When the global downturn was biting in 2009, economists were gloomy about the outlook for 2010. But the consensus was that from 2011 onwards, economies around the world would gradually start to pick up and that they would strengthen further in 2012. These predictions were only partly right: 2010 was indeed a difficult year and there was a slight improvement in 2011. But 2012 now looks like it is going to be even harder than last year, not easier.

We’re expecting a slowdown in the UAE as a whole, mainly as a result of the slowdown in the global economy

Andrew Gilmour, Samba Financial Group

The same is likely to be true for the UAE. After a decline in economic growth of 3.5 per cent in 2009, the income from oil sales brought a return to moderate growth in 2010, with real gross domestic product (GDP) growth of 3.2 per cent. In 2011, the loss of almost all Libyan crude production from the global market pushed up Abu Dhabi’s oil earnings still further, underpinning economic growth of 4.3 per cent across the UAE. But economists predict that in 2012, the rate of growth will fall to about 3 per cent, the lowest for three years.

Slow economic growth

This slowdown can be explained by three factors: the impact of a continued economic downturn elsewhere in the world; the return of Libyan production to the global oil market; and the newly conservative orientation of the Abu Dhabi government’s economic policy.

Dubai is far more globally integrated than Abu Dhabi, so the impact of the downturn will be greater

Richard Fox, Fitch Ratings

The indirect impact of the global economic situation is the most significant of the three. Far from returning to healthy growth, many of the UAE’s trading partners look set for economic stagnation, while the expected recovery in Europe is not just stuttering, but grinding to a halt.

This will have a disproportionate impact on Dubai, whose economy is highly integrated with the outside world and relies heavily on non-oil growth. “We’re expecting a slowdown in the UAE as a whole, mainly as a result of the expected slowdown in the global economy, which will affect Dubai’s non-oil economy,” says Andrew Gilmour, senior economist at Riyadh-based Samba Financial Group. “With so much of Dubai’s economy reliant on travel, logistics, trade and tourism, there’s not going to be much growth.”

Dubai’s tourism sector has been insulated from the worst of the slowdown as political turbulence elsewhere in the Arab region has diverted tourists to the emirate, one of the few parts of the Middle East not to be beset by instability. Other sectors are struggling and the recovery of the once-booming real estate sector looks as far away as ever. “The property sector is on its back and this isn’t going to change any time soon,” says Richard Fox, head of Middle East and Africa sovereign ratings at US ratings agency Fitch Ratings.

The lingering global economic downturn puts further pressure on Dubai’s highly leveraged economy, both directly and indirectly. The lack of inward investment means that Dubai remains short of capital, while the financial problems elsewhere continue to depress the appetite of international banks to provide debt facilities.

Dubai debt

With the help of $20bn in funding from the Abu Dhabi government and the central bank in 2009, Dubai has so far avoided a default on its debts. But large swathes of debt are due for repayment in the coming year, which will make 2012 another difficult year for the emirate.

“The non-oil economy in Dubai will struggle in 2012,” says Gilmour. “It has a challenging debt repayment schedule, with $15bn due for repayment in 2012 and only $1.5bn left in the Dubai financial support fund. This leaves Dubai very much dependent on refinancing, additional restructuring and asset sales.”

The combination of Dubai’s reliance on debt finance with an almost total lack of transparency means that as long as the global economy is struggling, it will continue to be affected. “The more leveraged economies are the ones that suffer the most,” says Fox. “The global situation is having a similar impact now as it did in 2008-09. Enterprises are having difficulties renegotiating loans, and Abu Dhabi has had to step in to help Aldar [Properties] again.”

The tourist sector aside, Dubai’s economic challenges have been exacerbated by the knock-on effect of political instability in the Middle East on the appetite for investment in the region. “The expectation last year was that 2012 would be a good year for oil producers, but investors from the rest of the world don’t seem to be able to get excited by the Middle East story,” says Reinhard Cluse, head of emerging Europe, Middle East & Africa economic research at Swiss lender UBS. “They still don’t fully trust the political situation and as a result don’t seem to be willing to make big bets on the equity side.”

