Economic Update: Middle East
The ICAEW Economic Update: Middle East, is a quarterly economic forecast for the region prepared directly for the finance profession.
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Q3 2019: The slowest year in more than a decade.
- Tough US sanctions, maximum pressure policy against Iran and steep oil production cuts will see the Middle Eastern economy slowing to a more-than-a-decade-long low this year at only 0.1%, down from an estimated 1.4% last year.
- The Saudi economy continues to tread slowly towards economic diversification and improving the overall business environment through various pro-business government policies and initiatives. For now, however, oil remains the dominant force and the single most important economic lever.
- The extension of the OPEC+ oil output cuts to Q1 2020 will have negative repercussions for Kuwait’s economy, amplified by pressure on oil prices. GDP growth is plateauing around the 1.2% pace registered in 2018, with the oil sector (which accounts for well over 50% of output) making a negative contribution to the headline figure. But government spending should continue to support non-oil activity in the near term, preventing a sharper slowdown.
The Middle-Eastern (ME) economy will slow in 2019 to the lowest it’s been in over 10 years, growing only by 0.1%, down from an estimated 1.4% last year. There will be, however, significant cross-country variations in the growth outlook among the region’s economies. The slowdown is largely driven by the outsized impact of two of the largest economies in the region, Saudi and Iran, on headline GDP growth. Iran has suffered from deteriorating economic conditions amid the White House’s policy of maximum pressure, with GDP contracting by 7% in 2019. Saudi, on the other hand, is expected to see very limited growth this year at only 0.5%, reflecting renewed oil production cuts by OPEC+, which the Kingdom has spearheaded in order to stabilise international oil prices. Aggregate oil production in the Gulf Cooperation Council (excluding Bahrain and Qatar due to missing data points), Iran and Iraq dropped from 24.8m barrels per day (b/d) in the first half of 2018 to 23.9m b/d over the same period in 2019, representing a 3.6% contraction. Downside risks to the global economy, ranging from an expected US recession in 2020 to an escalation in the US-China trade war, have also weighed on oil prices in the past few months, dropping to US$58pb recently. We expect oil prices to recover to US$65pb in Q4 2019.
Middle East: Total oil production
More positively, the PMI surveys of Saudi and UAE, the two largest GCC economies, signalled continued recovery and acceleration in the non-oil private sector. The UAE PMI averaged 58.2 in Q2 2019, the highest quarterly average in more than four years, supported by more rapid rates of expansion in output and new export orders. Similarly, the Saudi non-oil private sector expanded by 2.3% y/y in Q1 2019, the fastest in six quarters, and in June the PMI reached its highest level since December 2017. However, higher output has failed to translate into meaningful job creation so far, partially due to squeezed profit margins as firms grapple with rising input costs and discounted selling prices amid strong competition.
Elsewhere in the region, Iraq’s economy is expected to accelerate to 2.7% this year, up from a contraction of 1% in 2018, against a backdrop of improving security conditions and rising oil production. Bahrain is seen slowing marginally to 1.6% in 2019 as the government continues to implement sizeable fiscal consolidation measures, while relative improvements in exports, tourism and remittances will push growth in Jordan and Lebanon to 2.3% and 0.8% respectively.
Saudi Arabia outlook
The outlook for the Saudi economy remains closely linked to oil-sector developments, despite major diversification efforts. Preliminary figures from the General Authority of Statistics show that the economy grew by 1.7% y/y in Q1 2019, buoyed by an uptick in both oil and non-oil activities compared to the same period last year. Growth was broad-based with 'transport, storage and information' and 'financial and business services' growing fastest, both at 4.9% y/y. More interestingly, construction activity is finally showing some signs of recovery, expanding by 1.3% in Q1 2019 after contracting by around 3% a year in 2016−18. We expect headline GDP, however, to moderate for the remainder of this year, averaging around 0.5% in 2019, below the average of 2.2% last year, weighed down by renewed oil production cuts by OPEC+.
Saudi Arabia: Real GDP by sector
Oil production in Saudi Arabia averaged 10.06m b/d in Q1 and 9.78m b/d in Q2 2019, notably below the average of 10.3m b/d in 2018. With the extension of the OPEC+ supply cuts well into Q1 2020, oil production is unlikely to recover meaningfully in the second half of this year. As such, we expect the oil sector to contract by 1.8% in 2019, well below the growth rate of 2.9% registered in 2018. Saudi, the de facto leader of OPEC, is actively working to support oil prices amid growing fears of worsening global demand conditions, reflecting the escalating US-China trade war and the potential of a US recession by next year. Further, the oil sector will also be weighed down by lower oil prices this year, which we see averaging US$65.5pb, some 7.8% below the average of US$71.1pb last year.
The Saudi non-oil private sector, on the other hand, expanded by 2.3% y/y in Q1 2019, the fastest in six quarters, and the PMI, a gauge of the health of the non-oil private sector, reached its highest level since December 2017 in June, with both domestic and external demand conditions healthy. Business optimism in January 2019 was the highest in more than five years, while other proxy indicators – such as point-of-sale transactions, ATM withdrawals and credit to private sector – paint a similarly encouraging picture. However, solid economic growth and rising output have not yet translated into greater hiring activity in the private sector, with the employment sub-index of the PMI survey remaining close to the neutral level of 50 for more than two years.
