III. ECONOMIC TRENDS AND OUTLOOK A. Major Trends and Outlook The United Arab Emirates (U.A.E.) is a country of the Arabian Peninsula, located on the Persian Gulf. The U.A.E. has coastline and seaports inside as well as outside the entrance to the Gulf. The U.A.E. was formed in 1971 as a federation of six emirates, Abu Dhabi, Dubai, Sharjah, Ajman, Umm Al Qaiwain, and Fujairah. The seventh, Ras Al Khaimah, joined in 1972. The total area of the U.A.E. is about the size of Maine. Each emirate is ruled by a shaikh. The ruler of Abu Dhabi, Shaikh Zayid Bin Sultan Al Nayhan, is the President of the federation. The terrain is mostly sand desert, barren mountains, and salt flats. In the past, the economy of the emirates consisted of fishing, date growing, camel raising, trading, and pearling. The exploitation of petroleum deposits, beginning in the 1960's, has transformed the area from a subsistence economy into a prosperous country of global economic significance in a relatively short period of time. Cultural traditions have been maintained in a modern economy. Oil was first exported from Abu Dhabi in 1962 and from Dubai in 1969. Following significant increases in oil prices in 1973 and 1979, the speed of modernization of the U.A.E. increased dramatically. The road to development proved to be uneven when oil prices fell in the 1980's. Nominal U.A.E. GDP peaked at $33.79 billion in 1981 and did not reach that level again until 1990, when it hit $34.12 billion. GDP reached its low point in 1986, a drop of 34% in five years. A high degree of political and economic power resides in the individual emirates. Each shaikh retains control over natural resources including oil within his emirate, and regulates commercial activity. Because hydrocarbon reserves, and thus revenues, are not equally distributed, the seven emirates are not equal in terms of wealth, power, or level of economic development. Abu Dhabi, the largest oil producer, is the wealthiest and most powerful, followed by Dubai, the federation's commercial center and second largest oil producer. The swings in income noted above highlight dependence on oil exports. Given this, the authorities are looking for ways to diversify the economy, particularly in Dubai, whose mature fields are expected to cease production before those of Abu Dhabi. The search for diversification has been only partially successful, however. Government spending of oil revenues remains the engine that powers the economy. The price of Brent crude oil declined steadily from a 1990 average of $23.61 per barrel to a January-May 1994 average of $14.66. U.A.E. GDP growth was fairly flat over this period, but increased government spending on construction and infrastructure projects offset declining oil revenues. While it is not clear how these expenditures were financed, it is known that the U.A.E.'s bill for Desert Storm was considerably less than those of Saudi Arabia and Kuwait. Other states of the GCC have been borrowing at home and abroad, and adopting budget cuts and structural adjustment measures. Until very recently, the U.A.E. has taken none of these steps. The U.A.E. federal budget for 1994 showed virtually no spending increase over the previous year, indicating a decrease in inflation-adjusted terms, and the government of Abu Dhabi Emirate, which funds up to 80 percent of the federal budget, announced a twenty percent cut in its own, much larger, emirate budget in mid-June 1994. No details were provided on where the cuts would come. The emirate budget includes defense expenditures. U.A.E. economic fortunes will continue to be determined to a great extent by oil prices. In the long run, the four-year, downward trend in oil prices could make it difficult for the U.A.E. government to maintain a level of spending sufficient to ensure stability and growth in the non-oil sectors of the economy without drawing down foreign assets. The emirate of Dubai is likely to feel this pinch most acutely, given persistent reports of irreversible declines in crude oil output. Economic analysis in the U.A.E. is difficult because of the unwillingness of the federal and emirate governments and their semi-autonomous entities to publish comprehensive, accurate statistics in a timely manner. Similarly, private sector institutions, including banks and foreign oil companies, are not allowed to disseminate statistics to the public. Those who wish to follow closely events in areas such as oil and gas production and pricing, overseas investments, and government budgets, must rely on external sources. The penchant for secrecy will at some point collide with the aspirations of Dubai and possibly other emirates, styling themselves as the Hong Kongs of the Middle East, to play roles consistent with a less restricted flow of information. It also has implications for