Economic Update: Middle East

Economic Update: Oil output cuts weigh on economic fortunes

• GCC: Deeper oil output cuts force a downgrade in outlook
• Oman: Non-oil sectors will drive 2023 growth of 2.5%
• Kuwait: Oil output cuts drag growth

GCC: Deeper oil output cuts force a downgrade in outlook

• We have downgraded our Middle East forecast by 0.4pp, to 1.7%.
• Deeper oil output cuts weigh on growth in GCC countries.
• Inflation has slowed but interest rates will stay at current levels into 2024.

Incoming news for the global economy point to a soft start to Q3, supporting our forecast of weaker growth over the remainder of the year and into 2024. That said, our 2023 global GDP forecast has improved in the last three months because of strong Q2 outturns. By contrast, economic performance in the Middle East weakened in Q2, but much of the drag has come from the energy sector as countries lowered oil output, while non-oil activity has remained robust. Overall, we think the pace of GDP growth in the Middle East will slow to just 1.7% this year (0.4pp down on three months ago), from over 6% last year.

We have scaled back our expectations for GCC growth this year by 0.5ppts to 1.4%. While oil output cuts will continue to weigh on overall growth, high-frequency indicators point to resilient performance of domestic demand and the non-oil economy. The PMIs show domestic demand remains supportive of activity, with firms reporting expansion in both customer base and hiring. That said, we see some headwinds to this positive performance, with high interest rates set to weigh on consumption and private investment.

Energy prices have seen strong gains recently supported by Chinese stimulus measures, robust US demand and deeper supply cuts. Saudi Arabia has extended its voluntary 1mbd production cut through year-end, while Russia also pledged to reduce its oil exports further. As a result, Brent oil price rose above $US90pb, the highest since November last year. Consequently, we have raised our average Brent oil price estimate for this year to US$83.1, against our forecast of US$81.5pb three months ago. We don’t currently anticipate Saudi voluntary cuts to extend into 2024, but it looks increasingly likely OPEC+’ will keep its broader pact to curtail production in place for longer.

We expect Saudi voluntary oil production cuts to lead to a deeper decline in the GCC energy sector GDP of 3.9%, while we expected contraction of 1.8% three months ago. This will make 2023 the weakest year for the energy-sector in the GCC since 2017 (excluding 2020).  For Saudi Arabia specifically, we've downgraded this year's oil-GDP forecast from -1.9% to -5.6%, the weakest since 2009 (excluding 2020).

The non-energy sectors in the GCC continue to demonstrate resilience, underpinning our forecast of 4.3% this year. Tourism-related sectors have been the key driver of non-energy growth, with available data showing double-digit expansion in transport, storage, accommodation and food services. Dubai’s tourism sector grew by 20% y/y in Q1 2023, as it hosted a record of 8.6 million tourists, well above pre-pandemic levels. In Saudi Arabia, tourism sector revenue expanded rapidly in Q1 2023 to $9.9bn, up 225% from Q1 2022. In the same period, 7.8 million tourists arrived in the country. As part of Vision 2030, the government aims to attract 100 million visits (domestic and international) and the tourism sector contributing 10% of GDP by 2030. We think investments will continue to raise the appeal of Saudi Arabia as a tourist destination and expect 30 million international tourists to visit the kingdom this year, rising above 50 million by 2032. Meanwhile in Qatar, tourist arrivals exceeded 2mn in H1, increasing nearly threefold on the same period last year due to record high visitor numbers from the GCC, Europe, and Asia. We now forecast the number of visitors in Qatar to hit 3.17mn this year, an increase of close to 24% y/y, supporting diversification efforts.

Looking further ahead, the planned inclusion of Saudi Arabia and the UAE in the BRICS block in 2024 will help the two countries achieve their diversification plans by increasing trade and investment opportunities within the group’s framework. The group will likely conduct trade in their regional currencies, reducing dependence on the US dollar. We think logistics, technology, infrastructure, and finance will be among the key beneficiary sectors. According to our calculations, BRICS accounted for 26% of world GDP last year, and the new members will lift the group's contribution to 30% in 2024.

Lower oil prices have eroded regional current account and budget positions in H1, as governments attempt to cushion demand through higher spending. Several countries, including Oman and Qatar, have maintained surpluses. However, Saudi Arabia’s budget is now on track for a full-year deficit after a deficit in H1. Although the oil price will be higher in H2 relative to H1, energy exports will be lower due to mandated cuts in production. Overall, we expect a budget surplus of about 1.6% of GDP for the GCC region as a whole (3.5% three months ago), down from oil-fuelled 7.6% in 2022. 

