The ICAEW Economic Insight: Middle East, is a quarterly economic forecast for the region prepared directly for the finance profession.
Several economies in the Middle East, particularly those in the GCC, are transitioning towards a “new normal”, and 2018 will mark some interesting milestones. Households and firms will need to adapt to the implementation of Value Added Tax, as part of a more widespread trend towards increasing government revenues from sources other than fuels. Important social change will take place in Saudi Arabia, with the lifting of the ban on women driving – part of a broader effort from the new Crown Prince to ease barriers to economic growth and open up to the world. After a period of emergency austerity (which saw public spending cut by almost 20% from 2015-2017 at the GCC level), public finances now look to be on a more sustainable path in most economies, allowing spending to start gradually recovering.
Against this backdrop, our forecast is for GDP growth in the region to recover momentum in the years ahead. We forecast GDP growth of 2.8% in the GCC in 2018 (after growth of just 0.3% in 2017), and an acceleration from 1.4% to 3.2% in the wider Middle East1. There will remain a broad spread of growth performance though, with GCC economies bound by the OPEC agreement to keep oil output low, growing slower than other economies (although non-oil sectors are forecast to pick up).
With oil production cuts likely to be maintained through 2018, and reversed in 2019, we expect GDP growth to pick up to around 4% in both the GCC and wider Middle East. Within this, we forecast oil GDP to rebound from a 2.3% contraction in 2017 to growth of 1.7% in 2018 and around 1 percentage point stronger in 2019. Growth in the non-oil sector is forecast to pick up from 2.4% in 2017 to 3.7% in 2018 and 4.7% the year after.
However, several risks remain to growth in the region, including those from politics and security. In our baseline forecast, Iran is expected to be a standout performer, with GDP growth of 4% forecast for 2018, boosted by rising output (not being a signatory to the OPEC-plus deal), and the tailwinds of sanctions having eased in recent years. But recent political developments in the US are a clear risk to this positive momentum. Meanwhile the missile attack from Yemen into Saudi Arabia risks increasing Iran-Saudi tensions. Finally, the dispute between Qatar and other GCC members has if anything deteriorated a little, with Bahrain recently calling for suspension of Qatar’s membership of the group. Although the direct economic impacts have so far been relatively modest, the strains could undermine regional cooperation on economic policy issues, and broader investor confidence in the region.
2018 will be a key year of transition for Saudi Arabia in several contexts. For the first time, Saudi citizens will pay VAT on the goods and services they buy, Saudi women will be permitted to drive, and private (and foreign) investors may be able to take a stake in Saudi Aramco. Saudi Arabia is at the start of a potentially decades-long process of economic diversification and social change.
Nevertheless, in the near-term, familiar growth drivers remain crucially important. Most obvious is Saudi Arabia’s role in rebalancing supply and demand in the world oil market. As a key player in the “OPEC-plus” coalition, Saudi Arabia has cut production by around 650,000 barrels per day (around 6%) compared to a year ago. Partly in response to the lower quotas, prices have moved higher in recent months – topping $60 per barrel for Brent Crude in late October. However, demand is slowing in key markets, particularly China where the International Energy Agency expects demand growth to slow to 2.6% in 2018 (2pp slower than this year). As such, we expect Saudi to play a key role in securing an extension of the lower quotas at the November 30th meeting. We forecast Brent crude to average $55 in 2018 and a dollar or two higher the following year - around $5 higher than during our last forecast. This will offer some support to public spending and growth, but by no means fundamentally change the broader picture in the oil market or in Saudi Arabia specifically.
Away from the oil sector underlying business conditions remain relatively positive. 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 so far, compared to the “no-change” reading of 50, and an average of below 55 for 2016 overall. Private (i.e. business and households) bank deposits have also started to recover through the summer months, providing some support for spending power into 2018.
This cushion could be important, as households face a combination of additional drags on their income in 2018. Households are already dealing with the impact of cigarette and soft drink duties imposed in the summer, and these will be augmented in 2018 by the introduction of Value Added Tax, and possibly 80% hikes in motor fuels prices. More positively, plans to permit women to drive could save some households as much as $1,000 per month – particularly where women use a driver or taxis to get to their workplaces. The relaxation on women driving seems unlikely to have an immediate impact on female employment though. At 20%, female labour force participation is low even by regional standards (UAE leads the way at 42%, compared to 50-60% in western economies), and the government aims to raise this to 30% by 2030.
But to do so, it will need to narrow the gap in wage expectations between Saudi workers and expatriates. In the lower half of the skill distribution, Saudi workers (mainly in public sector organisations) typically receive salaries 3-4 times as high as expatriate workers (predominantly in the private sector). Barring a big downward shift in wage expectations, a surge in public sector job creation, or a willingness on the part of firms to pay Saudi women more to do jobs currently filled by expatriates, it seems unlikely that the permission to drive will translate into many more working women.
