Dubai Is All of a Sudden Becoming More…Well, Normal
Sharply reduced oil revenue will change the relationship between the ruling elite and society across the UAE, writes Jack Kennedy.
A taboo topic is being openly discussed in the United Arab Emirates.
It’s become blindingly clear that oil’s tumble from over $100 a barrel to less than $30 makes current economic management unsustainable for the UAE. That means reassessing the state-citizen social contracts that have characterized the region’s politics since the federation’s inception – and the final option: taxation.
Export earnings for the Gulf Cooperation Council nations – the UAE, Saudi Arabia, Kuwait, Qatar, Bahrain and Oman – were down $360 billion in 2015. The UAE relies on oil revenue for 60% of its federal budget.
Emirati citizens benefit from one of the most generous welfare states in the world, particularly in the wealthiest Emirates of Abu Dhabi and Dubai. And that’s the deal: the federation holds together politically by placating the relative absence of democracy and free speech with a bargain of abundant resource distribution.
Belts are being tightened – including enhanced oversight of Abu Dhabi’s Sovereign Wealth Funds, strengthening the position of Crown Prince Mohammed bin Zayed al-Nahyan. But the challenge for the UAE, and the GCC as a whole, will be navigating a new economic reality.
AI-Nahyan of Abu Dhabi
The AI-Nahyan are the ruling family in Abu Dhabi; Khalifa, the current Emir and President of the UAE, is the son of the UAE’s founding figure, Sheikh Zayed.
Khalifa was an only son of Zayed, and due to his poor health the de facto leadership of Abu Dhabi, and the UAE in general has passed to his Crown Prince and half-brother, Mohammed bin Zayed (MbZ). MbZ is the eldest of six full brothers, known as the ‘Bani Fatima’ after their mother, a daughter of the prominent al-Ketbi family.
With the consolidated loyalty network that accompanies a large group of brothers, MbZ has effectively ensured that all the major economic and political development institutions are part of his kinship network.
The crunch time is coming. Despite the slump in revenue and global trade, the UAE maintained a full-year budget deficit of 2.1% – less of a shortfall than predicted.
In part, this is explained by a renewed push by the Emirates to improve refining capability. The Ruwais refinery became operational in late 2014 and has more than doubled the UAE’s capacity to over 1 million barrels per day.
Economic diversification is also continuing at a pace, particularly in industries overseen by one of the Abu Dhabi government’s investment vehicles, Mubadala Development Group.
But in the short term at least, this won’t be enough to make up the oil revenue shortfall.
In response, the government has scaled back its expenditure excess, slashing spending on subsidies by more than 90% compared with 2014. This was most acutely felt with the end of petrol subsidies in August.
As yet, this has not been met with any significant popular protest. Notably though, as subsidies were cut, public sector compensation was increased by 37% during the first half of 2015.
Taxation is next.
As yet, there are no announced plans for any kind of income tax, but a draft corporate tax law has been discussed by decision makers in Abu Dhabi and is reportedly in a preliminary stage. VAT will be introduced, most likely with a start date in 2018, with an 18-month grace period for all sectors affected. Proposals that expatriate workers pay a tax on money sent home remain at the discussion stage.
Abu Dhabi’s proposal has to be finalized in a framework amenable to the GCC Customs Union. If successful, similar taxes are likely to be implemented across the region.
Taxation will need to be gradual as the authorities seek to retain the popular image of UAE competitiveness in trade. Keeping that advantage becomes only more important as Iran opens up to investment with the removal of sanctions.
Meanwhile, Sheikh Khalifa, President of the UAE, has focused on managing the national wealth. In June, he appointed his half-brother, Mohammed bin Zayed, as Chairman of the Abu Dhabi Investment Council.
ADIC is a wealth fund primarily responsible for overseeing the ruling al-Nahyan family’s investments in the UAE’s domestic market, particularly bank ownership in Abu Dhabi. The appointment of bin Zayed, who is also Chairman of Mubadala, consolidates strategic planning for the UAE’s economic development to endure pressures from falling oil revenue.
Rumors over Sheikh Khalifa’s ill-health may help explain the push to concentrate power in bin Zayed – who comes with a reputation as a dynamic decision-maker.