Firms have been grappling with rising costs in recent years following energy price reforms and subsidy cuts. More notably, however, private sector firms have struggled to adjust to Saudization policies, which favour the employment of locals over expats and include fees on expat workers and higher average salaries for locals. The private sector has long relied on expat workers, who constituted around 80% of the total private sector labour force in 2018. Not surprisingly, the number of expats in the private sector in Saudi Arabia has declined as the Saudi Government pushes its Saudization policies to tackle high levels of unemployment among locals – more than 1.2m expats have left the labour market since the end of 2016. But more worryingly, the total of employed Saudis has not picked up and in fact declined on an annual basis for two consecutive quarters in Q4 2018 and Q1 2019, by 1.7% and 1.2% respectively.
On a more positive note, the Saudi Government posted a US$7.4bn budget surplus in Q1 this year, the first in almost five years – though we expect the deficit for the whole year to widen to 6.7% of GDP. And the Private Sector Stimulus Office suggested that the US$53bn private sector stimulus, originally earmarked for 2018−21, may extend beyond 2021, reaffirming the government's commitment to Vision 2030 and economic diversification. The office expects to spend US$9.6bn this year and US$5.9bn in 2020. The stimulus plan includes funds allocated for export promotion, support for SMEs and investment in new technologies, among others.
The outlook for Kuwait remains closely tied to oil developments. Thus, the economy stands to lose from the recent oil sector dynamics, with the improvement seen at the start of this year proving short-lived against the backdrop of the extended OPEC supply cuts and depressed oil prices. Preliminary data for Q1 show GDP growth accelerated to 2.6% y/y from a downwardly-revised 1.8% in Q4 2018. While oil sector expansion cooled to just 1.3% y/y, non-oil activity strengthened to 4.1%, significantly above the 1.5% pace recorded in the preceding quarter but partly reflecting more supportive base effects.
Kuwait has maintained its tight compliance with mandated supply cutbacks. We expect oil output to continue hovering around 2.7m b/d for the remainder of the year, representing a 1.3% decline compared to 2018. Combined with lower oil prices, this will underpin a negative contribution from the oil sector to growth overall, notwithstanding ongoing expansion in refining capacity. Oil output should then rise by 0.6% in 2020 if OPEC+ cuts conclude on schedule, although OPEC’s next moves are uncertain. The policy of oil supply cuts may frustrate recently reinvigorated efforts to raise Kuwait’s oil production capacity to the ambitious target of 4m b/d set for 2020 (up from about 3.2m b/d today).
The non-oil economy is showing signs of recovery, with growth seen accelerating to 3% this year, spurred by an expansionary government budget and accommodative monetary policy. The evolution of credit growth, which averaged 5.2% in the first half of the year, boosted by an improvement in business lending in particular, low inflation (0.7% y/y in the same period) and potentially lower interest rates (in line with what we forecast for the US), all suggest that the private sector will spend more in the coming months, despite some recent weakening in confidence.
Kuwait: Resident credit breakdown
Overall, GDP growth is expected to drift downward in the second half of the year, averaging 1.2% for the year, in line with the pace registered in 2018. Growth should then rise to 1.7% in 2020 and stabilise around 3% in 2021−22. But risks to the medium-term projections lie to the downside. Lower oil receipts will limit the government’s ability to maintain stimulus beyond year-end, a traditional growth driver.
Project awards picked up modestly in H1 2019, driven by the construction and transport sectors. While historical trends suggest progress will likely be slow and subject to delays, the Silk City plan, which encompasses major infrastructure initiatives including a new port, and a number of residential projects, developed under the auspices of the New Kuwait 2035 strategic vision, have shown steady progress.
Meanwhile, the revamp of the stock market has culminated in a reclassification of the Kuwait bourse from frontier to emerging status, set for May 2020. This should support liquidity, particularly if complemented by further legal and regulatory reforms, such as the bankruptcy law. Privatisation efforts have advanced, but with the region’s most difficult business climate, Kuwait will continue to see low levels of FDI (0.2% of GDP in the last five years) necessary to diversify the economy. The proposed ‘Kuwaitization’ policy in the private sector may further deter foreign investment.
Moreover, the oil trends threaten deterioration in the external and fiscal dynamics, leaving the economy more exposed. Lower oil exports, which account for about 90% of total exports, will narrow the surplus on the external account and reduce government receipts, challenging Kuwait’s fiscal position. The budget gap narrowed to 3% of GDP in 2018 (excluding transfer to the Future Generations Fund), from 9% in 2017, despite a faster than expected increase in government spending of 13.5% y/y. However, lower oil revenues will widen the deficit this year. This will require further drawdown of the country’s savings as the debt law, which would allow sovereign bond issuance, has expired. The implementation of the selective tax (soft drinks, cigarettes, tobacco) and the value added tax (VAT), has been postponed until 2020 and 2021, respectively.