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Welcome to the latest edition of ICAEW’s Economic
Insight: Middle East, the quarterly economic forecast
prepared directly for the finance profession. Produced
by Oxford Economics, ICAEW’s partner and one of the
world’s foremost independent global advisory firms, it
provides a unique perspective on the prospects for the
Middle East as a whole and for the region’s individual
countries. We focus on the Middle East as being the Gulf
Cooperation Council (GCC) member countries (United
Arab Emirates [UAE], Bahrain, Saudi Arabia, Oman, Qatar
and Kuwait), plus Egypt, Iran, Iraq, Jordan and Lebanon,
abbreviated to GCC+5.
Growth in an era of weak oil demand
In this issue of Economic Insight: Middle East, we discuss
the fallout from the accelerated decline in oil prices in
recent months, as well as the potentially transformational
impact of the lifting of sanctions on the Iranian economy.
In summary, we find that:
• With no sign of a change in the Organisation of Petrol
Exporting Countries (OPEC) oil market policy and
increasing concerns over growth in China and other
emerging markets, oil prices are set to remain lower for
longer. Brent is seen below $70 per barrel (pb) for the
rest of the decade (see figure 1).
• Growth in the oil-exporting GCC region is showing
increasing signs of strain as liquidity conditions tighten
and governments get serious about fiscal austerity.
Recession may be avoided, but non-oil growth will be
its weakest this year since the early 1990s.
• The lifting of sanctions on Iran following
‘implementation day’ in January promises a sharp
acceleration in Iranian growth this year. However, it
will also add pressure to an already oversupplied oil
market and the regional implications of a resurgent
Iran are extremely uncertain.
• With little resolution expected to political discord
and various insurgencies in the region, activity will be
dampened by the needs of refugees, stifled tourism
and diminished investor confidence.
ICAEW Economic
Insight: Middle East
Quarterly briefing Q1 2016
BUSINESS WITH CONFIDENCE
No sign of end to oil market weakness
The drop in oil prices gathered dramatic momentum
in the final stages of 2015 and in early 2016, dashing
oil exporters’ hopes of a swift reversal from last year’s
weakness. Having already fallen some 43% to $52 pb in
the year to mid-October, the price of Brent crude then
underwent an even more intense decline, plunging by
a further 45% to just $28 pb in mid-January. Oil is now
cheaper than financial crisis lows, leaving many observers
unsure of exactly when or at what level a new bottom
might be reached.
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Figure 1: Brent crude oil prices
$ per barrel
140
120
Oxford Economics
forecast
100
80
60
40
Figure 2: Middle East countries’ real GDP
20
0
2005
Iraq, Libya, Syria and Yemen. In particular, low oil prices
will erode existing policy buffers in oil-rich Gulf countries
more rapidly, threaten to undermine long-standing
currency pegs and slow economic growth further as trade,
investment and capital flows fall back. Although recession
should still be avoided, growth across the Middle East
region is now expected at just 2.6% this year (elevated by
rebounds in Iran and Iraq). In the GCC, growth will be just
2.1% – its lowest since the financial crisis (see figure 2).
% y/y
5
2007
2009
2011
2013
2015
2017
2019
4
Source: Oxford Economics/Haver Analytics
3
• The nuclear deal with Iran and lifting of international
sanctions in January 2016 has opened the way for
an increase in sidelined Iranian oil in an already
fully-supplied market, with more to come if Iranian
production is ramped up over the medium term.
• The start of interest rate hikes by the US Federal Reserve
in December – with two further increases forecast
through 2016 – has provided continued support for
the US dollar. The stronger dollar raises the domestic
currency of oil for the rest of the world, and as such
weakens demand and dollar prices.
One thing that could change the near-term outlook for oil
prices would be a shift in OPEC’s year-and-a-half old policy
of keeping oil production high in order to maintain its
market share and squeeze higher-cost producers out of the
market. Although OPEC’s December meeting confirmed
major disagreements within the organisation over the
current policy, with some producers arguing for production
cuts to support prices, there appears to be little prospect
of a change in the Saudi-led plan anytime soon. While oil
prices may have fallen much further than some members
would have anticipated, the strategy’s proponents may
now feel that there is little alternative but to hunker down
and give it more time to work.
