Investors looking at new opportunities in Dubai's Islamic finance sector

Located at the mid-point between Europe and Asia, Dubai has built a diverse, competitive economy, well connected to the rest of the world by major transportation links. While the focus in recent years has been on Dubai’s recovery from the global financial crisis of the late 2000s, resumed growth has shifted the emphasis to a forward-facing outlook as Dubai seeks to introduce new catalysts for growth while reducing exposure to old risks. This means a continued effort to take advantage of its geographical strengths and developed infrastructure, as well as a push to leverage information and communications technology (ICT) wherever possible.

Dubai has continued to deal with debts that came with the global financial crisis in 2008-09, and those obligations remain a factor. While direct exposure to the financial crisis was limited as most Emirati banks and investments had steered clear of the complex derivative securities that led to the troubles, indirect consequences had spread to Dubai by 2009. Several major debts had to be restructured across the public and private sectors, and the emirate also suffered delays or cancellations of some signature real estate projects. In 2014 and early 2015 Dubai successfully renegotiated some of these remaining debts, spreading their repayment out over a longer time horizon.

Identifying Opportunities

With the next step being the creation of economic opportunities that will boost revenues, Dubai is focused on several options that play to existing strengths. It continues to add offerings in financial services, building on its growing reputation as a hub for Islamic finance. There is now a particularly strong focus on equities, with 2014 marking the end of a five-year drought in initial public offerings (IPOs) on its two equities exchanges. The latter part of the year featured more IPOs, and created hope that a regular pipeline of new stocks can be established. The emirate also plans to remain a leading source of sukuk, the sharia-compliant equivalent to bonds, both from public and commercial issuers.

Continuing development of the emirate’s infrastructure will reinforce its central place on the global stage, not only as a transit hub for people and goods but also as a tourism and shopping destination — important distinctions for the emirate’s economic strategy. Dubai’s main airport, Dubai International Airport (DIA), is on track to surpass London Heathrow Airport in 2015 as the world’s largest by annual passenger traffic. Meanwhile, Concourse D, which is currently under construction as part of the airport’s expansion plans, will increase DIA’s capacity to 90m passengers a year after the planned opening later in 2015.

Dubai International will soon be usurped, though, in part because there is limited room for further expansion at that location, as it is close to the city core. The existing Al Maktoum International Airport, situated farther from the city centre, opened in 2010. While it has thus far been used mostly for cargo, it is slated to be developed into the world’s largest airport. The current expansion plans will take six to eight years, and will eventually allow for the simultaneous accommodation of up to 100 Airbus A380 airliners, currently the largest passenger planes in existence. Capacity at Al Maktoum will be 120m passengers a year, with the ability to further expand to 200m.

GDP Growth

Dubai’s economy grew by 4.6% in 2013, over 4.1% in 2012. As of the end of 2013 GDP was at Dh325.68bn ($88.65bn), according to the Dubai Statistics Centre. Five economic sectors accounted for at least 10% of overall activity, with the largest being wholesale and retail trade and repairing services, at 29.2%. Transport, storage and communication was the second-largest component of GDP, at 14.8%, followed by manufacturing (13.7%), real estate (13.3%) and financial services (11.2%). Two other key areas, construction and hospitality, contributed 7.7% and 5%, respectively. For the construction sector, this was the first annual gain since 2008, at 1.3%.

Growth in these main sectors was at its most modest for financial services (3.6%) and trade (3.5%). That was still enough to reach an historic high in non-oil foreign trade, which was valued at Dh1.33trn ($362bn) in 2013, up from Dh94bn ($25.6bn) in 2012. According to Ahmed Butti, the director-general of Dubai Customs, imports rose to Dh811bn ($220.75bn) on the year, and exports, including re-exports, rose to Dh518bn ($141bn) from Dh498bn ($135.6bn). India was the largest trading partner, followed by China, the US, Saudi Arabia and the UK. In 2013 new trade licences climbed 12%, according to government statistics, tourist arrivals rose 10% to 11m people in the same year, according to Dubai Customs. Average daily hotel rates rose by 5%, IMF data show.

Dubai’s openness and connectedness to the global economy can make political risks in other countries an important element of the analysis. Regional turmoil in Arab countries has intensified demand for real estate and other assets in Dubai as a safe haven, for example. A sizeable opportunity for the future is Iran, across the Arabian Gulf. Dubai’s will be the economy most likely to benefit if and when sanctions against Iran are lifted and the country can integrate into the global economy. While some business was lost due to the economic sanctions imposed on Iran in 2012, this was actually offset by a sustained increase in trade flow with countries in Asia and Africa. If and when sanctions are lifted, UAE banks will be able to look forward to a boost to their balance sheets.

