The ICAEW Economic Insight: Middle East, is a quarterly economic forecast for the region prepared directly for the finance profession.
After a relatively slow start to 2018, the macroeconomic conditions are starting to seem more promising for the ME economies. The GCC unveiled expansionary fiscal policies in 2018 to prop up their economies, in contrast to the contractionary fiscal stance taken in recent years against a backdrop of lower oil prices. But the economic conditions were slow to bear fruit in 2018, as the oil sector was constrained by the OPEC-plus agreement, which saw the cartel reduce the global supply by around 1.7m b/d, while the non-oil private sector, as judged by the PMI readings, was slow to adjust to new macroeconomic realities such as the introduction of the 5% VAT in Saudi and UAE and various energy price reforms, weighing on the cost of doing business in the region.
Economic conditions, however, are starting to improve with the oil prices rising again in Q2 2018 to levels not seen since the end of 2014 due to heightened geopolitical tensions and potential supply disruptions from Libya, Venezuela and Iran in light of renewed US sanctions. OPEC-plus decided to ease its supply restriction in its latest meeting in June, allowing oil exporters in the ME to ramp up crude production. Saudi alone raised its oil production by around 0.4m b/d in June, while UAE and Kuwait increased their production by 30k b/d and 10k b/d over the same month respectively. Higher crude production and recovering oil prices, which we forecast at an average of US$78 in H2 2018, will aid growth in an otherwise sluggish oil sector and strengthen fiscal and external balances for the GCC economies. Similarly, the non-oil private sector is starting to show some signs of recovery after a slow start to 2018. The PMIs of Saudi and UAE, the region’s biggest economies, reached their highest levels this year in June, reflecting growing momentum in the non-oil private sector.
Downside risks to our cautiously positive outlook remain, however, as rising interest rates and tighter monetary conditions could slow down the momentum in the non-oil private sector through higher borrowing costs for households and corporations. And while the ME has been largely insulated from the trade spat engulfing the US, China and the EU, any escalation of the trade war could weigh on economic activity in the ME economies through weaker external demand and lower oil prices. On the geopolitical front, the possibility of a direct conflict between Iran and the US is still remote, but renewed US sanctions on Iranian exports could increase the chances of a miscalculation and raise regional tensions, hurting the overall business, trade and investment environment.
The outlook for the Saudi economy remains strongly tied to the developments in the international oil markets. Rising oil prices this year and potential supply disruptions from Libya, Venezuela and Iran have improved the economic prospects for the Saudi economy, given the Kingdom’s role as a major oil producer with substantial spare production capacity. The non-oil sector will be also supportive of growth, buoyed by pro-growth government initiatives and higher public spending. But In spite of the more promising economic prospects, certain challenges to the Saudi economy remain, notably the high local unemployment rate and the need to attract increasing levels of FDI to support Vision 2030 and expand the role of the private sector. On the social front, women were granted the right to drive in June and cinemas opened their doors for the first time in over three decades in April, signalling the steady progress of social and economic reforms in the Kingdom.
Preliminary figures by the Saudi authorities show that real GDP grew by 1.2% y/y in Q1 2018, which compares favourably to Q1 2017, when the economy contracted by 0.8%. The oil sector grew by 0.6% y/y in Q1 2018, while the non-oil sector grew by 1.6% over the same period. Overall, we see the Saudi economy accelerating by 2.1% in 2018, supported by improving activity in both the oil and non-oil sectors.
In recent months, oil prices hit their highest level since the end of 2014 at US$80pb following President Trump’s decision to pull out of the nuclear deal. The US withdrawal from the deal signalled the return of US sanctions on Iranian exports, which alongside other supply disruptions from Libya and Venezuela, meant that the global oil market will remain tight this year. As a result, the international oil cartel, OPEC, decided to ease supply restrictions in its June meeting, reportedly boosting production by 1m b/d. Saudi Arabia alone raise production by 0.4m b/d in June to 10.5m b/d, its highest level in 18 months. Further, any renewed supply disruptions in the near future are expected to be largely shouldered by Saudi Arabia, which has the highest spare production capacity among OPEC-plus members at around 2m b/d. Overall, we expect oil production in Saudi to average around 10.10m b/d this year, representing a 1.4% y/y increase on the 9.96m b/d registered last year. While for oil prices, we raised our forecast to an average of US$74.5pb in 2018 (compared to US$71pb previously). Higher crude production and oil prices will strengthen the outlook for the Saudi economy over the short term and improve the country’s fiscal and external balances.