Overall, therefore, we remain bearish about the mediumterm outlook for the global oil market. Given existing
stock levels, modest demand growth, relatively resilient
non-OPEC supply and a continuation of current OPEC
policy, we think that the oil market will return to balance at
2017 at the earliest, implying a prolonged period of price
weakness. Brent crude is expected to average $32 pb this
year and remain below $70 for the rest of this decade.
Middle East growth faces mounting challenges
Weaker oil prices present a serious challenge to the growth
outlook for the Middle East, which was already facing
concerns over fiscal sustainability, as well as headwinds
from structural economic weaknesses including low
productivity, stifling government bureaucracy and of
course, rising and deepening social and military conflict in
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1
0
2012–15
2016
Iran
Lebanon
Kuwait
Egypt
Jordan
Iraq
Saudi Arabia
Bahrain
-1
Oman
• Global crude and oil product stock piles have ballooned
and show no sign of falling back. According to the
International Energy Agency (IEA), a notional 1bn barrels
of oil were added to global inventories over 2014-2015,
with further increases expected in 2016.
2
Qatar
• Economic data from China suggest increasing problems
with overcapacity, further undermining expectations
over likely resource demand growth.
UAE
At least four factors appear to have caused the renewed fall.
2017
Source: Oxford Economics
True economic diversification remains elusive
There has undoubtedly been some progress in
diversification of GCC economies; however, true economic
diversification away from a heavy dependence on oil
exports is yet to be achieved. Strong growth in oil revenues
in 2003–2014 fuelled large, signature investments in the
region and rapid growth in sectors such as construction,
trade, tourism, real estate and business services. Non-oil
GDP growth averaged an impressive 7.2% per year
through this period – which incorporates the financial crisis
– and repeatedly reached double-digit levels. This pushed
the non-oil sector’s share of overall GDP from 48% to
60% in real (ie, inflation-adjusted) terms. Meanwhile,
governments implemented structural reforms that
improved the ease of doing business (although much
remains to be done) and the post-millennium boom put
Dubai on the global map as a regional business hub.
Although positive, these developments overstate the
true extent of economic diversification in the region.
Much of the growth in the non-oil sector was still fuelled
by oil-financed government spending – including on
infrastructure, key development projects, public sector
salaries, benefits and subsidies – which was in turn recycled
through the financial system, benefitting capital markets
and the banking sector. With government spending now
set to be cut back, these growth drivers will fade. And
although oil’s contribution to GCC economic output has
shrunk, it still accounts for around 80% of total budget
revenues and 50% of all export receipts, implying a
major deterioration in both the fiscal position and the terms
of trade.
In principle, lower oil prices should provide a serious
boost to net oil importing countries in the Middle East
region including Egypt, Jordan and Lebanon. But with
these countries suffering from political instability and
uncertainties of their own, we doubt that the boost to
growth will be that large. Moreover, they will also be hit by
a drop in cross-border trade, investments and potentially
weaker remittance flows from the GCC and elsewhere.
ECONOMIC INSIGHT – MIDDLE E A ST Q1 2 016
GCC governments now serious about
fiscal reform
The past few months have seen growing signs of
governments in the Gulf giving serious consideration
to fiscal consolidation. The Saudi Government’s 2016
budget announced a year-on-year (y/y) decline in planned
spending for the first time in at least 14 years, as well as
plans to reduce energy subsidies starting this year, capping
the public wage bill, the introduction of taxes on goods
including tobacco and soft drinks, more privatisation
and the establishment of a new finance unit to oversee a
medium-term expenditure framework.
Similarly, Oman has announced a 16% cut in budgeted
spending for this year, a rise in corporation tax and the
removal of certain tax exemptions. Moreover, all GCC
governments have committed to establishing a regionwide VAT over the medium term to lift non-oil revenues
and most have already made a start on cuts to energy
subsidies (particularly petrol which, nevertheless, remains
inexpensive by international standards). Additionally, there
is a general move to reprioritising expenditures towards
key development projects.
