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ICAEW Economic Insight: Middle East Produced by Cebr, ICAEW’s partner, and acknowledged expert in global economic forecasting, it provides a unique perspective on the prospects for the Middle East as a whole and for individual countries against the international economic background. 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. Global macroeconomic backdrop darkens The outlook for the global economy at the start of 2014 was mixed, but broadly positive. Advanced economies such as the US and UK were poised to see their recoveries accelerate, supported by falling unemployment and rising confidence. Even the stricken eurozone, still weighed upon by a substantial debt burden and economic imbalances, was expected to turn the corner, driven by periphery nations exiting recession. The weaker spots in the global economy seemed to be emerging regions, where structural and cyclical slowdowns were set to act as headwind to a continuation of the robust expansion seen throughout recent years. This improving outlook for advanced economies was set to help Middle Eastern output rise briskly from the 3.3% growth recorded during 2013. However, over the course of the year, the economic climate has darkened markedly. Geopolitical disruptions in the region itself have combined with a more muted global backdrop, helping constrain 2014 real GDP growth for the GCC+5 nations to an estimated 2.9%. ICAEW Economic Insight: Middle East Quarterly briefing Q4 2014 BUSINESS WITH confidence Poor weather dented activity in the US during Q1, while in the UK confidence is falling back slightly after rising strongly in 2013 and early 2014. The situation in the eurozone is far worse and concerning. The currency area has been affected by lacklustre performances from its three largest economies, and now teeters on the brink of a triple-dip recession. The continual fading of price pressures in Europe is increasingly worrying, with September data confirming that eight EU countries are already in outright annual deflation. This raises the prospect of businesses and consumers holding off from making purchases as they expect prices to fall further – causing economic conditions to worsen. icaew.com/economicinsight China’s economy has also experienced a bumpy year. Economic activity has slowed and there are concerns over diminishing returns from years of extensive credit-fuelled investment. While stimulus measures taken throughout the year are expected to help the economy meet the official target for GDP expansion of 7.5%, slower output growth in the future is almost certain. Meanwhile, Japan has seen confidence ebb away over the course of the year. Having slipped back into technical recession in Q3, it is still far from clear whether recent reforms and stimulus measures will help to shift the Japanese economy out of years of stagnant growth. The US has seen its share of GCC+5 fuel exports remain broadly stable. This reflects a falling market share for Saudi Arabia (the US accounted for 14% of external demand for Saudi fuel commodities in 2013, down from 24% a decade earlier), partially offset by greater imports from Iraq and Kuwait. In dollar terms, its purchases from the region amounted to $75bn in 2013, representing a 12% annual decline. The outlook for US demand for energy from the region is bleak – the shale revolution in the States has supported increases in oil production to the tune of 4.7 million barrels per day (mb/d) over the last five years, reducing its dependence on energy from the rest of the world. Bleaker global outlook weighs upon the Middle East One export market which has seen an increase in its share of GCC+5 fuel sales is India, having grown rapidly from a very low base to account for 11% of total fuel exports in 2013 (over a third of its purchases from the region in that year was accounted for by supplies from Iraq and Kuwait). This is a bright spot for the region’s exporters: India’s economic potential represents a substantial source of energy demand in future years, in particular through its ambition to expand and extend its manufacturing prowess. India is well-placed to claim a larger share of global manufacturing chains over the medium to long term, especially as labour costs in Chinese and south-east Asian factories rapidly rise and hold back their competitiveness. The sum of these downward revisions is that we expect global growth to reach only 2.7% during 2014, compared to our expectation of 3.2% at the start of the year. This slowdown, and the likelihood of sustained weaker growth in coming years, has important implications on energy demand – and the hydrocarbon-dependent economies of the Middle East. Figure 1 below sets out the nations and regions to which the GCC+5 export their energy commodities. Figure 1: Composition of external demand for fuel commodities from GCC+5 nations, measured in current dollars, 1995-2013 13% 2013 10% 2010 8% 11% 10% 9% 18% 19% 10% 33% 9% 34% 1% 6% 2005 15% 25% 12% 28% 1% 