Foreign Direct Investment In The United Arab Emirates Economics Essay

The purpose of this study is to examine and critically evaluate the economic environment for FDI (Foreign Direct Investment) in the United Arab Emirates. We elaborated this by examining the growth and direction of FDI in the UAE, by defining different forms of FDI’s and the industries and sectors that they have invested in the UAE. We also look into the theoretical implication and government policies and restrictions that apply towards FDI in UAE. Also furthermore we have analyzed and examined a successful FDI form; in our case this would be the vast investment made by SIEMENS in the UAE in various sectors, and discuss on benefits and issues faced by SIEMENS in the United Arab Emirates. This report not only reviews the latest developments in the institutional framework governing the activities of FDI enterprises, but also provides a general overview on the recent activities of SIEMENS in the UAE.

Introduction

Background

UAE

The UAE is a federation of seven emirates, each having its own ruler. The UAE constitution established a government which includes a President, Vice President, Council of Ministers, Supreme Council and a 40 member Federal National Council. The Supreme Council is the highest constitutional authority and is composed of the seven emirate rulers. The UAE is considered as one of the most open economies in the Middle East and a pioneer at being the first cosmopolitan hub for business in the Middle East. The current population of the UAE is at approximately 6.2 million residents, out of which only 15 to 20 percent are UAE citizens. According to a special report on Al Jazeera Network program – Middle East in Focus – over 90 percent of private sector output comes from non-UAE residents.

In 2005, foreign investment in the UAE was approximately $10 billion, accounting for nearly 40 percent of total foreign capital in the Arab world that year. Oil and natural gas production generated approximately 36 percent of the country’s GDP in 2005, in addition – the UAE controls almost 10 percent of the world’s oil reserves – most of the reserves are located in Abu Dhabi. (IMF Annual review, 2006).

FDI in Focus: SIEMENS

Siemens has a long-standing presence in the Lower Gulf region. It is currently represented by four regional companies that are based in United Arab Emirates (UAE), Bahrain, Qatar, and Oman. The company is also active in neighbouring Yemen, which completes the Lower Gulf territory. Although the company had a presence in the UAE for decades as a representative office; Siemens AG and a local partner established Siemens LLC in the late 1999 as a merger-acquisition.

Siemens has specialized in a wide array of industries and sectors in the UAE including:

Energy

Communications

Automation

Medical Solutions

Siemens is one of the largest employers in the region, their workforce consist 1,700 employees from 60 different countries across the globe and in the fiscal year 2008, the sales of all consolidated Siemens companies in the region amounted to EUR 1.714 billion (Siemens Corporate Website, accessed 2011). Siemens objective is to bring the world of innovation to the region (especially the UAE) in array of business areas and focused industries and would like to hold a position as an active partner in building infrastructure of the UAE.

Foreign Direct Investment in the UAE.

Before we discuss FDI in the UAE, I would like to define FDI. Foreign Direct Investment can be defined as the investment made by transnational corporations or multinational enterprises (MNE’s) in foreign countries in order to control assets and manage production activities in those countries (Padma Mallampally & Karl P. Sauvant, 2011). Many developed and developing countries promote FDI’s for the development and economic stability in the recipient countries – and so has the United Arab Emirates.

Economic Development in the UAE

A few decades ago the UAE was one of the least developed countries of the world. Today, it has achieved an GDP level comparable to that of the industrialized nations. Unlike most of the developed countries, UAE didn’t pass through the hypothetical development stages that most of them experienced. i.e. the United States of America, Canada, United Kingdom and even the likes of the aspiring developing countries such as India and China who have seemed to pass through certain development stages to get to the current position. Rather, UAE’s large oil revenues have allowed it to leap theses stages to the stage of a high end metropolitan, cosmopolitan oasis for global and local business hub. The massive oil revenue has given UAE the opportunity to avoid these stages and use the revenue acquired for aggressive economic development. Given this abundance of natural resources (oil & gas), UAE had embraced resource-based industries (RBI) as a development strategy; and in recent past years, UAE has embraced the approach on Foreign Direct Investments and Tourism, service industries and Business Hub of the Arab world to differ from RBI as a precautionary measure to reserve natural resources and to find alternative means for economic development.

