Economic Update: Middle East
The ICAEW Economic Update: Middle East, is a quarterly economic forecast for the region prepared directly for the finance profession.
- Despite major economic diversification efforts, oil continues to dominate and shape the macroeconomic outlook for Middle Eastern economies. With elevated oil production levels and notably higher oil prices compared to last year, the ME economy is forecast to rebound from an eight-year low of 0.9% in 2017 to 2.3% in 2018 – though growth remains below the 2010-2016 average of 3.9%.
- UAE’s economy continues to recover from last year’s slowdown, supported by rising oil prices, markedly higher public spending and investment and regional economic recovery. Real GDP is expected to rebound from 0.8% in 2017, an eight-year low, to 2% in 2018. Despite strengthening domestic activity, the property market remains weak and job creation is still quite modest.
- Oman’s economy is recovering from a contraction in 2017, with GDP growth seen at 3.6% in 2018, underpinned by an easing in oil output cuts and a significant boost from gas production. The pace of expansion will then slow to 2.9% in 2019. The upturn in oil prices is fostering higher spending but also facilitating a narrowing in twin deficits, even as they remain large. Gross debt accumulation will continue, pushing debt/GDP ratio above 50% this year.
Economic recovery in the Middle East is slowly gathering momentum after last year’s slump, when economic growth slowed to an eight-year low at only 0.9%. The slowdown in 2017 was caused mainly by generally low oil price environment, voluntary oil production cuts as outlined by the OPEC-plus mandate to push crude prices up, which limited oil sector growth, and various fiscal consolidation measures that weighed on non-oil sector growth.
The same factors are now contributing to the overall economic recovery: oil prices have hit their highest levels since the end of November 2014 in recent weeks at more than US$80pb, oil production has been elevated in the GCC compared to last year, notably in Saudi, to make up for output losses from Venezuela and Iran due to US sanctions, and the fiscal stance has been expansionary in 2018 across the GCC – in contrast to 2017.
GCC: Oil Production Vs Oil Price
The oil sector continues to play a key role in shaping the overall macroeconomic outlook in the Middle East, despite major efforts to diversify the economies and reduce the reliance on oil. Oil production in the GCC in the first five months of 2018 was in line with levels seen in 2017. However, mounting price pressures, evident by Brent price exceeding US$80pb, have led to an easing of the OPEC-plus supply cuts, with the overall oil production rising by 0.9m b/d in the GCC alone, from 17.0m b/d in Q1 2018 to 17.9m b/d in Q3 2018.
The GCC governments as a result are expected to benefit from a combination of higher oil prices and elevated oil production levels, contributing positively to oil sector growth, fiscal and external balances. We expect Brent price to average US$80pb in Q4 2018, retreating slightly to US$76.5pb in 2019.
Meanwhile indicators for the non-oil sector are also showing positive signs after a slow start in 2018. The PMI index, which measures the health of the non-oil private sector, slumped amid the introduction of the 5% VAT in Saudi and UAE in January, but recovered thereafter and remains in expansionary territory. Credit to the private sector, which measures bank lending to the private sector and a proxy of domestic economic activity, has accelerated in the top 3 GCC economies (Saudi, UAE and Qatar) in Q2 2018.
Credit to the private sector in Saudi was mostly in negative territory last yearand in Q1 2018, but has steadily trended up this year, reaching 1% y/y in August, a 19-month high. While in the UAE and Qatar, the indicator has accelerated from 1.5% and 7.4% in Q1 2018 to 2.3% and 10.4% in Q2 2018, respectively, reflecting the gradual strengthening in private sector activity.
Economic activity in the UAE is set to accelerate to 2% this year, up from the eight-year low of 0.8% in 2017, supported by rising oil prices, regional economic recovery, higher public spending and investment and a gradual build-up in business momentum.
Oil activity in H1 2018 remained subdued due to pre-scheduled maintenance and the OPEC-plus agreement, but production has gradually picked up in Q3 and is expected to remain elevated in Q4 this year. Also, the non-oil activity continues to show signs of acceleration, as evident by the latest official data by the Central Bank of UAE.
UAE: Real GDP
The oil sector is expected to remain a drag on growth in 2018, as overall production has remained limited in H1 2018 at an average of 2.85m b/d, down by almost 2% from the average of 2.91m b/d in H1 2017. The decline in production was primarily due to pre-scheduled maintenance in the oil fields in the UAE earlier this year, and comparatively stricter compliance by the UAE authorities with the OPEC-plus agreement in 2018 compared to last year. However, oil production increased in Q3 2018 by nearly 0.14m b/d to 2.99m b/d, higher than the 2.85m b/d seen in H1 2018, due to tighter global oil market conditions as countries brace for the effects of US sanctions against Iran.
Oil production is expected to pick up further by the year end, subject to market conditions, as the UAE continues to expand its production capacity to 3.5m b/d by the end of this year. Overall, despite the recent acceleration in oil activity, we see the sector declining slightly by 0.3% in 2018.
Recent data by the Central Bank of UAE for the non-oil sector, which represents close to 70% of UAE’s economy, confirm that the economy has been recovering from last year’s slowdown. Non-oil activity, as evident by the Central Bank's non-oil augmented economic composite indicator, has accelerated by 3.8% y/y in Q1 2018, marking the fastest expansion in eight quarters, before decelerating marginally to 3.6% in Q2 2018.