Real Estate

The sector drawing the most attention in late 2014 was real estate. Concerns have arisen due to rising prices, with housing prices having surged 24% in Dubai in 2013 as consumer sentiment on the economic climate picked up, according to Bloomberg data. On June 8 of that year the Central Bank of the UAE (CBU) raised concerns about an overheated market, and the ratio of house prices to incomes had reached a peak level matching that of 2008. The rise was partly due to speculation and anticipation of higher demand due to Expo 2020, but also because of limited supply. Nakheel, a government-related entity (GRE) and one of the largest property developers in Dubai, said its retail and leasing properties were near full occupancy in early 2014.

In January 2015 property agent JLL reported that average villa prices in the emirate had dropped by 1% during the final three months of 2014, while apartment prices remained flat during both the third and fourth quarters. Prices and rents in the city were expected to drop in 2015 by an average of 10%, with the agent citing a lack of affordability in the market and the fall in oil prices. At the turn of the year, the Dubai Land Department also reported that the total volume of real estate deals in the city fell 15% in 2014 compared with the previous year.

Construction Drive

With Dubai selected to host Expo 2020, an event expected to draw 25m people to the emirate, the government is now focused on ensuring it has the capacity to accommodate this influx in visitors. A construction drive is likely to get started in earnest by 2016, and for economic modelling purposes the event will provide an anchor on which to build forecasts for supply and demand in key markets and for GDP growth overall.

Expo 2020 is simultaneously an opportunity for the future and a reminder to avoid the mistakes of the past. Preparations will require multiple major construction projects, many of which will be initiated and financed by corporations wholly or partly owned by government. This is highly reminiscent of the development model pursued in the 2000s, which was left exposed to global cycles when the financial crisis spread to the emirate starting in 2009. Central to the Dubai story now, however, are public policies in place at the emirate and federal levels intended to stop domestic bubbles before they grow, which the leadership hopes will ease fears based on the recent past. Even in the real estate sector, where the bubble grew the largest before the market crash, demand has proven resilient, due to the emirate’s global reputation as a good place to buy residential properties.

Overall, however, investors perceive a declining amount of risk from Dubai, as seen by recent trends in the credit-default swaps market. In March 2013 the cost of credit default swaps had sunk to the lowest point since before the financial crisis, according to Bloomberg. Foreign direct investment (FDI) is rising as well. In the UAE as a whole, FDI grew by 25% in 2014 from to $10.4bn in 2013 to more than $13bn, according to the Ministry of Economy.

New Measures

Indeed, reactive reforms have come from the emirate and federal levels of government, as well as from individual developers. The Dubai Land Department, for example, doubled the transaction fee for freehold properties from 2% to 4%. Emaar Properties, a leading GRE in the real estate sector, only allows the resale of properties sold off-plan (before construction is complete) once 40% of the sale price has been paid, helping to dampen speculative buying. At the federal level, the CBU has rolled out new mortgage regulations. There is now a cap on the total amount of a property’s value that can be financed, with first-time buyers able to mortgage a maximum of 75% of properties. For off-plan properties, only 50% of the sale price can be financed.

In compiling its annual state-of-the-economy report for 2014, published in July, the IMF stated concerns over real estate prices and put out a reminder that Dubai retains the option of hiking transaction fees much higher, citing examples such as Hong Kong and Singapore, where property bubbles were averted by hiking transaction fees to 15% and 30%, respectively. These fees are an important element of cost control in Dubai because the majority of buyers pay cash and are not impacted by mortgage caps, according to the IMF. However, by October 2014 it seemed clear that what had already been done was working. “All of these [regulations] are little grits of sand in the machine that have helped to slow down that pace,” said Masood Ahmed, director of the IMF Middle East and Central Asia Department. “It’s important to keep watching that going forward, but compared to May [2014] our degree of concern would be lower.”

Federal Scene

Within the UAE, most political power lies at the emirate level, with each of the seven emirates enjoying full autonomy over fiscal policies and natural resources, as well as most areas of economic and social policy. Relevant economic policy at the national level comes from the Ministry of Finance and the CBU. The UAE’s trade surplus widened in 2013, to Dh503.7bn ($137.1bn) from Dh484.7bn ($132bn) in 2012, led by oil exports and re-exports, according to the 2013 annual report of the CBU. The value of the current account stood at Dh237.5bn ($64.65bn) at year’s end. Overall, however, the current account surplus declined on the year, moving from 18.5% to 16% according to the IMF, reflecting internal consumer demand for imported goods. Dubai has succeeded at deficit reduction at a faster pace than anticipated, according to the IMF, although the overall fiscal surplus fell in 2013, to 6.5% of GDP from 8.9% in 2012.

