The Global Financial Crisis (‘GFC’) had a very dramatic impact on the domestic economies of a number of global nations, in a plethora of ways, typically replicating the fiscal and financial health of such nations. United Arab Emirates (UAE) was one such nation that had a serious impact of the GFC and since then the myriad challenges posed by the capital markets has been an interesting area of focus for the Middle East. UAE is one of the oil rich economies of the Middle East. During the initial and developing years of the last century UAE discovered new abundance and wealth from its capabilities of oil production. As the cost of oil rose to sky rocketing levels in the global market and globalization started becoming a reality, this particular economy struggled in numerous areas of legislation and regulation for controlling the oversized family led economic structure in numerous key economic sectors. This paper examines the role of key areas of the financial markets of the UAE and analyses the way the nation has dealt with the challenges of the capital markets from numerous angles.
Capital markets are considered an important part of the transition of UAE from an oil-driven market to a diversified knowledge-based nation. At the moment, the three key financial markets are the “Abu Dhabi Securities Exchange (‘ADX’), the Dubai Financial Market (‘DFM’), and NASDAQ Dubai (previously known as the Dubai International Financial Exchange)”. A predominant aim of Dubai, especially, is to become a financial hub for the whole of Middle East, North Africa, and South Asia. Moreover, apart from this primary motive, there is another unofficial goal that Dubai has - to transform into both the Hong Kong and Singapore of Middle East, in the sense to become the centre for trade and financial markets.
The United Arab Emirates (UAE) Federation was shaped on the 2nd of December 1971 thus making it an independent nation due to a result of the so called “Trucial States” terminating their individual relationships with Britain due to a Treaty. Sheikh Zayed bin Sultan Al Nahyan was made the first President of the independent nation and he presided the President’s office until his demise in the year 2004 after which his son Sheikh Khalifa Bin Zayed Al Nahyan was elected as the country’s President and he presides office till date.
The economy of UAE is slowly recuperating from the economic crisis of the year 2009. The nominal GDP of UAE is currently 342 US billion dollars and the GDP per capita is 63, 626 US$. Japan, India, Thailand, Iran and South Korea are the major export partners, while Germany, The United States of America, Japan, China and India are the country’s major import partners. Oil, Pharmaceuticals, manufacturing, gas, and construction are the major industries of the nation. The current inflation rate of UAE is 0.9%. UAE is probably one of the few global nations that have the highest GDP per head. Despite being heavily reliant on revenues generated through hydrocarbons till date, the country is fairly well shielded from economic instances of reduced oil prices. This is probably the result of the country’s successful move in the direction of economic diversification, massive foreign exchange reserves that it holds, and also huge amount of foreign investments. “Abu Dhabi has approximately 10% of the world's proven oil reserves and 5% of the gas. The Emirate also has an impressive investment portfolio of about USD 627 billion financed from oil income”. The UAE is also believed to have the lowest amount of trade barriers among all the gulf nations. The average tariff as of the year 2008 was 2.96 per cent and this makes UAE the most sought after nation for trade relations according to the IMF’s World Trade Indicators .
UAE’s government is protected by the constitution of 1971 when the country became independent. The UAE government comprises of a Federal Supreme Council, a President, a Vice-President, Ministerial Council, and Federal National Council of 40 members drawn from all of the seven states of UAE. UAE was initially a tribal cultural that was heavily reliant on agriculture and fishing. However, with the advent of globalization, the country has, in less than four decades, transformed into a successful entrepreneurial entity that has remarkable top-notch infrastructure.
Ratio of Financial System to Economic Activity
According to Raymond Goldsmith’s financial "liberalization paradigm" public regulation of the banking system is believed to be decreasing the quality and quantity of capital that a nation accumulates. The World Bank (1989) also supports this liberal view and asserts that ''efficient financial systems help to grow, partly by mobilizing additional financial resources and partly by attracting those resources to the best uses".
Needless of any overemphasis, the UAE economy is certainly a great success story. The early developments of the economic activity of UAE were initiated through the oil revenues during the 1960s and 1970s. Through this period, the GDP of the nation remained 60% with specific relevance to the oil industry which is regarded as one of the major industries of UAE. Although development levels within the United Arab Emirates remain high, the period under review (February 2009 to January 2011) saw a small downturn related to the global economic crisis. UAE experienced a comparative economic retrieval through the whole of 2010 that were carried over from the economic slumps of the previous year. Even though development levels in UAE were quite high, the period February 2009 to January 2011 underwent a small slump as a result of the global economic crisis. The GDP growth during this recessionary period was floored from a peak of 13% in the year 2006 to a reduction of 2.7% in 2009. This slump in the GDP growth is predominantly attributed to the collapse of Dubai’s real estate sector (Bertelsmann Stiftung, 2012). Nonetheless, 2010 observed a return to uncertain growth of 2.1%, and the nation’s outlook is expected to be largely positive until 2015. The GDP of the nation has rose from $170 billion in 2006 to approximately $270 billion by the end of 2010.
