UAE Chemical Report

United Arab Emirates

©

United Arab Emirates
Chemicals
Report Q2 2006
Including 4-year industry forecasts by BMI

Part of BMI's Industry Survey & Forecasts Series

Published by: Business Monitor International

Publication Date: May 2006

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United Arab Emirates Chemicals Report Q2 2006

© Business Monitor International Ltd Page 2


Contents

Executive Summary .........................................................................................................................................5
Market Overview ................................................................................................................................................................................................... 5
Industry Developments .......................................................................................................................................................................................... 5
Regulatory Developments ...................................................................................................................................................................................... 5
UAE’s Plastics Sector............................................................................................................................................................................................ 5
UAE Chemicals Industry SWOT ............................................................................................................................................................................ 6
UAE Economic SWOT ........................................................................................................................................................................................... 7
UAE Business Environment SWOT ........................................................................................................................................................................ 8

Market Overview...............................................................................................................................................9
Table: Investment in UAE Chemicals Industry (US$mn) ....................................................................................................................................... 9
Table: Fertiliser Production Plants in UAE ........................................................................................................................................................ 10

Industry Forecast Scenario ...........................................................................................................................11
Table: Urea Capacity in Arab/Persian Gulf Region (in thousand tonnes)........................................................................................................... 12
Plastics Industry .................................................................................................................................................................................................. 12
Table: UAE Polymers Capacity (000 tonnes annual average)............................................................................................................................. 13
Plastic Imports, Exports And Re-exports ............................................................................................................................................................. 13
Plastics Growth And Outlook .............................................................................................................................................................................. 13

Industry Trends And Developments ............................................................................................................15
Business Environment.......................................................................................................................................................................................... 15
Regulatory Developments .................................................................................................................................................................................... 15
Industry Developments ........................................................................................................................................................................................ 16

Macroeconomic Forecast ..............................................................................................................................19
Success Confirmed............................................................................................................................................................................................... 19
Doors Still Open For Expat Workers................................................................................................................................................................... 19
Hydrocarbons: Going For Growth ...................................................................................................................................................................... 20
Table: Macroeconomic Data & Forecasts........................................................................................................................................................... 21

Company Monitor...........................................................................................................................................22
Ruwais Fertiliser Industries................................................................................................................................................................................. 22
Abu Dhabi Polymers Company (Borouge)........................................................................................................................................................... 24

BMI Forecast Modelling .................................................................................................................................25
How we generate our industry forecasts................................................................................................................................................................... 25
Chemicals Industry ................................................................................................................................................................................................... 26
Cross checks ............................................................................................................................................................................................................. 27

Appendix A: Global Economic Assumptions..............................................................................................28
Introduction ......................................................................................................................................................................................................... 28
The World Economy ............................................................................................................................................................................................ 28
Global Assumptions ............................................................................................................................................................................................. 29
United States............................................................................................................................................................................................................. 30
Eurozone................................................................................................................................................................................................................... 31
Japan ........................................................................................................................................................................................................................ 32



China ........................................................................................................................................................................................................................ 33
Commodities ............................................................................................................................................................................................................. 34



Executive Summary
Market Overview

The United Arab Emirates (UAE) chemicals industry comprises chemicals, plastics and fertilisers. The
industry has seen rapid growth, especially on account of growth in the region’s construction industry,
which has been driving demand. Chemical fertiliser production began in the UAE with the establishment
of Ruwais Fertiliser Industries (Fertil). The complex, situated in the industrial zone at Ruwais in
western Abu Dhabi, comprises an integrated production unit, storage, packing and cargo units.

Industry Developments

Fertil outlined plans to expand its urea production in association with France-based Total. Total is
carrying out a detailed feasibility study for Fertil, which envisages additional urea production of 1.2mn
tonnes per annum (tpa). As reported in April 2006, UAE-based Abu Dhabi National Oil Company
(ADNOC) signed an agreement with Austria’s Agrolinz Melamine International (AMI) for the
construction of a new melamine plant in Ruwais. UAE-based Gulf Energy Maritime (GEM) inked a
US$90mn loan deal with UAE-based First Gulf Bank for purchase of high-specification, double-hulled
product/chemical tankers being built at the Hyundai Mipo Dockyard.

Regulatory Developments

Abu Dhabi Environmental Research and Wildlife Development Agency, along with the Federal
Environmental Agency and other concerned authorities, has laid down rules to prevent chemicals from
arriving in the country without a proper licence, and against the dumping of hazardous materials. It will
also now be mandatory for UAE-based chemical dealers to register with and report their activities to the
government.

UAE’s Plastics Sector

The Middle East is witnessing an expansion, both in production capacities as well as in consumption
levels of rubber, plastics and processed plastic products. In 2004, the plastic industry in the UAE had a
production capacity of 150,000 tonnes and employed more than 13,000 people. Over January-August
2005, the UAE imported about US$240.59mn worth of plastics and rubber products from China.



UAE Chemicals Industry SWOT

Strengths Strategic location provides access to new and emerging Asian markets,
such as India and China
Availability of high-quality raw material helps in the production of basic
chemicals

Weaknesses Logistics comprises one of the largest costs to the industry, with the
average cost from plant to customer being 12% of the sales price
An extreme climate and a highly saline Arabian Gulf lead to high
investments to offset the corrosion caused in the oil, gas, process and
construction sectors

Opportunities Value of the cosmetics market in Dubai is over AED2bn (US$544.5mn) per
annum and is expected to grow further due to rising demand
Increasing international urea prices are encouraging UAE to build new,
world-scale plants

Threats Increases in oil and gas prices have affected stability in the chemicals
industry and could lead to pressure on margins
Increasing competition from Russian industrial chemical industry



UAE Economic SWOT

Strengths The UAE is a member of the Gulf Cooperation Council (GCC), which is a
free trade zone, and is targeting a common currency by 2010
The UAE has one of the most liberal trade regimes in the region, and
attracts strong capital inflows from across the globe
In common with most Gulf states, there are a high number of expatriate
workers at all levels of the economy
The UAE has successfully diversified its economy, minimising its
vulnerability to oil price movements
The International Monetary Fund (IMF) ranked the UAE economy as the
third largest in the Middle East and Central Asian region, after Saudi Arabia
and Iran

Weaknesses The UAE’s main trading partners are other Gulf states, which increases the
vulnerability of the non-oil sectors to oil price volatility
The state’s location in a volatile region means that its risk profile is, to some
extent, affected by events elsewhere; US concerns about Iranian Weapons
of Mass Destruction (WMD) and Islamic terrorism could affect investor
perceptions

Opportunities Oil prices are expected to stay high over the forecast period; economic
diversification into gas, tourism, financial services and high-tech industry
offers some protection against volatile oil prices
Driven by domestic and foreign investment, the construction, tourism and
financial sectors are growing rapidly

Threats Heavy subsidies on utilities and agriculture, along with an outdated tax
system, contribute to persistent fiscal deficits
There are fears that bubbles could be forming in the construction sector, and
also in the stock market



UAE Business Environment SWOT

Strengths The UAE, besides being a member of the GCC, a six-member free trade
zone, has also been a member of the World Trade Organisation (WTO)
since 1996
The State has invested large amounts in infrastructure
The UAE’s diversified economy reduces risks

Weaknesses Due to the state’s federal nature, regulations are not identical across the
Emirates
The regional economy is oil-dependent; this has historically been very
cyclical which increases risks for long-term projects

