United Arab Emirates: Selected Issues
Author:
International Monetary Fund. Middle East and Central Asia Dept.
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Publication Date:
03 Aug 2016
eISBN:
9781475522075
Language:
English
Keywords:
ISCR; CR; bank; debt; price; liquid asset; GRES debt sustainability; investment company; GRES' debt; GRE risk; Emirates telecommunications group Co PJSC; Loans; Oil prices; Insurance; Global
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United Arab Emirates: Selected Issues

Abstract

United Arab Emirates: Selected Issues

Performance and Risks Posed by Government Related Entities in the Uae1

  • Government-related entities (GREs) continue to be a major source for growth and development for the UAE, but they also pose significant fiscal and financial risks as GRE’s debt remains high, though declining and actively managed. Across a sample of 53 companies with government ownership and publicly available information, panel regression estimates suggest that leverage depends mainly on firm characteristics but also on macroeconomic variables like government gross debt to GDP and global financial conditions which makes GREs vulnerable to external shocks in the current uncertain environment. To mitigate GREs risks, the authorities should build on recent progress and develop an integrated approach, including implementing prudent fiscal policies, enhancing macro and micro-prudential frameworks, controlling GREs borrowing and integrating them to the public debt management framework, and further strengthening corporate governance and transparency.2

A. Introduction

1. GREs represent a large share of the UAE economy and played an important role in its economic diversification. In 2015, the assets of our sample of companies with government ownership and publicly available information reached about 132.5 percent of UAE’s GDP (108.7 percent of GDP in 2010), but this does not include many GREs for which data are not publicly available. The breakdown in our sample shows that GREs are present in a large number of sectors, including financial services, real estate, utilities, transportation, tourism, and health and education, among others (Table 1).

Table 1.

UAE Companies with Government Ownership and Publicly Available Information: Selected Indicators

article image
Sources: Bloomberg; Zawya; and IMF staff calculations.

2015q4 or latest.

Includes companies listed in the Abu Dhabi Securities Exchange.

2. GREs have strengthened their overall finances over the last years. GREs have been a major source of growth and development for the UAE economy. Benefiting from government transfers and extensive borrowing, in 2004-2008, GREs funded a major push for Dubai’s economy while major infrastructure projects were also developed in Abu Dhabi by GREs. Despite government support, in 2008–09 the global financial crisis and the price correction in the local property market, combined with the maturity mismatch between short-term liabilities and long-term cash flows forced several GREs to restructure their debt. Since the crisis episode, several GREs have actively managed their debt, making early repayments and lengthening their maturity profiles. According to our estimates, GREs’ debt, in percentage of GDP, has decreased, especially in Abu Dhabi, over the past six years (Figure 1). In 2015, Dubai GREs’ debt slightly decreased to 69.6 percent of Dubai GDP from 69.9 percent in 2010 (and declined substantially over the past two years), while in Abu Dhabi, in 2015, GREs’ debt declined to 27.4 percent of Abu Dhabi’s GDP compared to 48.7 percent in 2010.

Figure 1.
Figure 1.

UAE: GRE’s Debt, 2010–15

(U.S. dollar billions; unless otherwise noted)

Citation: IMF Staff Country Reports 2016, 266; 10.5089/9781475522075.002.A001

3. Looking forward, GREs’ appear better positioned to weather shocks but potential risks to the sovereign balance sheet and the financial system need to be monitored. Improvements in the GREs’ debt profile have lowered rollover risks. However, GREs could be particularly affected by lower transfers from governments, increased sovereign issuance to finance deficits and tighter global financial conditions. These could lead to GREs re-leveraging and higher financing costs. The objective of this paper is to identify potential risks posed by GREs.

B. Performance of Companies with Government Ownership

4. Overall, performance have improved for companies in our sample over the last years. While total liabilities have increased at a slower pace than assets, profitability has increased on average in our sample (Table 2 and Figure 2). Compared regionally, UAE’s corporate sector have generated relatively low returns on assets – about 8.1 percent on average in 2007-2014- only higher than in Kuwait. Average returns in UAE’s non-financial corporates are lower than returns in emerging markets, but above returns showed in developed markets in Asia and Europe. The return on assets observed in our sample of companies with government ownership are below the UAE’s average, though lack of comprehensive data on GREs prevents generalizable conclusions.