Economic Environment for FDI in UAE

The United Arab Emirates (especially Dubai) in the past recent years became an access point for most investors due to its central location, relatively lenient business policies in some sectors and aspiring mass of foreign and regional businesses. It has effectively become the regional hub that MNE’s and local companies use to support operation to reach more than 1.7 billion consumers in the Middle East and North Africa (MENA) region including South Asian Countries. UAE has quickly affirmed to the fact that the advantages of foreign direct investment drives the country to reform, improve quality of life and brings prosperity. UAE has confirmed to the notion that attracting FDI is one of the cornerstones of the country’s economic development.

Perceived Benefits of FDI

Reasons for Investment in the United Arab Emirates

Few of the identifying reasons for investment in the UAE are:

Types of Investments in the UAE

Total foreign investment in the United Arab Emirates were amounted to US$ 18.7 billion in the year of 2006 and about US$ 16.86 billion in 2005 with a growth rate of about 11% (Source: IMF website, accessed 2011). With major economic activity in the service industry, transportation, energy sector, wholesale and retail trade and financial intermediation and insurance.

(Source: FDI Inflows to the UAE, Kamal El -Wassal, accessed 2011)

Although the UAE as whole has a considerable account of FDI Inflow and as well as an Outflow but the distribution of foreign investments are not equally situated in all of the emirates creating a form of FDI Inflow race or competition within the country. In the UAE, Dubai as an emirate remains the largest recipient of foreign direct investment by all measures currently (although the emirate of Abu Dhabi is showing a keen interest in attracting FDI inflows – especially by showcasing an important factor that it still holds the remaining 90% reserve of the whole country’s oil reserve; promising foreign investors a lucrative integer for its resources). Emirates such as Ras Al Kaimah and Sharjah have also shown a great amount of interest in attracting FDI by extensively improving the infrastructure by creating their own Free zones and airports and transportation network and by easing and modifying business policies and laws.

Laws and Policies

Even though the United Arab Emirates claims to have one of the most reliable and business friendly environment for foreign investors, there are certain restraints that represent a large barrier for investors to operate in the country. One of these barriers is the Companies Law and the Agencies Law – it represents the largest legal barriers to foreign direct investment in the UAE. The Companies Law states that foreigners and foreign companies are prohibited from owning more than 49 percent of a company established in the UAE (out of Free Zones). Another barrier is the Agencies Law which states that foreign importers must operate through an agent to import goods into the country, this agent must a company owned wholly by a UAE national or either simply a UAE national (without company).

These laws where apparently implemented to protect and ensure country’s economic growth that would benefit its small citizen base; encouraging citizens to join the workforce. Since most of the outcome in the private sectors comes from the country’s large population of non-residents, these laws were made to attract the UAE citizens to the private sectors besides the government sector. These efforts are sometime are referred as the Emiratisation process or policy. In my opinion this effort would reflect constant tension between UAE’s claims of maintaining openness to the world and at the same time avoiding the social and political strife that can complement efforts to modernize.

Restrictions to Foreign Investment

Aside from the country’s claim of an open concept and the apparent freedom for Foreign Investors to apply and implement business focus in all of the business sectors the UAE has to offer (i.e. Agriculture sector, Service Sector, Industrial Sector and even Government Sector) there are laws that restrict and forces FDI’s to restraint either not entirely but partially to enter certain market for their (FDI’s) benefit. One of these laws for example is the Government Tenders Law and the Federal Industry Law which restrict foreign investment in the UAE. For example the Government Tender law states that suppliers and contractors to the government must be UAE citizens or either companies that are fully owned by UAE citizens or at least have a 51 percent ownership share by a citizen. In addition to this each emirate has its own rule on obtaining government contracts. In the case of industrial projects or procurement in energy sectors for example – the Federal Industry Law states that all industrial projects or energy sector projects must have a ownership percentage of 51 percent owned by a UAE national and that the project should be managed by a person who is a citizen or have a majority of UAE citizens as board of directors in the company.