His increased presence may also stoke some regional tension in the future. Effectively the key decision-maker for the UAE, bin Zayed has been alleged to have a long-running personal feud with the new Crown Prince of Saudi Arabia, Mohammed bin Nayaf. Tensions could cause policy incompatibility for the two states.
In August, Mohammed al-Hussainy was replaced as Chief Executive of Aabar Investments, part of the International Petroleum Investment Company (IPIC). This was part of a strategic overhaul of the company by the al-Nahyan family and illustrates the nature of kinship-based patronage in the Emirates.
Significantly, Al-Hussainy’s exit was preceded by the departure of Khadem al-Qubaisi. Al-Qubaisi, the managing director of IPIC, was accused of several conflicts of interest involving his chairmanship of Cepsa, the Spanish multinational also wholly owned by IPIC. Al-Qubaisi’s connection to an on-going corruption investigation in Malaysia might have helped convince his superiors to distance themselves from any potential odium.
Taking a step back, the overview is encouraging. Reshuffles at IPIC and Aabar indicate a culture of zero tolerance for mismanagement and any potential allegations of corruption.
Enhanced banking regulation will be introduced throughout 2016 by the central bank, with Basel III capital and liquidity standards are expected to be fully implemented by 2019.
At the same time, there are more burdens on the public purse – not least, the UAE’s increased regional military interventionism.
UAE is part of the Saudi-led coalition aimed at removing the Shi’ite Houthi rebels from control of Yemen. The conflict has not achieved a workable solution and casualties have been unexpectedly high; the UAE lost 45 men in a single rocket attack in September.
Saudi Arabia announced in December a united anti-terror coalition of 34 Muslim states also including the UAE. Ostensibly a move to confront the influence of Islamic State, the coalition has overwhelming political overtones, and purposefully excluded Iran, Iraq and Syria.
The UAE’s role as a core financial backer for the Egyptian regime is also a drain on resources and is arguably contributing to regional instability. Insulating the military regime of President Abdel Fattah el-Sisi from meaningful reform and democratic engagement is undermining regional efforts to confront radicalization.
The UAE’s close foreign policy cooperation with Saudi Arabia is part of the broader GCC alignment against Iranian intervention in the Arabian Peninsula and the Levant. This has most obviously manifested itself in Gulf opposition to the Assad regime in Syria, but has taken a further diplomatic dimension in 2015.
The Saudi execution of 47 people on terrorism charges in January, including the Shia leader Nimr al-Nimr, has fueled a rapid deterioration in relations with Tehran. The UAE has responded by downgrading its relations with Iran, which may presage a reduction in economic activity between the two. This would be harmful particularly to Dubai as it’s ideally situated to profit from an end to Iranian sanctions.
A militarized and forceful foreign policy will enhance the strategic military worth of the UAE for Washington, but entails significant risk.
The UAE’s attractiveness as an international destination for trade and finance is built on the perception of stability in the midst of regional instability, and competitive taxation. Both are under attack.
GDP Oil Reliance: Can the UAE Stay Investor Friendly?
- Public reaction to the introduction of further tax regimes may affect political stability. The Emirati population appears to be largely satisfied with its current level of governance, and the existing networks of tribal loyalty makes it unlikely that there will be any significant dissent in the short term.
- High-profile fires in public buildings towards the end of 2015 have drawn attention to potentially lax building regulations across the Emirates, possibly as a result of cost-cutting oversight from informal networks of influence. If this is the case, investors should be prepared for increasing oversight of construction projects as UAE authorities seek to limit any increase in reputational risk.
- The lifting of sanctions on Iran is going to represent a significant opportunity for the UAE as the region’s main trans-shipment hub. Trade links will almost certainly develop regardless of increasing regional tension, but authorities will have to be vigilant to the risk of an increase in illicit trade and financing.
Jack Kennedy is the lead Mideast & North Africa analyst at West Sands Advisory Ltd. An Arabic speaker, Jack has traveled the wider region for study and work. Over the past 18 months, he has conducted in-depth research into the political and economic elite networks of the UAE, mapping the crossover between public and private commercial interests.
West Sands Advisory is a business intelligence and geo-political risk advisory firm that has, since 2006, helped clients identify opportunities and reduce risk in emerging and frontier markets. More information at: http://www.westsandsadvisory.com