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Foreign Direct Investment in the UAE

Summary

Globalization necessitates several emerging trends in business. Foreign direct investment, for example, remains an emerging issue among major multi-national companies venturing into production or other business-related activities in countries away from their regions of origin. Businesses execute such entries into foreign markets purchasing other entities or expanding operations into the target foreign markets. Foreign direct investment does not include investment in stocks and bonds. Stock and bond trading is referred to as portfolio investment. However, FDI takes many forms and commonly encompasses acquisitions and mergers, reinvesting profits earned from overseas business branches, intra-company loans as well as erecting new facilities in a foreign country (Economic outlook, analysis, and forecasts par. 7).

Factors Favoring the Flow of FDI into the UAE

According to the Global Investment Report of 2013 published by UNCTAD, FDI inflow into the UAE ranks third in the West Asia region after Saudi Arabia and Turkey. In 2013, the UAB recorded $12 billion in FDI. The political and economic stability of the UAE amid the Arab uprising played an integral role in attracting such investment which led to the record figures. Similarly, the strategic geographical location of the UAE to the oil reserves, willingness to diversify its economy, low energy costs, and high purchasing power of the population, are other key factors that favor the FDI inflow (2013 Investment Climate Statement – United Arab Emirates 4). The UAE economy is largely dependent on oil and natural gas as they account for more than 35 percent of the GDP. Notably, in the last ten years, the UAE’s FDI has reached 2 trillion Dirham.

Several factors determine the flow of Foreign Direct investment in a country. These include population, availability of natural resources, corruption and bureaucratic red tapes, political stability, GDP growth rate, infrastructure, macroeconomic fundamentals, and degree of openness. Factors like research and development, domestic investment, education, risks, and risk instability also determine a country’s FDI flows (Nagraj par. 1).

According to a study conducted by Hesmati and Addison in 2003 that placed emphasis on the size of the domestic market, domestic purchasing capabilities and the country’s real income have a great influence on FDI flow. However, Hisarciklilar et al. in 2006 counteract this argument by showing that FDI flows get bearing from many factors dependency on the regional trade and a country’s economic standing in the international trade as the key factors. Even though foreign investors rely on the local markets, studies show that low-wage advantage plays an integral role in attracting FDI inflows (Shirazi, Rodrigues, and Karnik 12).

Jaumotte in his 2004 study on “FDI and Regional Trade Agreements,” indicated that the inflows of the FDI depended on the large market base in host countries provided by the Regional Trade Agreements. The study indicated that the size of the market, population size and the purchasing power of the population of countries in the Regional Trade Agreements gave some countries a competitive advantage over other countries in the same block in terms of Foreign Direct Investment. He further contemplated that a large proportion of FDI share went to financially stable countries (Jaumotte 12).

The incentives offered by the country for attracting FDI

A number of studies carried out in the MENA region, where the United Arab Emirates belong, indicate that the region possesses a high inflow of FDI due to the low wages in the region, proximity to strategic markets, expansion in logistics and infrastructure, domestic growth potential, improvements in the regulations, and improvements in the business growth potential. According to the study, investment incentives and trade policies are important for the UAE to maintain competitiveness with other members of the MENA (Shirazi, Rodrigues, and Karnik 3). The UAE has succeeded in protecting investment ventures by ensuring that there are various incentives through tax exemptions in the Free Trade Zones. The foreign investors are also favored outside the free zone in terms of property purchase, however, the freehold is restricted to specific projects (Jaber par. 6). The company that operates in the free trade zone does not pay the import and re-import tariffs. The UAE has also witnessed minimal cases of expropriation of foreign investors since opening up to the outside world.