the budding prospects of a U.A.E. stock market, with its attendant disclosure requirements. B. Principal Growth Sectors Overall growth in nominal GDP of 1.15 percent in 1993 was not evenly distributed among sectors. Crude oil contributed a negative 3 percent to growth while manufacturing, with a growth rate of 10 percent, considerably outperformed the other sectors. Construction grew at a fairly robust 4 percent, while financial services averaged between 3.5 and 4 percent growth. In absolute terms, however, manufacturing contributed only eight percent of overall GDP, and so was unable to offset the decline in oil revenues. U.A.E. authorities have not made any predictions for 1994, but if the announced 20 percent cut in Abu Dhabi's budget is genuine, the economy is unlikely to grow significantly, if at all. A positive development has been the recent short-term increase in oil prices, from their lowest levels since 1988, during the first half of 1994. It is unclear at mid year whether this trend will be sustained. The U.A.E. possesses about ten percent of total proven world oil reserves, approximately 100 billion barrels. Gas reserves, at 314,000 billion cubic feet, are also among the world's largest. The fact that 1994 will mark the fourth straight year of oil sector GDP decline does not reflect any inherent weakness in the sector, but rather the declining price of oil in the international market. In fact, hydrocarbon production has expanded greatly in recent years, especially in Abu Dhabi and Sharjah. However, production from Dubai's fields has begun to decline. The operators are proposing to address the problem with a pilot gas injection pressure maintenance program, but this has not been approved yet. The U.A.E. accepted an OPEC quota of 1.5 million barrels per day (mbpd) at the July 1990 OPEC conference (during the Desert Shield/Desert Storm period, quotas were withdrawn by OPEC, but they were imposed again afterward). The U.A.E. quota assigned at the June 1993 conference, almost exactly three years later, was 2.161 mmbd, an increase of 44 percent. U.A.E. production has steadily been right at or near quota since July 1990. Major expansions of oil and gas production capacity are underway in Abu Dhabi, at a total cost of about $5.0 billion. These projects will be completed in 1996. The aim is to expand maximum sustainable crude oil production capacity (MSC) to about 2.5 mmbd by the end of 1996. This has involved and will continue to involve business opportunities for U.S. contractors and suppliers. In addition to expanding oil MSC, production of liquified natural gas (LNG) from offshore gas reserves will double from 2.5 million tons to 5.0 million tons in a project due to be completed in 1994. Onshore gas production will also roughly double, to about 1,000 million standard cubic feet per day (MMSCFD), in projects slated for completion by 1995. The new onshore production will be used in power generation, water desalination, and industrial production. There are two oil refineries in the U.A.E., both located in Abu Dhabi. Their combined capacity is 195,000 b/d. The Abu Dhabi National Oil Company (ADNOC) has plans to expand the larger refinery, located at Ruways, to 400,000 b/d, but no decision has been taken to implement these plans as of June 1994. The banking sector has rebounded from Desert Storm and the failure of the Bank of Credit and Commerce International (BCCI). Steady economic growth and the implementation of new Central Bank directives to strengthen the banking system are leading to the emergence of a sounder, more rational, more profitable banking sector in the U.A.E.. In the U.A.E. there are 19 U.A.E.-owned banks with 207 branches inside the country and 43 abroad, 28 foreign banks with 119 branches, one restricted license bank, two investment banks, and 10 representative offices. The National Bank of Abu Dhabi, according to the Central Bank, operates an off-shore banking unit. The Central Bank requires a ten percent capital adequacy ratio for all U.A.E. banks. At present, the U.A.E. is rated by the Bank for International Settlements (BIS) as a high risk lending area. The Central Bank also prohibits lending an amount greater than seven percent of a bank's capital base to any single customer. The Bank defines "customer" as an individual, a company, or a group of companies under common ownership and capital base as local capital. Foreign banks with branches in the U.A.E. are not permitted to calculate loans as a percentage of their global capital (which may however be used to calculate the capital adequacy ratio). In a revision to the rule, the Bank in 1993 said it would exclude from the requirement non-funded exposures, such as letters of credit and guarantees, although no formal rules had been written by mid 1994. In general, the banking sector