Dubai enters an age of austerity

17 February 2010

The emirate has announced a 6 per cent cut in state spending for 2010 as it feels the strain of its debts in the aftermath of its real estate sector collapse

In contrast to the expansionist fiscal spending programmes in neighbouring Gulf states, Dubai announced a 6 per cent reduction in expenditure for its 2010 budget last month. Spending is projected to be $9.64bn this year, compared with $10.3bn in 2009. 

“Dubai is the only regional economy facing austerity measures,” says Simon Williams, economist at HSBC Bank Middle East. “Even if the budget is executed in full, spending will be at its lowest level since 2007.” 

Dubai’s revenues are forecast to show a 12 per cent decline to AED29.4bn ($8bn), while the budget deficit is projected to be $1.63bn, a 40 per cent increase from its first-ever deficit in 2009, which was budgeted at $1.1bn.

The predicted fall in revenues and the projected deficit, combined with the reining in of spending, highlight the emirate’s adverse economic conditions.

The fiscal challenges the emirate is facing are perhaps best illustrated by the fact that the spending cut this year compares with a 42 per cent spending increase, which was laid out in the previous year’s budget.  

Weakened finances

Dubai’s economy experienced a torrid 12 months in 2009, culminating in state-owned conglomerate Dubai World’s announcement in November that it was seeking a six-month standstill on its $22bn debt repayments.

A last-minute $10bn bail-out by Abu Dhabi staved off a major default on property developer and Dubai World subsidiary Nakheel’s $4.1bn Islamic bond in December. The remainder will be used to finance Dubai World’s needs until the end of April 2010.

Unlike the majority of its Gulf neighbours, which have been able to draw on their considerable hydrocarbons-backed wealth built up during the oil price boom of 2003-2008, Dubai’s public finances have been substantially weakened by the global financial crisis. 

At the end of last year, Saudi Arabia unveiled its largest-ever budget of $144bn for 2010, a 14 per cent increase in expenditure, compared with the 2009 budget of $126bn. This includes 16 per cent growth in the kingdom’s project sector, with $69bn-worth of investment in new and existing projects, as well as an above-inflation increase in public sector wages.

By contrast, Dubai’s spending constraints have been brought into focus by its announced spending cuts. Yet, in a continued effort to provide stimulus to the economy through the global financial downturn, Dubai has allocated AED17.45bn ($4.71bn) – just less than half the estimated budget – to infrastructure and transportation.

The social sector and public services comprise the second largest share of the budget at AED8.10bn. This includes health services, education and social development.  In addition, AED10.6bn has also been set aside for investment plans, AED6.98bn for the security and justice sector and AED2.80bn for administrative purposes and the handling of government affairs.

“I think infrastructure development is the most important element for the future of the Dubai economy,” says Giyas Gokkent, chief economist at the National Bank of Abu Dhabi (NBAD). “Notwithstanding the current difficulties, Dubai is the commercial hub for the region and its roads and transport infrastructure only cements that position. The emirate realises its importance for future economic development.”

Some 30 per cent of this, or AED10.7bn, has been earmarked for the Dubai Roads & Transport Authority (RTA) to ensure the continuation of infrastructure development in the emirate, giving it the largest share among all the emirate’s government departments.

Infrastructure expenditure also extends to the aviation, municipal and tourism sectors. According to regional projects tracker MEED Projects, the RTA, Dubai Metro and the Department of Civil Aviation currently have $8bn-worth of ongoing infrastructure projects. Some of the most high-profile among these include Dubai International airport’s Concourse 3 development and the construction of Dubai Metro’s Green line.

However, given that most of these projects are spread over two to three years, less than a third of this investment will be spent this year, which amounts to $3.5bn.

Economists are confident that Dubai is pursuing the right strategy in designating the lion’s share of the budget to the continued development of infrastructure.

“The current oversupply in the real estate sector means that the market is going to have to wait for the surplus to be absorbed, which has an immediate impact on economic activity and gross domestic product [GDP],” says Fahd Iqbal, a Dubai-based strategist covering the GCC for Egyptian bank EFG-Hermes.

“To counter the effect, the government has decided to spend heavily on infrastructure.”

It is hoped that these infrastructure projects will boost local and foreign investment this year, especially now that construction costs are falling as a result of lower building materials prices.

However, with Dubai’s debts estimated to be at least $80bn and conscious of the shadow cast by the Dubai World episode, investors’ confidence in the emirate has been damaged. Dubai World is due to approach the market with its standstill request on its $22bn debt before the end of February.

Prudent balance

Dubai World currently has access to about $4.9bn of the remaining funds provided by Abu Dhabi and the next major looming repayment is a $1.2bn Islamic loan at its property subsidiary, Limitless World, which is due to be repaid in March.

“Investor confidence has been very deeply affected and there is very little transparency about how the restructuring of Dubai’s debt is going to pan out,” says Iqbal.

“Investors’ appetite has not been helped by the severe lack of news about this and about the government’s future strategy.”

While the emirate’s debt problems remain an ongoing concern and have resulted in its current conservative levels of expenditure, government representatives have been keen to stress that Dubai has exercised prudence in compiling its budget.

“This sound and prudent balance will send a strong message to the business community about the seriousness of the government to push ahead with a rational budget in 2010,” said Hamad Buamim, director general of the Dubai Chamber of Commerce & Industry, at the time the budget was announced in mid-January.

Given that Dubai’s GDP is forecast to total $88bn in 2010, the projected $1.63bn deficit should not exceed 2 per cent of GDP, which is considered to reflect an adequate fiscal policy in the prevailing market conditions.

“The US just announced its budget for 2010, which envisions a deficit of 10.6 per cent of GDP,” says Gokkent.

“So, comparatively speaking, Dubai’s deficit figure as a proportion of its GDP really isn’t very large.”

At 10.9 per cent, Dubai’s budget expenditure as a proportion of estimated GDP is also considered comparatively small.

“Typically, budget expenditure will amount to 30-40 per cent of GDP,” says Williams, who observes that Dubai’s low figure largely reflects its position as an emirate within the UAE federation. This means that many costly public functions, such as defence, are the responsibility of Abu Dhabi, rather than Dubai. 

The emirate is reportedly considering selling assets as it seeks to restructure its debt and boost revenues this year.

These include the Queen Elizabeth II cruise ship, its 20 per cent stake in Canadian circus group Cirque du Soleil and the US luxury retailer Barneys.

“It is no secret that Dubai is in need of cash,” says Iqbal. “We have assumed that assets which are deemed to be non-core will be sold off and I would assume that the bulk of those will probably be the international assets.”

Clearly, 2010 will be another challenging year for Dubai, but it is not yet clear what the implications of this year’s spending decisions will be for future years.

The emirate’s budget for 2010 attempts to balance growth with economic welfare. The hope is that its emphasis on developing the emirate’s infrastructure will provide a welcome stimulus to the overall economy. 

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