Download a PDF copy of this week’s insight piece here.
As the world awaits results of the US election, oil prices have settled around the forty-dollar mark. Oil exporters in the region have had to deal with the Covid19 outbreak along with a global recession that have drastically reduced the demand for oil, as well as lower oil prices. Given the resurgence in Covid19 cases and renewed lockdown measures and the global energy transition away from fossil fuels, it is unlikely that oil prices will revert to the levels seen a few years ago, given weaker demand – the IMF’s latest World Economic Outlook puts oil prices, based on futures markets at USD 41.69 in 2020 and USD 46.70 in 2021 (versus an average price of USD 61.39 last year). Fiscal breakeven oil prices in the GCC range between USD 42 for Qatar to USD 104.5 for Oman this year, exerting additional pressure on most oil producers as they ramp up spending to support the economy (UAE’s emirates Dubai and Sharjah announced USD136Mn and USD139Mn respectively in additional stimulus in the last few days).
Oil exporters in the region are still highly dependent on oil revenues, with lower oil revenues implying limited fiscal room and higher fiscal deficits, which are averaging 10% in 2020 for the GCC countries. As real oil prices trend downward, fiscal sustainability becomes increasingly vulnerable.
The latest numbers from Saudi Arabia underscore the need to diversify away from dependence on oil revenues. Saudi Arabia managed to halve its fiscal deficit in Q3 compared to Q2, as overall revenues edged up by 4% yoy, thanks in part to the 63% surge in non-oil revenues (VAT rate was hiked to 15% From Jul onwards); however, spending increased by 7% yoy, driven by a massive surge in subsidies to SAR 8.2bn (From SAR 2.2bn a year ago) brought on by the need to support the economy during the Covid19 outbreak.

 
Among other GCC nations, Oman, in a bid to raise non-oil revenues, announced plans to introduce 5% VAT from next year, in addition to potentially introducing an income tax (currently being studied). Furthermore, costs of expatriates’ employment visa and work permit renewals will be increased by 5%, with a plan to redirect additional funds towards financing its recently initiated Job Security System. Kuwait meanwhile is facing the highest budget deficit in its history[1]. In Aug this year, the national assembly approved a law that makes transfers to the Future Generations Fund dependent on budget surplus, thus providing a much needed[2] but momentary respite. However, the Parliament is still holding the public debt law – which would allow the government to borrow KWD 20bn over 30 years – hostage. Bahrain’s deficit widened by 98% yoy in H1 this year (as oil revenues fell by 35% and overall revenues by 29%), leading it to issue a USD 1bn bond, while receiving a payment from its GCC neighbours (part of a support package approved in 2018).


Rising fiscal deficits following the previous decline in oil prices and lower growth have resulted in an accumulation of debt across all the MENA countries. The rising debt burdens and their servicing, leave limited space for increasing spending at a time when it is needed to support the economies. The IMF revealed that the median size of revenue and expenditure packages in the region’s oil importing countries this year was double that of oil exporters (2% of GDP versus 1% of GDP). For the GCC, adjustment has resulted from a combination of spending cuts, borrowing from commercial banks, tapping international/ regional markets (bond issuances[3], commercial loans) as well as drawing down from international reserves at the central banks and in Oman’s case direct external financial support from Qatar (with talks ongoing with the UAE, reports FT). As for support from sovereign wealth funds, given lack of transparent data, it will be difficult to gauge the actual value of their support/ contribution, but their optimal role would be to: (a) tap into investments abroad (starting with sale of money market instruments like T-bills); (b) re-assess long-term investment strategies to play a larger role domestically in supporting local industries, innovation and developing digital assets.
Faced with a complex situation, it is little wonder that measures to increase non-oil revenue are being introduced – Oman’s plan to introduce VAT in 2021, rise in visa fees and a potential income tax on high income earners and Saudi Arabia’s VAT hike. To achieve and maintain fiscal sustainability in the long-run, oil exporters will need to move away from pro-cyclical policies, rationalise overly generous and unsustainable entitlement programs, alongside revenue-enhancing measures. The policy agenda is full in the coming years!
 
