Dubai’s economy could shrink by 0.5 per cent this year as the emirate’s construction and real estate sectors continue to shed jobs, says the Washington-based Institute of International Finance (IIF), the global association of financial institutions.

Construction and real estate account for 25 per cent of the UAE’s banking system’s loans, and the two sectors could more than offset the modest recovery in Dubai’s core activities of trade, retail sales and tourism, says the IIF in its biannual GCC Regional Economic Overview published on 17 May.

This estimate is largely in line with UAE-based investment bank Shuaa Capital’s forecast that Dubai’s economy will contract 0.4 per cent in 2010. Dubai’s economy shrunk three per cent last year, according to the IIF.

The institute also forecast that the GCC’s gross domestic product (GDP) growth is likely to average 4.4 per cent this year, rising to 4.7 per cent in 2011. It recorded GDP growth of 0.3 per cent in 2009.

It predicts this solid growth will be underpinned by higher oil prices, but warned that it expects the recovery of credit to be slow and for banks’ balance sheets to remain constrained in 2010.

“While overall the banking system in the GCC is relatively healthy, deleveraging pressures and funding concerns suggest that recovery of credit will be slow,” says George Abed, senior counselor and director of the Middle East-Africa department at the IIF.  

“Further increases in nonperforming loans and the need for larger provisioning in 2010 suggest that banks’ balance sheets will remain constrained.”

Abed added that the default of the two Saudi Arabian family conglomerates and the Dubai World debt crisis had been “a wake-up call for policy makers in the region” and that Dubai should work to “significantly” reduce its debt and overleveraged position.

Going forward, he said that foreign participation in infrastructure development is crucial, but will depend on what kind of agreement Dubai World reaches with its creditors in the coming weeks.  

“That will be a huge determining factor in foreigners’ deciding if they continue to invest in Dubai going forward.”

The IIF’s baseline GCC projections assume a global economic growth of 3.3 per cent and average oil prices of $75 per barrel in 2010 and $80 per barrel in 2011.