Table 2.

Non-Financial Corporate Sector: Return on Assets

article image
Source: IMF Corporate Vulnerability Utility (CVU).
Figure 2.
Figure 2.

UAE Companies with Government Ownership and Publicly Available Information: Selected Indicators

Citation: IMF Staff Country Reports 2016, 266; 10.5089/9781475522075.002.A001

Sources: Bloomberg; and IMF staff calculations.

5. Despite improvements, leverage remains high while its composition has shifted from loans to bonds. Non-financial corporates are highly leveraged in the UAE (see Table 3). GREs’ debt, in percentage of GDP has decreased in both Abu Dhabi and Dubai, over the past six years. Total public debt (including GREs’ debt) in Dubai remained relatively high at 126.2 percent of Dubai’s GDP in 2015, with large maturities due by 2018. According to staff’s estimates, Dubai GREs debt amounted to 66.6 percent of Dubai GDP in 2015. In 2015, in Abu Dhabi GRE debt reached 27.4 percent of Abu Dhabi GDP. Although loans are still the largest component of overall GRE debt, the share of bonds has been growing rapidly from 39 percent in 2010 to 46 percent in 2015 (Figure 3). This increase has been particularly significant in Abu Dhabi, where bonds increased from 32 percent of total Abu Dhabi GREs’ debt in 2010 to 67 percent in 2015. Debt restructuring and new regulations on loan-concentration limits are some of the factors behind this evolution.

Table 3.

Non-Financial Corporate Sector: Debt to Equity

article image
Source: IMF Corporate Vulnerability Utility (CVU).
Figure 3.
Figure 3.

UAE: Debt Composition, 2010–2015

(Percent of total)

Citation: IMF Staff Country Reports 2016, 266; 10.5089/9781475522075.002.A001

6. As a result, GREs’ bond debt has become one of the highest in the GCC, though still lower than in many developed countries. Available data on GRE’s outstanding bond debt suggest that it is higher than in most GCC countries and emerging economies, though much lower than in many developed European countries, US and Canada (Figure 4). When adding government debt, total UAE outstanding bond debt continues being better than in most advanced and emerging countries. Unfortunately, comparable data on loans were not available. However, the UAE has large financial assets held by its sovereign wealth funds and therefore is among the top countries globally in terms of net financial assets.

Figure 4.
Figure 4.

Non-Financial Corporate Sector: Outstanding GREs and Government Bond Debt

Citation: IMF Staff Country Reports 2016, 266; 10.5089/9781475522075.002.A001

7. Across emirates and sectors, corporates in our sample offered a very diverse performance. Profitability has on average increased on both Abu Dhabi and Dubai, among the companies in our sample. However, the ratio of debt to capital has increased slightly in Abu Dhabi and lowered in Dubai. Available data in our sample show very volatile performance for most of the companies. While banks show a more stable and robust performance, overall real estate and construction companies seems to have improved over time in Abu Dhabi since 2010, but not in Dubai.

C. Main Risks Posed by GREs

8. The GRE debt servicing capacity is relatively low. Publicly available data suggest a very diverse and on average worse interest coverage ratio (ICR) for GREs (about 2 in 2014). This is much lower than the average ICR of the overall corporate sector in UAE, which was 10.9 in 2014, the second lowest in the GCC region after Kuwait (Table 4). Data in our sample show that “debt-at-risk” (defined as debt with ICR of less than 1.5 times) has increased in our sample to about U.S.$20.4 billion (Figure 5). High leverage and low returns on assets (below 5 percent) seem to be the reasons underlining this reduced servicing capacity in some of the GREs in our sample. Since mid-2015, the economic outlook has moderated, transfers to GREs have been scaled back and costs of funding have increased, and these factors might lead to a further weakening of the debt servicing capacity

Table 4.

Non-Financial Corporate Sector: Interest Coverage Ratio, ICR

article image
ICR = earnings before interest and taxes (EBIT) to interest payments falling due.
Figure 5.
Figure 5.

UAE: GREs Net Debt and Interest Coverage Ratio (ICR), 2006–2015q2

(Billions of USD corporate net debt by companies according to their ICR)

Citation: IMF Staff Country Reports 2016, 266; 10.5089/9781475522075.002.A001

Sources: Orbis; and IMF staff calculations.

