The ICAEW Economic Insight: Middle East, is a quarterly economic forecast for the region prepared directly for the finance profession.
The Middle Eastern economies slowed down to an 8-year low in 2017, growing by just 1.1%, against a backdrop of low oil prices, limited hydrocarbon output due to the OPEC agreement, various fiscal consolidation measures and sustained political challenges. But this year marks a turning point for the region as we expect growth to pick up to 2.9%, underpinned by rising oil prices (we raised our oil price forecast to $67 per barrel in 2018), expansionary fiscal policy and relative improvements in the overall security conditions. The Middle Eastern economies traditionally divide into oil exporters and oil importers. Though the outlook and risk profiles slightly vary by each segment, we maintain an overall positive economic outlook for both in 2018-2019.
The past couple of years have been difficult for oil exporting countries (GCC, Iran and Iraq), when the collapse of oil prices at the end of 2014 has led to a sharp economic downturn, straining government finances and exacerbating fiscal and external vulnerabilities. The oil sector suffered from low oil prices and limited output due to the OPEC agreement, while energy hikes and subsidy cuts weighed on the non-oil sector. According to our estimates, the GCC grew by only 0.1% last year, the slowest since 2009, while Iraq’s economy contracted by 0.3% in 2017. But we expect economic activity to pick up this year for oil exporters, supported by rising oil prices, where the price per barrel hit a three-year high recently at US$70, and increased government spending. We see an acceleration in growth in the GCC, Iran and Iraq, as we forecast real GDP growth of 2.4%, 4.1% and 2.5% respectively. And in 2019, as OPEC phases out its output cut, we expect growth to accelerate further across the board for oil exporters.
The outlook is similarly positive for oil importers (Lebanon and Jordan), as we see GDP growth in Lebanon accelerating to 2.7% in 2018 from an estimated 1.8% in 2017, boosted by public infrastructure investment and trade and tourism recovery. In Jordan, we see a marginal acceleration in growth to 2.5% this year, mainly due to improving external demand and positive outlook for Jordan’s main trading partners. Relative improvements in the security conditions in Syria, reflected by the defeat of IS, will also slowdown the spill overs from the conflict and aid overall growth in both countries.
However, the political environment remains challenging and continues to pose a downside risk to headline growth. The wars in Syria and Yemen are the most obvious challenges, but the recent Houthi missile attacks against Saudi risks escalating simmering tension between Saudi and Iran - indeed tension spilled over to neighbouring countries, with the resignation of the Lebanese PM Saad Al Hariri in November last year as a prime example. In the GCC, the Qatar blockade continues, albeit with limited economic impact thus far, but the short-lived GCC summit in December, where several heads of states were notably absent, underlines a weakened GCC institution with diminished relevance. In Iran, we expect the nuclear deal to hold for now, but the recent protests and Trump’s hawkish approach to the country highlight the still-risky investment environment.
Saudi Arabia is undergoing various fundamental economic and social changes and this year will be full of firsts: on January 1st, in an unprecedented but widely-anticipated move, Saudi introduced the 5% VAT; a sweeping anti-corruption crackdown generated more than US$100bn for the Saudi government according to the Kingdom’s attorney general, concluding a three-month long investigation; cinemas are expected to open for the first time in the conservative Kingdom as soon as March, while women will be allowed to drive from June this year. On the economic front, real GDP is expected to rebound to 2% growth in 2018, after contracting by 0.7% last year, underpinned by expansionary fiscal policy and recovery in oil prices.
Preliminary official statistics showed that the GDP fell by 0.7% last year, weighed down by the contraction of the oil sector and only modest growth in the non-oil sector, but we expect growth to rebound to 2% this year, underpinned by expansionary fiscal policy and recovery in oil prices. The oil sector contracted by 3.0% in 2017, primarily due to the OPEC deal that saw Saudi Arabia cut its supply by about 0.5m b/d. The country recorded one of the highest compliance levels among OPEC members, averaging 120% in 2017. The extension of the OPEC deal to end-2018 will put a lid on oil sector growth, which we forecast at 1.1% this year, but recovering oil prices –hitting three-year high at around US$70pb recently – will improve the overall outlook. The Jizan refinery, expected to have a refining capacity of 400,000 barrels per day, is expected to come online this year as well, which will contribute positively to growth in the oil sector.
The non-oil sector on the other hand proved to be resilient last year, despite the unfavourable macroeconomic environments of low oil prices and fiscal austerity measures, growing by 1.0% in 2017. We expect growth in the non-oil sector to pick-up pace in 2018 at 2.6%, supported by expansionary fiscal policy and various pro-growth government initiatives. The Saudi government announced the largest ever budgeted expenditure, including a 14% y/y increase in capital expenditure. Most notably, we expect the US$19.2bn private sector stimulus, equal to around 2.6% of GDP, to stimulate non-oil activity and contribute positively to the private sector. The scale and targeted nature of the stimulus will support overall economic growth, as it includes funds allocated for residential housing loans, economic projects, SME support, infrastructure development and investment, export financing, among others.
