IntroductionGovernments world wide use various fiscal policy tools in different economic times so as to obtain desired effects on the economy. The fiscal measures may be expansionary or contractionary. Each of the fiscal measures produces different economic results and may be used interchangeably at different times depending on how the economy is performing. This paper examines how the UAE government can apply the tools in its fiscal consolidation to promote economic growth while achieving the desired fiscal consolidation effects. SummaryDue to the fiscal consolidation measures being undertaken by the United Arab Emirates government, the country’s economic growth is expected to slow from 4.9% in 2011 to 2.3% in 2012.
The IMF expects UAE’s economic growth to moderate at 2.3% given the limited likelihood for further expansion in oil production in the short term. This forecast by IMF is stronger than the one by other analysts polled by Reuters while UAE’s Statistics Bureau has not yet released its estimates. UAE’s economy has been able to recover from the recent Dubai debt crisis owing to good oil prices and strong Asian trade flows. However, the IMF fears that uncertainty in global economic and financial environment could be dangerous to UAE’s outlook and if the global situation worsens, it would be difficult for some government companies to repay some of their debts.
Although there have been efforts at restructuring state linked entities debts, they are still faced with high refinancing needs as well as reliance on foreign funding. However, the plans for fiscal consolidation by UAE government after heavy spending during the debt crisis are appropriate according to IMF. ExplanationAfter the debt crisis, the UAE government found it necessary to institute fiscal consolidation strategies.
These strategies are aimed at minimizing deficits and curtailing accumulation of more debts. These efforts could either be expansionary or contractionary. It should however be noted that fiscal consolidation measures will affect a country’s GDP and hence growth either positively or negatively depending on the strategy that the government undertakes. It has been established that where interest rates and exchange rates are held constant, fiscal consolidation will have double effect on the GDP. For instance, after tow years, fiscal consolidation of 1% GDP will reduce GDP by about 1% while raising unemployment by 0.6 %.
The reduction in GDP may result from reduced government spending which could imply less demand for goods and services since when government spends money; it is released in to the economy thus boosting demand. When there is reduced demand, the supply is affected in a similar manner which leads to an overall slowing GDP growth in the short run. This could hence explain the reduction in UAE’s economic growth from 4.9% in 2011 to the estimated 2.3% as a result of fiscal consolidation.
However, the reduced growth is not expected to be permanent and the economy will recover and even perform better in the long run. It should be noted that with the debt restructuring efforts by the UAE government for its state owned companies including the $25 billion debt restructuring of Dubai world coupled with favorable oil prices and strong trade flows within the UAE economy and hence GDP is expected to improve further in future. It should however be noted that the fiscal consolidation efforts can only be expected to result in future growth in GDP if only the global economy remains healthy, the trade between the Asian countries remain strong while the oil prices remain robust.
Otherwise, there might be further decline in economic growth and hence decline in GDP. This explains why UAE should avoid overreliance on oil but should diversify its economy to other sectors such as tourism.