9. With about US$80.5 billion maturing in 2016-18, both Dubai, to a larger extent, but also Abu Dhabi face short-term rollover risks. Our estimates suggest that US$51.6 billion of Dubai’s debt will come due in 2016-18 (see Table 5), especially in 2018 with an estimated US$27.4 billion due. Over US$28.9 billion of Abu Dhabi’s debt will also come due in 2016-18 (Table 6). These are large maturities in a context of tightening domestic liquidity, competition from other governments in the region to finance deficits, and possible reversal of capital inflows. Short-term rollovers risk may also translate into higher cost of funding, which ultimately could put further strains on debt servicing capacity and ultimately on the fiscal accounts and, to a lesser extent, on the financial system. In addition, as most of the corporate debt is denominated in foreign currency (FX), rollover risks could be reflected in an increase in the forward exchange rate premium.

Table 5.

Dubai: Maturing Bonds and Syndicated Loans 1/ 2/

(In millions U.S. dollars)

article image
Sources: Dealogic; Zawya; Bloomberg; Dubai authorities; and IMF staff estimates.

Excluding bilateral bank loans and accounts payable, except for the sovereign.

Regardless of residency of debt holders.

Includes syndicated and bilateral loans.

Emirates National Bank of Dubai related party lending.

Does not include financial leases.

Includes DEWA, DIFC, DAE, Borse Dubai, and others.

Dubai GREs with government ownership below 50% (Emaar, DIB, CBD). It includes public banks’ loans to GREs without netting assets and liabilities.

RTA, Dubai World, and Dubai Airport.

Table 6.

Abu Dhabi: Maturing Bonds and Syndicated Loans

article image
Sources: Dealogic; Zawya; Bloomberg; Abu Dhabi authorities; and Fund staff estimates.

Includes Dolphin, EMAL.

Includes ADPC, GHC, ADNEC.

Below 50 percent government-owned entities; includes Aldar, FGB, NCCC, Sorouh, ADIB.

10. GREs pose contingent fiscal risks and an adverse scenario could worsen the government balance sheet. As public transfers have been made to support specific companies (financial and non-financial), the market perceives that governments implicitly guarantee GREs’ debt. An adverse scenario could worsen the government balance sheet, be transmitted to the financial sector and contribute to feedback loops3. A scenario that combines a global downturn with a real estate shock under which the government would take over 20 percent of the GREs’ debt would imply a substantial increase in the government debt-to-GDP ratio, to 32.1 percent, twice as large as under the baseline scenario (14.1 percent of GDP in 2016)4. In the case of Dubai, the debt ratio could triple to 59.6 percent of GDP if there would be a severe shock to the real estate sector compounded with a global downturn. However, these risks can be mitigated by the large fiscal buffers. Regarding financial risks, loans to GREs have increased by 6 percent so far in 2016 and correspond to about 7.6 percent of the assets of the banking sector. Greater corporate leverage could render firms less able to withstand negative shocks to income or asset values and quickly spill over to the financial sector, generating a vicious cycle as banks curtail lending.

D. The Evolution of GREs Leverage and Macroeconomic Conditions

11. The evolution of GREs leverage is expected to be closely associated not only with firm-specific factors, but also with macroeconomic and financial conditions. Chapter 3 of the 2015 Global Financial Stability Report (GFSR) showed that macroeconomic conditions, including public debt and interest rates, are positively correlated with leverage growth. This positive relationship implies that accommodative macroeconomic conditions can encourage increased leverage. This implies that corporates are rendered more vulnerable to cyclical macroeconomic and financial conditions and external shocks. However, given that this has not been the case for all GREs, precisely identifying the role of individual macroeconomic and financial conditions is essential to monitor risks. Cross-section weights are used to correct for heteroscedasticity.

12. Panel regression analysis is used to estimate the link between GRE-level leverage growth with key firm and other macroeconomic and financial variables. For GRE i, at time t a general specification can be written as follows:

DLeveragei,t = b1GREi,t–1 + b2MACROt + OTHER

In which the dependent variable, DLeverage defined as the change in the ratio of assets over equity. The term GRE includes measures of size (sales), profitability (return on assets), ICR, asset tangibility (to reflect collateral availability and asset quality), ICR. The MACRO factors include government gross debt to GDP, oil price, the inverse of the US shadow rate, an exchange market volatility index (VIX), and corporate spreads. OTHER includes the error terms.