The contract law also operates to protect FDI and has made a major impact on how UAE and foreign companies meet their contractual obligations in the UAE market. The law protects the legal rights of all the parties and allows them to determine their own remedies for dispute resolution and contract breach, which promotes investor confidence, and hence promotes foreign investments (Jaber par. 7). Another study conducted by Krogstrup and Matar on the “FDI, Absorptive Capacity, and Growth in the Arab World,” discovered a deficiency in the absorptive capacity to benefit from FDI among Arab countries. The deficiency areas that informed the findings included educational levels, technological niches, institutional development, and development in the financial sector. The study discovered that the absorptive capacity of a country informs the country’s economic rationale in its rationale to implement expensive incentive initiatives like investment subsidies, tax holidays, and export credits, which harms domestic investment and favors FDI (Shirazi, Rodrigues, and Karnik 3).

UAE is a member of the Organization of Petroleum Exporting Countries; it is the fourth-largest producer of oil with reserves estimated at 98 billion barrels representing 10% of the world’s reserves. Abu Dhabi has the greatest oil reserve that amounting to almost 94 percent of the country’s annual output. With oil fields slowly running out of precious minerals, the Abu Dhabi government currently encourages tourism to reduce the over-reliance on oil. Similarly, the State continues to invest heavily in education, especially in institutions of higher learning, as well as cultural and sporting attractions. The state currently boasts of a formula one racing track and hosts several international racing competitions. It is important to note that the country is a host to a prestigious Ferrari theme park.

Oil, discovered towards the end of the 1950s remains an important driver of this country’s economy. Before its discovery, the UAE’s economy relied on the fishing and pearling industries that were drastically declining. However, with such a discovery, the economy of the UAE as well as the welfare of its people has undergone a major transformation since Abu Dhabi started exporting oil in 1962. Sheikh Zayed who was one of the founding fathers of the federation ensured that revenue from oil exportation helped in improving core economic sectors such as education, health, transport and communication. Similarly, he ensured equal distribution of the revenue from the oil resources among the seven-member states. This led to a quick transformation of the economy and today the country has a per capita income.

The fast growth of the UAE has attracted millions of foreign workers, as well as expatriates from across the world. Indeed, three-quarters of the 5.4 million people in the federation are foreigners. Only a few are working in the oil industry as tourism, business, and construction sectors are booming. Dubai has cut a niche as the leader in the diversification policy; the state boasts of the highest man-made buildings in the world Burj Khalifa, as well as a home to the only seven-star hotel in the world (Burj al Arab) and a highly developed financial sector. Undeniably, Dubai is more famous for its service industry than its oil reserves. The state has also an island named Palm Island, as it is palm-shaped.

Even though the 2009 global economic crisis has greatly affected the construction and property sector with the national negative growth of -1.6 percent, other sectors like tourism, retail, and trade remained deviant. The environment in the UAE, especially in Dubai, remains conducive for people from diverse religious and cultural backgrounds as the federation is liberal compared to other countries in the Gulf region. The political environment is highly controlled with no political parties and no elections. The industrial and agricultural sectors have lagged behind and the federation relies on imported products and industrial goods. The Gulf Cooperation Council (GCC) formed in 1981 is a political, economic and defense alliance created with the aim of creating a common market. The UAE just like many GCC economies has a favorable balance of payments recording a huge balance of trade surpluses. The 2011 surplus was the best ever recorded while the 2001 surplus of AED 42 billion was the worst. Despite the growth of other sectors like tourism and retailing, oil and natural gas play a significant role in the economy (Katzman 33).

Amount of FDI during the last 10 years

The FDI growth rate hit about 27% in 2012 and was equivalent to $95 billion. The 2008/2009 financial meltdown lowered the country’s FDI; so strong was the crisis that the UAE has never recovered in its FDI flows. In 2003, a significant increase in the FDI in UAE occurred record $7 billion, equivalent to 5.3% of GDP. Notably, between 2000 and 2012, the country’s FDI remained higher than the FDI stocks of other Gulf nations. This was a true reflection of the UAE’s FDI inflow, not only in the GCC but also in the wider MENA region (Mina 13).

