Financial Sector in the UAE - Essay Example

? The Financial Sector of the UAE Introduction The financial sector of the UAE works as the economic backbone of the UAE’s economy. And, the GDP of the UAE is mostly and largely contributed by the financial sectors of Abu Dhabi and Dubai, aggregately both accounted for 40.7% and 41.7% from 2007 to 2008 respectively. And, 58 percent of the total employment is provided by the services sector in the UAE, which includes insurance, finance, trade, restaurants, hotels, transport, storage, real estate, insurance and so on. In the subsequent parts of this paper; first, the financial sector of the UAE has been accounted for. Subsequent to that, financial sector, employment and UAE’s GDP have been elaborated. Then, monetary policy effectiveness has been included. Inflation is provided before the balance of payments; and, before the summary, trade has been described. Financial Sector of the UAE The financial sector works as the backbone of the UAE’s economy. The financial services sector plays a pivotal role and has significantly contributed towards the diversification of the UAE’s economic strategy. And, Abu Dhabi and Dubai’s financial sectors, which are the main contributors of the UAE’s economy, from 2007 to 2008, registered their contribution of 40.7% and 41.7 % respectively (KAMCO Research, 2011). However, the subsequent wave of the global financial crisis greatly affected the profitability of the financial sector and at the same time, credit conditions also shrunk to a considerable extent. And, this fact can be authenticated by the provided contribution of the financial sector in the year of 2007 was 7.1% and which declined in 2008 to the level of 6.8 %. Its implications appeared in the shape of a decline in liquidity levels along with the reduction in the ability of the financial institutions to provide the same level of credit facilities that they used to provide before the emergence of the global financial crisis; and, the impacts of the crisis were so severe that the leaders of Abu Dhabi were required to intervene and provide financial assistance to Dubai; whose share of the financial sector declined and reached to the level of 39.7 % whilst Abu Dhabi’s inclined to 41.4% in the year of 2008; and, the same year observed in the reduction of foreign lending activity as well. However, despite the impacts of the global financial crisis and the subsequent reduction of the financial sector towards the UAE’s economy, the parallel growth in the non-oil sector even in the crisis period, the UAE’s budget surplus and the export earnings, which provide a considerable portion of economic output, have provided a fundamental source of the funding, necessary to feed the needs of the existing infrastructure and developments projects. Financial Sector, Employment and UAE’s GDP The service sector in the UAE contributes employment to 58 percent of the total workforce (Shihab, 2001). And, the service sector consists of trade, restaurants, transport, hotels, communication, storage, finance, real estate, insurance, community, business service, personal and social services. And, this highlights the importance of the financial sectors towards employment in the country. And, the rest of section of employment is provided by the oil industry; which is the main source of inflows. And, the level of employment provided by the oil sector can also be understood from the fact that the UAE’s is third largest oil producing country in the world. Undoubtedly, this highlights the significance of the financial sector, in which a considerable number of foreign and local banks serve in the country, for the GPD of UAE in terms of employment. And, in terms of GDP distribution by the seven emirates, the contribution of Abu Dhabi towards the UAE’s GDP is the biggest; and, is followed by the emirates of Dubai and Sharjah respectively. During the period of 2004 to 2008, Abu Dhabi’s aggregate contribution for the UAE’s GDP remained 53% to 57% during the period. In the year of 2008, Abu Dhabi’s GDP remained at AED 519.9 billion followed by Dubai which contributed a GDP portion of AED 301.5 billion, representing 32.3% of UAE GDP. In the same period, Sharjah, which provided 7.7% to the aggregate UAE’s GDP, provided AED 72 billion. Balance of Payments The concept of balance of payments can be defined as a summary statement mentioning all economic transactions between the residents of one country and the rest of the world during a particular period of time (Stern, 2009).The total value of the UAE exports have touched the mark of AED 878.5 billion, which is equivalent to USD 239.2 billion in 2008 in comparison to the 2007 exports of AED 656 billion (USD 178.6). In addition to that, the crude oil exports remained AED 313.7 billion, which were more than 40% crude oil exports of the 2007; whilst the gas exports increased by 37% to the mark of AED 39.1 billion in 2008. This increase from 2007 to 2008 remained considerably encouraging during that phase; however, the subsequent year of 2009 did not maintain the same tendency instead the exports decreased 20% to the amount of AED 705.8 billion. Moreover, in the same year, the crude oil and gas exports also diminished to 37% and 22% to the amounts of AED 198.77 billion and AED 30.50 billion respectively (KAMCO Research, 2011). And, the factors which contributed in the decrease were mainly associated with the decline in the demand of oil and gas by many countries. Likewise, the imports also observed a decline of 15% in 2009 to AED 551.1 billion in comparison with the figures of 2008 which remained at AED 647.4 billion. However, during the period of the global financial