enjoyed a very profitable year in 1993, with overall profits of the U.A.E.'s 47 banks at about USD 545 million, compared to USD 463 million in 1992. The Central Bank has also announced its intention to implement internationally recognized and accepted accounting principles, in the form of the International Accounting Standard (IAS) number 30 on disclosure. The rule would unify the basis of bank reporting and significantly increase the level of disclosure by banks in the U.A.E.. Other federal rules require banks to display interest rates, charges and fees and express loan rates on a reducing balance (annual percentage rate) basis and ban guarantors for personal loans for expatriates. The Central Bank is considering the introduction of a deposit insurance scheme. As the U.A.E. dirham is tied to the dollar, interest rates in the U.A.E. tend to parallel those in the U.S. When rates were low, banks and their corporate borrowers sought to strengthen their balance sheets rather than engage in new lending and borrowing. However, there are indications that interest-sensitive industries, such as construction, were able to maintain relatively high levels of activity through the second half of 1993 and the first half of 1994, when oil prices hit their lowest point in years, by responding to lower rates. The linkages between construction and manufacturing would explain the relatively good performance of the latter sector, noted above. The authorities believe that the exchange rate of 3.671 to the dollar, unchanged since 1980, promotes stability and confidence in the currency and mitigates against capital flight. The dollar peg also has the advantage of passing changes in the dollar's own effective rate of exchange directly through to the U.A.E. economy. This is important, given the continued reliance on a single export that is priced in dollars. The head of Dubai's Economic Department announced in May 1994 that inflation in the U.A.E. was currently running at seven percent, a much higher figure than the 3.4 percent for 1993 given by the Central Bank. If seven percent is correct, the divergence of inflation rates in the U.S. and the U.A.E. would tend to indicate an overvalued U.A.E. dirham. C. Government Role in the Economy The U.A.E. has a mixed economy, with the most productive assets owned by the governments of the individual emirates, but with considerable scope given to private enterprise, and a legal regime that favors U.A.E. nationals over foreigners. In Abu Dhabi, approximately 60 percent of the equity in the oil concessions is owned by the emirate government. The remaining 40 percent is retained by the original, foreign oil company concessionaires. In Dubai, the equity shares of operator Conoco and its foreign partners is a closely guarded secret, but is probably somewhere around 10 percent. The remainder is owned by the Dubai ruling family. Banks are privately owned, and one of the few types of commercial establishment in which stock is sold to the public. Only U.A.E. nationals are permitted to own stock in businesses in the U.A.E.. Foreigners are not permitted to own more than 49 percent of a business enterprise outside of the Jebel Ali Free Zone (JAFZ). The remaining 51 percent must be owned by a U.A.E. national. Foreign companies can only market their products in the U.A.E. through 100 percent U.A.E. national owned distributorships. Foreign contractors or service businesses require U.A.E. national sponsors, one for each emirate in which they do business. Foreigners are not allowed to own land in Abu Dhabi or Dubai. The federal government has nearly completed a 15 year long effort to establish a legal framework for doing business in the U.A.E.. The most recent additions to this edifice were the intellectual property rights protection laws to have been implemented in 1993 (but not yet enforced as of mid 1994), and a 1993 commercial code containing, for the first time in the U.A.E., provisions for bankruptcy. There are no restrictions on the import or export of either the U.A.E. dirham or foreign currencies, by foreigners or U.A.E. nationals, with the exception of Israeli currency and the currencies of those countries subject to United Nations sanctions. With the exception of the latter, all currencies can be freely exchanged in the U.A.E. at market rates. The government sector includes the accounts of the federal government as well as the accounts of the seven individual emirate governments. Only the federal budget is published. For 1994, revenues are projected at $4.42 billion, and expenditures at $4.8 billion. The emirate of Abu Dhabi is expected to make up the deficit out of its own resources. The (unpublished) budgets of the wealthier emirates, particularly Abu Dhabi and Dubai, are estimated to total significantly more than the entire federal