Incredible investments were made into infrastructure development and this lead to the absolute transformation of the physical face of the nation in a manner which was to be immediately obvious to intermittent visitors. Funded by a broad-minded economic program that was essentially constructed around aspects like economic liberalization, divergence and improvements of the private sector and its role, the UAE has hopped 23 places in the U.N. Human Development Index since the year 1980 and it currently stands at the 32nd position in the category of extremely high level of human development.
Despite no statistics of figures regarding the coefficient data pertaining to UAE being present, it is reportedly stated that the poverty level of the nation remains below minimal level and there seem to be no sign of inequality in terms of education based on the primary and secondary enrolment rates. In terms of aspects like personal health, standard of living, well-being, and strong social support structure, UAE ranks very high. Yet, there are few areas of concern that include the extensive discrepancy in terms of income and access to social services and the low levels of labour participation by the fairer sex as the current rate of female labour participation is roughly 42.5%.
Based on the Financial Structure and Development of Goldsmith, the above facts and figures pertaining to UAE indicate that there exists a statistically significant relationship between the economic growth and financial development as these two are interrelated with one another.
Depository Intermediary Sector
The banking sector in the UAE is quite disjointed, with the current market structure encompassing 23 domestic banks in total and an additional 28 international banks. Banks integrated in Abu Dhabi and Dubai hold a massive share of the overall domestic assets. A few aspects that constantly are troubling the banking industry of the UAE are the funding and liquidity pressures on the UAE banks as the average ratio of loan/deposit for a few principle banks of UAE are currently above 100% and even 120% in a few more cases. The growing cost of domestic deposits in a competitive market and limited entrée to the global debt capital market remain the foremost backers to the challenge in driving the banking sector with resources that counterpart the aspiring development strategies of the nation. The Federal liquidity funding procedures significantly facilitate the stabilization of the country’s banking system in the year 2009. Added to this, the federal support to the domestic banks of UAE, banks based out of Abu Dhabi also received Tier 1 capital funding that amounted to AED 16 billion which were precisely distributed among the four major banks and the same was believed to have contributed to banking sector’s liquidity on a whole.
The Capital adequacy ratios of UAE banks were reinforced in the year 2009 consequentially due to the government intervention and greater withholdings of net income by the banks and, in a few instances, assets that had lower risks. “The average regulatory Tier 1 and total capital ratios were maintained at significantly above the regulatory requirements, in some instances exceeding 20%, which will eventually strengthen the ability of banks to absorb higher non-performing loans (NPL) over the next 12 to 24 months”.
Despite all the above ups and downs, the banking and financial sector of the UAE has made substantial improvement in the recent past. This advancement is attributed to the increasingly strict control of financial institutions that the Central Bank of UAE has imposed. The numbers of foreign bank representative offices in the UAE have increased considerably over the last few years, and this trend of increase in the international banking representative is attributed to the launch of countless new organizations and to the nation’s membership with the WTO. A striking development in this relevance is the establishment of the Dubai International Financial Centre that is anticipated to appeal to huge number of financial intermediaries comprising banks that are instituted according to the DIFC laws.
All the banks, financial institutions, and all sorts of monetary transactions in the UAE are essentially regulated at the Federal level. Apart from the Central Bank, there exist various other types of banking and financial institutions. There are commercial banks which are further categorized as either domestic banks or international banks that have their branch in UAE; Restricted License Banks which are also similar to the commercial banks by nature but additionally are authorized to obtain deposits in international currencies alone; Investment banks that operate for providing medium or long-term financial assistance and are limited to this particular role; Finance organizations that are into providing “advances and/or personal loans for personal purposes, financing small trade and small businesses including letters of credit and issuing guarantees, participating in the capita of various projects”.
Contractual intermediary sector
The financial services sector is said to be the main source of financing investments and contributions towards preservation of economic value mainly of projects. Various financial services surveys have been conducted; however the official survey of financial services sector by the Dubai Statistics Centre is the most authentic of them all. The purpose of the survey is to provide complete statistical numbers of all the activities of financial institutions in the Emirate of Dubai. These institutions include financial intermediaries, insurance companies among others. The survey is supposed to help in identifying the contribution of this sector to the nation’s GDP. It is also supposed to reveal total value added, interest income on loans, and other income in this particular sector.
Financial intermediaries contributed maximum output at AED 20.7 billion accounting for almost 86% of the complete output of the financial sector. There were almost 173 establishments that were reported in the year 2007 survey. In the insurance segment, there were 68 establishments with a total output of AED 1.7 billion contributing almost 7% to the total output of the financial sector. The total value add of the financial sector was approximately AED 20.7 billion. The contribution of financial intermediary activity was AED 18 billion contributing almost 87% of the gross total. The total value adds of the insurance sector was approximately 6.5% of the complete financial sector contributing AED 1.3 billion. The input output ratio of financial intermediaries was 13.2% and the input value added ratio was 15.3%. This is possibly the lowest ratio in the complete financial sector activities. Input value added ratio of the contractual intermediaries is 30.7% while input-output ration is 23.7% This actually points to the key role played by the financial intermediaries including the depository intermediaries, contractual intermediaries and also investment intermediaries. Comparatively the productivity level in this sector is almost 10% more than the average productivity in financial sector. This indicates that there is a growing demand for the services of financial intermediaries as the entire economy relies intensely on these for production and other services.
