(S) UAEG FINANCIALLY OVEREXTENDED

S E C R E T SECTION 01 OF 02 ABU DHABI 000773 SIPDIS NOFORN STATE FOR NEA/ARP, NEA/RA, E, D, EB AND PMAT E.O. 12958: DECL: 02/17/13 TAGS: EFIN MARR MOPS PGOV TC SUBJECT: (S) UAEG FINANCIALLY OVEREXTENDED ¶1. (U) CLASSIFIED BY AMBASSADOR MARCELLE M. WAHBA FOR REASONS 1.5 (B,D). SUMMARY AND COMMENT -------------- ¶2. (S/NF) Senior UAEG officials have told the Ambassador on several occasions recently that the UAE is facing serious cash-flow problems. The basic problem is that the UAE has traditionally funded its fiscal deficits (which can be as much as 15 percent of GDP) out of income received from large overseas investments. In some years (such as 1996) the return on those investments exceeded income from oil. But with the UAE's overseas investments realizing negative real returns (authoritative sources say post-9/11 governmental portfolio investment losses ran as high as 30-40 billion usd),the UAE is having to tighten its belt. Unfortunately, controlling spending is proving quite difficult. Expenditures, particularly on social services (health, education),is increasing as a function of a growing population and higher citizen expectations. At the same time, assistance commitments to worthy causes (Pakistan, Jordan, Afghanistan, etc.) continue to mount and senior shaykh spending on prestige projects (Shaykh Sultan bin Zayid's Lulu Island project, the new GCC conference and resort center, etc.) are proving hard to switch off. We have heard the same concerns regarding cash-flow across all levels of UAE officialdom, leading us to conclude that this is not just poor-mouthing in advance of an expected U.S. request for financial assistance in funding an Iraq contingency. Our requests for future financial assistance from the UAE will need to be both judiciously chosen as well as particularly well-supported if we are to overcome the leadership's prevailing budgetary concerns. END SUMMARY AND COMMENT. ¶3. (S/NF) Beyond the representations by senior officials such as de facto Foreign Minister Hamdan bin Zayid, there are numerous other signs of a fiscal crunch: -- A senior expat banker says Abu Dhabi's subsidy to Dubai has been delayed for several weeks because of cash-flow problems; -- The Finance Department Undersecretary with day- to-day responsibility for budget issues says the government is seeking to defer non-essential projects because of its fiscal overhang; -- Several senior UAE military personnel have told U.S. contractors that money is exceptionally tight right now and is expected to remain tight through FY 2004; -- The managing director of the Abu Dhabi Investment Authority (ADIA -- the repository of the bulk of the UAE's overseas governmental investments) told us that his organization has had to defer certain requests from the government for cash because of an unwillingness to sell off depressed equities. ¶4. (S/NF) ADIA and Abu Dhabi Finance Department officials note that managing the expectations of the leadership with regard to income and rates of return has been difficult -- particularly after the fantastic returns of the 1990s. The ADIA managing director commented that a real return of 5-6 percent would be outstanding in the current environment, vice returns in the 1990s of 15-20 percent per annum. One well-connected banker stated that while the UAE still has significant assets, the drop in portfolio value combined with the cash-flow crunch because of reduced returns has created a very real sense of anxiety on the part of the UAE leadership -- particularly Abu Dhabi Crown Prince Shaykh Khalifa bin Zayed, who controls the purse strings and who is in any case not particularly noted for his generosity. The UAEG, like most investors, is feeling the pinch, and with some observers predicting oil prices likely to drop sharply once Iraq's production is fully restored, the medium-term outlook for government finances here is decidedly bearish. WAHBA