That suggests a break-even oil price — referring to the floor for crude sales on a per-barrel basis over the course of a year without triggering deficit spending — of $84, up from $78 in 2012, according to the IMF. It published its annual state-of-the-economy survey in July 2014, and found that a recovery in bank credit was helping underpin growth in financial services. Bank credit climbed 8.2% in 2013 after several years without growth in that area.

“Banks remain amply capitalised, and nonperforming loans (NPLs) have begun declining from their post-crisis peak”, the IMF reported. For 2014 the emirate’s government has predicted a GDP growth rate of 5%, while the IMF in July 2014 predicted 4.75% expansion in 2014 and 4.5% in 2015 for the UAE as a whole. The non-hydrocarbons economy is expected to lead the way, at 5.5% for 2014.

Increased Transparency

As well as support on matters of fiscal consolidation, the IMF is aiding improvements in statistical output at the federal level. Technical assistance is centred on the CBU and the National Bureau of Statistics, with the goal of compiling data to publish an international investment position, including foreign assets and debt, and an international transactions reporting system is being implemented. According to the IMF, statistical output in the UAE and Dubai could be improved in terms of the debt levels of GREs, contingent liabilities to government, and demographic and labour-market data.

For foreign investors in Dubai, the legal and regulatory environment is marked by a combination of emirate- and federal-level laws. Only banks and oil companies pay corporate income tax in the UAE. Foreign entities may hold up to 49% of the equity in companies established in the country, although profits do not have to be distributed according to ownership stakes. Foreign ownership of land on a freehold basis is allowed in certain designated areas, which in Dubai leaves plenty of room for options because outside investment is a key element of the market. Full foreign ownership of companies is allowed within the emirate’s economic free zones.

Free Zones

Of these, the two best known are the Jebel Ali Free Zone (Jafza), where manufacturing, trading and light industry are the dominant activities, and the Dubai International Financial Centre (DIFC). Jafza is the emirate’s flagship free zone. Located around 35 km south-west of Dubai City, and beside Jebel Ali Port, Jafza is host to more than 7100 companies.

DIFC is a financial services free zone that is a core element of the emirate’s offering as a global financial hub. Firms base themselves in the zone’s office towers in downtown Dubai and serve the region. The DIFC has its own securities trading platform, NASDAQ Dubai, as well as a commodities trading platform, the Dubai Mercantile Exchange, which has become a price-discovery point for futures contracts in Omani crude oil, the benchmark hydrocarbon in the region. DIFC’s offering includes a custom-designed legal and regulatory regime, implemented by its own regulator, the Dubai Financial Services Authority. The system follows English common law, and the DIFC provides its own courts and judges. In 2013 according to the DIFC annual report for the period, the value of claims adjudicated by the court reached $200m, with an average claim size of $6.8m.

Other key free zones include Media City, Internet City, Health Care City and Academic City. Along with 100% ownership, companies based here can avail themselves of tax incentives, physical facilities and operational control common to the basic free-zone model. The main downside to operating from Dubai’s free zones is that they are export-oriented, and not meant for domestic-facing operations. Bidding for federal projects is reserved to contractors at least 51% owned by UAE nationals, for example. The zones have to some extent been a victim of their own success, as demand for space has pushed up expenses. The rising costs in Dubai’s industrial zones may be starting to adversely impact the emirate’s ability to compete regionally. Financing activity has been largely centred on pre-existing firms, with very little demand seen from new companies.

Financial Sector

For foreign investors the financial services sector stands out for its variance from foreign investment rules. Foreign banks and insurers can win licences to set up branch networks, although in some cases face limits that domestic competitors do not, such as on the number of outlets permissible. While ownership of a domestic insurer is capped at 25%, it is in effect the most open sector because foreign branches can compete across all lines of business and retain a 100% ownership stake. The sector regulator, the UAE Insurance Authority, is not currently awarding new licences and that has put a premium value on existing licences of insurance companies that are possibly willing to sell to outsiders. One law that applies to all companies in the UAE of any kind is a strengthened anti-money-laundering law passed in April 2014, updating the original passed in 2002. Along with harsher fines and sentencing guidelines for offenders, the new law’s main change expands the scope of what qualifies as money laundering, according to a report by Tamimi & Co., a law firm operating across the region. As of July 2014 implementation was imminent, according to the IMF.