13. The results suggest that the relative contributions of firm specific characteristics, macroeconomic conditions and global financial factors in explaining leverage are mixed. The 2015 GFSR pointed out that global financial factors appear to have become relatively more important determinants of leverage in the post-crisis period as relative contributions of firms and spreads seem to have diminished in recent years. For UAE, the panel regression analysis shows that individual firm factors, especially profitability and the ratio of interest coverage continues to play an important role in determining the change in leverage. The fiscal position of the government proxy by gross government debt to GDP has also a significant impact as well as the domestic interest rate. Global oil prices are also significant and positively correlated with leverage. The results are robust to different specifications.

14. Most of the coefficient signs related to firm characteristics are in line with the literature. The literature offers different explanations on factors affecting corporate leverage5. The 2015 GFSR associates positive signs to the firm level characteristics (sales, profitability and tangibility), although for sales estimates that the sign can be positive or negative. According to the influential pecking order theory of capital structure which suggests that firms prefer internal to external finance and when outside funds are necessary, firms prefer debt to equity because of lower information costs associated with debt issues, sales and profitability are expected to have an inverse influence on leverage.6 The ratio of fixed assets to total assets (tangibility) is expected to have a positive relation with leverage, as more tangible assets can be used as collateral. A lag of the dependent variable is included to account for persistency.

15. The evidence shows some signs of elevated GREs exposure to a potential worsening of the domestic and global macroeconomic and financial conditions. In particular, the (inverse) of the UAE interest rate, government debt, global oil prices and the volatility in global financial market proxy by the VIX index seems to be particularly associated with leverage growth7. Leverage seems to be correlated with oil price increases. However, the impact of external shocks like oil prices could be partially offset by the use of countercyclical fiscal policy which may dilute the full impact of variables like oil prices.

Table 7.

EGLS Panel With Cross-section Weights

Change in Leverage (2006–15)

article image

E. Policies to Manage Risks Posed by GREs

16. While the UAE’s balance sheet as a whole is strong, potential fiscal and financial stability risks stemming from GREs need to be monitored. The size of UAE publicly-held government debt is rather small, while fiscal and external buffers are large. It is only when the debt of the GREs is accounted for that full scale of the risk faced by the sovereign balance sheet becomes visible, as well as its potential implications for the domestic banking sector and debt capital markets. Rollover risks have increased with tightening liquidity, fiscal financing needs and the lift-off of the US interest rate. In addition, worsening domestic and external conditions might lead to increased leverage of GREs and higher default probability, ultimately putting further strains on the financial system and the fiscal accounts.

17. Mitigating these risks would require an integrated approach. Prudent fiscal policies, while still promoting economic growth, together with stronger fiscal frameworks, including a strong consolidated multi-year budget framework, are essential elements to reduce and better manage fiscal risks. Strengthening fundamentals, improving the traction of liquidity management and monitoring corporate leverage buildup is also important to limit financial stability risks. Strengthening regulation, supervision, macro-prudential frameworks can help contain financial excesses, minimize foreign currency and commodity price risks, encourage safe credit creation and safeguard financial stability. These should include proper risk-weights for lending to GREs and continued enforcement of loan-concentration limits.

18. Proper management frameworks for GREs are crucial. Such frameworks entail assessing, monitoring, and reporting of contingent liabilities arising from the GREs, and transparent reflection of GRE contingent liabilities in government accounts. To this end, the debt management offices should have dedicated units collecting frequent data on GREs outstanding liabilities, their maturity profile, income and cash-flow statements, and assessing potential contingent liabilities to the sovereign. The authorities should also consider including a statement of this contingent risk as part of the annual budget documents, including discussion of past experiences, forward-looking estimates as well as a presentation of risk mitigation strategies. In addition, the authorities should push for more efficiency of GREs, including developing performance-based contracts with them, and could consider increasing private sector participation in their capital and management.