Opportunities Large number of free trade zones offering tax holidays and full foreign
ownership
Comparatively relaxed rules on expatriate employment
The UAE’s social stability and relative prosperity mean that there is far less
concern for security than in some other Gulf states

Threats The State is comparatively bureaucratic compared to its regional peers;
strong oil prices have massively increased liquidity in the region and this has
resulted in strong financial flows – increasing risks that projects of lower
investment potential are currently being funded



Market Overview

The UAE chemicals industry comprises chemicals, petrochemicals, fertilisers, plastics and
pharmaceuticals segments. The chemicals industry in the UAE has seen rapid growth in the past few
years, especially on account of growth in the region’s construction industry, which has been driving
demand. Investment in the region's US$33bn petrochemical and chemical sectors is growing at 10-15%
annually. Main domestic chemicals suppliers/producers in the UAE are: Al Futaisi Group, Emirates
National Chemicals, Falcon Chemicals, Geco Chemical, Golden Emirates Industrial Services &
Trade, Oasis Chemicals, Kanoo Group, Lootah General Trading, M.H. Enterprises, House of
Chemicals, Nav Sachi International, Petrochem Middle East, Al Khowahir Chemicals Trading and
Fujairah Polymer.

Registered chemical manufacturing enterprises in the UAE totalled 589 by the end of 2005, which adds
up to 17% of the overall industrial enterprises in the UAE. The number of chemical facilities in operation
in 2004 was about 542.

Table: Investment in UAE Chemicals Industry (US$mn)

2000 2001 2002 2003

Manufacture of Chemicals & Chemicals
Products 374 1276 1315 1401

Manufacture of Rubber and Plastic
Products 314 351 379 421

Source: Ministry of Finance, UAE

Abu Dhabi Fertiliser Industries’ AED5mn (US$1.36mn) chemicals fertiliser plant, having an annual
capacity of 200,000 tonnes, was built as a joint venture in June 1998 between the UAE-based
International Technical Trading Company (64% stake) and SQM of Chile (36% stake). The plant
produces 40,000tpa of fertiliser, mainly water soluble and granular compound products. The company has
a capacity of 200,000tpa and also produces liquid and suspension fertilisers.



Table: Fertiliser Production Plants in UAE

Company Name Products Capacity (tpa)

Ruwais Fertilizer
Industries Ammonia

Urea Ammonia- 1,340

Urea-1,850

Union Kemira Water soluble compounds 20,000



Industry Forecast Scenario

In 1985, the chemicals sector in the UAE started with a small acetylene and calcium carbide plant at Jebel
Ali Free Zone Authority (JAFZA). Since then, Jebel Ali Free Zone (JAFZ) has become the centre for
UAE’s chemicals and petrochemicals industries. Today, plants in this free zone also produce polymer
resins, liquid industrial chemicals and polystyrene. The first phase of a liquid industrial chemicals storage
facility was completed in the second-half of 1995 by All Industrial Chemicals Group of Canada.

UAE: Urea Exports by
Destination 2003 (in 000
120
95.9 tonnes)
100
80
60
34.3 33.4 31.7
40 26.8 27.3 24.1
20
0
Sri Lanka
Vietnam

Others

Africa
India
USA

Iran

Source: BMI research

Chemicals fertiliser production began in the UAE with the establishment of Fertil. The complex, situated
in the industrial zone at Ruwais in western Abu Dhabi, comprises an integrated production unit, storage,
packing and cargo units.

There are many fertiliser manufacturing projects located in JAFZA. Dubai’s first fertiliser plant has been
onstream since 1990, and produces 6,000tpa of water-soluble compound fertilisers. It was built by Union
Kemira, a joint venture of the UAE’s Union Agricultural and the Finnish chemicals and fertiliser group
Kemira.



Table: Urea Capacity in Arab/Persian Gulf Region (in thousand tonnes)

Country 2000 2001 2002 2003 2004 2005e 2006f 2007f 2008f 2009f

UAE 227 227 227 227 227 227 410 410 410 410

Bahrain 258 258 258 258 258 258 258 258 258 258

Iran 812 812 812 812 812 1,350 1,350 1,350 1,350 1,350

Iraq 718 718 718 718 718 718 718 718 718 718

Kuwait 364 385 466 486 486 486 486 486 486 486

Oman - - - - - 380 1,294 1,294 1,294 1,294

Qatar 642 642 642 642 1,135 1,135 1,135 1,135 1,135 1,135

Saudi Arabia 1,203 1,203 1,203 1,203 1,203 1,203 1,749 1,749 1,749 1,749

Total 4,224 4,245 4,326 4,326 4,839 5,757 7,400 7,400 7,400 7,400

Source: IFA Survey of Urea Capacities and BMI Research

Plastics Industry

The Middle East is witnessing an expansion, both in production capacities as well as in consumption
levels of rubber, plastics and plastic processing. Substantial growth in the UAE's construction industry is
driving the demand for plastic products, especially pipes and fittings, which in turn, is driving the growth
of the plastics industry. The population growth has considerably increased the demand for houseware,
industrial and commercial containers made of plastics. Along with this, other industries, including
refrigeration, furniture and pharmaceutical industries, have also increased the use of various plastic
products as substitutes for metallic products.

The expansion of the non-oil economy has also increased the demand for plastic products. This has also
led to a growth in plastic production, which over time has reduced dependence on imports. The industry
expanded rapidly in the 1990s and continues to grow, slowly making inroads into the export sector,
particularly in the packaging segment.



Table: UAE Polymers Capacity (000 tonnes annual average)

Additional Capacity (up to
2003 2004 2009)

HDPE 225 265 545

LLDPE 220 220 530

Ethylene 600 600 1050

Source: CIMA

Plastic Imports, Exports And Re-exports

Imported plastic products meet less than half of the demand for plastic products in the UAE. Imports of
pipes, tubes and related accessories for the construction industry are in particularly small quantities.
Meanwhile, imports of bags, sacks and films have also declined due to steadily increasing domestic
production. Import dependence is highest in the case of bottles, containers and miscellaneous products
such as toys and household goods. Demand volumes for such items are too small in the UAE to justify
domestic production. Over January-August 2005, the UAE imported about US$240.59mn worth of
plastics and rubber products from China.

While production is mostly for the domestic market, the UAE’s plastic industry also exports a significant
portion of its output, focusing on the Middle East region. Packaging products such as bags and containers
occupy a major portion of the plastic export basket. The UAE has also started manufacturing and
exporting some high-quality retail shopping bags, produced and printed locally, for the European markets.

There is a successful re-export trade in plastic products, and about 25% of the imports are re-exported.
The re-exports are spread over all categories; except for fibreglass products which have negligible re-
export value. Re-export is mainly concentrated on consumer plastic goods which are used in households,
such as bottles and containers. Meanwhile, virtually the entire imports of plastic bags and sacks (90%) are
meant for re-export.

Plastics Growth And Outlook

First initiated by the plastic building materials segment, growth in manufacturing is now led by the
packaging segment. Production and exports in the plastic industry have outpaced domestic demand as the



industry has grown on the strength of import substitution. Growth in the plastic industry has been led by
packaging related products, along with a noticeable decline in the net imports of plastic products and
materials.

The nation has a considerable potential for growth in the plastic industry due to the abundant availability
of feedstock. Development of a domestic petrochemicals industry is now gathering pace, which could
considerably enhance the growth of small and medium plastics enterprises.