Overall, we expect government spending in the GCC
region to decline by 8% this year and to rise much more
slowly in future years than it has done in the past. This
will leave the aggregate budget deficit at 11% of GDP in
2016: as large as 17% in Saudi Arabia and Kuwait and 16%
in Bahrain, with only Qatar recording a much-reduced
surplus of 4% of GDP. A gradual recovery in oil prices will
narrow these balances only slowly. Though there is a risk of
permanent deficits, cumulative region-wide surplus should
be restored by 2022 (see figure 3).
low cost or even free, putting additional pressure on bank
margins at a time when demand for borrowing has also
weakened.
Meanwhile, to alleviate some of the pressure on domestic
liquidity and to provide additional policy space, the Saudi
Government has mooted the issue of international bonds
in 2016 to accompany the issue of domestic bonds started
last July. Existing debt levels are extremely low at an
estimated 7% of GDP in 2015 and – despite a downgrade
by Standard and Poor’s in October – its debt rating
remains towards the upper end of investment grade. We
see Saudi government debt levels rising to around 30%
of GDP by the end of this decade and, although no firm
announcements have yet been made, other countries in
the region are likely to follow suit.
A further threat to stability and the growth outlook has
emerged from pressure on long-standing GCC currency
pegs against the US dollar, driven by prospects for weaker
growth, the deteriorating fiscal situation and declining
financial reserves. This pressure has intensified in recent
months. For example, 12-month Saudi riyal-dollar forward
contracts – or the difference between how many riyals
traders think a dollar will be able to buy a year from now
and how many riyals a dollar can buy today – reached
1,000 basis points (bps) in mid-January, unprecedented
in recent years (see figure 4). In other words, this is
an approximate indication that markets expect a 10%
depreciation in the riyal over the next year.
Figure 4: SAR/US$ 12-month forward rate
bps
1,000
Figure 3: GCC fiscal balance
800
600
% GDP
20
400
15
Oxford Economics
forecast
10
200
0
5
-200
0
2010
2011
2012
2013
2014
2015
2016
-5
Source: Bloomberg
-10
-15
2000
2003
2006
2009
2012
2015
2018
2021
Source: Haver Analytics/Oxford Economics
Weak oil prices intensify liquidity pressures
Sustained fiscal weakness will damage the long-term
growth outlook in the region, but the near-term
implications are becoming increasingly visible through
tighter domestic liquidity conditions. Stock markets in
GCC countries fell by between 15% and 25% last year and
some fell a further 10% to 15% in January 2016; aggregate
growth in broad money (used as a general estimate of
the supply of money in an economy) had slowed to just
1% y/y in November and was negative in some countries;
market interest rates have started to edge up from previous
lows amid higher official rates following the US Fed’s
decision to hike rates in December; and finally, there has
been a draw down in government reserves with funds
needed to cover emerging fiscal gaps. The latter has also
had the effect of depriving local banks of funds placed at
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This in turn forced the Saudi central bank to impose a
ban on domestic banks dealing in forward contracts. We
expect GCC pegs to remain under pressure through 2016,
with those in Oman and Bahrain – where relatively low
financial reserves provide the least defensive cover – most
vulnerable.
While de-pegging would generate greater government
revenues by lifting the dollar oil revenues in local currency
terms, it would also impose heavy costs, including rising
inflation, a loss of policy credibility and additional volatility
in oil revenues. We therefore think the authorities will
be determined to keep currency pegs intact, including
through verbal support and by increasing interest rates
further this year in response to further hikes by the US Fed
– but acknowledge the increasing risk of a market-enforced
change.
ECONOMIC INSIGHT – MIDDLE E A ST Q1 2 016
Maintain stability – but don’t forget about
reforms
In light of the above pressures, the near-term objective
for governments in the GCC will be to maintain financial
stability and avoid a deeper crisis that could push the
region towards recession. Already, the headline growth
outlook is weighed down by capacity constraints in the
hydrocarbon sector, where growth is expected to average
just 1% per year or so for the rest of this decade and
expansion plans have slowed. And GCC non-hydrocarbon
growth will slip to 2.9% this year, its weakest since the
early 1990s.
