Q2 2022: The ICAEW Economic Update: Middle East, is a quarterly economic forecast for the region prepared directly for the finance profession.
Economic Update: Region grappling with new uncertainties
- War clouds outlook but the surge in oil prices supports Gulf economies
- Kuwait: Economy benefitting from higher oil prices and production
- Oman: Oil sector improvement drives recovery
War clouds outlook but oil prices support Gulf economies
- Pressures from the war in Ukraine hang over the Middle East economies
- Oil windfall supports outlook for the energy exporters
- Lebanon has signed a preliminary IMF agreement but reform will continue to be slow
The global economic outlook has darkened amid considerably high uncertainty, with countries, including in the Middle East, adjusting to pressures stemming from the war in Ukraine, the weakness in the Chinese economy and tightening global funding conditions. However, the impact varies depending on the country in question. Regional commodity importing countries have been hit hard by trade disruption, rising import bills and inflation, while the surge in oil prices has provided strong support to the macroeconomic environment in the Gulf, more than offsetting the drag elsewhere. Consequently, our 2022 GDP growth for the Middle East now stands at 5.2% (4.2% three months ago), after an estimated expansion of 2.9% in 2021. That said, a scenario in which several large world economies slide into recession would weigh on oil demand and test GCC’s resilience.
We now expect Brent oil prices to average $112pb in 2022 ($100 three months ago), the highest on record, before easing to $103.5 in 2023 ($86 before). The price of Brent oil has remained close to $120 since late May in the wake of the EU's partial embargo on Russian oil that aims to restrict 90% of oil imports from Russia by year-end. The OPEC+ group has pledged to step up oil output increases in July and August in the face of disruption to Russian supply, but this has failed to calm supply concerns. In some OPEC+ countries, including Saudi Arabia and the UAE who retain the bulk of OPEC spare capacity, as well as Iraq, output is trending up. However, data continue to show several producers are still falling short of their output targets.
We anticipate the ongoing rise in oil production will be the main driver of a stronger growth rate in the GCC this year. Our forecast for the GCC economies has been revised higher for 2022, to 6.3% (1.5ppt above the projection three months ago) amid much stronger prospects for the oil sector and extensive investment initiatives focused on diversification. This reflects improved GDP growth prospects in Saudi Arabia, where we see output expanding by 7.1%, compared to 4% previously forecast. We are also optimistic about prospects for the UAE, where we expect the rise in oil output coupled with the reform agenda spanning the labour market and investment landscape to underpin growth of 6.7% this year.
GDP data for Q1 in Saudi Arabia reveals the strength of the expansion, with oil activities up 20.4% y/y, the highest rate of growth since 2011, thanks to booming oil prices and rising output. We expect forthcoming GDP statistics will confirm the picture to be similar in other GCC countries.
The GCC countries continue to enjoy strong non-oil growth beyond Q1 as well and our 2022 forecast for GCC non-oil activity stands at 4.0% (3.4% three months ago). Recent PMI surveys in the UAE and Saudi Arabia show some signs of business activity softening and global headwinds taking their toll on confidence, but they remain firmly in expansion territory. And in Qatar, the upswing in demand pushed the PMI to a survey high in May. Despite this resilience, firms, particularly in the UAE, are bearing the brunt of rising costs to allay pressure on consumers, driving margins down and leading to only modest job growth.
Travel and tourism indicators, one of the key drivers of non-oil recovery, look strong, albeit remaining below pre-pandemic levels. Dubai, for example, welcomed 3.97m visitors in Q1, over triple the numbers in Q1 2021. Dubai also hosted the Arabian Travel Market, where the Emirates airline sounded hopeful that their full operational capacity will be restored next year from about 75% now. This is in line with our expectations of tourism numbers returning to pre-crisis levels in 2023.
Higher income from hydrocarbons is buoying the fiscal outlook in the GCC producers and all countries but Bahrain will likely post budget surpluses in 2022 even as expenditure rises. The governments have been generally cautious in expanding spending plans, and some have signaled the energy-driven budget boost will be used towards debt repayment. As a result, the debt-to-GDP ratios will decline this year.