GCC inflation has surprised favourably in recent months thanks to a decline in food and fuel prices. Our forecasts show their impact on regional inflation dynamics will subside in the near term as commodity prices stabilise and base effects become less helpful. In turn, domestic factors will come increasingly to the fore in determining inflation rates across the GCC. Against the backdrop of robust, albeit moderating, non-oil growth, we see domestic inflationary pressures persisting, which will drive GCC inflation to average 2.7% this year (unchanged on three months ago). That said, average regional inflation should ease to 2.5% in 2024 and 2% in 2025.

Despite our outlook of inflation normalising, the GCC currency pegs to the US dollar will prevent regional central banks from cutting rates before the Federal Reserve starts its easing cycle. We believe the Fed will be slow to begin cutting rates next near, and we expect rate cuts will follow a very gradual path once they start. This means borrowing costs in the region will remain high over the near term, leading to a further slowdown in the pace of lending and weighing on non-oil GDP growth. We see non-oil GDP growth at 3.9% in 2024, down from 4.3% expected this year.

Elsewhere in the Middle East, we have cut our growth forecasts for 2023 modestly. For Iran, we think GDP growth will ease to 1.5% this year as high inflation constrains household spending. National accounts data for 2022 show the economy expanded 3.9%, more than we expected, despite widespread protests, which disrupted business and household activity. The rapid depreciation of the Iranian rial on secondary markets has stopped but the currency will remain weak, not least given the unlikely revival of the nuclear deal. In Lebanon, business activity is shrinking again as political impasse strangles reform and triple-digit inflation weighs on domestic demand and employment. We think Lebanon's economy will shrink 0.2% this year, which would make it the sixth straight year of falling GDP, and we expect any recovery to begin in 2024, at the earliest. For Iraq, we have cut our 2023 GDP growth forecast by 0.1pp, to 3.9%, given cuts in oil output, while water and electricity shortages undermine agricultural capacity and industry.

Oman: Non-oil sectors will drive 2023 growth of 2.5%

• Economy set to grow by 2.5% this year, down from 4.3% in 2022
• Lower oil production volumes weigh on oil sector prospects
• Budget will end the year in small deficit on weaker energy trade

We expect GDP growth in Oman to slow down to 2.5% y/y this year after expanding strongly by 4.3% y/y in 2022, the fastest since 2016. We think the non-oil economy will expand by 2.9%, up from 1.6% last year, driven by public investment, including in the renewable energy space. Meanwhile, the oil sector will be a drag on growth this year, shrinking by 2.1%. Oman's economy will likely expand by 2.3% next year.

The latest GDP data show Oman's economy grew 4.7% y/y in real terms in Q1, slightly faster than the average pace last year. Growth was driven by non-oil output, which expanded 4.6%, while the energy sector slowed down to 3.5%, with oil output growing by just 2.8%. Fishing, building, and construction returned to growth following double digit contractions last year and services climbed by 4.5%, supported by retail, transport, and real estate activity.

We expect tourism to be among key sectors boosting non-oil economic recovery. Although the hotel occupancy rates remain slightly below 2019 levels, other sectoral indicators such as the number of visitors highlight ongoing improvement. Oman also seeks to capitalise on growth and diversification plans in the region. For example, the UAE’s Etihad Rail will connect Oman with the UAE and Saudi Arabia.

We expect Oman’s oil production to average 1.042mn b/d this year, down 2.1% on last year. Oman has gradually reduced its supply since April in compliance with the OPEC+ agreement. We anticipate that the average oil output will be ease further next year. Meanwhile, gas production increased by 3.4% in 2022 and will continue to inch up as more projects come online, shifting the composition of energy trade further in favour of gas.

The government continues to unveil plans to support the medium-term growth. These include establishing a OMR2bn (US$5.2bn) Oman Future Fund to boost investment. Oman also announced expansion of the outskirts of Muscat, which will support the needs of residents on lower incomes, and several mega projects.

Oman is also advancing renewable energy projects in wind and solar with the aim of raising the share of renewable energy to 30% by 2030, from 5.5% currently. The government has signed agreements valued at US$20bn to develop green hydrogen, as well as biofuels. It has also embarked on creating a sustainable finance framework, with a focus on funding initiatives supporting energy efficiency.

