The United Arab Emirate’s economy continues to grow strongly and new commercial activity is springing up on a daily basis, but while reports of global-scale successes mount up, investors should be warned: growth brings pitfalls as well as fortunes, such as runaway inflation, housing shortages and some very volatile stock markets.

Dubai may have taken a lead, but cranes now increasingly dominate the skyline of the federation’s seven emirate capitals. Buoyed by high oil prices and Gulf investors’ post-9/11 determination to spend more of their money closer to home, the UAE is alive with projects. Some schemes are creating the biggest and tallest glass-encrusted sky-rise buildings, others spawning economic zones and cities, yet more laying the foundations for seriously world-class industrial ventures.

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“We missed the liberalisation boat in the 1990s, but now our markets are opening up,” says founder and chief executive of Dubai-based Rasmala Investments Ali Al Shihabi. Rasmala has invested in RAK Petroleum and in real estate developer iHilal Baghlaf Development Company; both do business in sectors that have been dominated by state-owned entities until very recently.

The UAE accounts for a large proportion of ongoing and planned infrastructure projects in the Gulf Co-operation Council (GCC) countries, although analysts appear divided over quite how big the regional project pipeline is. According to a report recently commissioned by Dubai-based private equity house Abraaj Capital, GCC countries alone have announced projects worth a staggering $723bn over the next five years.

Regional dominance

It was recently reported in Dubai that of an estimated $1.300bn of investments in the GCC between 2007 and 2012 – comprising about 2000 infrastructure projects – the bulk worth more than $300bn, are in the UAE, mostly in Abu Dhabi and Dubai.

New investments

The tables are turning too in the investment dynamics in a region traditionally known for putting its money in mature markets, with UAE-based firms playing a catalytic role. Major private equity investor Abraaj Capital is increasingly seeing European and US investors looking for regional exposure, according to executive director Fred Sicre.

“Around five years ago there was concern in the region over FDI flows. Now the concern has switched from the availability of FDI to how to manage its growth and make it stick – there is a new paradigm emerging,” he says.

This points to several emerging features on the region’s commercial landscape to interest investors. These include the emergence of locally bred global brands such as Dubai’s Emirates airline and property developer Emaar, Ras Al Khaimah’s RAK Ceramics and Abu Dhabi’s Rotana Hotels and more will emerge, among them Emirates Aluminium and Sharjah’s Air Arabia.

Cultural changes feature on the commercial landscape too, notably in family-owned conglomerates, built over the past 20 to 30 years on partnerships with multinational companies and global brands. Second-generation, often western-educated Gulf nationals are taking the helm at these ‘family groups’, and bringing a fresh entrepreneurialism.

Self-financing

Private equity is a new feature on the region’s investment landscape, with UAE firms playing prominent roles in the development of what has quickly become a multi-billion-dollar industry. “A good 60% to 70% of funds have been raised by UAE-based firms,” says Mr Sicre. “The capital is coming from around the region, but the firms are based here.”

Local investors are keen to participate in private equity deals and competition for prime investments is stiff. However, the impact of this asset class must be seen in perspective: since the region’s first major private equity deal in 1999, when Inchcape sold most of its marketing operations in the Middle East to Dubai’s Cupola Investments for £72m ($146m), regional private equity funds have raised around $25bn, says Mr Sicre, “a small amount compared to the total sum of investment opportunities”.

Mr Al Shihabi points out that private equity was virtually unheard of in the region before Rasmala launched its first fund seven years ago. “We’re finding it a much easier, more exciting environment now. You don’t have to explain to potential investors what private equity is. They have read about it in the press, and this is where they want to be,” he says.

Investors in the recently paid-off Rasmala Private Equity Fund 1 – Dubai’s first private equity fund, launched in 2000 with the objective of investing in the regional financial services sector – reaped handsome rewards. “We returned to investors over three times their capital in just over six years, equating to an annual return of 22% per annum,” says Mr Al-Shihabi.

The project boom has created new jobs on a near daily basis. “What unemployment? It’s negligible,”

said one Gulf-based economist – although the flip side for local employees who benefit from tax-free incomes and a value-added, tax-free purchasing environment is a population swelling between 8% and 9% yearly and the pressure that puts on the local infrastructure.

It is also creating inflationary pressure, and will slow down growth rates over the next few years, according to HSBC economist Simon Williams, who reported that “the shortage in supply of commercial and residential property has been a key driver of inflation, pushing price growth up to about 11% to 12%.”

Inflation warning

Although inflation is expected to fall to about 8% by end-2007, real GDP growth will also slow down to 6.2%, and is forecast to maintain that average until 2010. Williams argues that another economic constraint is the UAE’s continued dependence on developments in the oil market, although he concedes that a drop in oil prices would have to be severe to slow down growth.

“You’d need prices to fall 50% to something under $40 a barrel before the UAE began to move out of its comfort zone,” he says.

The federation’s non-oil sector is strengthening, now accounting for around two-thirds of GDP. Sustained investment suggests that the cyclical downturn that usually follows an oil boom may not re-emerge if oil prices diminish.

Critical success factors for non-oil growth include Dubai’s much vaunted real estate play and its bid through Dubai International Financial Centre (DIFC) to become a financial hub. Oil-rich Abu Dhabi’s industrialisation strategy and its planned establishment of a culture and heritage-oriented tourism sector that contrasts with Dubai’s thriving offering of sun, sand and shops should be watched.