4% 2000 15% 1% 26% 0 10 US 30% 4% 18% 1995 11% 20 China 32% 30 EU 40 50 India 11% 60 Japan 70 23% 80 ASEAN 90 100 % Other Source: UNCTAD, Cebr analysis1 The single largest consumer of the region’s hydrocarbons output remains Japan, which purchased $168bn of fuel commodities from the GCC+5 nations during 2013. It has traditionally been the dominant customer for several nations in the region, and as recently as 2002 accounted for over half of the energy exports from UAE and Qatar (by 2013, the equivalent proportion was 27%). This reduction in market share reflects not only diversification in the export partners of the two GCC nations, but also prolonged stagnation in Japan. A similar picture is evident when considering the EU, whose share of GCC+5 fuel exports fell by 10 percentage points between 1995 and 2013. In dollar terms, its purchases from the region have fallen by a quarter since 2011, from $96bn to $72bn. This reflects the economic malaise gripping Europe as well as structurally lower energy demand due to increasing efficiency, and the rapid proliferation of alternative energy sources. Looking further ahead, Europe’s stagnation could persist for years to come if deflationary expectations become entrenched, leading to delays in consumption and investment decisions. Industrial production, accounting for some of the most energy-intensive economic activities, remains languid, with monthly output at levels first seen nearly 15 years ago; 13% below its pre-financial crisis peak. icaew.com/economicinsight cebr.com The energy inputs required to deliver China’s economic growth will continue to fall, both through more efficient production, and its long-term rebalancing away from dependence upon commodity-intensive capital investments. China is a key customer for both Oman and Iran in particular, and accounted for 40% of fuel exports from those nations in 2013. The proliferation of alternative energy sources will continue to erode hydrocarbon demand growth. According to BP’s Statistical Review of World Energy, the total global stock of installed wind and solar capacity increased more than tenfold in the decade to 2013. Over 85% of this capacity growth has taken place in the US, China, Japan and Europe – even amid slowing growth and falling market shares, these economies comprise nearly half of energy demand for the GCC+5. Oil price fall driven by demand, supply, and dollars The sharpness with which oil benchmarks have tumbled represents a surprise adjustment to short-term demand and supply expectations. Nonetheless, the likelihood of sustained lower growth in coming years raises the prospect of the global economy entering a longer period of structurally weaker hydrocarbon demand. Due in part to the more sluggish path of global economic growth, the International Energy Agency (IEA) has sharply revised down its forecast for global oil demand for both 2014 and 2015. In its latest Oil Market Report, it forecast that 2014 would see annual demand growth of just 0.7 mb/d. In addition to this demand weakness, abundance of supply is also weighing on prices. September saw total global oil supply grow by an estimated 2.8 mb/d on an annual basis. This was supported by continued increases in output from Libya, despite the crises afflicting the country. economic insight – middle e a st Q 4 2 014 Currency movements are also having an effect. The US Fed’s tapering of quantitative easing (QE), and the expectation of interest rate rises during 2015, are leading to the US dollar strengthening against other currencies. This trend is being amplified as the weakness in other key regions of the global economy becomes more apparent. The greater purchasing power of the dollar therefore drives down the prices of other dollar-denominated assets – such as oil – and has contributed to the slide seen in recent weeks. This is in sharp contrast to the trend for much of the 2000s, when a weaker dollar coincided with rising commodity prices, to the benefit of exporting nations in the Middle East. Nations in the region, and commodityrich emerging markets more generally, were able to rapidly accumulate export earnings and foreign exchange reserves, funding ambitious investment programmes and bolstering growth. It also allowed them to weather the global financial crisis from a position of comparative strength. GCC+5 nations have varying levels of readiness for lower prices The impacts of the economic and technological trends discussed above will be felt over the medium term, meaning that the likelihood of prolonged softer demand and lower prices will present significant challenges for GCC+5 nations. Figure 2 below sets out the evolution of Brent crude’s spot price over recent months, compared with the IMF’s estimates for the 2015 fiscal break-even prices for selected GCC+5 nations. Fiscal break-even prices denote the level at which these countries’ government budgets would be balanced. They are a function of assumed production and export levels, government spending plans, as well as