Is there a threat of Dutch disease?

Going strictly by the above definition UAE does not fall into the category of countries facing Dutch disease because oil has been its prime export for over 3 decades and the government and the monetary authority have efficiently managed the economy through diversification of the economy and stable exchange rate through currency peg.

According to a recent IMF report, the UAE's non-oil sector has registered an average growth rate of 8 per cent since 1995, compared to an average of about 5 per cent for the other Gulf Cooperation Council (GCC) countries.

“The pace of reduction in oil dependency in the UAE has been the fastest in the GCC countries. Based on the oil dependency ratio, measured by the ratio of the oil revenue as a share of total government revenue to oil exports as a share of total exports, the UAE has gone from being one of the most dependent (about 90 per cent) in 1980 to one of the least oil dependent by 2004 (about 50-60 per cent),” the report said.

Dirham's peg to the dollar has kept the exchange rates stable. However, the relative devaluation of dirham due to the fall of dollar (dollar has been on decline due to US trade deficits) against major international currencies has resulted in rising imported inflation. Although many economists have recommended an upward revision of dirham against dollar or a change in the peg to a managed float against a basket of currencies, the central bank has indicated that it is likely to carry on with the peg until the GCC monetary union 2010.

The rising domestic costs on account of surging liquidity and the added pressure from imported inflation could make local production and service sectors more expensive. Like the manufacturing sector, the services including tourism and financial services could become less competitive as the rising costs eat into their margins, while rising prices could make the goods and services less attractive.

“Higher inflows of liquidity, though a source of investment, do not create jobs by themselves, if not managed well; it often crowds out other economic sectors. In the case of UAE, the recent stock market correction is proof enough for the asset price inflation and the growing investment focus on real estate sector could create an asset bubble that could threaten the long term stability,” said a Dubai based economist.