The expansion rates compare favourably to the levels seen in Q1 and Q2 2017 at 0.8% and 2.4% respectively, reinforcing the story of strengthening domestic economic activity this year. Indeed, we see the non-oil sector growing by 3% in 2018, up from 2.5% in 2017.
Other proxy indicators also paint a similarly positive picture. The PMI index, which measures the overall health of the non-oil economy, has remained in expansionary territory this year, while Credit to the private sector continued to trend upwards over the last few months, reaching a 19-month high in August at 5.4%.
Going into next year, we see further acceleration in the non-oil sector to 3.6%. The UAE government has recently announced additional reforms to support the economy, dubbed Ghadan 21 (or Tomorrow 21), entailing a AED50bn (US$13.6bn) stimulus plan that includes various measures to prop up investment and facilitate doing business in the country. Economic reforms will also be complimented by the recent approval of the largest federal budget in the country's history, of AED60bn (US$16.3bn), with more than half allocated to education and social development.
On the downside, however, the real estate market is yet to recover. Residential sales prices in Dubai fell by 2% y/y in September, while Abu Dhabi saw a sharper 9.3% drop. Strong supply growth in housing, a soft jobs market and subdued demand were the main reasons behind the decline.
In addition, job creation in the UAE has been quite modest this year as judged by the Emirates NBD employment index – in fact it turned into negative territory in August and September 2018, indicating a decline in jobs. But as the overall macroeconomic conditions continue to improve, the pace of job creation should gradually pick up.
The outlook remains for an improvement in 2018, underpinned by an easing in oil output cuts and ramp-up in gas production, which both facilitate an increase in government spending. But weak domestic demand continues to weigh on non-oil activity and despite stronger hydrocarbon activity, poses a downside risk to our 3.6% GDP growth forecast for 2018, while we still see the overall pace of expansion slowing to 2.9% in 2019.
Oman’s economic fortunes remain largely tied to the oil sector and government spending. Recent data releases show Oman’s real GDP shrank by 0.9% in 2017 (we forecast a 0.2% expansion), after downwardly revised growth of 5% in 2016, amid a decline in oil production and fiscal retrenchment. Meanwhile nominal GDP growth was revised down to 7.3% in 2017 (from 8.7%), which followed a deeper than previously estimated contraction of almost 7% in 2016.
Oman: Real GDP
Despite being a non-OPEC country, Oman has adhered to OPEC production cuts’ agreement, reducing supply by about 50,000 b/d(around 3.3%). Oil production has only just begun to climb back – it rose to 990k b/d in September – the highest level since the country cut output in January 2017.
Combined with higher oil prices, which we forecast will average US$74pb and US76.5pb in 2018 and 2019, respectively, the strengthening in the hydrocarbon output is helping to cut the fiscal and current account deficits. Although balance of payments data is only reported annually, we see the current account deficit narrowing sharply to about 4% of GDP this year from over 15% in 2017.
This is particularly true as the Khazzan field, which began operating in September 2017 and is now operating at full capacity (1bn cf/day), provides a key support to the 2018 oil sector recovery and government receipts. Together with the LNG contract with Singapore, stronger gas output is also bolstering export revenues. Going forward, the development of Ghazeer, the second phase of the Khazzan project, will allow a further increase in gas output (of 0.5bn cf/day), keeping the economy growing around 3% in 2019-21.
The turnaround in the oil price has facilitated an increase in spending, alleviating some pressure on activity. Nonetheless, with oil output rising only modestly so far, the space for government stimulus remains constrained in the context of still significant fiscal imbalances.
Our oil price forecast has come down modestly since our July update and while the upturn in oil prices this year has facilitated a 37% narrowing in the January-July budget deficit compared to the same period in 2017, we see the gap at a still wide 6.5% of GDP in 2018 as a whole (OMR 1.9bn), albeit down from 13.8% of GDP in 2017.
Moreover, despite a 25% year-to-date increase in budget revenue, the government continues to borrow to finance spending as evident by its US$1.5bn issue in Islamic bond (known also as Sukuk), which is the second this year, following the US$6.5bn sovereign bond issue in January.
This will reinforce the fast pace of debt accumulation, lifting the debt-to-GDP ratio to over 50% of GDP this year and maintaining the risk of further credit rating downgrades. Meanwhile, FX reserves have continued to decline, to US$14.5bn, the lowest level since early 2013.
With the oil sector in long-term decline, the authorities are taking steps to strengthen the non-oil sector, with manufacturing, transport, logistics and tourism benefitting from a rise in investment. However, weak domestic demand continues to weigh on the outlook.
Tourism arrivals are declining and revenues slowing, the value of traded properties was 5.7% lower in January-August compared to a year earlier, while vehicle registrations plunged by 27% y/y in the same period.
Notwithstanding the 26% rise in spending on subsidies and grants in the first seven months of this year, household spending power remains under pressure, however, particularly for low-income earners. The introduction of Value Added Tax on the horizon implies purchasing power will remain constrained in 2019, as inflation rises to 2.7% y/y, from a projected 1.1% this year. Moreover, private sector credit growth has slowed in recent months, even as lending rates have remained stable, posing a further headwind to spending in the coming months.
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1 Our Middle East aggregation incorporates Iran, Iraq, Jordan, Lebanon, Saudi Arabia, Syria, Bahrain, Kuwait, Oman, Qatar, UAE, and Yemen.