The UAE recorded a $1.2 billion rise in FDI flows in 2001, an equivalent of 1.1% of GDP. This was optimized in 2007, with $14.2 billion, an equivalent of 5.5% of the GDP, before the global financial crisis. Between 2010 and 2012, the FDI flow rose gradually with $9.6 billion, an equivalent of 2.7% of the Gross Domestic Product at the end of 2012 (Analytical report on economic and social dimensions in the United Arab Emirates 2009 17). However, it has never risen past the growth in 2007. It is significant to note that the UAE FDI flow in 2011 and 2012 was still above the total FDI flow for Kuwait, Bahrain, Qatar, and Oman (Mina 12).

Sectorial FDI trends during the last 10 years

The analysis of the UAE’s dispersal of FDI inflow per sector from 2005 to 2009 shows that approximately two-thirds of the UAE’s FDI stock emanated from the real estate, production, and financial sectors. As per the 2012 WTO Trade Policy Review the construction sector amounted to 21%, the financial institutions amounted to 23%, and the real estate sector amounted to 21% of the FDI stock (Anwar 75). For instance, the 2008/2009 global financial meltdown led to the reduction in the FDI of the real estate sector by 12% points, that is, from 27% to 15%. The federation’s GDP grew by 3.3 percent in 2011. The highest growth rate occurred in 2003 when the economy grew by 11.9 percent, while the worst economic moment was during the recession with a negative growth of -1.6 percent (Anwar 75). The country has a low unemployment rate averaging around 3 percent. This has never gone beyond 5 percent, even at the worst economic times. The unemployment rate stood at 4.6 percent in December 2011. The inflation rate has always been very low for the past two decades (2.5 percent). The federation imported goods worth 742 billion AED (Economic outlook, analysis, and forecasts par. 8); its major importers of products are India, China, the USA, Japan, and the European Union. On the other hand, it exported products worth AED 1034 billion; major export destinations are Japan, China, Iran, and Iraq. The difference between exports and imports led to a surplus in the balance of trade (Katzman 34).

Factors hindering the flow of FDI into the country

The move to a modern flexible approach from the rigid traditional approach is one of the key challenges that the country has faced in ensuring constant flows of its FDI. The modern approach aims at the creation of a generic environment for the investors, contrary to the traditional approach that depends on the free zones, and the provision of advantages to FDI like concessions and other forms of foreign investment preferential treatment. The 2006 and 2012 WTO’s Trade Policy Reviews of the UAE noted that investment policy in the UAE restricted FDI, with an exception in the free zones in order to protect the local industries (Mina 21).

The modern dynamic approach requires the UAE to make use of environmentally conducive factors like the transparent, stable, and reasonable tax system, a corruption-free instrument to attract FDI in modern times. The conventional methods like the preferential treatment and low taxation rate do not help in the attraction of FDI in contemporary society (Jaber 4).

Legislations that enhance investment create a stable, favorable, and certain environment suitable for foreign investors. Such legislation will come with various benefits to the UAE, such as advancements in terms of technology and productivity (Jaber 5). In addition, the elimination of other restrictive policies and preferential treatment to national companies remains necessary. It is important to replace the restriction on 100% ownership with an administrative one, which permits ownership of 50% to 100% (Jaber 7). The UAE should also revise its FDI policies in order to acquire a competitive advantage in the attraction of FDI inflows, as well as comply with the World Trade Organization’s provisions in the FDI (Jaber 14).

It is imperative for the UAE to provide a favorable climate that involves uniform taxation and ownership policies in order to attract more inflow of FDI. Retention of professionals and foreign investors should also be a priority to the UAE through the provision of permanent or long-term visa permits in crucial sectors of the economy (Jaber 9).

The role of FDI on the development of the country

FDI plays a vital role in the economy of the UAE in its efforts to achieve the Abu Dhabi Vision 2030 and UAE Vision 2012. This is because it diversifies the economy and reduces over-reliance on natural resources in the long term, hence ensuring the sustainability of the economy (Sbia, Shahbaz, and Hamdi 194). The UAE projects to major in the key sectors like education in order to establish a high value-added economy that meets the global economy standards, and higher value and accessible opportunities for the population. This indicates the role the FDI inflows plays in solving the unemployment problem in the UAE (Mina 5).

