Economic Update: Middle East
The ICAEW Economic Update: Middle East, is a quarterly economic forecast for the region prepared directly for the finance profession.
Economic Update: Easing of COVID-19 restrictions sets the stage for economic rebound
- Economies have turned a corner with recovery accelerating in H2
- Saudi Arabia: Domestic investment will underpin recovery
- Kuwait: Budget constraints weigh on growth outlook
Economic re-opening bodes well for activity in H2
- Relaxation of restrictions will trigger a stronger rebound in activity
- Oil producers begin to wind down production cuts as outlook for global demand brightens
- It looks increasingly likely that Iran oil sanctions will be lifted
The Middle East continues to face challenges posed by the COVID-19 pandemic, with many virus-related restrictions remaining in place, but there are increasing signs that an economic recovery is underway. The global demand picture has continued to improve, supporting the outlook for oil prices and trade. Business sentiment has strengthened in the past few months and vaccination programmes are progressing, albeit unevenly. The economy still has a lot of ground to make up before it reaches its pre-pandemic level, but we remain relatively upbeat about the pace of recovery in H2 and beyond. We now expect regional GDP to grow by 2.4% this year, only 0.1pp lower than we projected three months ago and similar to the average growth trajectory in the last decade. We estimate the economy shrank by 4.4% in 2020.
The GCC region is also taking time to heal. Oil production cuts are weighing on output and new outbreaks have forced tighter lockdown measures in recent weeks, disrupting the recovery process. However, strong PMI readings, where available, support our view of growth accelerating in the coming months, boosted by rapid vaccine roll-outs in several countries that will help domestic activity move back towards normality. Against this backdrop, the region’s economies are in a good position to capitalise on pent-up demand for travel when the rest of the world opens up. Preparation for various regional events, such as Expo in the UAE and World Cup 2022 in Qatar, an easing of regional tensions and spending by the Saudi Public Investment Fund (PIF) will also support growth. Overall, we believe the GCC GDP will grow by 2.1% this year (up 0.5pp compared to three months ago), after the 5% contraction in 2020.
Middle East: Real GDP in 2021
Although global COVID-19 cases are still high and new outbreaks are possible, the pandemic looks to be under control in China, Europe and the US and with the summer tourist season approaching, oil demand is trending up. This, alongside ongoing supply restraint by OPEC+ producers, has stabilised the oil price at above US$65pb. The potential production boost from Iran suggests the oil rally is likely behind us but we have raised our forecast for Brent crude to US$64.4pb in 2021 (from $62 previously). Given the continuously fragile demand outlook and plentiful scope for stronger supply growth, the upside for oil prices remains limited through 2022 and 2023. We forecast Brent to average US$61pb during that period.
The rise in the oil price has boosted revenue prospects for GCC producers, which derive 40-90% of total fiscal income from oil. Higher oil revenue gives governments more scope to support post-pandemic recoveries without undermining efforts aimed at improving medium-term fiscal sustainability. Higher budget spending would potentially result in faster expansion in GCC non-oil activity this year than the 3% we currently expect. It would also be consistent with medium-term policies, such as Saudi Vision 2030, geared towards increasing the share of non-oil revenue in regional budgets and lowering susceptibility of economic growth to fluctuations in the oil price.
Given the high reliance on the oil sector for growth (both direct and indirect) and vulnerability to rising temperatures, climate change is also an increasingly important issue in the GCC region and is receiving a sharper focus in diversification plans in countries such as Saudi Arabia and the UAE. Saudi Arabia’s green initiative, for instance, aims to cut CO2 emissions in the Middle East by 60% by 2030 and generate half of the country’s electricity from renewables in the same period. With many sectors, including much of industry and even travel and tourism, relatively oil-intensive, the authorities recognise they can’t continue business as usual as they will be exposed to policies to tackle climate change such as carbon taxation and border carbon adjustments.
We see a sizeable upside for growth prospects in Iran from the potential return to the Joint Comprehensive Plan of Action (JCPOA) and the lifting of sanctions. Although the economy would only regain its pre-sanctions size in 2023 at the earliest, an increase in oil exports would raise GDP growth considerably over the next few years, with a positive impact felt both in the oil and non-oil sectors. The recovery is lagging in some countries, however. Lebanon has made no progress in tackling its deep economic crisis over the past three months. Government formation remains deadlocked and the population is struggling to cope with soaring inflation, fuel shortages and progressively longer power cuts. Reduced access to subsidised goods will also exacerbate the distress. We still expect GDP to fall by 5.3% in 2021, with risks heavily on the downside, following an estimated 25% plunge last year. Finally, in Iraq, short-term growth prospects remain subdued, though an upturn in oil production should provide some fiscal relief.