But the move signals a desire to ease constraints arising from social and religious conservatism. The Crown Prince made this very clear in recent weeks, saying he wanted to return the country to “a moderate Islam open to the world”. He has also made tackling corruption a priority, and this is welcome in the context of the country’s relatively poor rankings on global comparisons, such as those published by Transparency International. But as with much of the diversification agenda, the two recent flagship policy initiatives (a major tourism zone in the Red Sea region, and an industrial mega city spanning) will draw heavily upon inward investment and expertise. So care needs to be taken to ensure the enforcement of anti-corruption measures supports, rather than inhibits, the confidence of overseas investors and trade partners in doing business in Saudi Arabia.
Nevertheless, there is clearly increasing momentum behind the shift towards a more market-driven economy. This shift will take some time though, and for the coming years the economy will remain heavily influenced by traditional growth drivers – the oil sector, and the importance of government spending. We forecast the economy to pick up from a 0.3% contraction in 2017 (largely a result of lower oil output) to growth of 2.3% in 2018. As oil output is restored to pre-cut levels in 2019, we expect GDP growth of 3.8%. But in the absence of more ambitious reform efforts in the coming couple of years, this is likely to be the speed limit for growth.
Lebanon’s economy has suffered from a protracted period of below-potential growth, due to a combination of domestic political paralysis and the impact of regional conflicts, particularly in Syria. Recent political developments had yielded important improvements to policy-making, with the prospect of more to come after elections next year – the resignation of the Prime Minister does raise the risk of further policy paralysis in the meantime though. The cost of hosting 1.5 million refugees places a heavy burden on the economy, but this is likely to be offset by a rebound in key sectors as economic activity starts to pick up. We are optimistic of a solid pickup in economic growth, from an average of just 1.7% per year from 2011-2017 to 3% in 2018, and on to 4% by 2020.
Along with Jordan, Lebanon has been one of the most heavily-impacted countries from the crises in Syria and Iraq. Lebanon currently hosts around 1.5 million Syrian refugees (equal to around 30% of the domestic population), who have been arriving since the conflict broke out in 2011. This has put an immense strain on public finances, as the government struggles to accommodate and feed the new arrivals. Goods exports fell by 30% from 2012-2016 due to the disruption in trade, which relies predominantly on overland routes, with Lebanon’s key trade partners in the region, while tourism arrivals fell 40% between 2010-2013 (although have rebound around half-way since). Additionally, austerity measures have hit the spending power of traditionally high-spending visitors from GCC economies. The increase in public spending and contraction in revenues has driven the government budget into a deficit consistently around 10% of GDP in recent years. And while Lebanon has avoided being directly involved in the conflict, this has come at the cost of policy paralysis, with divergent views on how to deal with the crisis and Lebanon’s approach to Syria leading to the collapse of the government in 2013, further dampening business and household confidence.
Some of these pressures are starting to ease though. After more than two years without a formal head of state, Lebanon finally elected a president in October 2016, which has brought some momentum back into policy circles. Most positively perhaps parliament ratified a new electoral law in June, paving the way for elections scheduled for May 2018. Parliament also ratified the government’s budget (the first since 2005), and implemented substantial increases in public sector pay (which should help stimulate demand), paid for by increases in VAT, corporation tax and taxes on the banking sector. The resignation of the Prime Minister in early November raises the risk of a period of policy paralysis between now and the elections though. But based on the assumption the elections yield a durable government with a mandate to govern, we forecast the budget deficit to start to come down, albeit only very gradually, especially as pre-election spending may offset improvements in revenue-generation.
There are also signs of economic recovery. Tourist arrivals grew by 11% in 2016, and a further 4.6% in the first half of 2017. This is boosting activity in the sector, as well as confidence among firms more broadly. Lower oil prices are also helping, given Lebanon’s reliance on imported oil – although recent discoveries of oil and gas fields off Lebanon’s coastline will change this. Parliament recently approved a petroleum tax law, and it is hoped that production can start in 2018. Overall, assuming the election of a government with a solid mandate and that the country continues to be relatively shielded from neighbouring conflicts, we feel this range of positive trends, can help push GDP growth towards 4% by 2020.
However, the new government will face several challenges in returning Lebanon to stability and prosperity. Public debt has risen to 156% of GDP, among the highest in the world, and leading ratings agencies to downgrade Lebanon to single B. Lebanon remains one of the most externally imbalanced countries in the world, with an especially severe reliance on remittances from Lebanese diaspora. This leaves the economy exposed to foreign exchange and refinancing risks. More generally, substantial economic reform is required to improve the underlying business environment – at 126 in the World Bank’s latest Doing Business ranking, Lebanon compares far from favourably with other economies in the region such as Morocco (68) and Tunisia (77).
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1 Our Middle East aggregation incorporates Iran, Iraq, Jordan, Lebanon, Saudi Arabia, Syria, Bahrain, Kuwait, Oman, Qatar, UAE, and Yemen.