With energy sector trends being less supportive, we anticipate small budget deficits both this year and next. Fiscal data for January-July show a positive balance due to lower spending. But the decrease in energy revenue will increasingly weigh on the balance in the rest of the year. The government ran a budget surplus of 2.7% of GDP last year. The commodity price boom was a key driver, facilitating a shift from earlier budget and trade deficits into surpluses and repayment of external debt. We estimate this lowered the public debt-to-GDP ratio to 40% last year, down from a peak of over 65% in 2020.

Oman’s inflation has eased below 1% amid a deepening drag from transport prices and slowing food price increases. We forecast 2023 CPI at 1%, the second lowest in the GCC, but expect inflation to rise by 1.7% next year. Oman's central bank will continue to follow the US Fed's path, which we expect to start easing policy in 2024.

Kuwait: Oil output cuts drag growth

• Oil production cuts are the key drag on growth
• Non-oil recovery is slowing but showing resilience
• Inflation will remain the highest in the GCC at 3.4% this year, before stabilizing at 2.6%

We see Kuwait’s GDP growth slowing to 1.6% y/y this year, from 7% in 2022, given oil production cuts, lower oil prices, an easing in consumer spending, political gridlock, and delayed reforms. While we expect oil GDP to contract by 5.8%, our non-oil GDP forecast shows growth of 4.1%, down modestly on 4.7% last year. Our long-term headline growth projection for Kuwait is 1.9% y/y over the next 10 years.

Our 2023 oil production forecast for Kuwait stands at 2.5mn b/d, nearly 6% down on last year. As a result, the oil sector, which accounts for about 50% of GDP, will shrink by 5.8% this year, following an 11.6% expansion in 2022. Oil output has held around 2.55mn b/d in recent months, with the country producing 130,000 b/d below its target and 300,000 b/d below its spare capacity. The gap between the target and actual production is expected to close as a third train from Al-Zour refinery recovers from outages in Q2. We project oil production to remain flat in 2024 before rising by 3.6% in 2025.

High-frequency indicators underpin our view that the consumer sector will not be immune to the impact of higher borrowing costs. The pace of credit growth has more halved year-to-date, to 3.3% in July, with consumer and housing loans growing by 2.3% and 3.9%, respectively. That said, the government's support through higher salaries and subsidies will sustain spending.

Political gridlock has continuously weighed on activity given delays on fiscal reforms, diversification efforts, and attracting foreign investments. Kuwait has endured chronic cabinet reshuffles and administration changes, limiting the state's ability to implement policy and fiscal reforms. Kuwait has had three parliamentary elections in as many years and has recently formed its fifth government in less than a year, with Sheikh Ahmad Nawaf Al-Sabah being appointed as the country's new prime minister. The impasse has stalled the passage of several bills – including the debt law, that would allow the government to borrow from international markets and the VAT launch.

Political changes have also stymied project activity, with few new awards last year. The government hopes to boost project momentum through a recently unveiled development plan, of which the housing industry is a big beneficiary.

Budget plans aim to use any surplus towards replenishing the General Reserve Fund that was depleted during the pandemic. In line with our forecast, the government pencils in fiscal deficits for both this year and next. For next year, the parliament expects a fiscal deficit of 6.8bn dinars (KWD) based on an oil price of US$70pb. Total revenue is projected to be KWD19.5bn, of which 88% is expected to come from the oil sector. Total expenditure is pegged at KWD26.3bn, of which only 9% is directed towards capital expenditure. Nearly 80% of the total expenditure is directed towards wages, salaries, and subsidies. We expect the government's budget deficit to equal 1.4% of GDP this calendar year, widening to 2.4% in 2024. Excluding last year, the budget has been in deficit since 2014.  

Kuwait continues to print the highest inflation in the GCC region this year, around 3.7%. The food and housing sectors, which account for half of the CPI basket, contribute 54% of total inflation. This year, the ppt contribution of food prices has come down by 14%; however, this has been completely offset by rising housing prices. While we expect inflation to come down in the coming months, our 2023 forecast stands at 3.4%, with upside risks, compared to the GCC average of 2.7%.

The Central Bank of Kuwait has raised the deposit rate by 275bps since in the last 18 months to counter rising inflationary pressures and improve the competitiveness of the Kuwaiti dinar, providing stability in financial and monetary markets. Monetary tightening will add to borrowing costs, underpinning our view of weaker credit demand, consumer spending and non-oil GDP growth.