Windfall for UAE government coffers continue

Global Investment House – UAE Economic & Strategic Outlook II- Public Finance - In the backdrop of the continuously increasing oil prices, UAE’s consolidated financial accounts, which cover the federal budget and expenditure by each emirate, presented a much more improved picture compared to the past. Total revenues increased by 22.6% to AED94.4bn in 2004. Oil revenues, which form 78% of the total revenues, were the main driver, growing by 29.2% to AED73.3bn. However, after growing at a robust rate last year, non-oil revenue growth decelerated to 4% in <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />2004. In comparison to the rising revenues, total expenditure increased by just 4.2%, effectively diminishing the fiscal deficit.

High oil prices continue to boost finances

Needless to say, the main reason for the improvement in finances in ’04 was the steadily increasing price of oil. By the end of the 2004, the price of OPEC reference basket had soared to more than US$58/b, well beyond the expected band that the OPEC cartel expects to keep. Continuing with the trend in 2003, to arrest the rise in oil prices, OPEC countries raised the production beyond the assigned quotas in 2004 too. Average production in UAE went up by 5.2% to 2.36mn bpd. UAE’s oil revenues in 2004 were at the highest level in more than two decades. The record revenues were despite the fact that the reported accounts exclude those from a few sources. For instance, revenues earned by the state-owned Abu Dhabi National Oil Company (ADNOC) were not accounted for in the budget and is channeled to major infrastructure projects or is used to build up Abu Dhabi’s foreign asset base.

Tax revenues take a leap

While an increase in oil revenues is a ubiquitous feature in GCC countries, what was more encouraging was the steady growth in non-oil revenues in the last two years, mainly driven by tax revenues. Tax revenues increased by 31.4% to AED9.25bn in 2004. Customs revenues continued to soar, growing at 24.1% in 2004, over and above the 47.3% growth in the previous year. While the unified customs tariff agreement increasing the rate to 5% from 4% in the UAE, boosted the customs revenue in 2003, robust import growth kept it afloat in 2004 too. Other tax revenues grew by 35.3%, which comes after a blip in 2003 when collections declined. Huge profits made by oil companies, which pays corporate tax of 50-55%, could have been the prime reason for this.

In the meantime, as part of the efforts to insulate public finances from fluctuations in oil prices, GCC finance ministers have proposed the introduction of a value added tax (VAT) to be levied on the goods sold in the six member countries. The plan is to first target the harmful goods like tobacco, while others would initially be taxed at a very low rate. The IMF also called on the UAE to introduce a property tax and extend corporate tax across all sectors. It warned that state budget surpluses cannot be sustained indefinitely without boosting tax revenue. However, there are also fears that the introduction of VAT would negatively affect UAE’s reputation as an international shopping destination. These fears are not unfounded as introduction of VAT would increase the already high prices (relative to the past) of goods in emirates like Dubai. Also, considering the current state of the finances, the GCC economies are not in any dire need of more sources of revenues. In this context, we believe that it is better to focus and augment the investments in non-oil industries to hedge against future decline in oil revenues, rather than introducing taxes.

The huge increase in tax revenues was to some extent offset by a decline in the non-tax, non-oil revenues. However, we do not see much into this, as there has been no particular trend in the past. The CAGR of non-tax, non-oil revenues was 11.9% in the period 2000-2004. Overall growth of non-oil revenues in the last three years was lesser than that of oil revenues, thus reducing the non-oil contribution to 22.3% in 2004 from 24.7% in 2001. This still does not give an accurate picture as the revenues reported excludes the income that the state receives from its large stock of foreign assets and investments as well as some element of oil revenue, as mentioned before.

Expenditure growth continues to be relatively low

On the other hand, total expenditure has increased by 4.2% in 2004, lower compared to the 5.6% growth of revenues in the corresponding period. Expenditure growth was low in 2004, mainly due to the current expenditure remaining almost flat. Moderate growth in ‘Salaries and Wages’ continued, with this expenditure segment growing at 2.1% in 2004. Increase in ‘Subsidies and Transfers’ too was limited, considering that there was a 30% fall due to an overall curtailing in the previous year. It is worth noting that share of ‘Subsidies and Transfers’ in total expenditure has come down to 11.8% in 2004 from 16.7% in 2000. Abu Dhabi, the largest emirate has taken initiatives in this direction, by reducing agricultural subsidies, and also by moving towards privatization of various utilities. In spite of the control, subsidies still help in absorbing the inflationary pressures created by the high growth and liquidity environment.

Inline with the current expenditure, capital expenditure too saw moderate growth in 2004. This is unusual considering the past trend of capital expenditure growth which had mirrored the movement in oil prices. However, the various developments indicate that this is just due to the timing of a few large projects rather than a slowdown in investment. Projects were launched in 2004, mainly in the areas of construction, petrochemicals and metals.

Table 1: Financial Consolidated Accounts

<?xml:namespace prefix = v ns = "urn:schemas-microsoft-com:vml" />Source: Central Bank of UAE

Deficit diminishes, surplus expected next year

Substantially lower growth of expenditure compared to revenues reduced the deficit to AED855mn in 2004, which is just 0.23% of GDP compared to 4.6% last year. We expect a surplus for the current year, based on higher oil prices and the marginally higher oil production. Average oil prices for the first 8 months of ’05 was US$49.03/b, as against ’04 average of US$34.11/b. UAE’s average daily oil production also increased to 2.41mn barrels in the first eight months of ’05, compared to 2.36mn barrels in ’04.

Public expenditure set to increase

On the expenditure side, one can expect fair bit of increase next year, thanks to large scale initiatives planned for the years to come. Most significant is the announcement by the government to increase the salaries of the UAE nationals working in federal ministries by 25% and that of expatriates by 15%. In Abu Dhabi, government and government-backed companies continue to invest in infrastructure projects including road building, public housing and expansion of capacity in the oil and gas sector. DubaiMunicipality is also in the same vein, while Dubai Electricity and Water Authority has a rolling investment programme to keep the supply ahead of demand. Additionally, there are plans in the pipeline to reform the UAE welfare system. The continuing strength of the oil prices can be expected to encourage all round investments in the future.

Overall, we expect total expenditure to grow at a higher rate than the CAGR of 3.2% in the period 2000-2004. At the same time, the high oil prices would mean much higher growth on the revenue side. In effect, based on our calculations, 2005 financial accounts would have a surplus of around AED25bn.

The budget deficits that the country has been experiencing has never been an area of concern as the revenue figures exclude the income that emirates generate from the UAE’s large stock of publicly owned foreign assets estimated at around US$250bn. External debt as a proportion of GDP too has come down from the high levels in late ‘90s as shown below.

Chart 1: UAE’s external debt as a % of GDP

Source: IMF Article 4 consultation

Balanced federal budget

Apart from the consolidated financial accounts given above, which cover budget and expenditure by each emirate, the central government also announces federal budget, which does not include the accounts of individual emirates. On the basis of the federal government budget, surplus in 2004 has remained almost at the same level as the previous year, while no surplus is budgeted for 2005, which we believe is on the conservative side. It is the first time in 24 years that the country saw a nil deficit, thanks to the Ministry of Finance and Industry’s plan to strike a balance between projected expenditures and revenues.

Table 2: Federal Budget