This backdrop will make the case for economic reforms
in areas such as privatisation and competition policy,
housing, the labour market and education, and the public
sector bureaucracy even more complex on a country-bycountry basis.
Governments will need to avoid jeopardising public
support but at the same time boost private sector
confidence and prospects for longer-term growth that
could be important for accessing international capital
markets. Either way, a period of skillful policymaking will be
required to balance the need for both growth and stability.
IRAN AND THE NUCLEAR DEAL
Sanctions relief in Iran also has implications
for the region and the oil market
The Iranian economy has been given a potentially
transformational lift, despite weak oil prices.
‘Implementation Day’ was reached in January, when
it was agreed Iran had fulfilled certain nuclear-related
commitments. As a result, some sanctions were lifted,
bringing in from the cold a potentially vibrant emerging
country to the international economy and a major regional
player in the Middle East. In addition to the lifting of
sanctions on the energy and banking sectors, assets put at
over US$100bn were unfrozen. However, a few sanctions
remain or have been introduced by the US since − for
example, on the specific companies and individuals
suspected of aiding the ballistic missile programme.
Evidence shows that Tehran is in a strong position
to increase its oil output rapidly in the first year. Oil
production crept up to 2.9m barrels per day (b/d) in
December, its highest level since June 2012, as storage
tanks were filled up ahead of sanctions easing. A rise
towards pre-sanctions capacity of some 3.6m b/d should
be seen within six months (see figure 5).
Reclaiming its position as OPEC’s second biggest producer
and raising production in excess of more than 4m b/d
will require more advanced technology and therefore
foreign investment. However, international oil companies’
appetite for investment will remain dampened until a new
improved version of Iran’s former buy-back investment
contract is fashioned and the threat of snap-back sanctions
deteriorates.
Despite the continued expected weakness in oil prices
(itself exacerbated by Iran’s extra expected oil supply),
Iran’s growth rate should accelerate from a predicted
1.2% in 2015/16 to 4% in 2016/17. This will be driven
by a 16% increase in oil production, sanctions relief in
other important industries and some increased foreign
investment. Meanwhile, an improving political outlook
should underpin better economic policymaking and
gradually improve international relations. The success
of the sanctions easing should boost reformists further,
although hardliners are fighting back.
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Further prospects for growth come from a relatively
diversified economy; indeed, taxes now being considered
in the rest of the region have already been implemented
in Iran.
The implications for geo-political risk are uncertain. An
economically emboldened Iran could simply pursue its
regional ambitions with greater vigour, which may involve
proxy wars in Syria, Yemen and Iraq. There is clearly a risk
of the escalation of regional conflict, which could have an
adverse impact on the economy. On the other hand, the
US hopes that closer relations with a more moderate Iran
will facilitate progress in the conflicts in Syria and Yemen
and increase cooperation in Iraq in the fight against ISIS.
On the economic front, the biggest regional impact of
the deal is to depress oil prices and keep them lower
for longer, thus adding to the need for painful fiscal
adjustment programmes among the GCC countries and
other oil exporters like Libya and Iraq. However, with Iran’s
GDP growing more and its trade picking up, the region
should also benefit – especially countries with particularly
close ties, such as the UAE.
Figure 5: Iranian oil production
Million barrels per day
4.1
Oxford Economics
forecast
3.9
3.7
3.5
3.3
3.1
2.9
2.7
2.5
2000
2003
2006
2009
2012
2015
2018
2021
Source: OPEC/Oxford Economics
GCC+5 country outlook for 2016
Low oil prices in 2016 will result in governments more
committed to fiscal consolidation; the budget of Saudi
Arabia led the way, with its dedication to a prolonged
period of subsidy cuts, public wage constraint and nonoil taxes. Alongside multi-year lows in high-frequency
indicators such as private bank lending and money growth,
non-oil sector expansion will slow. Capacity constraints
and a less aggressive policy stance will limit increases in oil
production, leading to total GDP growth of 1.2% this year.