Studies by UNCTAD have shown the benefits that accrue to the FDI inflow to UAE; the studies show that FDI enhances employment opportunities, capital formation, environment conservation, and exports economic growth (2013 Investment Climate Statement – United Arab Emirates 7). These benefits depend on the presence of a developed financial system and the presence of human capital (Mina 24). The local industries also benefit from the FDI in terms of forwarding and backward linkages like an imitation of the MNEs, as well as using the skills of workers trained by the MNEs. Such benefits are significant in the realization of a knowledge-based economy and a diversified economy (Mina 24).

Projections

According to the Inward FDI Potential Index in UNCTAD, the UAE ranked third in 2008, and fifth in 2009 on a list that involved 142 countries (Sbia, Shahbaz, and Hamdi 196). This potential shows the ability of the UAE to become an investment hub globally (Bains 12). Political economy deals with the interactions between political ideologies and economic methods and theories. The ease of doing business of a country, as well as its economic performance depends on the structure and operations of its legal system, political system, and societal norms and values. Political economy, therefore, cuts across several players, such as the state, market, society, individuals using economical, sociological, and political tools and methods of analysis. Studying the UAE’s political economy is imperative before investing in the country since it helps investors to understand the logistics and agencies involved in starting, managing, and closing a business.

Manager of MNC

As the manager of the MNC, I believe that investing in the UAE’s economy is highly necessary due to the relatively stable market conditions within the country. The UAE is growing in regional and global dominance. Its growing competitiveness and the business environment thus inform the decision to invest in the UAE economy. The confidence is boosted by the World Bank’s 2006, 2009, 2010, and 2012 “Doing Business Reports” that indicates the UAE’s ease to making business rankings improve from the 69th rank in 2006, 46th position in 2009, and the 33rd place in 2010 and 2012 (Mina 25). The reform initiatives taken by the UAE to encourage investment and ease business are also a factor for investing in the UAE economy. This will enhance the protection of property rights, thus making the UAE an attractive investment destination. The UAE has also eased the process of acquiring construction permits. These reforms in the aspects of international trade play a vital role in ensuring that foreign investor enjoys competitive market conditions with native investors thus increasing chances of business success. Clearly, the UAE’s political environment must support foreign investments by addressing security concerns, fighting corruption, and putting in place clear trade regulations. The country’s rule of law, open market, and regulatory efficiency have witnessed massive improvements over the past two decades. Positive changes in trade freedom, business freedom, financial freedom, and fiscal freedom are some of the reasons that increase the ease of doing business in the UAE.

Works Cited

2013 Investment Climate Statement – United Arab Emirates. N.p., 2013. Web.

Analytical report on economic and social dimensions in the United Arab Emirates 2009. N.p, 2010. Web.

Anwar, Syed Aziz. “Determinants of Foreign Direct Investment in UAE.” Journal for International Business and Entrepreneurship Development 1.1 (2003): 75. Print.

Bains, Elizabeth. A guide to doing business in the UAE. 9th ed. Dubai, UAE: Meed Media, 2012. Print.

Economic outlook, analysis, and forecasts. N.p., 2011. Web.

Jaber, Sultan Ahmed. An analysis of foreign direct investment in the United Arab Emirates. Abu Dhabi: Emirates Center for Strategic Studies and Research, 2008. Print.

Katzman, Kenneth. The United Arab Emirates: Issues for US policy. N.p., 2006. Web.

Mina, Wasseem. United Arab Emirates FDI Outlook. N.p., 2013. Web.

Nagraj, Aarti. The UAE’s Foreign Direct Investment Windfall. N.p, 2013. Web.

Sbia, Rashid, Muhammad Shahbaz, and Helmi Hamdi. “A contribution of foreign direct investment, clean energy, trade openness, carbon emissions and economic growth to energy demand in UAE.” Economic Modelling 36.7 (2014): 191-197. Print.