Economic Update: Middle East
The ICAEW Economic Update: Middle East, is a quarterly economic forecast for the region prepared directly for the finance profession.
The challenging year: 2019 Q2 summary
- Renewed oil production cuts and a deep recession in Iran are expected to slow growth in the Middle Eastern economies to only 0.6% in 2019, the slowest in almost a decade.
- Oman’s economy, like its GCC peers, remains largely driven by the oil sector and government spending. Against this backdrop, Oman will experience modestly weaker growth of 2.8% this year, down from an estimated 3.3% in 2018. Both domestic demand and the external sector face persistent headwinds, the latter reinforced by the fractious US-China trade relations. Renewed pressure on oil prices complicates fiscal adjustment, as the overall thrust of policy remains expansionary.
- Economic growth in Bahrain more than halved last year, from 3.7% in 2017 to 1.8% in 2018, with further deceleration seen in 2019 to 1.6% amid a major drive to overhaul government finances, which include spending cuts, new taxes and other fiscal consolidation measures.
GCC: Oil GDP Growth
The Middle Eastern economy is expected to slow down from an estimated 1.5% last year to about 0.6% in 2019. The downward revision to our Middle East GDP growth forecast, which was around 1.3% in our Q1 2019 report, is primarily driven by a deeper-than-expected recession in Iran, one of the largest Middle Eastern economies. We now expect the Iranian economy to contract by 7% in 2019, weighed down by tougher American sanctions and the US administration’s recent decision to stop granting waivers to Iran’s oil import partners, which took effect earlier in May this year. Oil producers in the Middle East will also see limited growth in the oil sector, the traditional engine of economic growth and a primary source of government revenues, given the anticipated extension of the output cuts by OPEC+ to balance the international oil markets. We see oil prices averaging around US$67pb in 2019, down by some 5.6% from the average of US$71pb last year. Lower oil prices pose a challenge for a number of GCC countries that rely heavily on hydrocarbon receipts to balance their budgets, notably Bahrain and Oman.
GCC: Non-Oil GDP Growth
The burden of generating economic growth and employment is expected to fall more on the non-oil sector in 2019, supported by various pro-growth government initiatives, expansionary budgets and fiscal stimulus plans, especially in Saudi and the UAE, the two largest GCC economies. We expect the non-oil sector in the GCC to accelerate from an estimated 2.3% last year to 2.6% in 2019. Indeed, several proxy indicators of economic activity paint a positive picture, with the credit to the private sector trending up in most GCC countries, while the quarterly average of the PMI index, a gauge of the health of the private sector, continued to show some improvements in Q1 2019 in both Saudi and UAE compared to Q4 2018.
In other notable developments, deflationary pressures were evident in several GCC countries in the beginning of 2019, largely reflecting material declines in the ‘housing and utilities’ component of the CPI index, which traditionally has the largest weight in the consumer basket. The drop in the ‘housing and utilities’ component comes amid weak real estate markets in several GCC economies in the face of sluggish job markets, subdued demand, an exodus of expat workers in Saudi and supply and demand mismatches in the real estate market in the UAE.
The outlook for Oman’s economy looks challenging in 2019, with oil production curbs and oil price volatility weighing on incomes and sentiment. The ramp-up in gas output over the past 18 months has partly compensated for lower oil production, cushioning oil sector performance. Meanwhile, non-oil activity remains tepid, though it should improve, anchored by economic diversification efforts and infrastructure spending under the Vision 2020 plan. However, the public sector budget’s heavy reliance on energy receipts will continue to limit the authorities’ room to support spending and activity. We forecast slower GDP growth but wider fiscal shortfall this year, entrenching accumulation of external debt further above 50% of GDP.
Oman’s economy is still in the early stages of recovery and remains highly sensitive to fluctuations in oil receipts. Headline GDP growth is seen at 2.8% this year, down from an estimated 3.3% expansion in 2018, but up from the 0.9% drop in 2017.
Despite being a non-OPEC country, Oman has adhered to the OPEC+ oil quotas, cutting output to just above 970,000 b/d in January-April, 25,000 b/d below the average for Q4 2018. It is looking increasingly likely that the current round of cutbacks will be extended into H2 2019, which would further weigh on the contribution of the oil sector to GDP growth this year. Looking ahead, natural gas exploration will be a more significant driver of oil sector growth.
Oman: oil production
Oman continues to see little improvement in terms of non-oil activity as well. Despite increased state spending, domestic demand remains under pressure, reflected in slowing private sector credit uptake. The real estate market remains on a downward trend, with the value of sold properties falling by 12.2% in Q1 from a year earlier, while vehicle registrations continue to register double-digit y/y declines. Tourism has been the bright spot, showing a jump in the number of visitors in the first four months of the year, accompanied by a strong uptick in revenues. Overall, these trends are likely to linger this year, implying GDP growth deceleration to 2.8% in 2019, from an estimated pace of 3.3% in 2018.
Oman: Tourism Statistics
Oil prices have again become less supportive for Oman’s outlook as our current oil price forecast stands at $66.5pb for 2019, 6.4% below the 2018 average. This, alongside lower oil production levels, should drive down oil revenue, which contributes about 60% of total budget revenue.