The UAE was one of the more fiscally aggressive states
towards the end of 2015, removing fuel subsidies and
increasing electricity tariffs. Nevertheless, its reputation
as a trade hub makes it one of the most diversified gulf
economies. Continued infrastructure investment in
anticipation of the World Expo 2020 should lead to growth
of 2.7% in 2016.
The wage bill and subsidies make up two-thirds of
government spending alone in Bahrain, so authorities are
looking at cuts despite political sensitivity. Petrol prices
increased in January for the first time in 33 years, following
gas price hikes and meat subsidy removal. Oil production
is expected to fall after technical problems at the Abu
Saafa field, which Bahrain shares with Saudi Arabia and
relies upon for 75% of its oil. The economy is expected to
expand by 1.9% this year.
ECONOMIC INSIGHT – MIDDLE E A ST Q1 2 016
Oman also hiked petrol prices in January and further
spending cuts are expected for the ninth five-year plan
2016-20. The authorities are loath to cut capital spending
given the long-term strategy to diversify into transport and
logistics, manufacturing, tourism and mining.
Qatar’s greater diversification of revenues, large policy
buffers and immovable infrastructure requirements
associated with the 2022 World Cup will mean government
spending cutbacks will be modest compared to other
GCC countries. These plans include a new railway, airport,
seaport, roads and real estate schemes. Meanwhile, a boost
from the Barzan gas-to-liquids project coming online from
early 2016, and stabilisation of crude oil production will
support oil sector growth and drive total GDP growth of
4.3% in 2016.
Capital spending will also remain fairly robust in Kuwait,
supporting expected GDP growth of 2.3% in 2016.
Economic diversification will be driven by government
commitment to key infrastructural projects set out in
the development plan such as in transport and power
generation, in spite of pledges to cut overall spending and
raise non-oil revenues. Oil output will remain constrained
by lack of capacity and the unresolved dispute with Saudi
Arabia over the Neutral Zone.
The growing needs of the many refugees and the conflicts
in Iraq and Syria will dampen economic activity in Jordan.
Indeed, recent data on trade, tourism and investor
confidence have been weak. The government has cut
current spending but is planning more fundamental reforms
to petrol, electricity and water subsidies. Nevertheless,
the impact of spending cuts on private consumption and
net exports should be limited by low interest rates, rising
infrastructure spending funded by external investment and
low oil prices, as Jordan is a net oil importer. We see GDP
growth at 3% in 2016.
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There is little hope of political paralysis ending in
Lebanon, given the ongoing Syrian civil war. The recent
garbage crisis has added to widespread corruption
and rickety electrical and water systems, badly in need
of structural reform. The costs of supporting at least
1.5m Syrian refugees, plus the impact of weak growth
and the lack of government action has put pressure on
government finances. As a result, economic confidence
will remain low, trade flows will continue to be disrupted
and violent clashes will occur. With little imminent
improvement, we anticipate growth of 1.7% in 2016.
The political situation in Iraq also remains volatile and an
early return to stability appears impossible. The domestic
political scene is less polarised, however international
efforts to combat the ISIS insurgency have not prevented
the likely long period of uncertainty, violence and poor
security. The resulting deterred investment combined
with spending cuts will weigh on economic growth,
though it is still expected to be 3.8% this year.
Social instability in Egypt has deterred tourists, and
we see growth in overnight tourist arrivals falling to
3.4% this year, from 8.8% in 2015. Meanwhile, forex
shortages and capital constraints will restrict business
activity. The new parliament elected at the end of last
year could improve relations with foreign governments
but also pose a governance risk. We expect the economy
to expand by 2.5% in 2016.
The lifting of sanctions in Iran and increasing oil
production is likely to drive growth of 4% in 2016.
Nevertheless, clear downside risks include a ‘snapback’
of sanctions at any time should Tehran fail to honour
its nuclear commitments and the impact on structural
reforms and inward FDI if the hardliners strike back.
ECONOMIC INSIGHT – MIDDLE E A ST Q1 2 016
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