crisis, the total imports experienced an upward trend at a Compound Annual Growth Rate (CAGR) of 23% the past seven years from AED 120.5 billion in the year of 2001 to AED 647.4 billion in 2008, highlighting the expansion in the domestic demand along with emphasizing how the UAE’s economy and GDP are evolving by the force of demand. For imports, China remained the biggest exporter to the UAE in 2008 in which 11.3 % of total imports were received. Monetary Policy Effectiveness Monetary policy denotes to those policy steps, which are taken by the Central Bank of a country, to control and regulate the money supply in the country (Deepashree, 2007).Currently, the UAE’s Dirham is pegged with the US dollar. And, this pegging leaves the Central Bank of the UAE with a few options to control the inflation along with managing the money supply in the country. The impacts of such pegging are that the money supply growth is considerably managed by attaching the domestic interest rates with the interest rates movements in the U.S. (KAMCO Research, 2011). This would mean that any subsequent effects over the interest rates taking place in the US would directly influence the interest rates in the UAE as well. If the interest rates in the US are diminished, the interest rates in the UAE would also follow the similar in the UAE as well. As a result, the cut in the interest rates, which led to a serious rise in the credit growth in conjunction with the government’s expansionary fiscal policies, encouraged the higher inflationary pressures in the recent years. However, in line with Gross Domestic Product (GDP) growth, the relevant monetary indicators displayed positive growth. And, this positive growth in the money supply can be measured by M2, which grew at a CAGR of 19.6% to AED 786.4 billion in the year of 2010 from AED 156.5 billion in 2001. The inflation rate in 2010 remained relatively stable in comparison with the previous year rate. In 2010, the inflation rate stood at 1.7% not much higher than the inflation rate of 2009. Despite the moderate rise, the constant downward trajectory of rents and housing moulded the inflation rate considerably in the lower range in comparison with the foregoing years. And, the subsequent two months of 2011 also witnessed the decrease on a month over month basis that was largely contributed by the decline in the housing prices. The KAMCO Research (2011) also maintains that at the end of February, 2011, the Consumer Price Index (CPI) slumped by 0.27 percent in comparison with its value existed at the end of the previous month of the same year. And, the estimates of the IMF on the UAE highlighted that inflation would increase by 3 percent in 2011. Consequently, the rise in the housing supply was expected to put downward pressure on the rentals and housing prices, which consumes a considerable portion of the price basket. Inflation Inflation has been defined as a sustained general rise in prices of goods and services (Anderton, 2000); and can be presented as a percentage change in the general price level over a period of year. In the UAE, inflation rates reached to the level of 12.3% in 2008 from 2.8% in 2001. Interestingly, the sharp rise in the inflation rates from 2007 to 2008 was mostly contributed by the rental and housing prices as well as the increase in the food costs, and the more imports during the same year in conjunction with a remarkable economic growth and development that took place during the same period as well. Trade Trade can be defined as an exchange of goods and services for other goods and services or for money (Andrews, 2009).Trade plays a pivotal role for the economic growth and economic development of any country. And, the major trading partners of the UAE include China, India, Iran, Germany and the USA. And, all these business and trading partners of the UAE represents 40% of the total trade of the UAE. As the economy of the UAE is considerably doing business with a number of countries, the impacts of the external environment cannot be avoided. Particularly, soon after the emergence of the global financial crisis, the international trade observed a slow and low trade among and between the trading and business partners as the period of uncertainty was prevailed till this point of time. In 2009, the UAE’s total trade declined to AED 660.4 billion from the level of 788.9 billion in 2008, aggregately representing a total reduction of 16% of the trade. Summary The financial sector has obtained a central position in the UAE’s economy. And, the importance of financial sector can be comprehended from the fact that 58 percent of the employment is provided by the services sector in the country. However, due to the impacts of the global financial crisis, the UAE’s economy has observed a decreasing trend in the trade. As the UAE economy considerably relies on the international trade, the improvement in it would directly bring the positive impacts for the UAE’s economy as well. References Anderton, A. (2000). Economics. (3rd Ed.). Harlow: Pearson Education. Andrews, C. (2009). What is trade: Economics in Action? New York: Crabtree Publishing. Deepashree, (2007). General Economics for CA Common Proficiency Test (CPT). New Delhi: Tata McGraw-Hill. KAMCO Research, (2011). KAMCO Research: United Arab Emirates (UAE) Economic Brief and Outlook 2011. Retrieved from: http://www.menafn.com/updates/research_center/UAE/Economic/kamco130411.pdf . Shihab, M. (2001). Economic Development in the UAE. Retrieved from: http://www.uaeinteract.com/uaeint_misc/pdf/perspectives/12.pdf Stern, R.M. (2009). Balance of Payments: Theory & Economic Policy. New Jersey: Aldine Transaction. Read More