 

 
[1] Kuwait posted a fiscal deficit of KWD 5.64bn in 2019-2020 (ending Mar 2020): this was higher by 69% yoy and inclusive of a KWD 1.72bn (10% of total annual revenues) transfer to the Future Generations Fund.
[2] The finance minister stated in Aug 2020 that the country has just KWD 2bn (USD 6.6bn) worth of liquidity in its Treasury and it was not enough to cover state salaries beyond Oct.
[3] Abu Dhabi issued a USD 5bn multi-tranche bond; Dubai sold USD 2bn in bonds; Saudi Arabia sold USD 7bn in 3-part bonds; Qatar sold USD 10bn in USD-denominated bonds.
 
 

Download a PDF copy of this week’s insight piece here.
FiveThirtyEight, in its extensive analysis and simulations, favours Biden to win the election, barring a major polling error. A contested election is probably on the cards. But, with less than a week left for the US Presidential elections, what would a potential change of guard at the White House mean for the Middle East? Interestingly, a recent YouGov-Arab News survey shows that respondents have little confidence in either candidate: only 12% preferred Trump versus 40% for Biden.
First and foremost is a potential return to multilateralism and international cooperation from the current (unilateralism) policies of withdrawal from the Paris climate accord, the Trans-Pacific Partnership or the World Health Organization or the Iran nuclear deal. International, multilateral cooperation – such as the Global Access (COVAX) Facility – will be critical when effective Covid19 vaccines are available to be rolled out and need to be distributed globally. A discriminatory or preferential national treatment would be detrimental to the global economy and recovery. More broadly, a US reversion to multilateralism would be welcomed internationally: less confrontation on trade/ tariffs and investment policies with China, the EU, Canada-Mexico and others would lead to a win-win globally and would lead to a cheaper dollar by encouraging non-US trade and investment.
Lower oil prices and a strong dollar along with US tariffs on aluminium and steel, have been strong headwinds and costly for the GCC. Currently, GCC members are pegged to the dollar (Kuwait pegs a basket dominated by US$), oil is priced in dollars, financial assets are largely dollar denominated, trade is dollar denominated and dollar financing is popular, while bond issuances have been on the surge (taking advantage of globally low borrowing costs) as nations adjust to rising fiscal deficits. Given the Covid Great Lockdown, the energy transition away from fossil fuels, it is unlikely that oil prices will revert to prices seen a few years ago given weaker demand – the IMF’s latest World Economic Outlook puts oil price, based on futures markets at USD 41.69 in 2020 and USD 46.70 in 2021 (versus an average price of USD 61.39 last year). But a cheaper dollar would support an economic recovery in the region driven by tourism and services exports, as countries reopen in phases.
More important, will be the impact on the oil market. A re-elected Trump administration would continue its policies supporting US shale oil, encourage drilling and roll back of climate-related regulations and support US oil & gas exports, weakening OPEC+ and oil prices. By contrast, a Biden Administration would be climate and environment policy friendly, revert back to the Paris Agreement, support renewable energy, including through “Green” and “Blue” New Deals. In a scenario where fossil fuel demand is already weak, an additional push towards renewables would tend to reduce US supply but also reduce demand, the oil price impact would depend on the balance between demand and supply effects.
Oil exporters in the region are still highly dependent on oil, with lower oil revenues implying limited fiscal room and higher fiscal deficits which are averaging 10% in 2020 for the GCC countries. As real oil prices trend downward, fiscal sustainability becomes increasingly vulnerable. The elephant in the room remains the risk of being left with stranded assets. According to the IEA, stranded assets refer to “those investments which have already been made but which, at some time prior to the end of their economic life, are no longer able to earn an economic return”. The strategy imperative is the need to emphasise diversification policies, along with a policy to de-risk fuel assets. National oil companies and related state-owned enterprises, that are majority owners/ operators of oil and gas assets, would need to pursue a low-carbon energy transition plan in addition to the privatisation of fossil fuel assets. Examples are the Aramco part-privatisation, and ADNOC’s part-pipeline privatisation. This should be complemented by a major drive to accelerate investment in and adoption of green/ clean energy policies by both government entities and the private sector.
The bottom line is that the outcome of the US elections will directly impact a host of global issues from dealing with Covid and climate change, de-escalating confrontation and preventing a Cold War with China, restoring confidence in multilateral agreements and institutions like the WHO, the WTO, the UN and geopolitics, with repercussions on regional power struggles involving Israel, Iran, Turkey and the Gulf states. Important as these issues are, the other bottom line is the need for a renewed focus of the GCC and the regions oil producers on economic diversification strategies and de-risking fossil fuel assets within a well-designed energy transition strategy.
For additional views about this and the wider regional economic outlook, listen to the IMF panel discussion from yesterday.