For the non-oil sector, we expect growth to pick up pace to 2.7% this year, up from 1.1% last year, supported by various pro-growth government initiatives and expansionary fiscal stance. This comes in contrast to the past couple of years, when the Saudi government introduced various austerity measures to reduce its fiscal deficit due to the slump in oil prices. We expect the US$19.2bn private sector stimulus to play a key role in driving growth in the non-oil sector and cushioning businesses from changing macroeconomic landscape. The cost of doing business in Saudi increased this year due to energy price reforms and the introduction of the 5% VAT and expat levies. Indeed, the Saudi PMI reached a record low in March, reflecting weak output and new orders by the non-oil private sector. But the index recovered the following months, reaching its highest level this year in June as business conditions started to gradually improve.In other developments, FDI inflows to Saudi Arabia fell to a 13-year low in 2017 at only US$1.4bn. The drop was widely attributed to the economic slowdown as well as the anti-corruption purge at the end of last year. But going forward, the recent inclusion of Saudi Arabia in the MSCI Emerging Market Index is expected to attract up to US$40bn in foreign investment. Raising the level of FDI has been a key element of Vision 2030 in order to expand the role of the private sector in the economy in generating output and creating jobs, as unemployment among Saudi nationals remains high at 12.9% in Q1 2018.
The outlook for Bahrain’s economy remains stunted by the ongoing contraction in the oil sector and lack of policy space due to persistently wide budget deficits and high and rising levels of public debt. The fiscal risks arise largely from reliance on debt-fuelled spending and a bloated public sector while reform implementation has generally lagged peers, eroding the competitive edge gained from early diversification of the economy. The economy is seen benefitting from the steady stream of investment in 2018, funded mainly from the GCC Marshall Fund, while additional support will be provided to address the fiscal shortfall and currency pressure.
In contrast to other GCC countries, activity in Bahrain is driven primarily by the non-oil sector, which has averaged over 4.3% annually in 2014-2017, cushioning the economy from the oil shock. Against this backdrop, overall growth expanded by 3.8% in 2017, supported by a buoyant projects market. While this trend is seen continuing in 2018, the pace of investment is moderating, which will result in a slowdown in headline growth to 2.6%, rising to 2.8% in both 2019 and 2020.
Meanwhile, the contribution from the oil sector has continued to decline and the oil sector will remain a drag on growth this year notwithstanding the turnaround in the oil price. Recently reported data show the oil segment shrank almost 15% y/y in Q1, depressing overall performance of the economy, which saw a drop of 1.2% y/y.
Oil output fell by almost 1% in 2017 and we see a further contraction of 4.5% this year. Production averaged only 169k bpd in Q1 2018 due to required maintenance work, a y/y decline of around 20%. As a result, we expect oil output to average 190k bpd, down from around 200k bpd in 2017, reflecting also a gradual erosion of existing fields’ capacity. Oil output should rise by 1% annually in 2019-20 and medium- and long-term prospects for the oil sector have improved given Bahrain’s recent discovery of its largest oil field since 1932. The new field is expected to be operational within five years and is estimated to have a capacity of 200k b/d, essentially doubling current capacity.
The economy may have become less dependent on the oil sector, but oil proceeds remain a key driver of government spending trajectory. Our forecast for Brent now stands at US$74.5pb in 2018, over 37% higher than the 2017 average of $54bp. While this is still significantly below Bahrain’s estimated fiscal break-even of $113, the highest among GCC oil producers, we expect it to support an acceleration in expenditure this year to 3.1%, from an estimated 1.4% in 2017.
Higher revenues should also allow for a narrowing in the budget deficit to 7.5% of GDP, from almost 10% in 2017. It is clear, that despite the expected narrowing, the fiscal position will remain a weakness requiring a significant fiscal adjustment on top of steps taken in recent years. Public debt has risen from around 30% of GDP in 2010 to over 76% according to latest estimates for 2017 and will likely creep up above 83% in 2019-20 as large budget deficits persist.
This highlights the need for a comprehensive strategy to ensure fiscal sustainability and reduce the reliance on external financing. In March, Bahrain had to cancel a conventional bond sale and make do with only a US$1bn from a sukuk offering as investors thought the strategy was lacking, demanding higher premium. The implementation of VAT still planned before year-endshould help diversify revenue streams, alongside the excise taxes announced at end-2017, but containing public expenditure is the biggest challenge for the government. The revenue enhancing measures are also expected to contribute to higher living costs – we project inflation to accelerate to 2.7% this year, from 1.4% in 2017, weighing on household spending.
In addition to economic vulnerabilities, lingering political issues could re-surface, weighing on business and consumer confidence and further weakening Bahrain’s position as an important finance, business, logistics and tourism centre, hurting the non-oil economy.
Economic Insight reports are produced with ICAEW's partner Oxford Economics, one of the world’s foremost advisory firms. Their analytical tools provide unparalleled ability to forecast economic trends.
1 Our Middle East aggregation incorporates Iran, Iraq, Jordan, Lebanon, Saudi Arabia, Syria, Bahrain, Kuwait, Oman, Qatar, UAE, and Yemen.