A major growth opportunity for the plastic industry is expected to flow in from the export market. Large
volume plastic products, such as plastic pipes used in construction, are unlikely to grow beyond domestic
demand. However, packing products such as plasma bags, sheets, covers and strips have considerable
potential for being exported to several major world markets.



Industry Trends And Developments
Business Environment

Before 1984, the Emirates of Dubai, Abu Dhabi, Sharjah, Ajman, Ras Al Khaimah, Umm Al Quwain and
Fujairah followed their own individual procedures governing the operations of foreign business interests.
In 1984, the ‘Commercial Companies Law’ and its by-laws were issued. The law made it conditional that
nationals must wholly own the companies or that nationals must own at least 51% of the share capital,
while the remaining 49% may belong to foreigners. The government of UAE plays a supervisory role in
legislation and organises the functioning of the various economic sectors.

The first free-zone area, Jebel Ali in Dubai, was established in 1985. The success of this free zone led to
the development of ‘Free Zones’ in other Emirates. There are now more than 10 free zones in the UAE,
each governed by its own regulatory authority.

The UAE follows a liberal immigration policy reflecting the need for an expatriate workforce to operate
and develop a fast-growing economy. The majority of the resident UAE population is expatriate, and in
general, employers, particularly those located in a free zone, have minimal difficulty in sourcing labour
from the resident population.

Regulatory Developments

Abu Dhabi Environmental Research and Wildlife Development Agency, along with the Federal
Environmental Agency and other concerned authorities, has laid down rules to prevent chemicals from
arriving in the country without a proper licence, and against dumping of hazardous materials. The UAE
authorities have also decided to make it mandatory for UAE-based chemicals dealers to register and
report their activities to the government.

From 2005 onwards, under the provisions of the Trade Related Intellectual Property Rights (TRIPS)
agreement, the UAE is required to grant patent protection for agricultural chemicals and pharmaceutical
products.

The Abu Dhabi Industrial City (ADIC) was built by the UAE government to streamline industrial
development and to provide the necessary infrastructure. It covers an area of about 14km2 and is about
30km outside Abu Dhabi city. It has been designed to feature different types of industrial activities,
including food processing, textiles, wood furniture, engineering, plastics, chemicals and building
materials.



In March 2005, UAE and Australia concluded the first round of the free trade negotiations that are
expected to culminate in a free trade agreement (FTA) by the year 2006. In May 2005, it was reported
that UAE was also expected to sign a FTA with Singapore. An economic pact was inked between the two
nations earlier in 2005. The UAE was expected to offer investment opportunities for Singaporean
companies in JAFZA in various industries such as oil and gas, petrochemicals and construction.

In February 2005, JAFZA moved into the next level of diversification with the launch of South Zone, a
project for developing specific industry sectors through eight different clusters at an estimated cost of
about AED2bn (US$0.54bn). Facilities at this field are to include hazardous and non-hazardous waste
disposal and special water treatment covering 1mn m2.

Industry Developments

In April 2006, Fertil outlined plans to expand its urea production in association with Total. Total is
carrying out a detailed feasibility study for Fertil’s planned additional urea production of 1.2mn tpa. A
granulation plant is also to be built to supply the UAE market with granulated urea. Currently, Fertil has a
production capacity of 625,000tpa of urea and 450,000tpa of ammonia. The granulation plant is to be
completed by Q408 and the additional urea production of about 1.2mntpa is to come onstream in mid-
2010.

As reported in April 2006, GEM signed a US$90mn loan agreement with First Gulf Bank for high-
specification, double-hulled product/chemical tankers, being built at the Hyundai Mipo Dockyard. The
four 47,000 tonne double-hulled oil product and chemical tankers are likely to be delivered in 2008-2009.

On March 1 2006, the Gulf Petrochemicals and Chemicals Association (GPCA), a voluntary, Dubai-
based non-profit organisation, was launched. The association aims to encourage fair and free trade and
competition. GPCA is to primarily focus on plastics and intends to promote plastic products by
supporting industry innovations. Eight petrochemical makers, including Saudi Basic Industries
Corporation (Sabic), UAE-based Abu Dhabi Polymers Company (Borouge), Kuwait-based Equate,
Bahrain-based Gulf Petrochemical Industries, Kuwait’s Petrochemical Industries, Qatar
Petrochemical, Qatar Vinyls and Saudi Arabia’s National Industrialization Company (Tasnee) signed
a memorandum of understanding (MoU) at the launch of the association.

In February 2006, Chemstore FZCO, a joint venture between UAE-based Modern Freight Company
(MFC) and Horizon Terminals Limited (HTL), a wholly-owned subsidiary of Emirates National Oil
Company (ENOC), opened phase III of its JAFZ facility. Chemstore is a centre for hazardous chemicals,
with 8,000m2 of storage space, capacity for 36,000 drums, and with loading bays capable of handling up
to 30 trucks at any one time. Chemstore also accommodates various hazardous chemicals, drummed or



bagged and palletised or non-palletised, falling under the National Fire Protection Association (NFPA) 30
classifications IB, IC, II, IIIA and IIIB.

In January 2006, US-based Foster Wheeler signed a management services contract with Abu Dhabi Gas
Industries (Gasco) for the engineering, procurement and construction (EPC) phase of its Habshan Gas
Complex Expansion Project in Habshan, UAE. Foster Wheeler has completed front-end engineering
design and ECP contractor selection.

India-based JBF Industries outlined plans to build a US$84mn polyester polyethylene terephthalate
(PET) resin packaging chips plant in the UAE in a joint venture with UAE’s Ras Al Khaimah
Investment Authority, as reported in January 2006. The plans include the establishment of a complex
with a total installed polymerisation production capacity of 900tpa. The output will consist of 600tpa
single-stream processor (SSP) chips and 300tpa of polyester film. The produced material is to cater to the
large markets of the US, the EU and China.

As reported in December 2005, Emirates Float Glass (EFG), founded by Dubai Investments, signed
licence and construction agreements to establish a 600 tonne per day (tpd) float glass plant in the UAE.
US-based PPG Industries is expected to provide EFG with the technology services, process assessment
and product licensing rights. The float glass facility is likely to begin production in 2007.

Fertil outlined plans to double production at its existing urea plant. The expansion is expected to increase
the capacity to 2,700tpd from 1,500tpd. Of the total output, 800tpd is to be supplied to the Abu Dhabi
National Oil melamine plant, while 1,900tpd of granular urea is likely to be produced. The front end
engineering and design is likely to be completed by April 2006, while the EPC contract is expected to be
awarded by Q306. Project completion is scheduled by the end of 2008. However, the investment outlay
was not disclosed. Further, Fertil also plans to establish new ammonia and urea plants that are likely to be
operational by the beginning of 2009.

As reported in April 2006, ADNOC signed an agreement with Austria’s AMI for the construction of a
new melamine plant in Ruwais. The plant is to produce 80,000tpa of the petrochemical, which is to be
used to produce surface laminates and adhesives as well as other industrial and commercial products. The
project is likely to cost US$200mn and to be operational in Q109.

In October 2005, Ras Al Khaimah Ceramics reportedly formed a joint venture with Italy-based Smal
Tu Chemica. The joint venture, Chemica, is expected to be engaged in production, marketing and
distribution of chemicals used in ceramic production. Ras Al Khaimah Ceramics holds 55% of the joint
venture, with Smal Tu Chemica holding the balance.