Debt Declines

Dubai’s current focus on the future is a change from what was previously an emphasis on recovering from the problems of the recent past. Dubai escaped the direct effects of the global financial crisis, but by 2009 it was beginning to feel the impact. In November of that year Dubai World, one of the leading GREs in Dubai, won a six-month moratorium on debt repayments. Nakheel was also successful in restructuring its sukuk debt, and in 2014 had recovered to the extent that it was able to pay off outstanding debts a year before maturity. “Early repayment of debt clearly shows the improved cash flows and would encourage future lending,” said Redmond Ramsdale, the director of financial institutions ratings in the Dubai office of Fitch Ratings.

The government has prioritised debt obligations to bond and sukuk holders, and has sought to restructure debts to banks — indeed, some of the banks are themselves GREs. Dubai Holding restructured $10bn in debt in 2014, and in early 2015 Dubai World agreed a deal to restructure $14.6bn in debt. Creditors have been asked to extend $10bn due in 2018 to 2022 in exchange for a higher interest rate, the introduction of amortisation targets, additional collateral and an early repayment of $2.92bn maturing in September 2015. Debt to Abu Dhabi and the CBU totalled $20bn was extended by five years from 2014, and at an interest rate of 1%. “The government-related entities would like to push repayment further into the future so that asset prices can continue to come back, asset sales are more palatable, and new revenue streams can be built up,” Ramsdale said.

As it stood in July 2014, the total debt load in Dubai (including GREs, in which the government has a minority ownership stake) was $141.7bn, according to the IMF. Of that total, $16.44bn, or 11.6%, is made up of bonds and loans, and is meant to be paid back by the end of 2015. A larger share of the whole — $67.51bn, or 47.6% — comes due in 2018 or beyond. In 2013 the debt-to-GDP ratio in Dubai was 60%, down from 66% at its peak in 2009, according to the IMF’s July 2014 update, which reported that while Dubai’s debt could still become unsustainable under severe shocks, the outlook has improved and continued fiscal consolidation and improving growth prospects have been strengthening Dubai’s resilience to external shocks.

Fiscal Policy

Dubai’s budget for 2014 anticipates deficit spending at 0.26% of GDP. About 37% of the total will be spent on wages and salaries, as the government has committed to adding 1650 new jobs on the year, 50 more than the number created in 2013. Goods and services will account for a further 33% of government spending, followed by development expenditures (17%), debt servicing (10%) and capital expenditures (35%). Infrastructure development is categorised within development expenditures, including projects to prepare for Expo 2020.

LOOKING AHEAD: Revenue on the year is expected to climb 13% from 2013, to Dh37bn ($10bn). The main source is fees and fines, which are expected to account for 67% of the total. Tax revenue is expected to be 21%, with oil providing 9% and profits from enterprises 3%. In 2014 a tourist tax was introduced, and the proceeds will be used to fund Expo 2020 construction. The tax has been built into hotel bills, and will range from Dh7 ($1.90) to Dh20 ($5.40) per room, depending on the type. At the federal level there has been discussion ongoing about the possibility of imposing individual income tax, but in late February 2014, just after the tourist tax in Dubai was announced, the Ministry of Finance said that it had ruled out the option and would consider other types of fees to boost revenue. One option under consideration in late 2013 was to tax remittances, and the ministry solicited feedback from the banking industry in September of that year; however, implementation was considered a challenge. At the federal level, budgeting is done in a three-year cycle. The Ministry of Finance’s 2014-16 budget increased by 15% to Dh140bn ($38.1bn), with a spending focus on electricity, water and housing projects.


Expo 2020 is likely to inform Dubai’s economic development in the coming years, with an expected $8bn in funding requirements for new developments that can accommodate 25m visitors. It is likely that the emirate’s future will once again see GREs using financing for major real estate developments. As in the real estate sector in general, there are new rules in place to avoid the outsized exposures that contributed to the crisis of 2008-09. For example, UAE banks are now subject to caps on how much they can lend to any one party, at 25% of their total loans. A problem specific to GREs, however, is that unless they have credit ratings and balance sheets strong enough to qualify for an exemption, they all count as one entity, and lending to all of them as a group cannot exceed 25% (see Banking chapter).

The impact of this change is to incentivise GREs in order to gain the financial strength needed to increase their access to bank credit, but also to diversify their funding sources. GREs are being encouraged to sell sukuk or equity in IPOs instead. For the emirate this change will accomplish two complementary goals: financing development without systemic risk to the banks, as well as further developing Dubai’s status as a financial hub through increased capital markets activity. Opportunities could be significant for portfolio investors, as government officials have said that they are planning IPOs of many key government assets. With is diverse, competitive economy and strategic location, Dubai is well-positioned to generate growth.

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The Report: Dubai 2015

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