19. Containing GRE borrowing is a pre-condition for fiscal sustainability and financial stability at the emirate level and requires a strong institutional framework. In order to contain further risk-taking, the authorities should consider introducing a mechanism to manage GREs borrowing (including through setting limits on changes in GRE borrowings or overall liabilities). Any borrowing at the emirate level would then require the assent of the emirate finance department, which would provide a strong signal to financial markets about GREs debt sustainability.

20. Improved corporate governance and transparency are also key for mitigating risks posed by GREs. In particular, it would be important to delineate clearly between the commercial and noncommercial operations carried by GREs, clarify the government support strategy, and standardize the accounting, auditing, and financial reporting practices. Better information disclosure would help attract investors and ultimately will translate into lower funding costs. Improvements in corporate governance and risk management will also help investors to assess GRE risks. Also, regulators, such as the central bank and the securities and commodities authority, should step up their supervision of business conduct by GREs that are under their oversight.

References

  • De Jong, Abe, Kabir, Rezaul, Nguyen, Thuy Thu, 2008, “Capital structure around the world: The roles of firm-and country-specific determinants”, Journal of banking & Finance 32 pp. 1954–1969.

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  • Frank, Murray Z. and Goyal, Vidhan K, 2003. “Testing the pecking order theory of capital structure”, Journal of Financial Economics 67, pp. 217–248.

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  • Gungoraydinoglu, Ali and Oztekin, Ozde, 2011, “Firm-and country-level determinants of corporate leverage: Some new international evidence”, Journal of Corporate Finance, 17 pp. 1457–1474.

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  • Kayo, Eduardo, K. and Kimura, Herbert, 2011, “Hierarchical determinants of capital structure” Journal of Banking & Finance, 35 pp. 358–371.

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  • International Monetary Fund (IMF) 2015. “Corporate Leverage in Emerging Markets – A Concern? Global Financial Stability Report, Chapter 3.

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1

Prepared by Pilar Garcia Martinez and Juan Carlos Flores.

2

This paper used different sources of data with different companies since comprehensive consistent data are not available.

3

For details on the underline assumptions on the severe shock scenario see Appendix II on Debt Sustainability Analysis of the 2016 Staff Report of the Article IV Consultation with UAE.

4

For most non-listed GREs annual reports are not published, including audited balance sheets and income statements. Information on off-balance sheet liabilities is often unavailable and so are data about overall activity, employment and investment

5

De Jong, A. et al. 2008, Gungoraydinoglu, A. and Oztekin, O, 2011, Kayo, E. and Kimura, H, 2011.

6

Frank, M. Z. and Goyal, V. K, 2003

7

VIX represents the Chicago Board Options Exchange Market Volatility Index.

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Cover IMF Staff Country Reports
United Arab Emirates: Selected Issues
Author:
International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2016: Issue 266
Publisher:
International Monetary Fund
ISBN:
9781475522075
ISSN:
1934-7685
Pages:
52
DOI:
https://doi.org/10.5089/9781475522075.002
  • Figure 1.
    View in gallery
    Figure 1.

    UAE: GRE’s Debt, 2010–15

    (U.S. dollar billions; unless otherwise noted)

  • Figure 2.
    View in gallery
    Figure 2.

    UAE Companies with Government Ownership and Publicly Available Information: Selected Indicators

  • Figure 3.
    View in gallery
    Figure 3.

    UAE: Debt Composition, 2010–2015

    (Percent of total)

  • Figure 4.
    View in gallery
    Figure 4.

    Non-Financial Corporate Sector: Outstanding GREs and Government Bond Debt

  • Figure 5.
    View in gallery
    Figure 5.

    UAE: GREs Net Debt and Interest Coverage Ratio (ICR), 2006–2015q2

    (Billions of USD corporate net debt by companies according to their ICR)

Figure 1.

UAE: GRE’s Debt, 2010–15

(U.S. dollar billions; unless otherwise noted)
Figure 2.

UAE Companies with Government Ownership and Publicly Available Information: Selected Indicators
Figure 3.

UAE: Debt Composition, 2010–2015

(Percent of total)
Figure 4.

Non-Financial Corporate Sector: Outstanding GREs and Government Bond Debt
Figure 5.

UAE: GREs Net Debt and Interest Coverage Ratio (ICR), 2006–2015q2

(Billions of USD corporate net debt by companies according to their ICR)