Budget spending will also be complemented by the release of state funds amounting to SAR50bn from the National Development Fund and up to SAR83bn from the Public Investment Fund, boosting overall public expenditure. Indeed, the Emirates NBD Purchasing Managers’ Index for Saudi Arabia (a gauge of activity in the non-oil private sector) has averaged a reading of 56 for 2017, compared to the “no-change” reading of 50, and an average of below 55 for 2016 overall, reflecting expansion in the non-oil private sector and growing business optimism. Additionally, point of sale transactions, an indicator of consumer spending, increased by 20% m/m in December last year, its fastest monthly increase since June 2014.
The outlook for Oman’s economy looks brighter for 2018, with the main boost coming from higher oil prices and ramp-up in gas output, which will boost government and private sector incomes and lift confidence. Oman continues to push ahead with the process of economic diversification (Tanfeedh) but the economy remains highly reliant on oil revenue, which makes up 70% of the budget. The fiscal position remains a key vulnerability – the government missed budget deficit estimates for the second consecutive year in 2017, but higher oil prices facilitate a more expansionary stance in 2018, even as VAT launch is delayed into 2019.
In line with regional trends, activity in Oman remains largely driven by the oil sector and government spending. Against this backdrop, growth is expected to have slowed to a six-year low of just 0.2% in 2017, depressed by cuts in oil output and fiscal austerity.
Despite being a non-OPEC country, Oman has adhered to OPEC production cuts’ agreement, reducing supply by about 50,000 (around 3%). This has contributed to a recovery and stabilization of oil prices in H2 2017 at close to $70 per barrel for Brent Crude in January. We forecast Brent crude to average $67 in 2018, a significant $12 higher than during our last forecast, with prices slipping to about $65 in 2019 as market gets more into balance.
The turnaround in the oil price brightens the outlook for Oman’s economy for 2018-19 as it will facilitate much-needed stimulus. Nonetheless, the extension of OPEC cutbacks through to end-2018 implies only modestly higher oil output in the near-term and in general the space for government stimulus is limited; notwithstanding higher oil prices. Still, the ramp-up of gas production at the Khazzan field, which began operating in September 2017, will provide key support to 2018 recovery and alongside stronger non-oil sector activity should lift 2018 GDP growth to 3.6%. As oil output is restored to pre-cut levels in 2019, we expect GDP growth to stabilize around 3% assuming continued reform efforts in the coming couple of years. Unclear succession plan is a potential threat to domestic and regional stability.
The Vision 2020 plan aims for the economy to become more reliant on the non-oil sector (manufacturing, transport, logistics and tourism, with the Duqm economic zone gaining prominence), as oil output falls. These sectors have remained under pressure amid challenging business conditions, but there are green shoots in a number of areas. Among them is the tourism sector, whose share in the economy looks on course to rise to the targeted 3% share of GDP by 2020, up from 2.8% in 2016. Although tourist numbers were down in 2017 compared to 2016, weighing on hotel occupancy rates, they were spending more, resulting in higher overall revenue. Moreover, private bank deposits have also started to rise at a faster pace in H2 and should reinforce the improving outlook for spending in 2018.
Government efforts to address the high unemployment rate, which triggered a wave of protests in early January, are also marginally supportive of consumption. The moratorium to suspend employment of non-Omanis in 10 sectors is a short-term fix but it will help deliver on the promise to create 25,000 private sector jobs for Omanis (just under 10% of the current private sector Omani workforce), making a small dent in Oman’s overall unemployment rate (around 17%, the region’s highest). However, it will not fix the underlying drivers of unemployment, particularly among the youth, with skill mismatch continuing to be a major hindrance.
Household spending power will remain constrained, however, particularly for low-income earners. Although the introduction of Value Added Tax has been postponed until 2019, petrol price increases after subsidy removal, and impending excise taxes will pose a drag on purchasing power in 2018 as inflation rises.
Despite diversification efforts and non-oil activity rising (transport, logistics, tourism among others), the economy remains vulnerable to downturn in oil prices amid limited reserves expected to last just 15 years and stretched government finances. The fiscal position remains a key vulnerability – the government missed budget deficit estimates for the second consecutive year in 2017 and we forecast the balance to remain negative despite consolidation efforts.
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1 Our Middle East aggregation incorporates Iran, Iraq, Jordan, Lebanon, Saudi Arabia, Syria, Bahrain, Kuwait, Oman, Qatar, UAE, and Yemen.