UAE subsidy reforms to bolster public finances

Spurred by reduced revenues due to the sharp fall in oil prices since last year, subsidy reforms in the GCC have been speeded up.

Oman ended subsidies on industrial gas use this year, followed by the UAE’s decision last month to end petrol subsidies to shrink current spending by a planned 4.2 per cent during the present fiscal year.

Although partial, subsidies for natural gas remain, the UAE’s curtailment of fuel subsidies is in line with IMF recommendations and follows the earlier ending of some electricity subsidies in Abu Dhabi and Dubai.

In a further effort to improve public finances, the authorities in the UAE continued to work on plans to introduce value-added tax and corporate tax, with draft laws due to be ready in the third quarter of this year, according to ministry of finance officials.

A number of market participants have welcomed these plans to put state finances on surer footing, which are seen as positive for the UAE’s credit rating.

Other positive developments in the UAE that took place last month included cabinet’s approval of new insolvency and bankruptcy laws, and the release of reports that suggest the medium-term outlook for the Dubai real-estate sector remains relatively positive.

Conditions in the rental sector are thought to have improved in the second quarter, while real estate agency Core Savills issued a report in which it predicted that the decline in apartment and villas prices in Dubai would reach a trough next year, and return to growth by 2017.

Nonetheless, volatility in investor flows warrants caution and we are turning defensive on credit spreads in general. Record outflows from high-yield exchange-traded funds in the second quarter and corporate balance sheets in the United States that show signs of deterioration explain this caution.

There are also reasons to be concerned about possible developments in China, as growing capital outflows have been eroding currency reserves at a time of uncertain domestic growth prospects.

For example, car sales have been sluggish in recent months and long-term market demand seems to be cooling.

Furthermore, the Chinese stock-market rout threatens to dent consumer sentiment. Jitters on the Chinese stock market are also causing unease among observers because of the potential fallout for the world economy. This unease has been compounded by the downturn in exports to China, and to Asia in general.

In the US, the Fed has been at pains to signal that rate increases, when they come, may well be gradual and shallow.

Adding to the complexity of the situation, China, Japan and Europe continue to ease even as the Fed moves toward tightening.

While monetary easing outside the US should favour emerging markets as a whole, emerging markets’ exposure to the US dollar presents well-documented difficulties, particularly at a time of weakening growth.

While this problem is particularly acute for commodity-reliant countries, the currency peg to the US dollar or to a basket of currencies maintained by GCC countries offers a large degree of protection. This peg, coupled with the strong reserves and liquidity buffers, built up specifically to deal with the volatile conditions of the present, have helped the region record strong risk-adjusted returns this year and is likely to continue to do so in the months ahead, in our view.

Mohieddine Kronfol is the chief investment officer for fixed income and global sukuk at Franklin Templeton Investments Middle East.

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