The rise in commodity prices since the start of the Russia Ukraine conflict has been positive for the GCC’s fiscal and external balances but negative for inflation. Global developments are maintaining upward pressure on food and transport prices, driving inflation higher, with additional pressures coming from tourism and recreation as travel and social activity pick up. We see GCC inflation averaging 3.1% this year (2.7% three months ago), up from 2.3% in 2021, before falling back to 2.5% in 2023.
The GCC US$ currency pegs mean the region’s monetary authorities have been forced to follow the US Fed rate hikes in March and May, which given the backdrop of strong growth and rising inflation in the region have come at an opportune time. The Fed is increasingly determined in its intent to tame inflation and we now see US rates rising by a total 250bp this year, a faster pace compared to three months ago. The resulting rise in financing costs should not pose an immediate risk to growth, but it may dampen the non-oil recovery in 2023 even though the region should continue to expand.
Elsewhere in the Middle East, progress on the Iran nuclear deal appears stalled. While Iran's GDP grew by 5.1% in 2021, and a surge in oil prices is supporting growth in 2022, we expect that a no-deal situation could limit growth in the medium term. We have raised our 2022 GDP growth forecast by 0.4ppts to 2.5%, with oil prices expected to drive the expansion, though global and local inflationary pressures will continue to weigh on demand. We still expect the Lebanese economy to grow this year but have cut our GDP forecast for 2022 to 0.9%, from 1.4% previously. Lebanon has reached a preliminary agreement with the IMF for a $3bn bailout package but this remains conditional on reform, which encompasses a number of areas including the budget and the exchange rate and which we doubt the new fragmented parliament will be able to advance. Finally, we have lowered our 2022 GDP growth forecast for Iraq to 4.4% from 4.8% previously, due to higher inflation and a rise in social unrest, amid domestic political fragmentation.
Kuwait: Economy benefitting from the surge in the oil price
- A better performance from both oil and non-oil sectors underpins forecast
- Monetary tightening is set to keep a lid on domestic price pressures
- Weak capacity to implement reforms clouds outlook beyond this year
Higher oil prices and rising oil output have strengthened the economic outlook for Kuwait; we see overall GDP growing at 7% in 2022, compared with 2.5% in 2021. All Covid-related restrictions have been scrapped, paving the way to a strong bounce-back in activity after a modest pullback in Q1. The non-oil sector is seen expanding by 4.7% this year, on the back of higher consumer spending and robust real estate sales, following growth of 3.1% in 2021. Lending trends are also supportive of recovery, with corporate credit growth picking up, despite persistent project delays. And the Al-Zour refinery is close to completion, which will increase the country's total oil refining capacity by over 0.6m b/d, to 1.4m b/d.
The oil sector, which accounts for over half of GDP, is providing a key impetus to the economy this year, with growth projected at 11.8% y/y. Kuwaiti oil production has risen above 2.6m b/d as the OPEC+ production limits ease. The oil sector grew a subdued 0.1% in 2021, due to OPEC+ restrictions, following a 10% plunge in 2020.
A stronger outlook for oil output and prices will underpin a further improvement in Kuwait’s fiscal position. With Brent forecast at $112pb in 2022 – oil prices are significantly above Kuwait’s break-even price estimated at around $65 – the government will likely post its first budget surplus since 2014 this year, at 6.2% of GDP. Fiscal performance has been on an improving trajectory since the record budget gap of KWD10.7bn posted in 2020, thanks to stronger oil income, with preliminary results indicating that the budget gap narrowed to KD3.6bn in 2021. The spike in oil prices has boosted liquidity and reduced the urgency to deal with sticky current expenditure on wages and subsidies (90% of overall spending). We don’t expect the oil windfall to lead to a big increase in spending, but stronger government activity will support non-oil sectors as well.
The state’s ability to implement important policy reforms, including fiscal adjustment, has been hampered by frequent cabinet reshuffles and administration changes. Although we expect the reform process to remain slow, we assume the impasse on passing a new debt law, which expired in 2017, will be broken. This will allow the government to borrow internationally. Meanwhile, future surpluses will be used to replenish the General Reserve Fund, which has been instrumental in funding shortfalls in recent years.