Abu Dhabi and Dubai are the two major emirates, but the performance of the smaller emirates may also be critical for the UAE’s future.

Other emirates

Ports, resorts and even a financial centre are springing up in the northern emirate of Ras Al Khaimah, where Crown Prince Sheikh Saud Bin Saqr Al Qasimi seems determined to make his fief into a business emirate. A $1bn project has been unveiled by the recently formed Rakeen real estate company to develop the RAK Offshore financial centre and free zone; this will eventually consist of 12 high-rise towers offering commercial and residential space on an estimated 750,000-square-metre site.

According to Rakeen, the first phase, which includes building the two central towers, landscaping and supporting infrastructure, will be completed within three years. The whole project is scheduled for completion by 2011. Officials seem undeterred by the proximity of Dubai and its growing financial sector, and are confident of capturing their target market share.

“Our feasibility study on the outsourcing of financial services have shown that by taking 1% of the $57bn worldwide outsourcing of financial services consisting for example of payroll, audit, call centres for banks and other financial back-office services, RAK Offshore will contribute to a significant share of Ras Al Khaimah’s growth,” says Rakeen chief executive Imad Haffar.

He adds that RAK has a distinct identity and could even be a more attractive investment option than the other emirates, and says RAK enjoyed higher anti-money laundering compliance standards and was 30% cheaper to set up in business, with no red tape.

Rakeen is the developer of RAK’s flagship Al Marjan Island project, a cluster of coral shaped islands. RAK Offshore – located within the $1.7bn Al Marjan Island development – already has more than 80 companies registered. “We have German, French, British and Asian companies coming in,” says CEO of RAK Investment Authority and adviser to the crown prince, Dr Khater Massad. These include 15 ancillary service providers, insurance and financial companies.

Dr Massad dismisses speculation that RAK’s financial centre would struggle to compete with Dubai. “We are really quite different from the DIFC. This free zone is for a more comprehensive range of financial and ancillary services, such as insurance, legal, even logistics and registration services. In that sense, we are not competing, we complement each other.”

RAK benefits

RAK’s economy is driven by industry, led by RAK Ceramics, RAK Cement, RAK White Cement and RAK Pharmaceuticals. Industry has attracted around $2bn in foreign investment over the past three years and in 2006 created 250,000 new jobs. Real estate has also attracted $2bn of foreign investment in RAK over the past three years, but vast tracts of land remain underdeveloped. Few expatriates have moved there yet, but foreigners can now buy freehold property and land in designated areas, mainly on the coast.

RAK’s real estate plan appears to banking on the affordability of property in the northern emirate, compared with Dubai’s soaring prices. Dubai-based real estate consultants Colliers International says a two-bedroomed townhouse overlooking a golf course in Dubai will cost about $1m, while its equivalent in RAK will cost $200,000. Commercial property is much cheaper too: the average price in Dubai is $410 to $820 per square foot, while in RAK it is about $120 to $190 per square foot. Prices for land range from just over $0.50 per square foot to about $110per square foot for land by the coast. Town centre land prices range from $40 to $55 per square foot.

Ease of business

Free zones, where companies can remain totally foreign owned and benefit from low taxes, less red tape and usually facilities designed specifically for the zone’s target sector, have become prominent features across the UAE’s business landscape. Smaller, emerging emirates, including Fujairah and Ajman as well as RAK, are now emulating this tried-and-tested model, largely pioneered by Dubai, to capture new economic activity.

Dubai’s free zones, meanwhile, are moving into pastures new, with operators such as the Jebel Ali Free Zone (JAFZA) and Tecom Investments helping other countries implement the same concept. JAFZA’s international arm, JAFZA International (JAFZI), is working to develop the Djibouti Free Zone. JAFZI is also working on the development of an air-sea-land trade link for neighbouring land-locked states through an airport free zone, and another business free zone.

“Our mission in Djibouti is to position the free zone as the regional logistics, distribution and marketing hub for the import, warehousing, processing and re-export of goods to and from eastern African countries,” says JAFZI managing director Chuck Heath.

Tecom Investments, a subsidiary of Dubai Holding Group, owns and operates several of Dubai’s free zones, including Biotechnology and Research Park, Media City and Internet City. It too is working abroad with the governments of South Korea, Malta and Kerala (India) to develop business zones.

Outward looking

“We have had many offers to expand our activities abroad,” says Tecom chief executive Abdullatif Al Mulla. The company looks at several criteria – including government stability, the availability of local talent and proximity to Dubai – before making an investment decision abroad. “We have had enquiries from Jordan, Pakistan, Syria, Morocco, Nigeria and many more countries in Africa, Europe and South Asia,” says Mr Al Mulla.

Tecom’s overseas adventures will not stop it from developing its domestic business. “We want to strengthen our Dubai portfolio by developing existing activities and introducing new ones,” says Mr Al Mulla. He sees new initiatives emerge organically out of existing ones in Dubai. Thus, “two separate cities were born out of Media City: Studio City and the International Production Zone”.

Tecom is also making investments abroad with another Dubai Holding subsidiary, Dubai Investment Group. These include a 35% stake in Tunisie Telecom, a 60% stake in Maltacom and a stake in European communications specialist Interoute. In the UAE, Tecom has a 20% stake in UAE mobile provider Du and 40% of mobile phone retailer Axiom Telecom.