Fiscal consolidation and UAE vision 2021: a small scale macroeconomic model approach

الملخص EN

Given the persistence of low oil prices, which has become the new norm, and the continued shrinking of government revenues, the United Arab Emirates (UAE) is facing a new challenge for the upcoming years.

The government should strike the balance between the need to adjust their spending policies to accommodate declining oil revenues and secure fiscal sustainability, versus adhering to the growth objectives as outlined in the 2021 Vision.

The UAE aims to achieve sustainable growth in the non-energy sector (targeted at 5% in 2021), by prioritizing spending and preserving growth-conducive government expenditure on infrastructure and development projects.

In order to understand the future implications of oil price volatility and the impact of fiscal consolidation on the UAE economy, we build a small-scale macroeconomic model for the UAE that takes into consideration all different channels through which main macroeconomic drivers can affect the economic activity.

The results show that the oil price fluctuation has a significant impact on banks’ liquidity, domestic credit and foreign direct investment, but a negligible effect on non-oil GDP growth, assuming that the government keeps the same level of spending, i.e., no fiscal consolidation pro-cyclical stance with the decline in oil price.

However, the budget deficit and the need for financing would grow significantly.

Moreover, using different scenarios for the pace of fiscal consolidation going forward, the model suggests that government expenditure is quite effective in raising aggregate demand and supporting non-oil real growth, in line with the UAE’s vision 2021.

This necessitates a countercyclical stance, where public spending increases with the decline in the oil price to preserve targeted growth in the non-energy sector.

Hence is the challenge to reduce the pace of fiscal consolidation in response to continued fluctuations in the oil price, without compromising the need to support non-energy growth to attain further diversification of the economy.