Also in October 2005, Desmet Ballestra reported the installation of the first MiniLAB plant based on
UOP detal linear alkyl benzene (LAB) alkylation technology. The plant has reportedly started
commercial operations. The plant has been supplied by Desmet Ballestra to Emalab and has been
installed in JAFZ. It forms a part of the UOP and Desmet Ballestra’s joint development, focused on
making the installation of medium capacity LAB plants economically viable by serving regional markets
having insufficient LAB production.

In September 2005, US-based Nalco outlined plans to establish a US$2.5bn worth smelter at Abu Dhabi,
UAE. Earlier, in August 2005, it had outlined plans to build a 250,000-300,000tpa aluminium smelter in a
Gulf country by 2009-2010.

In September 2005, India-based Karnataka Agro Chemicals, a leading Indian organic fertiliser
manufacturer, outlined plans to expand operations in markets outside India. The plans include
establishment of a bio-fertiliser manufacturing plant in Dubai through a joint venture with the
Government of Dubai. The plant is expected to produce organic manure based on coir pith and is likely to
start operations in 2006. The Dubai government is expected to provide financial assistance to the project,
while Karnataka Agro Chemicals is likely to provide the ‘know-how’.

In September 2005, Oman Chemicals and Pharmaceuticals (OCP) outlined plans to establish a
US$200mn ammonia plant in the Hamriyah Free Zone Authority in Sharjah. The plant is expected to have
an annual production capacity of 400,000 tonnes and is likely to start operations by April 2007. OCP has
reportedly entered into a 25-year agreement with UAE-based Crescent Petroleum for the supply of
natural gas. It is likely to be charged US$1.50 per million British thermal units (btu) for the supply of
natural gas and is expected to export about 75% of the output. The plant is also expected to start
production of urea and other products including nitric acid, ammonium nitrate and ammonium phosphate
in 2008.

Also in September 2005, Dubai Aluminium (Dubal) and Indian engineering and construction major,
Larsen & Toubro (L&T) reportedly entered into a US$3.6bn joint venture deal for a two-phased bauxite
mining and alumina refinery project and smelter in Orissa, India. The agreement is being considered as
UAE’s largest foreign direct investment (FDI) in the industrial sector in India. The first phase is expected
to include a capacity of 1.5mn tonnes and is likely to cost US$1.1bn. The construction is expected to start
in 2007. The Gulf has been a major market for L&T’s engineering and construction expertise and has
been granted various orders for projects in the UAE.

In August 2005, Fertil reportedly granted a US$3mn project management contract to Australia-based
Worley Parsons. The contract includes a project to debottleneck Fertil’s 690,000tpa urea unit by
90,000tpa and to revamp its 350tpd carbon dioxide recovery unit in Abu Dhabi. Both the projects are
expected to be complete by the end of 2008.



Macroeconomic Forecast
Success Confirmed

Recent reports by the UAE Central Bank and the International Monetary Fund (IMF) confirm the strong
economic performance seen in the past year, and generally point towards a healthy future. Importantly,
attempts to diversify the economy are paying off and growth in the non-oil sector is looking good.
Meanwhile, ambitious plans have been unveiled boost oil output.

Though the weak dollar has taken some of the shine off the UAE’s economic performance, particularly in
the oil sector (the currency in which oil barrels are denominated), the depreciation of the dirham in real
terms is proving a boon for the other export-oriented sectors of the economy. The liberalisation of the
property market will also boost growth, by attracting FDI that will help to sustain the construction boom.
We estimate that GDP growth was 6.2% in 2005, and will be 4.3% this year, with an upside given the
evidence of the non-hydrocarbons sector’s robust performance.

Our GDP forecast assumes 5.5% non-oil growth in 2005, but risks are weighted to the upside owing to
the strong performance of manufacturing exports. The construction boom is also boosting non-oil growth,
and is likely to continue given the recent changes to property ownership laws. With no sign of a
slowdown to the construction boom, the non-oil sector’s growth is likely to match the prodigious
hydrocarbons sector this year, particularly if heightened flows of FDI can be maintained. Meanwhile, the
impressive export and re-export performance will be buttressed by continued strength of demand in
UAE’s main export markets.

Doors Still Open For Expat Workers

The rising UAE national unemployment rate has precipitated measures that have raised the costs
associated with hiring expatriate workers – whose value to the UAE’s economic competitiveness is
widely acknowledged. However, in a positive move, the UAE, unlike some other Gulf states, has avoided
the imposition of employment quotas. The authorities are as aware as anyone that the ‘open doors’ policy
is a critical component of the UAE’s competitive advantage.

In order to address the unemployment issue, the federal government has instituted a number of training
and job placement programmes targeted at the private sector – but these are unlikely to impose a
significant burden on businesses.

While the government has hiked up public sector wages for UAE nationals in recent months, the UAE’s
open-border foreign labour policy should continue to allow the private sector to recruit expatriate workers



at relatively low wages. Future reforms should aim at equalising benefits for nationals in the private and
public sectors.

Hydrocarbons: Going For Growth

With global oil markets unsated by recent OPEC quota increases, the UAE is moving ahead with plans to
raise crude production levels. Oil Minister Mohamed Dhaen al-Hamli told the September OPEC meeting
in Vienna that crude production would increase by 8% by Q106, to 2.7mn b/d. The 200,000b/d increase
would come in two increments – a 100,000b/d jump in Q405 and another hike in the succeeding quarter.
This will help to maintain the UAE’s spare capacity buffer, which stands at around 250,000b/d – one of
the highest in the cartel.

The increases will be sourced from production boosts at onshore fields. ADNOC says the development of
the New Dhabiya field will account for 100,000b/d of the planned increase, with 90,000 extra barrels
resulting from ongoing upgrades at the mature Bab field. Flushed with new investment funding as a result
of the rocketing oil revenues, which BMI expects to exceed US$40bn in 2005, ADNOC is in an
expansive mood. It is planning to increase output capacity from onshore fields to 1.8mn b/d, as part of an
effort to step up long-term production capacity to 3.5mn b/d. Offshore expansion plans envisage boosts to
the Umm Shaif and Lower Zakum fields by 130,000 b/d to a total of 600,000 b/d by end-2008. Another
200,000 b/d of increased production will come as a result of the increase in capacity at the Upper Zakum
field, which is jointly operated with US supermajor Exxon Mobil, taking production there to 750,000b/d.

ADNOC is spending more than US$2bn in order to maintain or increase production levels. A number of
projects to upgrade oilfield infrastructure are underway. Increases in the capacity of the onshore Bu Hasa
field will involve the construction of gas separation units, drilling of gas reinjection wells, and water
injection. One of the major focuses is to deal with a rising water cut in the oilfields, along with the
increased demand for gas reinjection. Many new projects aim at reinjecting gas and water into the
reservoir in an effort to maintain production.

The positive side-effect for the UAE is that these efforts will also help to boost production of gas, whether
in condensate or natural gas liquid form. There is a growing gas focus in the UAE, which is attempting to
make money from reserves estimated at 212 trillion cubic feet (tcf) – the world’s fifth largest. The
ongoing onshore gas development (OGD-3) and second phase expansion of the Asab Gas Development
(AGD-2) are the two major projects absorbing attention at the moment. The Asab expansion will result in
800mn cf/d production, while the OGD-3 project will see a two-train 1.3bn cf/d gas plant. New spend of
US$1bn is earmarked for two big gas projects, building a 200km pipeline to transport some 470mn cf/d of
gas from offshore fields to a processing plant at Habshan. Much of this gas is designed to feed into
domestic downstream projects.