The average labour productivity in the contractual intermediary sector was AED 656, 000 almost equal to the financial sector’s 671, 000. The reason attributed for such high numbers is due to very low number of employees in this sector of the country’s financial system.
Investment Intermediary Sector
This sector of UAE’s financial system encompasses institutions principally involved into intermediation activities like underwriting, originating, and/or maintaining markets for issues of securities. The various Investment bankers of this sector predominantly serve as principals; precisely stating, investors who either buy or sell on their own, through firm guarantee transactions and standby promises. This industry also encompasses institutions that act as principals in buying or selling securities typically on a spread basis.
In the investment intermediary sector of UAE, there are investment banks that are into offering medium and long-term financing alone. There are also financial investment companies that operate by opening investment accounts and manage the various portfolios for both individuals and Corporates and additionally incorporate and manage various investment trust funds along with a variety of other investment funds.
The latest quarterly Economic report that was reported by Standard Chartered UAE underpins the strong rudiments, and the healthy economic environment in the UAE. It is expected that the economic conditions of UAE would continue to remain strong with incessant support by the higher oil prices towards the end of 2012. It is also anticipated by Standard Chartered that the real GDP of the nation to score a 3.4% and 3.7% growth in the years 2012 and 2013 respectively.
Remarking on the economic situation of UAE, Jonathan Morris, the CEO of Standard Chartered UAE, stated that, "Through turbulent times, the UAE has maintained consistent economic growth and continues to present lucrative investment opportunities for international investors. The UAE is one of Standard Chartered's most strategic markets globally and supporting this forum is part of our efforts to encourage trade and capital flows from and into the country".
Critical Analysis of the Financial Markets and Regulation in UAE
The government of UAE has proactively chased a liberal economic strategy and encouraged competition. Though the country is rich it is still considered to be developing and there remain gaps and areas of lack of transparency in almost all areas of the institutional framework. This inhibits certain open business practices. For instance, exclusive distribution agreements are tenable and are in place to ensure that traditional families have monopoly in certain sectors. Though free economic zones have been established and encouraged, not much of progress has been made. One of the important delineation that is evidently missing is the lack of clarity of division between private and public sectors. As a matter of fact, UAE is placed at 40th position in the World Bank’s Doing Business Index published in 2010.
Another important area is that monopolies and oligopolies are not well regulated, in spite of the WTO’s 2006 review which recommended that monopoly practices should be curtailed. It is a matter of serious concern that very few leading merchant families manage to exercise immense control over several key activities and sectors. In the year 2010, the Ministry of Economy of UAE drafted a competition law to encourage competition and stimulate UAE’s development. Efforts are being made by the government to put in place regulations aimed to bridge gaps in commercial regulations and arbitrations as well. The primary objective of such efforts of the government is to increase efficiency and transparency leading to investor confidence in the businesses. Despite all these efforts, even as of January 2011 there was nothing implemented at the ground level. Some key sectors like telecom are said to be open to competition but it has only managed to move from monopoly to state-controlled duopoly.
Despite the fact that UAE is one among the extremely active members of WTO and it has actually submitted voluntarily a trade policy review in 2010, not much has been done. As part of that report UAE’s minister of foreign trade Sheikha Lubna bint Khalid al Qasimi has actually gone on record to state that the trade policy is one of the key growth engines for the economy and hence UAE actively seeks to increase its export base as well as international trade partners.
Being a GCC common external tariff member, the common tariff of UAE has been set at 5%. Additionally, being the member of the GCC’s customs union which leads to removal of barriers of tariff among member states, the GCC customs union law has been enacted by the government of UAE. Despite the fact that UAE’s trade agencies law restricts import and distribution activities to agents of UAE, the export centres are free zones and are not covered under licensing agencies and majority ownership obligations that are prevalent to other parts of the country. Export subsidies have not been suggested by the WTO but in the same breath it has called upon UAE to ensure establishment of superior quality legislations on several issues like trade safeguards, subsidies, and anti-dumping rules among others. Internally, it was recommended that a body should be created for ensuring harmful practices in international trade be established. At the regional level, a number of free-trade zone dialogues are underway between the GCC states and other countries. Agreements with China, Korea, European Union, USA, and India are underway.
The banking system of UAE and its capital markets are mature but the international crisis of 2008 highlighted lack of overseeing and several disclosure rules. Several local and foreign banks operate in the UAE. There was a period of high economic growth from the year 2003 wherein the domestic banks extended large amounts of credit and when exposed to an international downturn this left them coping with serious issues like several debt restructuring and reduction of asset quality, severe strain of liquidity and almost negative economic growth.
The financial systems are developing in this emerging market and if the government takes serious measures to ensure stability this country has got everything to be an economic power definitely in the region.
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