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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Economic Update: Middle East recovery blown off course as coronavirus spreads
Published 23 March 2020
- Coronavirus pandemic disrupts recovery.
- Saudi Arabia: Escalating concerns over the outlook as the collapse of OPEC+ adds to virus woes.
- UAE: Economic performance takes a turn for the worse as virus hits trade and tourism.
Uncertainty over the fallout of the virus
- Coronavirus is whipping up a perfect storm for regional economies
- Oil activity is seen temporarily surging but non-oil sector in distress
- Iran and Lebanon will contract this year
The escalating coronavirus outbreak has halted the growth recovery in the Middle East, at least temporarily. Most countries in the region have been quick to act, both in using containment measures to slow the spread of the coronavirus and in outlining policy responses on the fiscal (stimulus packages) and monetary (rate cuts/credit measures) sides. Although these steps will soften the economic blow of the outbreak, we see a sharp slowdown in activity in H1. We assume activity will strengthen in H2 as both demand and supply side disruption fades, and we forecast Middle East GDP will grow by 1.0% in 2020, above the 0.2% pace of 2019, but still weak in a historical context.
Higher oil production in Saudi Arabia and the UAE will lift GCC GDP growth to 2.6% this year. But the steep decline in oil prices implies painful fiscal adjustment to contain fiscal deficits, which will drag down non-oil economies, reinforcing headwinds from the coronavirus and mounting pressure on diversification efforts. We now see growth in GCC non-oil activity grinding to a halt in 2020.
Middle East: Real GDP in 2020
The impact of the coronavirus sent shockwaves across the oil market, pushing oil prices down. Then, contrary to expectations of further supply cuts, Saudi Arabia and Russia announced a hike in oil production as the OPEC+ alliance faltered on 5 March. The move worsened the supply glut as demand for oil had already weakened substantially, and saw Brent crude prices tumbling further to below $30pb. We now expect Brent to average $38.5/b in 2020, 40% lower than last year, and $46/b in 2021.
Brent crude oil prices
The region has employed similar measures to the rest of the world to contain the spread of the coronavirus, with varying severity of restrictions. Current limitations include travel bans, closure of most venues, including schools, and a halt to some industrial activity. Mindful of the impact of the isolation and semi-shutdown of the economy, regional authorities have followed the lead of other countries and have taken steps to support demand. Gulf central banks, whose currencies are pegged to the US dollar (except Kuwait), have slashed the cost of borrowing. Conventional monetary policy easing is being combined with stimulus packages to minimise the damage caused by the outbreak. Measures include additional liquidity, custom duty exemptions, rent relief, loan deferment, lower utility charges and credit guarantees for SMEs.
But despite these measures, some GCC countries are now staring at recession in their non-oil economies. Many businesses, particularly in the consumer-facing sectors, including tourism, will come under severe pressure. Travel and tourism have become a mainstay of the non-oil economy in most GCC countries, but especially in Bahrain and the UAE. With supply chains facing disruption, travel restricted and events cancelled due to the virus outbreak, the sector will weigh on the performance of the broader economy.
Elsewhere in the region, growth will also disappoint, with two economies, Iran and Lebanon, seen contracting this year. For Iran, it will likely be the third year of recession, though official data have not been disclosed since 2018. Economic conditions have deteriorated following additional US sanctions in January, with the region’s worst coronavirus outbreak exerting additional pressure on the vulnerable economy. Lebanon’s downturn worsened significantly in Q4 amid disruption to business from protests, informal capital controls and the emergence of a parallel currency market. The economy probably shrank by about 3% in 2019 overall and we now forecast a massive contraction of almost 9% this year. Inflation has spiked in both countries against the backdrop of currency devaluation and will be in double digits this year and next. Iraq, with the least diversified economy in the region, will also come under pressure amid low oil prices.
Oil price drop prompts sharp spending cuts
- Oil sector to surge this year and decline thereafter
- Non-oil economy to take a hit from virus and spending cuts
- Investment plans may be temporarily shelved
While preliminary 2019 GDP data showed encouraging signs for the Saudi economy earlier this month, recording marginal growth despite the very weak oil sector, concerns over the outlook are now escalating as the collapse of OPEC+ adds to the economic woes caused by the spread of the coronavirus. With oil prices now expected to average below $40 per barrel this year, the government budget will come under substantial pressure. Against this backdrop, and with tightening restrictions on travel and everyday life, we have slashed our 2020 non-oil growth forecast to 0.7% (from 2.8%).
The oil sector declined by 3.6% in 2019, the worst performance since 2009. But oil GDP will make a positive contribution to growth in 2020, as oil production spikes. We now assume Saudi Arabia will temporarily pump 11.5m b/d in Q2, from under 10m b/d in recent months, and then sustain a production of 11m b/d thereafter, with oil sector growth strengthening to over 8% in 2020. This will boost overall growth to 3.8% this year, representing an improvement on 2019 and the strongest pace since 2015.
But the oil price slump will weigh on public finances – we expect the deficit to widen to 8.6% of GDP this year, despite an estimated 8% cut to expenditure. This could undermine recent progress on the diversification agenda, which is financed through public spending; however, we believe the Public Investment Fund will continue to boost private sector investments to cushion the impact on the non-oil economy.