Abu Dhabi is also preparing to sell gas to neighbouring Oman via the Dolphin gas export scheme. A gas
sales agreement with Muscat will deliver 200mn cf/d to Oman Oil Company from early 2008. The gas is
originally sourced from Qatar’s North Field and transported via subsea pipeline to Abu Dhabi.

The UAE is also looking to inject private sector dynamism into the gas sector, with the initial public
offering (IPO) in Dana Gas launched in late September 2005 expected to be the largest in the UAE to
date, and the first in a private gas company in the Gulf. The US$560mn IPO, launched on September 20,
envisaged sale of 34% of the capital. Originally set up by local energy groups Crescent Petroleum, Sajaa
Gas and United Gas Transmissions Company as a gas supplier, the aim is to now expand its Gulf
operations upstream. It is also expected to source gas from Iran.

The net effect of these expansion efforts in the oil and gas sectors will lend an upside risk to our 2006
hydrocarbons sector forecasts. If the UAE meets its crude expansion targets as early as Q106, exports
could exceed the envisaged 2.38mm b/d for the full-year. In light of the continuation of tight
supply/demand conditions, on top of increased production levels, oil export revenues may yet match this
year’s expected peak of US$41bn. The UAE’s slow emergence as a gas exporter will also add ballast to
its hydrocarbon prowess. ADNOC’s money appears to be well spent, and the thirsty global oil markets
will doubtless be thankful for the new supply.

Table: Macroeconomic Data & Forecasts

2003 2004 2005e 2006f 2007f 2008f

Nominal GDP (US$bn) 79.8 85.1 92.7 99 105.5 113

Real GDP growth (%) 7 4.8 6.2 4.3 3.9 4.5

Population (mn) 4 4.3 4.6 5 5.3 5.7

Consumer price inflation (an. avg %) 3.1 3 2.5 2.5 2.5 2.5

AED/US$ (eop) 3.7 3.7 3.7 3.7 3.7 3.7

Merchandise exports (US$bn) 65.9 80 100.8 102.2 103.8 113.5

Merchandise imports (cif, US$bn) 45.7 48.9 52.9 56.2 59.5 63.4

Trade balance (customs, US$bn) 20.1 31.1 47.9 45.9 44.3 50.1

Current account (US$bn) 6.3 18.3 34.7 32.9 31.1 37

Current account (% GDP) 7.9 21.5 37.5 33.2 29.5 32.8

External debt (% of GDP) 16.5 15.8 15 14 13 12

Sources: Ministry of Economy and Commerce, Central Bank of the UAE e/f = BMI estimates/forecast



Company Monitor

Ruwais Fertiliser Industries

Fertil was established in 1980 as a joint venture between ADNOC and Address
PO Box 2288, Abu Dhabi, United
Total. ADNOC holds a two-thirds stake, with the remainder held by
Arab Emirates
Total. The Fertil plant was commissioned in December 1983 and is Tel: +971-2-602 1111
the leading producer of ammonia and urea in the UAE. Located in the Fax: +971-2-602 6800
Ruwais Industrial Zone, close to ADNOC's Jebel Dhanna Oil Web: www.fertil.co.ae
Terminal, Fertil was established to produce fertilisers for local use and
export, using onshore associated lean gas from the Bah and Asab oil Key Statistics

fields, as well as non-associated gas from the Thammama field. Number of Employees: 360
(2004)

The plants have fully integrated utility units with storage facilities. At Key Personnel
present, ammonia production has reached 1,340tpd and urea 1,850tpd. Chairman: Yousef Omair Bin
The company had granted a project management contract worth Yousef
Managing Director and General
US$3mn to Worley Parsons to debottleneck the company’s
Manager: Saif Ahmed Al Ghafly
690,000tpa urea unit by 90,000tpa, and to revamp its 350tpd carbon Deputy General Manager and
dioxide recovery unit in Abu Dhabi. The projects are likely to be Production Manager: Andre
Cadet
completed by the end of 2008.
Finance and Information Systems
Manager: Ayoub Moh'd Saleh
The company exports about 600,000 tonnes of urea annually, Head of Urea Export Sales:
Mohamed Al Anazi
including surplus ammonia. Fertil’s export markets change from year
Head of Ammonia Sales: Adil Al
to year as many buyers look for short-term contracts or spot Hameedi
deliveries.

The company sells through traders, including US-based ConAgra and
Germany’s Toepfer, to customers in most countries, while India and
Sri Lanka use tenders to purchase urea. India is expected to become
an important market for Fertil in the future, as insufficient gas
supplies are likely to necessitate India to import more urea. Further,
the domestic UAE agricultural market reportedly purchases about 12-
15% of Fertil’s annual urea production.

In April 2006, the company reported sourcing of carbon dioxide
recovery technology from Mitsubishi Heavy Industries. Fertil is to
use the technology at its urea fertiliser production plant in the Ruwais



Industrial Zone. The recovery unit is to be completed towards the end
of 2008 and is to capture up to 400 tonnes of carbon dioxide per day.
The technology recovers carbon dioxide from flue gas emitted during
the urea fertiliser production process.



Abu Dhabi Polymers Company (Borouge)

Borouge was established in 1998 to manufacture and sell polyethylene Address
PO Box 6925, Abu Dhabi, UAE
(PE) for use in technically demanding applications, primarily in the
Tel: +971-2-6312333
flexible and rigid packaging and construction industries. Borouge is a
Fax: +971-2-6312999
joint venture owned by ADNOC and the European polyolefins
Website: www.borouge.com
producer Borealis.

Key Personnel
Borouge invested US$40mn to expand the PE capacity at its Chief Executive Officer: Harri
Bucht
US$1.2bn petrochemicals complex in Abu Dhabi so as to produce
Vice President, Common Support:
580,000tpa. Borouge is fully converting its ethylene production into Jamal Al Ramahi
PE products, which helps meet the needs of the packaging and pipe Vice President, Supply Chain
industries in regions such as East Africa, Middle East and Pacific Management: Mohamed Al
Rayyes
along with the North East and South East Asia. The facility comprises
a 600,000 tonne ethane-based ethylene cracker and two PE plants,
each with an annual production capacity of 225,000 tonnes of linear
high, medium and low-density PE.

Borouge’s products are used for the manufacture of plastic film and
moulding packaging for the pharmaceuticals, food and beverages,
cosmetics and chemicals industries. The products are also used for the
manufacture of high-pressure pipes, agriculture, mining, water, gas
and sewage distribution, as well as for coating steel pipelines. In
addition to promoting its own PE products, Borouge also oversees the
distribution and marketing of Borealis’ speciality polyolefins in the
Middle East and Asia Pacific.

In March 2006, the company became an official member of the
PE100+ Association, an industry organisation comprising PE
manufacturers. Also in March 2006, the company proposed expansion
of its petrochemical complex in Ruwais, Abu Dhabi.

In July 2005, it was reported that Borouge is planning to expand its
petrochemical manufacturing capacity from 600,000tpa to 2mntpa of
enhanced polyolefins, consisting of PE and PP in Ruwais. The cost of
the project – expected to be completed by 2010 – is expected to be
around US$2.5bn.



BMI Forecast Modelling
How we generate our industry forecasts

BMI's industry forecasts are generated using the best-practice techniques of time-series modelling. The
precise form of time-series model BMI uses varies from industry to industry, in each case being
determined, as per standard practice, by the prevailing features of the industry data being examined. For
example, data for some industries may be particularly prone to seasonality, meaning seasonal trends. In
other industries, there may be pronounced non-linearity, whereby large recessions, for example, may
occur more frequently than cyclical booms.