Saudi Arabia: Domestic investment will boost recovery
- Strengthening domestic and global demand support business confidence
- Domestic investment will be central to economic recovery in the next few years
- The investment drive will help generate employment, consistent with Vision 2030 targets
Business conditions are improving in Saudi Arabia, as demand strengthens, supporting the outlook for recovery - we forecast GDP to expand by 2.4% this year. Non-oil GDP has regained its pre-pandemic level and will continue to rebound amid the gradual lifting of restrictions and aggressive investment strategy. Meanwhile, we expect the hydrocarbon sector to benefit from higher oil production in H2. Saudi GDP fell by 4.1% in 2020, the worst performance in over three decades.
Although concerns surrounding possible future COVID-19 outbreaks weigh on business optimism, activity indicators suggest growth is gaining momentum. Indeed, the headline PMI rose to 55.2 in April (the 50-mark separates expansion from contraction), the highest reading since January. Consequently, we have raised our 2021 non-oil GDP forecast to 2.8% (up from 2.4% three months ago). Higher retail and recreation activity levels should extend the improvement in employment metrics.
Domestic investment spending aimed at advancing the realisation of Vision 2030, the ambitious reform plan to transform the Saudi economy, will be a key driver of non-oil growth recovery this year and beyond. In the face of weak inflows of foreign direct investment, the authorities have unveiled a broad investment programme (Shareek) valued at SAR 12 trillion ($3.1bn) by 2030. The programme will be led by domestic entities including the Public Investment Fund, which is set to inject $40bn annually in 2021-22 to foster private-sector growth, oil company Aramco and petrochemical firm SABIC. We expect the share of non-oil GDP to rise from 58.8% in 2019 to 62.2% by 2030, in line with the official ambition.
Five years on from the announcement of Vision 2030, the economy has made mixed progress towards meeting the main economic targets around diversification, unemployment and building local content. This is unsurprising given the ambitious targets and repercussions of COVID-19. However, the Saudi authorities have made significant business and social reforms, implementing business-friendly measures that have propelled Saudi Arabia up in the rankings such as the World Bank’s Ease of Doing Business, and over the past year plans for mega-projects such as Neom have started to emerge.
GCC: Ease of Doing Business
Recent dynamics in the labour market show more women are entering the workforce. This suggests actions being taken to meet Vision 2030 targets for female participation in the workforce are also beginning to work. The unemployment rate among Saudis fell to 12.6% in Q4 2020, from 14.9% in Q3, with recovery supporting business sentiment and helping to create more jobs. We expect job creation to pick up in H2 this year alongside economic activity, with investment spending to boost jobs for locals taking pressure off the already-bloated public sector. However, the rising cost of living due to higher VAT, the ongoing pursuit of workforce nationalisation and travel uncertainty may undermine the appeal for expatriate workers. Indeed, the number of expats continued to fall at the end of 2020.
The recent easing of travel restrictions imposed at the onset of the pandemic should slow the outflow of migrants and provide a further boost to the tourism sector that makes up just under 15% of non-oil GDP. That said, the Kingdom has, for now, maintained a travel ban on numerous countries, with those on tourist visas still unable to enter.
The rise in the oil price this year will boost government funds despite a fall in oil production as part of the OPEC+ agreement. The government relies on oil sales for about half of fiscal revenues despite moves towards diversification including introducing (and then hiking) VAT. However, fiscal diversification measures are feeding through to non-oil revenues with a hefty 75% increase in tax income boosting non-oil revenue by 39% y/y in Q1 2021. The fiscal deficit is set to fall sharply to 1.5% of GDP, the best outcome since 2013, from 11.2% in 2020 when the COVID-19 pandemic cut oil prices.
Headline inflation remains elevated following the tripling of VAT in July 2020. Food inflation has stabilised, while lower migrant demand has dampened housing costs. Notwithstanding the positive growth momentum from the domestic economic recovery, price growth will drop in H2 as tax base effects take hold; we forecast average inflation at 4.1% this year.