Non-oil GDP rose by 3.3% in 2019, the fastest rate since 2014. The increase was supported by consumption, buoyed by higher consumer confidence and falling prices, and investment. But the coronavirus outbreak will take a toll on sentiment and activity this year. The latest PMI survey, which fell to its lowest level since April 2018, likely offered a glimpse of what’s to come. While it continued to signal expansion in non-oil manufacturing, it highlighted a slowdown in demand and a drop in business optimism. Latest measures to contain the spread of COVID-19 will dent private sector activity further. Current restrictions include a ban on international travel, closures of schools and events, and a halt to some industrial activity until the end of March. These are bound to derail further non-oil expansion, especially given planned budget cuts. This would also negatively impact non-oil revenue generation, a key metric in the country’s efforts to diversify away from oil.
GCC: Purchasing managers’index
Moderating levels of demand will also reinforce weakness in hiring activity. The unemployment rate among Saudi nationals is the second highest in the GCC at 12.0% (as of Q3 2019) and is considered one of the biggest challenges for the economy. Almost two-thirds of Saudi nationals work in the public sector, while the private sector continues to struggle to create jobs for locals despite new policies of expat levies and expat-dependent fees aimed at encouraging Saudization. The government might be forced to absorb new labour market entrants as the private sector job market falters, which would put a further strain on public finances.
With improved non-oil growth momentum last year, Saudi Arabia has moved out of deflation and prices edged up for a second consecutive month in January. But with consumption and investment decelerating, inflation expectations will also likely slip.
Economy faces pressure from coronavirus
- Strong uplift from the oil sector on the way
- Non-oil sector likely in recession already
- Expo 2020 underpins hope for rebound in H2
The UAE economy looks set to be severely impacted by the coronavirus pandemic. While our 2020 GDP forecast of 2.5% is stronger than in recent years, this is driven entirely by expectations of robust oil sector performance, with the non-oil economy close to stagnation.
We have significantly revised down our forecast for the non-oil economy and we now expect the sector to be in recession in H1. This is partly related to the slump in oil prices but is mainly due to the ramifications of the escalating coronavirus pandemic. For the year as a whole, we now expect non-oil GDP growth to be just 0.1%, down from 2.5% forecast previously.
Although the number of coronavirus cases in the UAE is still limited, the pandemic is taking its toll on activity. Momentum already slowed in H2 2019 and the latest PMI survey data painted a rather sombre picture. In February, the PMI fell to its lowest level since Dubai’s 2009 debt crisis, with output levels contracting. Further sharp declines are unavoidable. Only 39% of respondents in the survey were hopeful that activity would improve over the next year.
The tourism sector, a key pillar of the UAE economy, is looking particularly vulnerable, given the spread of the virus across Europe – the key market for inbound travel and tourism. The industry contributes over 10% of GDP directly and through its impact via the supply chain and spending by employees within the sector. Travel restrictions in place around the world and reluctance to travel from countries where restrictions aren’t in place, means tourist arrivals and hotel occupancy have slumped. In addition, tourist attractions, bars and clubs, and many other activities are closed, with shopping malls empty and operating on reduced opening hours, limiting the scope for domestic visitors to compensate. Most restrictions are scheduled until the end of March/early April but it is hard to imagine them not being extended and the economy grinding to a standstill in Q2. Any extension of restrictions would trigger further downgrades to our forecast. Expo 2020, due to start in late October, has yet to be cancelled, and this remains a big forecast risk.
GCC: Travel and tourism contribution to GDP in 2018
The total economic impact will be offset by an increase in oil production starting in April. Like other regional producers, the UAE has had to abide by OPEC-mandated oil production cuts, which has held back the contribution to growth from the oil sector. But with the OPEC+ deal collapsing, oil output may rise by over 8% this year, the strongest pace since 2011.
The public purse will be temporarily squeezed by the plunge in the oil price, but the UAE’s finances are robust enough to sustain spending during this temporary weakness. The Dubai Government started the year with its largest ever budget, which underlined its commitment to a successful implementation of Expo 2020. The Abu Dhabi Government is also implementing its own stimulus plan announced in H2 2018.
The UAE Central Bank and federal governments have announced additional measures to support the economy through the crisis. Measures from the Central Bank include support for banks through zero-interest collateralised loans and freeing up banks’ capital buffers. The Dubai and Abu Dhabi Governments have announced measures to help businesses with rents, lower utility bills, and accelerating capital investment measures. The policies are aimed to help households and businesses bridge the crisis period and enable them to benefit in the subsequent upswing.
The weakening momentum in the economy will weigh on prices. Inflation remains negative, with the CPI falling 1.9% y/y in 2019. Headline inflation is mostly being dragged down by the weak property market that has resulted in an ongoing decline in rents. While the authorities have taken measures to tackle oversupply, residential sales prices have continued to fall. Market conditions are unlikely to see much of a rebound in the near term given the job market uncertainty and subdued demand. Price pressures in other sectors are also at best lukewarm, so we see another year of deflation in the UAE.
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1 Our Middle East aggregation incorporates Iran, Iraq, Jordan, Lebanon, Saudi Arabia, Syria, Bahrain, Kuwait, Oman, Qatar, UAE, and Yemen.