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Strong wealth fund growth boosts UAE fiscal stability
posted on 24/06/2008
When oil prices were as low as US$10-20 a barrel two decades ago, the UAE seriously considered borrowing from the local market to finance its swelling budget deficit. But the plan was shelved in favour of painful spending cuts. Such reductions, however, could not be maintained for a long time because of the rising domestic development needs and a seven per cent growth in the population. As a result, the deficit in the country sharply widened.
Yet authorities still never considered borrowing or introducing income taxes for two reasons: the country's petrodollar income was swelling and a gigantic overseas investment empire was taking shape. It was this massive increase in the assets of the country's sovereign wealth fund – the Abu Dhabi Investment Authority (Adia) – that has prompted the UAE to completely dump plans for issuing bonds or imposing income taxes.
Despite the sharp rise in revenues, the budget reeled under massive shortfalls because of excessive expenditure until it reverted into huge surplus only three years ago. During the previous years, the deficit was almost totally financed through return from the country's overseas investments. Besides providing a cushion against oil price volatility, the steady growth in Adia's assets allowed the UAE to enjoy the strongest fiscal stability in the region.
At a time when most other Gulf oil producers reeled under heavy public debt due to widening budget gaps, the UAE remained free of that burden except for relatively small short-term borrowing to fund some projects. Like most other SWFs, the government-owned Adia has never disclosed the size of its assets. But Western bankers and economists put them at between US$250-875 billion, (Dh917bn-Dh3.2 trillion) making it one of the largest SWFs in the world.
Its wealth began to rapidly grow nearly four years ago after a surge in oil prices and the UAE's crude output sharply boosted its income and turned budget deficit into a massive surplus. In contrast with other Gulf countries, the UAE has never had any real budget deficit over the past 15 years.
Economists consider it as a nominal shortfall on the grounds the investment income is normally not included in the revenues when the budget is drafted.
In the case of the federal budget, the shortfall has been financed through additional contributions from Abu Dhabi during the fiscal year. As for the deficit in the consolidated finance account (CFA), which covers the federal budget and spending by each emirate, it has been mostly covered through return from overseas investment. The other funding source, albeit smaller, was withdrawals from the government deposit with local banks.
According to data from the Ministry of Finance, the UAE has suffered from a cumulative CFA deficit of around Dh139.8bn during 1998-2004. But the shortfall was easily covered through investments and withdrawal from deposits. The surge in oil prices over the past three years turned the deficit in previous years into a surplus, which stood at Dh39.4bn in 2005 and climbed to a record Dh72.4bn in 2006. Although no official figures have been released for 2007, bankers expect the surplus to have remained high after oil prices jumped by at least US$10 above their 2006 level of around US$60 a barrel. Central Bank estimates showed the surge in oil prices boosted the country's crude export earnings to a record Dh261bn last year from around Dh213bn in 2006 and Dh159bn in 2005. The income stood at only Dh79bn in 2000 and less than Dh40bn in 1999 and 1998.
The budget recorded large surpluses despite a sharp rise in expenditure, which swelled to Dh104.4bn in 2005 from Dh96.2bn in 2005. It rocketed again to around Dh128.2bn in 2006 and was expected to be higher last year. Apart from meeting its spending targets, the surge in its SWF assets allowed the UAE to shun painful borrowing that jolted Saudi Arabia and other oil producers.
According to the International Monetary Fund, the UAE had the lowest debt-GDP ratio in the Arab world during 1998-2002 and it remained among the lowest in the following years.
The UAE debt GDP ratio stood at around 5.5 per cent during 1998-2002 and grew to nearly 6.6 per cent in 2003 and an average eight per cent during 2004-2006. The ratio was estimated at around 7.7 per cent in 2007. The large surplus in the UAE budget allowed the government to increase its deposits with banks over the past two years.
From around Dh79bn at the end of 2005, the deposits grew to Dh86.6bn at the end of 2006 and nearly Dh104.5bn at the end of September last year, according to the Central Bank.
In a report last week, the Oxford Business Group said Adia has plans to reshuffle its portfolio and that these plans had been supported by US Treasury Secretary Henry Paulson, who visited Abu Dhabi early this month. It referred to Paulson's remarks that the United States would keep its markets "open at home to investment from private firms and from sovereign wealth funds.
"Paulson's visit comes at an important time, as Adia is restructuring its portfolio. According to reports, the SWF is divesting itself of much of its hedge fund portfolio in exchange for so-called passive funds which follow a set selection of stocks, and are often linked to the fluctuations of a specific index," it said.
"A statement issued by Adia suggested that the fund is not getting good value from its hedge fund-managed investments." It quoted Adia's Executive Director Said Mubarak Al Hajeri as saying: "Adia is keen on identifying real management skills and talent and is not prepared to pay the usual fees charged by hedge funds for strategies that can be replicated in an index." –Emirates Business 24/7
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