunications (UAE Embassy).
Short-Term and Long-Term Prospects/Forecasts
Short Term Forecast and Prospects
As the UAE continues to recover from the global financial struggles, growth in the next few years will be slower than the extreme growth rate it enjoyed in the recent past. The UAE’s GDP is expected to grow by 3.3% in 2011 (7days). Dubai plans to pay off its debt in 2011, which is a positive for the country. After 2011, the economy’s anticipated growth is 5% per year for the next few years (EIU). Inflation in the UAE is expected to rise by 2.8% in 2011(Arabian Business).
Oil exportation will remain a solid revenue stream for the country. Existing and newly developing non-oil industries will also enjoy growth in the coming years. Trade, tourism, and business service industries should maintain strong growth as the UAE continues to diversify its economy. Healthcare and Information Technology (outsourcing services, smartphones, servers, and disk storage) industries are anticipated to increase by 15-20% this year (Arabian Business).
High food prices are an immediate concern to the UAE and other countries in the Middle East. The UAE government has subsidized the food markets in the country. Political unrest in the Middle East and unused real estate in Dubai are also concerns. Inflation from rapid economic growth in non-oil industries is also a risk.
Long Term Forecast and Prospects
The UAE economy should remain strong for the next twenty years. Oil exports will provide a constant income source to the country. Volatile oil prices can be a threat to the economy, but the country’s foreign investments should provide enough support if and when oil prices drop (EIU). Other UAE industries should develop further as long as the country continues to invest in expanding these industries. Developing and employing its country’s people will be a focus in the coming years, as the country is heavily dependent on foreign workers. Inflation could also be a concern as the country continues to grow.
Exchange Rate Behavior and Forecasting
The United Arab Emirates dirham is pegged to the International Monetary Funds’s Special Drawing Rights. It is effectively also pegged to the U.S. dollar most of the time with the average exchange rate at 3.6725 USD/AED (See Exhibit 5).
In 2008, after reviewing its currency regime, the UAE decided to keep the dirham pegged to the US dollar for the next 30 years.
The capital markets of the United Arab Emirates are very modern. There are two stock exchanges in the UAE: the NASDAQ Dubai and the Abu Dhabi Securities Market (ADSM). In keeping with Muslim teachings, all trading is based on assets or other tangible goods in order to avoid what is considered usury, which is not in compliance with sharia, an Islamic ethical foundation. Sharia has impacted the structure of financial institutions and the way certain investments such as gold are traded, but most offerings and services are similar to other parts of the world.
NASDAQ Dubai opened in September 2005 and maintains investment standards that it considers comparable to those of leading international exchanges in New York, London and Hong Kong. NASDAQ Dubai offers both primary and equity listings for companies based in the region, as well as internationally-based companies representing Australia, China, United Kingdom and the United States.
NASDAQ Dubai offers a variety of options of investments including equities, debt, derivatives and other securities. As the market continues to grow, it has plans to expand its offerings including exchange-traded funds, subject to regulatory approval.
NASDAQ Dubai has set itself up to be the “international listing destination for equity securities in its region”. (NASDAQ Dubai) The region is defined as the Gulf Cooperation Council (GCC), which includes the UAE, as well as the Middle East and North Africa, Turkey and the Indian sub-continent.
NASDAQ Dubai is the only exchange in the GCC region that offers:
A book-building IPO with full access for foreign investors
A free float of as little as 25% of issued share capital
International standards of regulation
Links to investors through a broad mix of local, regional and international Members
Contractual market-making, to provide liquidity
Multi-currency listings – including US dollar and UAE Dirham
Minimum lock-up period of 180 days for founding shareholders
Over The Counter (OTC) trading
The Abu Dhabi Securities Exchange (ADX) was established in November 2000 and is primarily UAE companies. ADX is located in the emirate of Abu Dhabi but also has branches in Fujeirah, Ras al Khaimah, Sharjah and Zayed City.
The exchange has high standards of protecting investors by requiring fair and accurate transactions with stringent controls. They also ensure financial and economic stability by creating trading that ensures liquidity and stability of the prices for the securities listed on the exchange.