expected tax revenues from both the oil and non-oil sectors. Figure 2: Brent oil spot price, and projected 2015 fiscal break-even prices for selected GCC+5 nations, $/bl 140 Iran 130 120 Bahrain 110 Oman 100 Iraq The downward price pressures are an immense challenge for Iran, which has the highest breakeven price among the countries in the region. Its response was to sell at a discount to Asian markets, pricing its production $0.82/ bl below the regional benchmark, its largest cut since late 2008. In addition to price competition, producers more broadly are maximising output from producing fields, running at capacity and postponing maintenance outages. Such efforts among exporters to retain market share and earnings are weighing on prices further. Some GCC+5 nations are much better placed to withstand a prolonged revenue squeeze than others. The UAE, Saudi Arabia and Qatar have large and mature domestic banking systems and access to international markets. These nations and Kuwait also have large sovereign wealth funds generating ample investment income. Iran’s economic and financial isolation, by contrast, has led to suppressed export earnings, curtailed access to financial markets and international asset freezes. Fiscal pressures will mount with oil earnings suppressed While a reduction in oil export earnings will impact revenues in many of the GCC+5 nations, fiscal pressures continue to mount on the spending side. Some insight into the drivers of the break-even price levels in Figure 2 can be gained through the current and projected future fiscal balances of the region’s governments (ie, the balance between annual tax receipts and government spending at both central and local levels). Figure 3 below sets out the IMF’s latest projections for net government lending/borrowing in the Middle East region. Figure 3: General government net lending (+) or borrowing (-), % of GDP, 2013-16 Kuwait Qatar 80 UAE 70 Qatar UAE 60 Mar 2014 Saudi Arabia’s apparent willingness to tolerate prices at these levels has been interpreted as an attempt to heap financial pressure on shale producers in the US and elsewhere. Extracting a barrel from these wells is much more costly than in the readily-accessible oil fields of Saudi Arabia. Rather than endeavouring to prop up prices in response to the drop-off in demand, the Kingdom actually cut prices for its November output of all grades and in all markets. Saudi Arabia 90 50 However, a shift in policy response may follow the next OPEC meeting, scheduled for 27 November. Kuwait Apr 2014 May 2014 June 2014 July 2014 Aug 2014 Sep 2014 Oct 2014 Nov 2014 Saudi Arabia Oman Iran Source: US Energy Information Administration, IMF Iraq The oil prices at which the 2015 fiscal budgets of these nations will be balanced varies hugely – from $131 in Iran, to just $53 in Kuwait. Saudi Arabia, which has in the past organised with its OPEC partners to jointly cut production levels in response to falling prices, is perceived as unlikely to scale back production at present. Indeed, the spending plans inherent in these break-even prices imply that most exporters in the region do not have the flexibility to endure sustained reductions in output or revenues. icaew.com/economicinsight cebr.com Bahrain Jordan Lebanon Egypt -20 -10 2013 0 10 2014 20 2015 30 40 % 2016 Source: IMF economic insight – middle e a st Q 4 2 014 Substantial government spending plans are common – each of the countries with a projected surplus for 2014 is expected to see it narrow in the coming years. However, government spending is not in principle unsustainable. The ambitious plans for investment and infrastructure building across the region are substantial drivers of the fiscal expansion represented in Figure 3. They involve activities which stimulate growth in the short term, and can also improve productive capacity and raise long-term productivity. However, a large share of government budgets in the region are swallowed up by current spending, such as generous public sector wages and salaries, widespread subsidies for food and fuel, or direct cash transfers to households. Current spending to curb discontent amid elevated unemployment and inflation can be financed during periods of high oil prices and abundant revenues. Nonetheless their sustainability will be brought into sharp focus by the likelihood of lower oil receipts for a protracted period. For example, Saudi Arabia is among the Middle Eastern nations with the most ambitious medium-term infrastructure plans. However, public sector wages are considerable budget items, presently accounting for 35% of total government spending. Iran, having partiallyreformed its indirect subsidy regime in recent years, replaced it with a programme of direct cash transfers to Iranian households, which will continue to place strains on public finances. Relative to GDP terms, Egypt has the largest government borrowing needs of any country in the region. Despite taking the courageous step of enacting subsidy reforms which immediately