According to the IMF, the medium-term outlook for the UAE is very positive and stable
The UAE's outward oriented economic development strategy and speedy diversification away from the hydrocarbon sector is helping the country to deliver a stellar performance despite the increased inflationary pressures in recent years.
According to a recent report by the International Monetary Fund, the UAE's economic performance remains very strong. Real GDP growth exceeded 9 per cent in 2006, with oil production rising by 8 per cent and the non-oil sector growing at double-digit rates.
"The rapid expansion is supported by an outward-oriented development strategy, a favourable business climate and sustained high oil prices," the IMF said in a recent country report.
Both the IMF and World Bank have said that the UAE is following sustainable fiscal policies, although inflation is a worrying factor.
Strong domestic demand and housing shortages have led to sharp increases in rents and contributed to upward pressure on prices. As a result, consumer price inflation, according to official figures, exceeded 9 per cent in 2006.
"The recent surge in inflation in the UAE is the result of capacity constraints. Government and the private sector have embarked on massive projects to ease these constraints.
"The large fiscal outlay has further aggravated their domestic inflation," says Mohsin S. Khan, IMF director for the Middle East and Central Asia department.
The real GDP of the UAE is growing close to 10 per cent annually. With the surge in growth, the country is facing high inflation primarily driven by supply constraints.
"Large-scale government spending is inflationary by nature. But we have to distinguish between the types of spending. If the new expenditures are targeted at easing future supply constraints and economic diversification, they will eventually help to ease inflation," Khan says.
The IMF expects the UAE's inflation to begin falling in 2008.Reflecting record high oil prices, the fiscal and external current account surpluses remained large in 2006, and have allowed further accumulation of official foreign assets.
According to the IMF, the medium-term outlook for the UAE is very positive, with real GDP growth projected to remain strong in 2007 and slightly decelerate thereafter due to temporary capacity constraints.
The fiscal and external accounts are projected to remain in large surplus.
Efficient macro strategy
The financial system is sound and has not been affected by the correction of the UAE stock markets in 2005-06. The growth of private sector credit remains high, and banks' exposure to the real estate sector has increased recently.
The stock market correction last year increased the risk profile of the banks' retail loan portfolios and triggered additional provisioning requirements that raised the average cost of risk, which has weighed on their future profitability.
"Reforms are under way to strengthen the prudential and regulatory oversight of the banking system and the capital markets," the IMF report says.
The World Economic Forum's Global Competitiveness report ranks the UAE 37th. According to the report, the UAE's public institutions are considered transparent and free from corruption, and government spending is judged by the business community to be efficient.
Earlier this year the UAE authorities announced a major reform plan that sets the UAE strategy for the next three years. A key focus of the strategy will be to improve government efficiency and strengthen the cooperation between the federal and emirate governments.
Progress is also being made to improve the business climate through updates of key legislation, such as the labour, company, and competition laws.
Diversification
The UAE has undergone remarkable development over the past few years. One of the main vehicles for this development was the creation of free trade zones, which have become a widely imitated success story in the region.
Dubai pioneered this development but other emirates, in particular Abu Dhabi, followed.
Today, diversification away from the energy sector continues to be a priority - the country focuses not only on further developing financial services, but also health care, industry, outsourcing, and ICT.
In recent years, much of the available liquidity has been invested in creating supportive environments for these sectors and new free trade zones have been created.
Monetary policy
The UAE authorities are committed to the dirham's peg to the dollar. Despite the high liquidity and external surpluses generated by high oil revenues, the UAE Central Bank has consistently aligned domestic interest rates with the US Federal Reserve to keep the dirham's parity with the dollar.
On the back of higher inflation in the UAE than in most other Gulf countries, the exchange rate of the dirham has appreciated in real terms by about 6 per cent since 2004.
The peg is also weighing on the earnings of the expatriate workforce and the inflation caused by rising prices of imports.
Although the target for achieving the Gulf single currency could be pushed beyond the original target of 2010, the UAE Central Bank and the UAE government have said that they will maintain the peg in the period leading up to the establishment of the monetary union.