KSA: No of employed expats and housing index
Kuwait: Budget constraints weigh on growth outlook
- Non-oil sectors are slowly reopening but output will not regain its pre-pandemic level until 2022
- Oil output will rise only marginally this year
- Ongoing tensions between the government and parliament bode poorly for reform outlook this year
Kuwait’s economic prospects are slowly improving, as it benefits from higher oil prices, though deep oil production cuts set by OPEC+ and the persistence of the pandemic are weighing on the pace of recovery. Our 2021 GDP growth forecast stands at 2.6%, expected to be driven by non-oil sector expansion. We estimate the economy contracted by 8.1% in 2020, the deepest decline since the 1991 war and the worst performance in the GCC region.
Oil output will rise only marginally this year, limiting growth in the oil sector (about 50% of GDP) to just 0.9% and thus hampering recovery in the economy more broadly until the OPEC+ agreement expires in April 2022. The non-oil GDP is gradually regaining lost ground but is unlikely to return to its pre-pandemic level until 2022. The recent end to curfew should allow more businesses to reopen, with indoor dining resuming as well, which should boost household spending further. Nonetheless, many activities remain off limits, including in-person teaching, which is not expected to restart until September, highlighting ongoing challenges to business activity posed by the pandemic. We forecast non-oil growth of 3.1% and 4.7% in 2021 and 2022, respectively.
Moreover, the vaccine roll-out in Kuwait has accelerated recently but lags many of its neighbours, with only around 27% of the population having received at least one jab, undermining consumer and business confidence in the recovery.
The recent decision to ban travel for unvaccinated citizens and their immediate relatives should encourage the uptake of the vaccine among locals and offering optimism for herd immunity before year-end. However, with entry still banned for non-locals, businesses may hit a bottleneck in hiring from abroad as domestic restrictions ease and hiring picks up. Kuwait’s expat population is reported to have dropped by 4% in 2020 as the pandemic hit hiring activity in key sectors, especially construction, real estate and manufacturing and we do not expect a significant rebound in the near-term.
COVID-19: Vaccination doses (per 100 people)
Additionally, Kuwait is adopting increasingly nationalistic immigration policies, with the government aiming to reduce the share of expat population to 30% from the current 65%. Such an approach will weigh on recovery and diversification, limiting both actual and potential growth. This is in stark contrast to the policies and reforms introduced by the UAE and Qatar, which are embracing foreign contribution to growth.
Budget constraints are also weighing on the growth environment. Kuwait’s revenue base remains heavily dominated by the oil sector, with oil receipts accounting for almost 90% of overall revenues in 2019. Progress on diversification and boosting non-oil revenues remains stagnant despite the government committing to reforms after the oil price shock of 2014-15. Perhaps of more concern is bloated government spending, with a ballooning ‘cradle-to-grave’ welfare state and the large state sector allowing for little short-term flexibility in reducing expenditure in line with shocks to revenues.
The twin shock of the coronavirus pandemic and low oil prices put extra pressure on an already strained government balance sheet in 2020. We estimate the budget deficit widened to almost 29% of GDP, one of the widest globally, as oil receipts plummeted by over 32%. The recovery in oil prices closer to Kuwait’s budget breakeven levels should support budget receipts and narrow the gap this year, but the balance will remain in deep deficit of about 16% of GDP.
Kuwait has ample savings estimated at around 435% of GDP but they are legally earmarked for future use and are inaccessible to meet current needs. As a result, in a matter of months, the government may face a shortage of cash to pay wages and salaries, which alone account for around 75% of total government spending. The government has dragged its heels on curbing spending while the parliament has blocked reform to current laws, including tax reform, such as VAT, impeding government efforts to tackle budget financing pressures, hampering capex spending and support for the economy.
At the core of the problem is Kuwait’s inability to borrow after its debt law expired in 2017. Our baseline forecast for this year assumes the government will eventually manage to reach consensus with the legislators on how to reform the law. If, how and when the government tackles the debt legislation crisis will dictate the extent to which Kuwait can stimulate the recovery this year and beyond.
Rising food prices have pushed annual inflation above 3% this year, but demand-side pressures remain contained with services inflation falling. This will limit average inflation to 2.6% this year.
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1 Our Middle East aggregation incorporates Iran, Iraq, Jordan, Lebanon, Saudi Arabia, Syria, Bahrain, Kuwait, Oman, Qatar, UAE, and Yemen.