Oil receipts saw a significant boost in 2018, reflecting a combination of higher prices and production, lifting government revenues by about 25% according to preliminary figures. This facilitated a rise in spending, primarily current spending, while capital outlays shrank. Although spending will rise less this year (the budget targets a 3% increase, compared to an estimate of 3.7% in 2018) and the authorities are implementing excise taxes, the budget deficit will climb to above 9% of GDP, from an estimated 7.3% of GDP in 2018, weighed down by lower income from oil. The increase in non-oil revenue has been generally slow to materialise – for example, VAT implementation does not feature in the 2019 budget and will probably be delayed until 2020. In the absence of fiscal consolidation, debt dynamics will continue to deteriorate, with public external debt seen reaching 56% of GDP at the end of 2019.
The weakening in the sovereign balance sheet, particularly the rise in the public debt ratio, has resulted in more credit rating downgrades, with Moody’s following its peers in lowering the rating to sub-investment in March. This will make financing the deficits more expensive – yields on Oman’s securities have remained above the 2018 average – although we expect a return to the bond market before year-end.
Running large deficits has done little to strengthen employment prospects for the local population. Notwithstanding the expat hiring freeze, now extended to a larger number of professions, the private sector created just 13,444 jobs for Omanis in 2018, short of the 25,000 target, and a further 5,780 in January-April. But, the total number of private sector jobs in fact shrank by 15,000 this year already. Although no data is available for the public sector, its ability to fill the gap will have likely remained limited. Coupled with slow progress on addressing the underlying skill mismatch, labour market dynamics will continue to constrain consumption and overall outlook in the coming months.
The outlook for Bahrain’s economy remains clouded by persistent weakness in government finances, evident by significant fiscal deficits and rising public debt levels, large external financing needs, general slowdown in non-oil activity and limited prospects for oil sector growth. Indeed, the economy expanded by its slowest pace in more than two decades last year at only 1.8%. The outlook for this year is similarly challenging as we expect the economy to decelerate further to 1.6%, weighed down by fiscal consolidation measures, lower oil prices and only a modest rise in oil production. But continued project spending, supported by the GCC US$10bn financial package, is expected to balance out the overall impact.
The economic slowdown last year was felt across a range of sectors. The non-oil sector, which comprises over 80% of total economic activity, almost halved to 2.5% in 2018 from 4.9% in 2017. The slowdown was broad-based, but notably in the services sector, where all sub-sectors slowed from 2017 rates. More alarmingly, 'hotels & restaurants' contracted by 1.1% y/y, while 'wholesale & retail trade' and 'transport & communications' grew just 0.1% and 0.2% respectively. We see growth in 2019 in the non-oil sector slowing further to 1.5%, notably below the 4.4% average between 2014 and 2017, weighed down by several fiscal consolidation measures, including the introduction of the 5% VAT earlier this year.
In its efforts to reign in public spending and address large and persistent fiscal deficits and spiralling public debt, the Bahraini Government unveiled in October last year an ambitious Fiscal Balance Programme that aims to balance the budget by 2022. This entails slashing public spending, a voluntary retirement scheme for government employees, more efficient distribution of cash subsidies and other measures. We expect the range of measures to reduce the fiscal deficit from an estimated 10.1% of GDP in 2018 to around 7% of GDP in 2019. Bahrain has relied on external financing to address its persistent deficits in the past few years, leading to a ballooning of public debt as a percentage of GDP from an estimated 42% in 2014 to almost 93% in 2018, the highest in the GCC.
Bahrain: Fiscal balance and public debt
The oil sector on the other hand contracted by 1.1% in 2018, reflecting pre-scheduled maintenance in the first half of last year and the gradual erosion in the overall production capacity in Bahrain. On a more positive note, following Bahrain’s discovery of its largest oil field since 1932 in April last year, the country is likely to start shale oil production by the end of this year, with well-drilling reportedly started a few months ago. However, production is likely to remain slow and gradual, so we see only a modest 1% rise in oil activity this year.
Though the Bahraini economy is the most diversified of the GCC countries, where oil’s share of GDP is less than 20%, oil revenues still disproportionately dominate government finances, comprising more than 70% of government revenues. Our forecast for oil prices now stands at US$67pb in 2018, some 5.6% lower than the 2018 average of $71bp. This remains substantially below Bahrain’s estimated fiscal break-even point of $113, the highest among GCC peers. Bahrain is reportedly expected to return to international bond markets in the second half of this year to support its finances and prop up its currency. Recent data from the Central Bank of Bahrain show foreign currency reserves were close to US$2.4bn in April 2019, covering just barely over one-months’ worth of imports – a sign of relative weakness.
The US$10bn support package from the GCC is expected to help the government address its financial shortcomings and support certain infrastructure projects, balancing the overall economic trajectory over the medium term. The government has already received the first instalment of US$2.3bn late last year and is expecting another US$2.3bn this year. Several important infrastructure projects are expected to be supportive of growth this year as well, including Alba's (major aluminium producer) new Line 6, Bapco’s (main oil producer) modernisation programme and the airport modernisation project, which includes a US$1.1bn passenger terminal due to be completed by Q3 2019.
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1 Our Middle East aggregation incorporates Iran, Iraq, Jordan, Lebanon, Saudi Arabia, Syria, Bahrain, Kuwait, Oman, Qatar, UAE, and Yemen.