While the economic recovery in the United Arab Emirates is gaining strength, the International Monetary Fund Monday warned about the risk posed by debt-laden government-related entities, saying unrest in the wider region could result in challenging borrowing conditions as they seek to rollover massive amounts of debt.
Going forward, limiting the overall borrowing of these government-related entities will be key to reducing the risks they pose to the UAE economy, the IMF said in a statement detailing the results of the April 21 Article IV consultation with the Gulf Cooperation Council member.
“The economic recovery in the U.A.E. is gaining strength, supported by a favorable global environment but subject to increased regional uncertainty,” the IMF said. However, “risks to the recovery remain, including from possible economic spillovers of regional events.”
In particular, IMF staff said the current re-pricing of geopolitical risk in the region could lead to more challenging market conditions, which may put pressure on the entities that need to roll over external borrowing.
“The real estate overhang and short-term refinancing needs from overleveraged GREs continue to weigh on the near-term outlook,” IMF said.
At more than 100% of GDP, Dubai’s GRE debt is large and IMF staff said its rollover needs are expected to remain substantial for the medium term, posing continued fiscal and financial risks to the UAE overall.
The real estate overhang refers to the excess supply of property in Dubai, and the uncertainty regarding the scale of oversupply in the emirate.
“Mitigating GRE risks should remain a policy priority,” the IMF said. “In the short term, the authorities should complete the restructuring of GRE debt, ensure the viability of these entities through writing-off impaired assets, and communicate their strategy on GRE debt refinancing.”
Going forward, IMF staff proposed that to reduce GRE risks, the UAE authorities should limit overall GRE borrowing by emirate, developing a GRE risk management framework, and reporting contingent liabilities arising from GREs in the fiscal accounts.
GRE governance also needs to be improved, including making the ownership structure clear, the government support strategy, and delineating commercial and noncommercial operations carried by the GREs.
“Finally, better information disclosure about GRE financial accounts would improve investor confidence and ultimately translate into lower funding costs,” the IMF said.
Given the fragile nature of the recovery, IMF staff advised UAE authorities to focus on supporting domestic demand, while adjusting to the economic spillovers from the unfolding regional events.
“An overall neutral fiscal policy stance following last year’s fiscal contraction would support the economic recovery, while Dubai should consolidate,” the IMF said.
And while the Central Bank of the UAE should maintain its accommodative stance — which mirrors that of the Federal Reserve — the IMF said the central bank should be prepared to inject liquidity into the financial system “in case the re-pricing of risk in the region triggers a reversal of the recent deposit inflows to the banking sector.”
The central bank should also continue to prepare the banking system for further possible deterioration in asset quality and future risks, the IMF said.
Given the likelihood of further increase in non-performing loans, IMF staff said the central bank should continue to ensure that banks provision adequately, while monitoring the performance of restructured loans.
“Higher capital charges on risky GREs, and continued retained earnings by banks would also limit the potential financial risks posed by the GREs,” the IMF said.
As for the UAE’s policy of pegging its dirham to the U.S. dollar — a practice followed by other GCC nations with the exception of Kuwait — the IMF said the exchange rate is broadly aligned with fundamentals, and the dollar peg continues to serve as an effective nominal anchor for the economy.
Developing the domestic capital markets will reduce the UAE’s dependency on external markets, the IMF said, but, given the limited scope for federal securities in the short term, UAE authorities should explore stable funding from non-traditional sources, such as term deposits from government sources.