As fiscal pressures ease, government spending will support domestic demand, alleviating impact of higher funding costs. Kuwait’s central bank tends to adjust rates in the same direction as the US Fed, where our baseline sees a total of 250bp in rate hikes this year, but its currency basket peg means they don’t always move in tandem. So far, Kuwait has raised rates by 50bps this year, compared to a cumulative increase of 75bps seen in the US and elsewhere in the GCC.
Reduced monetary stimulus will help suppress domestic price pressures. In line with regional and global trends, Kuwait's inflation is rising, pushed up primarily by higher food and transport prices but core inflation is now rising at a faster pace too, showing price increases are broad-based. Inflation will remain elevated into H2, when it will likely start to ease as supply chain disruptions fade. Overall, inflation is expected to average 3.9% this year compared with 3.4% in 2021.
Aside from risks stemming from a renewed oil downturn, which would rekindle liquidity worries and slow reform progress, the country remains vulnerable to new Covid variants - Kuwait's booster campaign has been less successful than those of its neighbours, with less than 10% of the population receiving a third dose of the vaccine.
Oman: Oil sector improvement drives recovery
- Oil gains bolster macroeconomic environment
- Non-oil recovery is also underway
- Annual budget on course to post the first surplus in over a decade
Oman's direct economic exposure to the conflict in Ukraine is minimal and the impact on the outlook stems primarily from higher commodity and food prices; we expect Oman's GDP to grow by 3.3% this year, up from 3% in 2021. The oil sector will be the main driver of the recovery: oil production has risen above 1m b/d in Q1, from an average of 970,000 b/d in 2021 and, overall, it is set to rise by more than 5% this year, while oil prices remain elevated. Gas output inched lower in January-February, but has rebounded since, and continued investment should boost capacity by a further 0.5bn cubic feet within the next two years, helping GDP growth to recover.
Stronger growth is also expected from non-oil industries, including tourism. Oman managed to bring the pandemic well under control. Although some health restrictions came into force in April, these have now been relaxed, driving up tourism and supporting economic recovery. Project spending and reforms geared towards attracting foreign investment, including allowing full foreign ownership of local companies and more flexible property purchase rules, should serve to encourage growth. Sultan Haitham bin Tariq al Said has made great strides towards tackling domestic challenges since he assumed power two years ago and his policy will continue to focus on increasing investment, guided by diversification objectives enshrined in Oman’s Vision 2040.
The latest reforms will also support job creation, extending labour market recovery. The number of private-sector jobs has grown steadily since September 2021, primarily among the expat workforce, following a decline since the 2017 peak, including a steep 15% y/y drop in 2020 as businesses adjusted to the impact of the pandemic. But we expect a full recovery in the labour market to take several years.
Oman's economy is beginning to reap the benefits of fiscal and broader economic reforms over the past two years, garnering its first credit rating upgrade from S&P since 2007. The windfall from higher crude prices is easing budget constraints. Non-oil revenue generation is also improving, including from VAT introduced last year. The budget recorded a surplus of OMR357m at the end of March, primarily thanks to the impact of improved oil market dynamics on revenue. Against this backdrop, the authorities announced they would boost development expenditure to OMR1.1bn (up OMR0.2bn from the original budget) in 2022, with additional allocations in subsequent years. They also plan to provide extra security payments to help cushion consumers against price increases.
Overall, we see the annual budget balance turning positive for the first time since 2008 and estimate a surplus of about 5% of GDP. The gap narrowed to below 4% of GDP in 2021, from about 16% in 2020. Outsize dependence on oil revenue remains a risk to the medium-term fiscal trajectory and a renewed downturn in oil prices would renew financing challenges. In the near-term, we see some headwinds to external demand arising from lockdown-induced economic slowdown in China, the biggest customer for Oman's oil.
Like elsewhere, households and businesses face rising costs, with the war in Ukraine exacerbating price pressures stemming from disrupted supply chains and food and energy prices increasing strongly. But the base effect from the VAT launch last year has caused the inflation rate to slow to 2.6% in April, from 4% in Q1 and we see inflation averaging 2.8% this year, before falling back below 2% in 2023.
Like its GCC peers, Oman's central bank is following in the Fed’s footsteps by raising interest rates, and the rial's dollar peg points to further hikes ahead as the US Fed continues to tighten towards an expected cumulative increase of 250bps this year. Higher borrowing costs will keep credit demand weak, though the reopening of the economy should offer support to domestic activity.