The UAE created the Securities & Commodities Authority (SCA) in 2000. Its mission is:
to protect investors and enhance the principles of sound and fair practices, and to improve the efficiency of UAE capital markets through the development of the necessary legislations, the enhancement of supervisory regulations and the development of investment and legal awareness. (Securities and Commodities Authority (UAE))
The UAE is trying to ensure that its markets are attractive to investors from around the world for listing and investing.
Government-owned Investment Institutions
The UAE has created several government-owned investment institutions that act like private-equity firms to help invest diversify the government’s investments. The focus is to create more overseas investments because the UAE realizes that its natural resources will one day be depleted.
These investment institutions recently clarified their roles and investment approaches in order to enhance international understanding and cooperation. In particular, they clarified that they haven’t ever and will never use its investment organizations or individual investments as a foreign policy tool. (UAE US Embassy)
The Arab World Competitiveness Report 2007, issued by the World Economic Forum (WEF), ranks the UAE in the top position among Arab countries and in the 29th position among the 40 most advanced economies. It states that “Sound economic management has contributed to stabilizing the macroeconomic environment and strengthening public institutions.” (UAE US Embassy Financial Sector)
The UAE is considered a global business center and is trying to diversify from their reliance on natural resources by building up their economy in a variety of industries. While the UAE is becoming a more global economy, business is conducted on the basis of personal relationships and mutual trust so it is important to be patient and build these relationships rather than being too direct. Companies are still a family affair, with the ultimate decision-maker being the head of the family.
Establishing a Business
The regulations around the establishment and conduct of businesses are shared at the federal and emirate levels. There are three methods for establishing a business in the UAE:
Free Trade Zone
In order to establish a business that sells products or services freely throughout the UAE, at least 51% of the business must be owned by a UAE national. This type of business structure offers the broadest alternatives for operating a company in the UAE. All businesses require a license and licensing procedures vary from emirate to emirate.
Foreign companies can establish wholly-owned branches and representative offices in the UAE, provided that a UAE national is appointed as a local agent. The UAE considers a branch office as a regular business that is permitted to perform and enter into contracts or conduct other activities as specified in the license of its parent company.
The UAE national that is the local agent for the branch office assists with all the administrative requirements of setting up the office including obtaining visas, licenses and dealing with local authorities.
The UAE has numerous Free Trade Zones (FTZs) that can be an attractive alternative for foreign investors and businesses to set up operations. There are over 20,000 companies in 21 Free Zones around the UAE. Businesses in a FTZ can only conduct business within the FTZ or abroad. If the company desires to sell products in the UAE, a UAE official agent is required, and a joint venture needs to be formed.
Companies located in FTZs do not have the UAE ownership requirements that come with a joint partnership. All imports and exports in and out of the FTZ are exempt from tax and all profits are fully repatriated without penalty back to the company’s parent country. FTZs also offer no corporate tax for the first 15 years which is renewable for an additional 15-year period. No personal income tax exists either.
An independent Free Zone Authority (FZA) governs each free zone and is responsible for issuing FTZ operating licenses and assisting companies with establishing their business in the FTZ. Companies can either register a new company in the form of a Free Zone Establishment (FZE), which is a limited liability company governed by the rules and regulations of the Free Zone in which it is established, or establish a branch or representative office of their existing company based within the UAE or abroad.
Financial Market Performance, Future Outlook and Investment Opportunities
As a mainstay to the economy, oil exports now account for about 30 percent of total UAE gross domestic product. Since the UAE began exporting, it has been using the associated revenues to improve the quality of life for her people since 1969. The UAE is in a strategic location bordering the Gulf of Oman and the Persian Gulf, a vital transit point for world crude oil. With a prime location on the global map, the UAE has invested billions of dollars in logistics and infrastructure, capitalizing on its potential as a world-class logistics hub.
As the UAE builds wealth from oil exports, their rapid development will continue. The building of roads, office buildings, housing and so forth – all require more energy. Rising populations consume more energy as well (See Exhibits 6). Natural gas plays a disproportionate role in energy generation, accounting for 98 percent, and the increasing demand is surpassing available supply.
Economic growth across the UAE has led to massive increases in the demand for electricity. Current estimates indicate that the domestic demand for power will more than double by 2020, even given the global economic slowdown.