Download a PDF copy of this week’s economic commentary here.
Fig 1. Global Economic Growth to decline by 4.4% this year, before rebounding to 5.2% in 2021

The IMF’s World Economic Outlook, released in October, forecast upwardly revised growth estimates for most country groups this year though stating that the recovery is “long, uneven and uncertain”. The IMF forecasts still seem relatively optimistic with all regional aggregates indicating a wobbly V-shaped recovery. Emerging markets and China are expected to recover much faster than their advanced counterparts while also noting that the plunge in growth was more severe for the advanced nations. A recovery in trade, PMI numbers and consumer spending are cited as supporting global recovery, though the sudden surge in Covid19 confirmed cases across Europe is likely to dampen the rebound, presaging a second wave and extended recovery.
Germany, Italy, Portugal and UK recently reported their highest number of infections since the start of the pandemic and many nations are reimposing restrictions – Belgium’s nationwide curfew, Switzerland making masks compulsory in indoor public areas, a 9pm curfew at many major cities in France – though a full-fledged lockdown is likely to be avoided. While Q3 may show an uptick in growth, Q4 is likely to slide back into negative territory (though not as sharp as Q2’s plunge). Mobility indicators how a decline in footfall across many European cities (https://on.ft.com/2TmvOkZ); PMI data reveals a divergence between manufacturing and services, with the latter reporting a drop in Sep. As we enter the cold winter months, the partial recovery seen in Q3 may be just temporary.
In the Middle East and North Africa (reeling from the effects of the global recession, Covid19 impact and oil exporters facing lower oil prices and demand), growth is expected to recover a tad later and slower compared to the rest, rising to only 3.2% from a 5.0% dip this year (Source: IMF Regional Economic Outlook: Middle East & Central Asia, Oct 2020). Egypt is the only country in the region forecast to grow this year (+3.5% yoy in spite of the massive decline in tourism). GCC growth is forecast to shrink by 6.0% this year – with oil and non-oil GDP contracting by 6.2% and 5.7% respectively.

A recent uptick in Covid19 cases might add to economic uncertainty in the region – Jordan has reimposed some restrictions since the beginning of the month, but none of the nations have gone back to the stringency levels seen during Mar-Apr 2020. The immediate concerns remain on the fiscal side, with most nations rolling out stimulus packages to ease the impact from Covid19. For the GCC, fiscal deficits are projected at 9.2% of GDP this year (2019: -2%) while the fiscal breakeven oil price ranges from USD 42 for Qatar to USD 75.9 for the UAE and as high as USD 104.5 for Oman. Dependence on oil is still pronounced in spite of diversification efforts and the rising fiscal deficits are being met with a combination of debt issuances, tapping domestic markets, reduction of reserves and via sovereign wealth funds.
Though countries in the Middle East emerged from Covid-19 containment in Q2, the economic costs/ impact are likely to be protracted through the year and next given the many spillover risks: debt obligations and financing needs, job losses/ unemployment, potential NPLs affecting banking sectors, business closures leading to insolvency/ bankruptcy, and for the oil importers decline in remittances as well as rising poverty and inequality. IMF estimates foresee that five years from now countries could be 12% below GDP level expected by pre-crisis trends.
 
 
Powered by:

Download a PDF copy of this week’s economic commentary here.
1.Global PMIs, shipping & trade

PMIs across the globe were released last week. The headline JPMorgan global composite PMI fell for the first time in five months, dipping to 52.1 in Sep (Aug: 52.4). Most manufacturing surveys still indicated an expansion (a reading above 50) though the pace of recovery has slowed as a result of capacity constraints and supply chain delays. Sector-wise, the most significant beneficiary has been the automotive sector, where production capacity increased and new orders posted the most gain since Dec 2019. On the other extreme, tourism and recreation sector continues to be the worst hit – reflecting the glaring divergence between the manufacturing and services sector PMIs (Figure below). September’s PMI readings in the services sector have declined from Aug’s 7-month highs, as many countries witnessed a resurgence in Covid19 cases (and in some, new record daily cases!), leading to restricted lockdowns which added on to the restrictions due to social distancing policies. Employment posted a net increase for the first time since Jan: though jobs growth was faster in the services sector in Aug-Sep, remember that the sector had also seen the steepest job cuts earlier this year.