While Dubai relies on non-oil investment to fuel economic growth, Abu Dhabi is dependent on oil earnings. Here, the return to market of Libyan crude could well dent the UAE’s export income.

Where Abu Dhabi increased production to make up for lost output from the North African oil exporter, it may now have to cut back. “Growth rates in the oil sector will be lower in 2012 than in 2011 because the fillip from Libyan production going offstream and the Gulf making up the shortfall will no longer be there,” says Cluse.

European recession

An even greater threat to the UAE’s oil earnings is the possibility of a deeper recession in Europe. If the eurozone’s attempt to prop up an increasing number of struggling economies fails, the region could fall into a crisis that could prove disastrous for global oil prices.

“The key risk is if the eurozone goes to the dogs and the oil price falls dramatically below the $100 a barrel mark,” says Cluse.

“Oil demand would also fall and producers would suffer a lot. There could be a psychological impact too. When oil prices fell in 2008-09, it had a massive effect on financial markets in the Gulf.”

In contrast to some of its neighbours in the Gulf, Abu Dhabi has responded to these external economic headwinds by replacing a fiscally expansive economic policy with a much more conservative approach to spending.

“Abu Dhabi is in consolidation mode,” says Fox. “This is partly because they had to spend more than they would have liked in 2009-10, but it also reflects a change of view as to what they are doing and how to achieve it. It wants to avoid the mistakes that were made in the past.”

Where there is spending, it is now more likely to be focused on meeting the needs of the local population than on the type of vanity projects associated with neighbouring Dubai.

“Investment will diminish as it focuses on priority projects, mainly related to the socio-economic needs of its citizens,” says Gilmour. “The Abu Dhabi government has realised that the old model no longer applies. The mindset at the moment is for it to put its house in order and not go ahead with white elephant spending programmes.”

Real estate spending will continue to slow, while a bearish oil market means that there is little incentive for energy sector spending to return to the eye-catching levels experienced up to 2008. “There is already spare capacity in the oil market, so adding infrastructure now is less pressing,” says Cluse.

“If there were bottlenecks in supply there would be more of a hurry, but there’s no reason to rush at the moment.”

Abu Dhabi’s economy is in a strong position to weather the current slowdown. “Government finances have certainly been feeling the strain over the past two years, but it’s still in a healthy position,” says Gilmour. “They have substantial assets and oil earnings are high due to high prices and high production volumes.”

By comparison, the impact on Dubai will be severe. “Dubai is far more globally integrated than Abu Dhabi, so the impact of the downturn will be greater,” says Fox. “It is in no position to spend counter-cyclically because it doesn’t have the resources.”

Like Abu Dhabi, Dubai is reining in its spending. “The leveraged model has fallen,” says Fox. “They’re concentrating on their traditional strengths. Real estate is clearly not a growth area, but Dubai has lots of strengths, and will benefit from any recovery in the global economy.”

While most analysts believe 2012 will be a year of consolidation for the UAE, there is some upside potential. Most believe that the despite its sovereign debt crisis, the eurozone will hold together and economic disaster will be averted. If all goes smoothly in Europe in the coming months, it could even outperform expectations.

“The UAE is a bull market play if the situation in Europe improves and people go back to acknowledging the strong fundamentals of the Gulf region,” says Cluse.

Oil output

While the resumption of Libyan production is a downside risk for the UAE’s oil earnings, there is equally a potential upside from production outages elsewhere.

In early January, Japan fell into line with the US and Europe in pledging to cut its purchases of Iranian hydrocarbons.

Tehran in response has threatened to blockade the Strait of Hormuz, a major export route for crude exports – a course of action that might threaten some of the UAE’s oil exports, but would also drive up prices.

Further political unrest in the Middle East and North Africa, or unforeseen events elsewhere in the world, could also lead to crude production outages. Nigeria narrowly averted the possibility of a shutdown of oil and gas infrastructure in January when the government acceded to union demands to partially restore energy subsidies.

Taking into account these risks, US investment bank Goldman Sachs expects Brent oil, the UK benchmark, to trade at an average of $120 a barrel in 2012.

If this proves to be the case, the UAE can be assured that even without the stimulus of an expansive government fiscal policy, its economy will continue to grow.