Other detracting factors also include in restriction of the limitation of foreign ownership of land (outside of free zone) which have varying rules from emirate to emirate. Other limitation factor is the sector by sector limits on foreign ownership. Sectors including insurance, telecommunication and travel agencies are still mostly closed to foreigners. And as for the UAE’s oil and natural gas sectors foreign investment is limited to 40 percent and the remaining 60 percent is owned by the Emirates government control.

Quick Fact: Telecommunication Monopoly

Exceptions to UAE’s FDI restrictions

To safeguard the Emiratisation policy and at the same time to promote FDI inflow to the country, UAE had created certain exceptions to the Agencies Law and the Companies Law by the introduction of free trade zones throughout the country, currently there are 33 free trade zones (FTZ) throughout the country. These free zones are basically special administrative areas which are governed by the respective individual emirates and country specific exemptions. And some have even introduced clustered design for easy access to business and customers alike. (for example Dubai Media City for media related business market, Dubai Internet City for the information technology related market and Knowledge village for academic & vocational market).

These free zones are not subject to any federal law except criminal and are also exempt from the Agencies, Companies, Government Tenders, and Industry Laws. Free Zones provide foreign companies to own 100 percent of the enterprise and provide lower labour and tax requirements making them an attractive location for foreign companies to invest, but if any companies in these free zones attempt to invest in non-free zone area (local market) they would be subjected to the UAE’s traditional foreign investment laws and regulations that I previously discussed. Due to these laws in my perspective have created two different economies in the UAE market (a local market economy and one strictly a Free Zone market economy that utilizes UAE’s geographical position as a means to supply and distribute to other markets in neighbouring countries and emerging markets to the east).

We also need to keep in mind that many of these barriers associated with FDI’s are not applied to the GCC countries (such as Qatar, Kuwait, Saudi Arabia, Oman and Bahrain). The result being that the UAE has three levels of access for investors, where UAE citizens receives most investment access, GCC countries receive the second most highest level of access and the non GCC foreign countries receive the least accessible opportunity to invest in the UAE.

Business Sectors available for FDI and Practices

Although the UAE does not have any formal design or structure of where and where it cannot accommodate foreign investment in a particular business sector or market, foreign investors are informally notified of key factors and issues associated with attempted investments. For example some sectors, like the military production is associated to national sovereignty and a case of national security which contain sensitive technology that essential to the national security – hence are clearly off limits to foreign investors. Additionally other sectors like natural gas and oil also contain sensitivity to national sovereignty but still allow a limited profile of foreign investors to this sector (mostly from countries the UAE has exceptional ties for a long period of time such as the United States).

Foreign companies are also expected to understand this practice and if the companies are persistent to invest in an area that the UAE deemed as unapproachable, the investors will be privately redirected. This practice is an informal approach for variety of reasons; since the UAE wants to create a reputation of having an open business environment it does not want to publicly disclose that the given sector is closed to an investor to avoid discrimination. Another reason being, since business deals in the UAE are based own personal relationship, the government generally believes it’s better to handle rejection discreetly. Furthermore UAE and individual emirates try to direct foreign investment where they see the need of development.

National Security Concerns

Part of these informal restrictions that the country pertains on foreign investors is because the UAE has several national security concerns; while not publicly stated – the government considers these national security concerns when assessing foreign investments. For example, UAE stance on oil and natural gas production and water and power generation production systems are high priority concern and an issue that is not taken lightly, mainly because these industries represent the major portion of the country’s GDP portfolio. So as a consequence the government strictly controls investment in these areas and selectively acquire investors from countries it has a more relaxed or mutual beneficial ties (such as US, UK and Germany). Another concern for the UAE is the labour market since the vast majority of the private sector markets are expatriates.

Recent Developments

In the recent years, mainly after the global financial crisis – UAE officials are in the process of amending and relaxing its investment laws, mainly because the current laws that persist are incongruent to UAE’s efforts to grow its diminishing foreign investors who closed businesses due to the global credit crunch. However this will be a difficult task, mainly because for the past few decades the UAE nationals have enjoyed the benefits from the laws that currently exist and have created interest group within the nationals of the country that depend solely on these benefits. Allowing 100 percent ownership to foreign investors outside the Free Zones – the idea itself is entrenched with oppositions from the local business community; especially those with agency agreements making any changes in mind to amend policies further a slow process. Currently the government is trying to amend the current laws to benefit foreign companies by providing limited freedom, for example the ability for investors to dissolve contract with a nonperforming agent (although the legal recourse and process of dissolving such contracts is a lengthy process which discourages the idea as whole making it extremely difficult for foreign companies to consider).