Our approach varies from industry to industry. Common to our analysis of every industry, however, is the
use of vector auto regressions. Vector autoregressions allow us to forecast a variable using more than the
variable's own history as explanatory information. For example, when forecasting oil prices, BMI can
include information about oil consumption, supply and capacity.

When forecasting for some of our industry sub-component variables, however, using a variable's own
history is often the most desirable method of analysis. Such single-variable analysis is called univariate
modelling. BMI uses the most common and versatile form of univariate models: the autoregressive
moving average model (ARMA).

In some cases, ARMA techniques are inappropriate because there is insufficient historic data or data
quality is poor. In such cases, BMI uses either traditional decomposition methods or smoothing methods
as a basis for analysis and forecasting.

It must be remembered that human intervention plays a necessary and desirable part of all our industry
forecasting techniques. Intimate knowledge of the data and industry ensures BMI spots structural breaks,
anomalous data, turning points and seasonal features where a purely mechanical forecasting process
would not.



Chemicals Industry

Plant capacity
The ability of a country to produce basic chemicals products depends on domestic plant capacity. The
number and size of ethylene crackers determines both a country’s likely output, but also its relative
efficiency as a producer. We therefore examine:

Stated year-end capacity for key petrochemicals products, mainly ethylene but also propylene, PP,
PE and so forth. Government, company and third-party sources are used;

Specific company and/or government capacity expansion projects aimed at increasing the number
and/or size of crackers and downstream processing facilities.

Chemicals supply
A mixture of methods is used to generate supply forecasts, applied as appropriate to each individual
country:

Basic plant capacity and historic utilisation rates. Unless a company imports chemicals products for
domestic re-sale, supply is likely to be governed by production capacity;

Underlying economic growth trends. The chemicals industry is highly cyclical. Strong domestic or
regional demand is expected to be met by increased supply and higher plant utilisation rates;

Third party projections from national and international industry trade associations.

Chemicals demand
Various methods are used to generate demand forecasts, applied as appropriate to each individual

country:

Underlying economic growth trends. Strong domestic or regional demand is expected to require
larger volumes of either domestically-produced or imported olefins (ethylene, propylene), polyolefins
(PE, PP) or downstream products;

Trends in end-user industries. Strong demand for motor vehicles, construction materials, packaging
products and pharmaceuticals imply rising demand for basic chemicals;

government/industry projections;



third party forecasts from national and international industry trade associations, etc.

Cross checks

Whenever possible, BMI compares government and/or third party agency projections with the reported
spending and capacity expansion plans of the companies operating in each individual country. Where
there are discrepancies, BMI uses company-specific data as physical spending patterns ultimately
determine capacity and supply capability. Similarly, BMI compares capacity expansion plans and
demand projections to check the chemicals balance of each country. Where the data suggest imports or
exports, BMI checks that necessary capacity exists or that the required investment in infrastructure is
taking place.



Appendix A: Global Economic Assumptions

Introduction

Here, BMI analysts give their view of the state of the world economy and the main challenges faced. In
this context, they outline their forecasts for growth, inflation, interest rates and the exchange rate in the
US, the eurozone, Japan and China over the forecast period of the report (2006-2010). There are also
separate sections on the oil price and commodities markets. The forecasts contained in these sections
represent the basic assumptions which underpin the analysis in BMI's country reports.

The World Economy

Downside Risks To Growth Pick-Up
Our baseline forecast is for real growth in the global economy to accelerate in 2006 to 3.8%, from 3.6%
last year. The US will remain the key driver of growth, maintaining its impressive rate of 3.5%, as its
consumers continue their spending binge. Recovery in the eurozone is another important factor, as will be
Japan’s ongoing re-emergence from economic stagnation. Nevertheless, the world’s fastest growing
region will remain Asia (excluding Japan), which we forecast to grow by 7.0% in the year ahead. Looking
to the medium term, we expect global growth to stabilise at a trend rate of around 3.4%, as China’s
blistering rate of expansion eases and the US consumer begins to feel the pressure of increasing debt
levels.

Higher global inflation, in an environment of surging oil prices, will be a key risk to global growth in
2006. The effects of last year’s rise in oil prices will continue to flow through into overall prices,
particularly in emerging economies where governments are still withdrawing fuel price subsidies.
Furthermore, oil prices are expected to climb even higher this year (see page viii). Rapid global growth
also means that many countries may be pushing against capacity constraints, further contributing to
inflation. If inflation does creep higher in 2006, consumer and business confidence will falter as real
wages and profit margins are squeezed. The result would be slower global growth.

A further downside risk to our forecasts is the exacerbation of global imbalances. The US current account
deficit remains alarmingly wide, reaching an unprecedented 6.5% of GDP in 2005, and looks set to
deteriorate even further in 2006. We are particularly concerned by protectionist sentiment developing in
the US. China looks unlikely to allow a significant appreciation of the yuan, which will give
encouragement to those in Washington seeking tariffs on Chinese goods. Whereas a yuan appreciation
has little chance of addressing imbalances, protectionist measures threaten to thoroughly disrupt global
growth. A large proportion of US imports from China are intermediate goods used in manufacturing, and
placing tariffs on them will only serve to raise costs for US firms. Furthermore, imposing greater barriers



to the US market is likely to provoke retaliatory measures from China, undermining the potential of US
exporters. The resulting fall in business confidence could significantly impact on the US economy and the
global economy with it.

Global Assumptions

2003 2004 2005e 2006f 2007f 2008f 2009f 2010f

Real GDP growth
(%) US 2.7 4.2 3.5 3.5 3.3 3.3 3.3 3.4

Eurozone 0.7 1.8 1.4 2.1 1.7 1.7 1.7 1.7

Japan 1.8 2.3 2.8 2.8 2.1 1.8 1.5 1.4

China 10 10.1 9.9 9.3 9.4 9.5 8 7.4

World 2.7 4.1 3.6 3.8 3.5 3.5 3.4 3.4

Consumer inflation
(year-end) US 2.3 2.7 3.4 2.8 1.9 2 2.1 2.4

Eurozone 2.1 2.1 2.2 2 2.2 2.2 2.2 2.2

Japan* -0.3 0 -0.3 0.3 0.4 0.6 0.6 0.6

Interest rates Fed funds
(average) rate 1.13 1.35 3.21 4.83 5 4.69 4.5 4.5

ECB
refinancing
rate 2.34 2.11 2.19 2.6 3.06 3.06 3.06 3.06

Exchange rates
(year-end) US$/EUR 1.26 1.36 1.19 1.3 1.28 1.26 1.25 1.24

EUR/US$ 0.79 0.74 0.84 0.77 0.78 0.79 0.8 0.81

JPY/US$ 108.8 112.04 109.15 108.49 101.85 95.19 92.16 89.58

Commodity Index
(2000 = 100) Metals 98.43 133.98 169.33 230.18 192.5 155.74 147.47 140.5

Agriculture 100.38 105.88 108.43 110.16 112.89 115.7 118.51 121.35

Oil - OPEC
basket
Oil prices (average) US$/b 28.09 35.7 50.64 55.75 50 45 45 45

*Calendar-year basis, year-end inflation is average of fourth quarter compared with average of same period a year
earlier; Source: BMI.