budget. Abu Dhabi announced in mid-1994 that it would slash its 1994 budget by 20 percent. The federal government does not borrow either domestically or internationally to finance deficits, nor do the governments of Abu Dhabi or Dubai. Some of the rulers of the less wealthy emirates borrow from commercial banks, however, to finance deficits in their fiscal accounts. There is no income tax in the U.A.E.. Foreign banks pay a 20 percent tax on their profits. Foreign oil companies with equity in concessions pay taxes and royalties on their proceeds. There are no consumption taxes, and the highest customs duty assessed is one percent. There is no minimum wage. D. Balance of Payments Situation In 1993, the U.A.E. ran a positive balance on merchandise trade of USD 3.95 billion, a current account balance of USD 182.51 million, and a capital account balance of -USD 359.58 million, for an overall balance of payments deficit of -USD 177.06 million. The merchandise trade balance fell by -39.3 percent from the previous year. The balance on current account fell by an even greater factor, a staggering -94 percent. The current account balance was 0.5 percent of GDP in 1993, down from 8.6 percent in 1992. The swings can be accounted for by a -13.8 percent decline in oil export revenue. Imports, including re-exports, increased in 1993 by 12.5 percent. The fairly liberal trade regime prevailing in the U.A.E. is designed to develop non-oil sectors of the economy. A nominal four percent tariff is not implemented. In practice, the highest tariff charged is one percent, but this may change. The Gulf Cooperation Council (GCC), grouping the U.A.E., Saudi Arabia, Kuwait, Bahrain, Qatar, and Oman has been discussing a common external tariff for some years and there are indications that the GCC summit in December 1994 will approve a minimum common tariff, probably of four percent but possibly as high as eight percent. The U.A.E. maintains a booming re-export trade. In 1993, 31 percent of all imports were subsequently re-exported. Traditional re-export markets are the GCC states and Iran, but U.A.E. traders have aggressively sought out new markets in such areas as Russia, the newly independent states of central Asia, and South Africa, particularly as Iran, formerly the largest re-export market, has sharply restricted imports in 1994 in an attempt to come to grips with a deteriorating economy and mounting debts. E. Trade and Investment Barriers The regulatory and legal framework heavily favors local over foreign business. There is no national treatment for investors in the U.A.E.. Except for companies located in the Jebel Ali Free Zone (JAFZ), at least 51 percent of a business establishment must be owned by a U.A.E. national. A business engaged in importing must be 100 percent U.A.E. owned. Subsidies for manufacturing firms are only available to those with at least a 51 percent local ownership. Foreign companies wishing to do business in the U.A.E. must have a U.A.E. national sponsor, agent, or distributor. In practice, this means a separate sponsor or distributor in each of the major emirates. Once chosen, sponsors, agents, or distributors have exclusive rights. They cannot be replaced without their agreement. Foreigners cannot own land or buy stocks. The tendering process is not conducted according to generally accepted international standards. Retendering is the norm, often as many as three or four times. To bid on federal projects, a supplier or contractor must either be a U.A.E. national or a company in which at least 51 percent of the share capital is owned by U.A.E. nationals. Federal tenders are required to be accompanied by a bid bond in the form of an unconditional bank guarantee for five percent of the value of the bid. The U.A.E. has no requirement that a portion of any government tender be subcontracted to local firms. There is a ten percent price preference on procurement and tenders. The U.A.E. requires a company to be registered in order to be invited to receive government tender documents. To be registered, a company must have 51 percent U.A.E. ownership. However, these rules do not apply on major project awards or defense contracts, where there is no local company able to provide the goods or services required. The U.A.E. requires offset investments by winners of defense contracts. The guidelines are complicated, but generally sixty percent of the technical value of the contract must be reinvested in the U.A.E.. This figure can be reduced, however, if the contractor meets certain conditions. In 1992, the U.A.E. passed three laws protecting intellectual property: a copyright law, a trademark law, and a patent law. The three laws were to have been implemented by the end of March 1993. By May 1994, effective implementation of the three had not yet begun. Implementing