However there is a probability for UAE officials to implement a much lenient amendment in the Companies Law and the Agencies Law to encourage foreign investments and eventually dissolve the Laws as whole in near future; by gradually increasing the current 49 percent cap on foreign ownership from 60 to 70 percent and later 100 percent down the road; but given the circumstances the liberalization will probably be opposed initially and if it happens it will gradually start on sector to sector basis.

SIEMENS as an FDI in the UAE

Siemens success in the UAE

The key to Siemens success in the lower gulf region (the GCC countries) is to their ability to be proactive rather than being reactive. Unlike other foreign companies who entered the Gulf States and Kingdoms only after the discovery of oil; Siemens was one of those key pioneer companies who entered the Gulf Region decades before the discovery of oil and natural gas to find the current need and accommodate and dominate a market of the rural Sheikdoms of that time (where in case other corporations at the time found the market as “unwanted”). Siemens quickly developed good relationship with the governing bodies of that time (mainly nomad tribes and Sheikdoms) by accommodating their basic needs of water supply and effective irrigation development in the late 1800’s and early 1900’s. Once oil was discovered and foreign entities developed to show some interest, Siemens had already won the hearts and minds of the Arab world and had gradually started expanding their projects in the region; eventually making Siemens a trusted “ally” of these “new” developing countries (especially the UAE).

Siemens: Understanding the client’s needs and requirements

Once the UAE started growing and expanding its economic development strategy by inviting foreign investors to its market and upgrading its infrastructure. Siemens had already acquired the required amount of trust and with the company’s good relationship with the ruling party undertook high value projects in sectors that were of high in value and priority to the ruling government. It achieved this by maintaining good relationship with ruling family and by abiding with all the regulations and laws the country had imposed on foreign companies. Siemens AG formed a merge-acquisition with the ruling family and developed Siemens LLC in 1999 (it took them a while to do this because initially Siemens was also sceptical on the policy of 49 percent cap of foreign ownership, but later came in terms to avoid losing position in a very lucrative developing market).

Now Siemens is a market leader in

Industry Sector (note: as previously discussed this sector is a national security concern to the UAE)

Energy Sector (National security concern for the UAE)

Healthcare Sector

Cross-Sector Business

Strategic Equity Investments

Transportation and Infrastructure

Siemens LLC acquired all these sectors and became a market leader by truly agreeing with the laws and regulations of the country. It also achieved sectors that were of a national concern to the UAE by placing its partner (the ruling family) as Board of Directors members. Currently Siemens is a dominant figure in both economies of the UAE (the local economy as well as the Free Zone economy). Siemens also took in consideration that if they want to be dominant figure in the neighbouring Lower Gulf countries they need to apply the same strategy which they applied in the UAE and go by the rules and laws of the country since they already have an upper hand by establishing the name of the brand in the Arab world by keeping personal relations in good standing with ruling Sheikdoms of the GCC and their long history together with each other as the driving force to acquire business. (The Arab culture has a strong sense of building and doing business based on personal relationships).

Conclusion

In conclusion the United Arab Emirates, even after all its barriers, regulations and laws is still a lucrative market, mainly because of its resources (oil and natural gas), secondly because of its geographical location as a business Hub that has become a focal point of connecting the East with the West. Even after the world global financial crisis IMF studies indicates that the Middle East and namely the United Arab Emirates would be one of the first countries to catapult if self from this crisis – this “push” it self brings foreign investors towards the UAE and also overlook the restrictions and barriers facing them for the time being. But if UAE doesn’t change its policies soon enough, chances are that the FDI’s that are an important source of development for the UAE can easily go towards its neighbouring country Qatar for they (Qatar) is offering them a much better bargain for their investment.