 
Recent manufacturing PMI readings have shown an increase in new export orders, supported by a pickup in demand. Global shipping indicators have improved during the summer, with both the Baltic Exchange Dry Index (tracks rates for ships carrying dry bulk commodities) and the Harpex shipping index (index created using container shipping rates across different classes of ship) picking up pace. Both indices rose to its highest in more than a year last week, after having touched 3-year highs in mid-2019 and declining sharply during the Feb-Jun period. However, the air freight sector has not recovered in tandem with shipping (Figure below), a result of cheaper ocean trade – a pattern visible during downturns – as well as insufficient air cargo capacity (according to IATA).

2. Regional PMIs

 
Regional non-oil private sector PMI’s indicate a slow restart: Sep’s modest improvement followed Aug when four of the countries moved into the contractionary territory (i.e. below the 50-mark). Significantly, demand growth has been picking up and the significant price discounting on offer has led to an increase in sales.
Job cuts are still occurring, as businesses adjust to reduce operating costs. The ILO estimates that Arab states witnessed a 2.3% drop in working hour losses in Q1 this year, followed by 16.9% and 12.4% respectively in Q2 and Q3. Job postings are slowly ticking up, though anecdotal evidence suggests that potential employees are willing to accept a significant pay cut to undertake similar work. This will lead to a wider disparity in public-private sector wages, not to mention the impact it would have on wider gender disparities (during Covid19, women are already more likely than men to witness a larger drop in mobility to lose jobs in the informal economy or see a reduction in working time).
Furthermore, with lack of access to finance/ liquidity, not all businesses will recover or survive in the next few months, should uncertainty remain. This could result in a structural change bought about due to Covid19 (e.g. the increase in number of online shopping platforms which are relatively less labour-intensive versus actual physical stores). Being faced with limited financial capabilities (due to job losses or salary cuts and depletion of savings), expatriates could also decide to return to their home countries (negatively affecting consumer spending in the region).
3. Stringency Index vs. Retail and Recreation sector activity
The Middle East has seen a resurgence in Covid19 cases in the recent weeks, and many nations are in the process of reimposing partial lockdowns or shorter nationwide lockdowns: the first panel in the figure below shows that the Government Response Stringency Index[1] has increased for the UAE in the past month (in line with the increase in cases). This is the best way forward, if we are to take into consideration the IMF’s recent World Economic Outlook analysis which found that early adoption of stringent and short-lived lockdowns curbed infections and could be preferable to mild and prolonged measures. The enforcement of lockdowns and social distancing policies was an important factor contributing to a recession: however, such short-term costs of lockdowns may lead to medium-term gains if the virus is contained.

Google Mobility indicator for retail and recreation show that none of the three nations – Bahrain, Egypt, or UAE – have yet returned fully to the pre-Covid19 baseline. Among the three, Egypt, which had declined the most initially, recovered faster in comparison. More interestingly, within the UAE, recovery in retail sector mobility in Sharjah (-14% from baseline in Oct) and Abu Dhabi (-21% from baseline) has outpaced Dubai (-23%). This could potentially be due to higher confidence in these emirates – given mass testing in Sharjah, border controls in Abu Dhabi and a relatively longer lockdown period – compared to Dubai.
What next? Note that a second (or even third) wave  of Covid19 is unfolding, as we enter the cold winter months: given the likelihood of resurgence of Covid19, partial recovery – as indicated by PMIs – may be temporary. If further virus containment measures are introduced, though it will dampen economic activity in the short-term, medium-term gains might be achieved. Initial restrictions will likely affect the customer-facing service sectors more than others, but risks to other sectors will increase if further restrictions are imposed. Overall, an air of uncertainty is unlikely to boost confidence among firms, negatively affecting investment decisions and economic activity. Governments need to signal willingness to continue stimulus measures if required and take decisions to introduce “circuit-breakers” if necessary.
 
[1] The Stringency Index is a composite measure based on nine response indicators that include school closures, workplace closures, and travel bans; the index ranges from 0 to 100 with 100 being the strictest. This index does not track the effectiveness of the response. More: https://www.bsg.ox.ac.uk/research/research-projects/coronavirus-government-response-tracker
Powered by:

Charts of the Week: Last week, both Bahrain and Saudi Arabia released Q2 GDP numbers: as expected, overall growth contracted, with private sector activity significantly affected. The initial sections offers a forward-looking perspective on the two nations based on more recent data and proxy indicators. Saudi Arabia also disclosed a medium-term fiscal strategy, which forms the last section of this Insights’ edition.