regulations had been written and offices had been set up to accept registrations for copyrights, trademarks, and patents. But no significant enforcement measures had been taken against the major copyright pirates who use the U.A.E. as a base for manufacturing and distributing pirate audio/video materials throughout the region. Pirate computer software in June 1994 continued to control the market, and importation and distribution of pirate compact disks was growing rapidly. It is difficult to determine the extent of trademark fraud, but U.S. companies unearthed new evidence in early 1994 that highly sophisticated pirate copies of their products, including cosmetics and detergents, were being exported from the Far East to the U.A.E. for sales as well as onward distribution throughout the region. The U.A.E. copyright law does not protect U.S. works. The U.A.E. has not adhered to any international conventions on intellectual property that would provide protection for U.S. works. Consequently, U.S. firms have been reluctant to test the U.A.E. copyright law in U.A.E. courts. The U.A.E. government announced in February 1994 that by September of that year all distribution of pirate copyright products in the U.A.E. must stop. According to the ruling, producers and distributors could continue to manufacture and distribute pirate materials up to the September deadline. Subsequently, the Ministry of Information announced in April that the September deadline had been rescinded, and all pirate activity must end immediately. As of June, however, the pirates continued for the most part to operate without interference. F. Labor Force At least 80 percent of the labor force is expatriate labor. Expatriates fill 100 percent of manual labor and clerical positions and most technical and middle management positions as well. There is a shortage of skilled U.A.E. national labor with managerial and technical expertise. The federal labor law requires the Ministry of Labor to regulate expatriate labor, and employment contracts must be registered with the Ministry of Labor. Individual emirates issue permits for foreign laborers as well. There is no minimum wage. Employment contracts must describe cost of living allowances, transport, housing benefits, and bonuses. The U.A.E. is a member of the ILO convention protecting worker rights. Labor factors do not affect the choice of technology in the U.A.E.. The U.A.E. is well endowed with oil and gas and has established itself as a center of regional commerce. But energy intensive industries are not necessarily capital intensive. An inexhaustible supply of skilled, low wage labor is nearby, and despite the apparent desire of policy makers to steer the economy toward high tech, capital intensive sectors that do not require a large number of workers, the government continues to permit employers to import as much foreign labor as they want. The right to organize and bargain collectively is not granted in law, and public sector strikes are criminal offenses. Despite the lack of respect for worker's rights, labor-management relations are good. Most of the foreign labor force comes from countries that have even less protection for workers than the U.A.E. The reason for coming to the U.A.E.is that the pay is better than at home. Employees believe that their employers can easily replace them. The blue collar labor force is mostly from the Indian subcontinent. A typical salary for outdoor manual labor is about 225 USD per month. G. Major Local and Third Country Competitors in specific sectors Competition is fierce in the U.A.E., and profit margins are slim. Contract awards tend to go to the lowest bidder among the prequalifiers, not the most technically competent. Increasingly, third world bidders, such as China on major infrastructure construction projects, are challenging established Western contractors. H. Infrastructure Situation re: Goods and Services Distribution The U.A.E. has a fairly well developed and modern infrastructure. Land transportation is by road. A concrete road network links all main cities. Authorities in Abu Dhabi and Dubai are busily engaged in widening existing roads and replacing worn stretches. There is no rail system in the U.A.E., nor any domestic air transportation network, despite the fact that all the emirates have modern airports. All emirates also have modern seaports. Goods are imported for the most part by sea and distributed by truck. I. Major Infrastructure Projects Underway Projects underway or planned include power generation, water desalination, airport expansion, road building, construction of hospitals and schools, and expansion of port facilities. There will continue to be opportunities for U.S. business to participate in these projects, most of which will be located in the emirates of Abu Dhabi and Dubai.