Another possible catalyst for a disorderly unwinding of global imbalances would be a collapse in US
house prices. US consumers have undoubtedly raised housing outlays beyond what would be warranted
by fundamental factors, such as income growth. An expectation of continually higher returns is
supporting their confidence in property assets; this confidence would be shattered by a collapse in
housing prices. Without the US consumer to drive the global economy, growth could slow considerably.
Furthermore, excess liquidity has created bubbles in a number of asset markets around the world, and
there is a risk that a US house price adjustment will culminate in these eventually bursting as well.
Clearly, a global collapse in property prices could have severe effects on growth.

United States

The US In 2006 & 2007
The US economy grew strongly in Q106, with annualised quarterly GDP growth at around 5.0%. While
the recovery can be partially attributed to Q405’s low base of comparison (due to the effects of Hurricane
Katrina), the fundamental strength of the US economy is the driving factor. In particular, private
consumption was up 6.7% year-on-year (y-o-y) in January and 6.2% y-o-y in February. While housing
prices may ease gradually towards the end of 2006, we do not expect the bubble to burst – though this
remains a key risk, and our latest scenario test in chapter 3 explores this eventuality in more detail. We
expect growth of 3.5% in 2006, and 3.3% in 2007.

Ben Bernanke’s first move as US Federal Reserve chairman was to boost the Fed funds rate for the 15th
straight time to 4.75%. Stronger-than-anticipated employment figures and upside risks to energy prices
will keep the Fed vigilant. We expect a further 25 basis point (bps) hike to take the rate to 5.00% over the
next quarter – where it should stabilise (though greater tightening is an outside possibility). This view
assumes that growth will moderate over H206, calming inflationary pressures and allowing the Fed to
move to a more neutral policy stance. Should growth and inflation stabilise at sustainable levels, the rate
could peak at 5.50% over the next few quarters. Inflation should continue to abate over 2006 and 2007, to
2.8% and 1.9% respectively.

The big question mark hanging over the economy remains the massive current account deficit. Figures
from early 2006 point to a growing trade deficit. There may be, however, some relief in sight. The
eurozone and Japan are showing signs of economic strength, while mounting international pressure on the
Chinese to revalue the yuan could pay dividends.

Eurozone strength and the prospect of an end to the Fed’s tightening cycle in H206 may cause dollar
depreciation as eurozone interest rates climb higher. However, when seen in the context of a 5.00% Fed
funds rate, US assets will remain attractive vis-à-vis their Japanese and European equivalents. As such,
while some dollar weakness is to be expected, it will not fall beyond US$1.30/EUR in 2006. We see this



recovering to US$1.28/EUR in 2007. With the Japanese economy’s renewed strength, we expect the yen
to appreciate against the dollar (reaching JPY108.5/US$ in 2006, and JPY101.9/US$ in 2007).

The US’s Medium-Term Prospects
While the spectre of a housing market collapse could threaten our forecasts, there is reason to believe that
economic prospects are solid looking forward. According to the results of our latest scenario test, an
adjustment of US property prices would not cause a recession. Moreover, if the property market avoids
such a correction, we think growth will average at about 3.3% through to the end of 2010.

Meanwhile, the current account deficit may not be the monster that many fear it to be. In fact, we feel that
trends in the eurozone, Japan and, hopefully, China will help the current account deficit to improve over
the forecast period – from 6.6% of GDP in 2006 to approximately 5.0% of GDP in 2009 and 2010. Stable
growth, low inflation and a Fed funds rate of around 4.50% through the end of the forecast period will
help the greenback against the euro, even as the ECB refinancing rate climbs to 3.06% in 2009 – bringing
the dollar back to US$1.24/EUR by 2010.

Eurozone

The Eurozone In 2006 & 2007
The macroeconomic outlook for the eurozone is characterised by the upbeat indicators of regional
confidence, on the one hand, and persistently weak real data, on the other. This is particularly the case in
the eurozone’s largest economy, Germany. In March this year, the benchmark Ifo index of confidence in
the business climate rose to a 15-year high. However, despite this apparent boost, national accounts data
have not yet supported hopes of an unmistakeable economic recovery. In Q405, German GDP increased
by just 1.6% y-o-y, and was unchanged on a q-o-q basis. While q-o-q growth is expected to have
improved slightly in Q106, bad weather appears to have constrained the output of vulnerable sectors, such
as construction. Those anticipating firm evidence of a turnaround in Germany will have to wait a bit
longer.

Against a background of fragile consumer spending, we continue to expect that eurozone growth will stay
at around 2.0% in 2006 and 2007. Of the region’s three largest economies (France, Italy and Germany),
only France will outperform this trend. The interest rate policy of the European Central Bank (ECB) is
unlikely to have a significant effect on growth. However, gradual rate rises, to around 3.25% by end-
2007, should allow the ECB to keep annual inflation below its upper ceiling of 2% in the coming years.
Given that the bank’s charter establishes the achievement of price stability as its primary objective, this
should help restore some credibility in an organisation that has been much maligned for its failure to
achieve policy targets since its inception.



The exchange rate channel is unlikely to impart any stimulus to the eurozone economy in 2006 and 2007,
especially given our expectation for a steady strengthening of the euro against the US dollar. Still, given
the strong macroeconomic rationale for the dollar to fall against a range of (mostly Asian) currencies to
correct global imbalance, the euro-US dollar exchange rate should avoid a destabilising adjustment.
Currency strength against the US dollar will restrict the competitiveness of eurozone exports, and ensure
that the current account surplus is fairly constant in nominal terms, and declining as a percentage of GDP.
Nevertheless, in view of the imperfect nature of integration in the single European market, and persistent
labour market inefficiencies, it would be imprudent to ascribe any underperformance of the external
sector to exchange rate issues alone.

The Eurozone’s Medium-Term Prospects
The current structure of the eurozone economy, in addition to the long lead time between reform and
results, lead us to conclude that the region will fail to permanently raise GDP growth from a level of
around 2% over the remainder of the forecast period. Although we expect the eurozone to make some
progress in reducing unemployment, it will still have over 2% more of its workforce unemployed than the
US by 2010 (eurozone unemployment should fall to around 7%, in comparison to a stable rate of 5% in
the US). In this light, it is difficult to see the eurozone bridging the GDP growth differential with the US
without an improbable surge in productivity.

Japan

Japan In 2006 & 2007
There are growing signs that Japan’s economy is finally emerging from the economic doldrums which it
has been in for most of the past 15 years. The economy grew by 2.8% in 2005, including an impressive
4.5% y-o-y expansion in the final quarter, which made Japan one of the world’s fastest growing
developed economies. The recovery, supported by strong export demand (especially from China and the
US), higher consumption, and improving business confidence, is looking more durable than it has for a
long time, and as a result, we have raised our economic growth forecasts for 2006 to 2.8%, and 2.1% in
2007.

In an important development, in March the Bank of Japan (BOJ) announced the end of its policy of
quantitative easing. The central bank will now start to drain excess liquidity from the system as part of its
strategy to normalise monetary policy. The announcement followed more signs that deflation had finally
come to an end, after consumer price inflation reached 0.5% y-o-y in January. The monetary authority’s
decision to abandon its policy of quantitative easing should see the return of positive interest rates,
possibly by as early as the end of the year. While there is concern that such a policy change may be
premature as it could lead to the return of deflation, it is a sign that the authorities are more confident
about the durability of the current economic recovery than in previous upturns.



The Japanese yen is forecast to appreciate against the US dollar over the next two years, reaching
JPY101.9/US$ by the end of 2007. The appreciation is the result of two main factors. The first is the
general weakness of the US dollar, reflecting ongoing concerns over the size of the US current account
deficit; the second is the forecast narrowing of the interest rate differential between the US and Japan,
amid signs that US monetary tightening is coming to an end, and the expectation that interest rates in
Japan will soon begin to rise.

Japan’s current-account surplus is forecast to widen over the next two years from 3.6% of GDP in 2005,
to 3.7% in 2006, and 4.4% in 2007. The widening is mainly the result of an increase in the trade surplus,
mostly due to strong export demand from China. There is a possibility, however, that high oil prices and
strong domestic demand will result in stronger-than-expected import demand, which may lead to a fall in
the trade surplus.

Japan’s Medium-Term Prospects
Japan’s medium-term economic prospects remain uncertain, with two main factors set to depress growth
prospects over the next five years. One major concern is the growing public-debt to GDP ratio, which is
now well over 100% of GDP, and the size of the government’s fiscal deficit, which is over 7% of GDP.
The government is committed to raising taxes and cutting spending in a bid to reduce its deficit. This
policy, while welcome, will depress growth. Demographics are another major concern. Japan’s
population is already the oldest in the world, and actually started to fall for the first time last year.
Although the government is increasing incentives to boost the birth rate, the demands on the pension
system and on the labour market of a rapidly ageing population will be significant.

China

China In 2006 & 2007
China’s red-hot economy is showing no signs of slowing, with growth accelerating in the first quarter of
2006 to reach 10.2% y-o-y. The main drivers were again fixed-asset investment and net exports. The
momentum will continue for the rest of this year when we forecast the economy will expand by 9.3%, and
by 9.4% in 2007. The government is trying to re-balance growth away from investment, and towards
consumption, however, in the first quarter, investment again expanded by over 25%. There are concerns
that this rate is not sustainable, and that it is leading to a build-up of spare capacity, which could cause a
more sudden slowdown later in the forecast period.

Inflation is forecast to increase to an average of 2.5% in 2006 and 3.4% in 2007, compared with just 1.8%
last year. The main cause of the increase is robust demand, especially for commodities, which is leading
to higher producer price inflation. This will eventually feed through to higher consumer price inflation.
There are, however, significant downside risks to our forecast, most notably the possibility that the high
levels of investment over the last couple of years have created significant spare capacity in the economy,



with the result that an estimated 90% of all manufactured goods suffer from over supply. This is already
leading to some manufacturers cutting prices in an attempt to sell surplus stock.

The exchange rate, after last July’s revaluation, will continue to experience a modest appreciation, with
the rate to the US dollar forecast to average CNY7.9/US$ in 2006 and CNY7.6/US$. The Chinese
authorities may allow a faster appreciation in the event that trade tensions with the US worsen, or that
further attempts to slow the economy fail. The authorities are also likely to focus more attention in
keeping the trade-weighted value of the yuan fairly stable. In the event that the US dollar undergoes a
sudden and steep depreciation against other major Asian currencies this year, the Chinese may allow the
yuan to appreciate more against the US dollar.

The current-account surplus, after reaching an estimated 4.7% of GDP in 2005, will narrow slightly over
the next couple of years, reaching 3.6% of GDP in 2006 and 1.8% in 2007. The main cause of the fall will
be a smaller trade surplus, which is set to narrow as import growth, fuelled by booming domestic demand
and the high oil price, outstrips exports, which are set to grow at a more moderate pace over the next
couple of years.

China’s Medium-Term Prospects
The government’s main focus over the medium term will be to rebalance growth away from investment
and exports, which at their current rate of growth are unsustainable, towards consumption. Attempts to
boost personal consumption are finally showing signs of working, with retail sales growth slowly
increasing. To boost consumption further, the government needs to introduce a comprehensive social
security and health care system, which it hopes will encourage the average Chinese person to save less
and spend more. However, these reforms will take some time to introduce on a countrywide basis, and
until such time, consumption will continue to grow at a slower pace than the rest of the economy.

Commodities

Industrial Metals Breaking Records
BMI’s metal price index considers the following industrial metals: aluminium, copper, iron, lead, nickel,
tin and zinc. The index has risen sharply since its low of 83.6 in Q401. We remain bullish short term as
prices are yet to reach their peak of 240.0 in Q206, after which they will fall gradually over the medium
term, reaching an average of 230.2 for the year, before slowly dropping off to reach 140.5 by 2010.

Base metals have set new records in 2006 and further upside could be ahead. Indeed, the global
environment for industrial metals has rarely been so benign. Coupled with still low G7 interest rates (and
signs that the US tightening cycle is near its peak), strong global economic growth in recent years has
propelled base metals to new heights. The fundamental outlook for metals looks good too, with key
economies likely to expand at a fast pace this year and next. US real GDP growth is likely to be in excess



of 3.4%, China’s as high as 9.0%, and there are signs that Germany’s hitherto moribund economy could
post 2.0% growth. Meanwhile, continued instability in the Middle East and high oil prices mean that
investment funds continue to direct large proportions of their holdings into commodities. Structural
supply-side dynamics also continue to point towards upside for our metals index, particularly given that
the rally in base metals over recent months has occurred despite upward trending stock inventories – a
sign of strength in the market. These tight markets will continue to push up metals but prices will
gradually decline from Q206 as markets move into surplus.

Strong demand and supply constraints are the key supports to high and rising metals prices, and changes
on either end of the equation would force us to revise our outlook. On the downside, slower-than-
expected growth in the US or China could ease demand, although we continue to be constructive on the
prospects for both economies. Similar risks exist should major suppliers manage to increase production
ahead of schedule. Still, in the event of a supply shock affecting any major supplier, prices could continue
to rally as inventories remain tight.

Agricultural Prices Boosted By Alternative Fuels Demand
Agricultural prices look set to retain their upwards trend, although some commodities are performing
better than others – sugar supply, for example, continues to fall short of demand pointing to further price
rises, while fats and vegetable oils fell over the year ended March, according to the World Bank. BMI’s
agricultural price index promises steady stable growth as far as it is possible to anticipate volatile
agricultural prices. The index is forecast to rise steadily throughout the forecast period to reach 110.2 in
2006, climbing to 121.4 by 2010.

In the long term, the main structural trend is likely to be an increase in demand from the booming
economies of South East Asia, a point which was recently stressed by the World Bank’s chief economist
for Africa, John Page. Not only is China’s per capita income rising – we forecast real GDP per capita will
be 61% higher in 2006 than five years ago – but demand for Western style goods and food has been on
the up. Emerging as a core driver of our agricultural price index is the growing popularity of bio-fuels as
an alternative fuel, ethanol (sugar-based) and soy-based fuels in particular. Indeed, record high oil prices
have promoted a move by governments around the world to seek out more sustainable (and cheaper)
sources of fuel, and ethanol provides an attractive option. Agricultural prices are typically volatile and
adverse weather conditions and political developments present the main risks to our outlook.

Oil
Concerns over Iran and Nigeria dominated the oil markets in Q1, keeping the OPEC basket price above
US$60/bbl for most of the quarter. Indeed, while oil prices declined in early February on the back of
lower demand projections and surging US crude inventories, the market became more bullish in response
to disruptions to Nigerian supply and ongoing tensions between the West and Iran. Since these political
risks to supply are likely to persist through 2006, while the market will remain very tight, we expect the


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