1. Bahrain GDP & economic activity

GDP in Bahrain declined by 8.9% yoy in Q2 2020, following a 1.1% drop the previous quarter. This was primarily due to the non-oil sector which plummeted by 11.5%. As expected, the largest dips in GDP came from the hotels and restaurants (-61.3%) and transport & communication (-47.4%) – both directly affected by the Covid19 outbreak. Spillover effects were also visible across the board: the financial sector, which accounts for the largest share of non-oil GDP (16.8% in Q2), posted a 5.8% drop while the sub-sectors real estate and business activities and construction slipped by 7.9% and 2.1% respectively.

With Covid19-related restrictions slowly being phased out in Bahrain, can we expect a resumption of economic activity? The data for Jul-Aug show the pace of recovery has been slow, with readings for retail and recreation still at an average 26% below the baseline data (pre-Covid19). Recent announcements of extended government support – be it the exemption of tourism levies for 3 more months or extended support to KG & nursery teachers, taxi drivers or Bahraini citizens’ payment of utility bills and about 50% of salaries in the private sector (only those affected) – will provide direct support and likely nudge recovery. hotel occupancy rates in four- and five-star hotels increased by 13.3% mom and 17.6% in Jul and Aug respectively. Opening borders with Saudi Arabia will not only increase the number of trucks crossing the King Fahd Causeway (improving transport/ trade) but will also attract visitors from Saudi Arabia (supporting hospitality and retail).

2. Saudi Arabia GDP & economic activity

Saudi Arabia’s overall GDP plunged by 7% yoy in Q2 2020, with falls in both the oil and non-oil sectors. The oil sector’s 4.9% drop in H1 is a result of the reduction in oil production in line with the OPEC+ agreement. Within the non-oil sector, all sub-sectors posted declines in Q2 ranging from trade and hospitality (-18.3%) to finance, insurance and real estate (-0.7%). The share of GDP by economic activity shows that the oil sector continues to dominate (45% of overall GDP), closely followed by manufacturing (13%) and trade and hospitality (9%).

To gauge any underlying change in activity during Q3, we refer to the central bank’s data on consumer spending and point-of-sale (PoS) transactions by category. There is a spike before the VAT hike came into place in Jul, as expected, but the Aug data seems to indicate a slight recovery for hotels (+2.6% yoy, following 6 months of double-digit declines) while items like jewelry and clothing continue to register negative growth. The construction and real estate sector look well-placed to improve in H2 this year: not only has letters of credit opened for building materials imports increased by 64% yoy in Aug (following 5 months of double-digit declines), cement sales has also been picking up during Jun-Aug; a temporary boost for the sector will also come from the recent announcement that real estate would be exempt from the 15% VAT (to be replaced instead by a 5% tax on transactions, of which the government would bear the costs for up to SAR 1mn for the purchase of first homes).

3. Saudi Arabia’s fiscal space

With oil prices around the USD 40-mark, extended government support in Saudi Arabia during the Covid19 outbreak will put a strain on finances. From the H1 2020 estimates disclosed by the Ministry of Finance, it is noticeable that the share of taxes as % of overall revenue has declined to 18% (H1 2019: 23%). Compensation of employees remain the biggest strain on the expenditure side, with the single component accounting for 53% share, though it is commendable that subsidies have declined by 27.8% yoy to SAR 13bn.

If Saudi Arabia’s fiscal consolidation plans are to be met, reforms are required on both revenue and expenditure side. The Kingdom has already increased VAT to 15% from Jul: however, with subdued demand and consumer spending, it seems unlikely that this move will add substantial revenue this year. We have highlighted in previous editions that Saudi Arabia can benefit from the introduction of other more revenue-generating taxes – e.g. carbon taxes, which will also contribute towards a cleaner environment. Additional measures could include energy price reforms (thereby reducing subsidies) as well as a consolidation or removal/ reduction of various small fees and taxes after undertaking an impact exercise (i.e. do these fees raise significant revenues or do they hinder development of the related sector?). The other major route to take is lowering “compensation of employees”: this can be done either by reducing the public sector workforce (and increasing productivity through increased digitalization) or by decreasing wages (and synchronizing public holidays) to be on-par with the private sector – these moves could also support creation of jobs in the private sector, lead to higher productivity levels and growth.

Powered by: