Morgan Stanley expects the United Arab Emirates economy to contract 2 percent in 2009, but projects a "mild recovery" for 2010, the bank said in a research note.

"The worst may indeed be behind us," Dubai-based analyst Mohamed Jaber said in the note, dated June 29.

"Given the recent improvement in the global economic momentum, the rise in oil prices over the past few months, and the general stabilisation in domestic markets, we believe that as far as the UAE is concerned, we may have reached the bottom of this downturn", he said in the note.

During the current year, the UAE, the world's third largest oil exporter, would experience lower domestic oil production levels, with the oil sector contracting by 6 percent as global demand falls away in the economic downturn, Jaber wrote.

The Gulf region has been hard-hit by a drop in oil prices to the mid-$30 range earlier this year after prices peaked at nearly $150 a barrel last summer.

Gulf countries invested heavily during a six-year oil price rally to try to wean their economies away from a reliance on oil export revenues, but most are still vulnerable to price volatility.

Morgan Stanley said there would be a significant downward adjustment in domestic spending in the UAE this year, as well as continued weakness in the real estate sector and significant tightening in domestic credit markets and foreign financing.

The non-oil sector was projected to remain flat in real terms during the year, the note said.

The strength of the recovery of the UAE economy would "depend on the momentum for global growth and the timely resolution of imbalances in its domestic real estate and credit markets," the note said.

Inflation in 2009 was expected to slow to 6.4 percent, compared to a 12.3 percent rise in prices in 2008. This decline would be mainly caused by a projected 15-percent fall in housing rents, the note said.

"This will mainly be driven by the lower expected population growth and the large number of housing units expected to be delivered during 2009-10," Jaber said in the note.

Rents in Dubai, one of the UAE's seven emirates and home to an indoor ski slope and the world's tallest tower, doubled or more during a building boom that came to an end late last year as the financial crisis hit. - Reuters