increased petrol prices by up to 78% in July, energy subsidies still account for about half of the budget deficit. Egypt will be supported in meeting its borrowing needs through aid payments from Saudi Arabia, the UAE and Kuwait. Figure 4 sets out the industrial components of GDP among the GCC+5 nations (excluding Iran) in 2011. These are the latest available data on a comparable basis and give insight into the structural features of these economies. Such structural compositions are the result of long-term trends, with the relative proportions illustrated below unlikely to have changed substantially since 2011. The most noticeable trend is, of course, the predominance of mining and fuel extraction in overall economic activity. However, even these shares do not fully capture the importance of, or dependence upon, hydrocarbons across these nations. For example, some proportion of manufacturing comprises downstream activities such as refining and petrochemicals. In addition, some of the commerce (wholesale trade) and transport-storage sectors are also oil and gas-related activities. More crucially, government revenues in these nations are even more dependent on oil and gas than is suggested by their shares of economic output. The sustainability of both economic growth and fiscal stability across the region will only be assured in the long term through more diversified growth and a broader tax base. Middle Eastern growth revised down for 2014 Figure 5: Real GDP growth forecasts, Q4 2014 % 8 6 4 2 0 Stability through broader growth 90 2014 2015 Iran Kuwait Lebanon Oman Bahrain Egypt Saudi Arabia Jordan -4 UAE % 100 Iraq Figure 4: Industrial composition of total GDP, 2011 Qatar -2 2016 80 70 Source: IMF, national statistics offices, Cebr analysis 60 Saudi Arabia’s output contracted by 3.1% during Q2, with activity weighed upon by falling exports and a tightening of government spending. The stronger headwinds from weakened export earnings will drag on GDP over the coming years, leading annual growth to slow from 4.2% this year to 3.9% in 2016. However, a more dramatic deceleration is not anticipated, given the Kingdom’s commitment to stable growth, its plans for medium-term fiscal expansion and its ample flexibility to deliver this. 50 40 30 20 Agriculture Transport & storage Mining & fuel Finance & insurance Manufacturing Property Utilities Government services Construction Other services Commerce, restaurants & hotels Lebanon Jordan Egypt Bahrain UAE Oman Saudi Arabia Iraq Qatar 0 Kuwait 10 Despite the pace of job creation in the UAE’s non-oil sector slowing down in recent quarters, it has seen robust output expansion across the year, supported by export orders and domestic demand. Annual growth in real GDP should amount to 4.6% in 2014, slowing only marginally to 4.4% in 2015. The UAE’s progress in diversifying its economy (and revenue base) away from oil means it will be relatively well-sheltered from the hardest impacts of Source: Arab Monetary Fund, Cebr analysis icaew.com/economicinsight cebr.com economic insight – middle e a st Q 4 2 014 falling oil prices. However, recent sharp downturns in equity markets – with Dubai’s property index down over 15% since September – underline risks to this outlook. While the fall coincides with a broader slide in global equities, a puncturing of confidence in the prospects for the UAE’s property market could slow investment growth in the coming years. Qatari GDP contracted on a quarterly basis during Q2, with strong growth in non-hydrocarbon activities only partly offsetting a slowdown in the oil and gas sector. Annual growth is expected to amount to 6.3% this year, rising to 7.2% in 2015. This forecast, which assumes that announced infrastructure projects proceed as planned, is set to be supported by a continuation of brisk and broadbased growth across construction, financial and business services, and tourism. Intensive capital investment will buttress GDP expansion across the medium term, even at lower oil prices. Oman’s hydrocarbons production has grown sluggishly this year, leading to annual growth slowing to an estimated 3.3% during 2014. Due in part to the lower expected oil price constraining fiscal expansion, GDP growth is not likely to accelerate markedly in the short term. The outlook further out is brighter, with new gas fields expected to begin production, and developments in downstream and non-oil activities boosting output. After posting strong growth during the first half of the year, we estimate that Bahrain’s output will expand by 4.0% over 2014 as a whole. However, growth is expected to slow in coming years, to an average of 3.5% over 2015-16, due to flat oil production, and weaker growth in non-oil activities. Bahrain’s economic potential remains constrained, with confidence in the business environment shaken by enduring social tensions. IS militants will continue for some time, activity will continue being disrupted in coming years, substantially squeezing Iraq’s future economic potential. Lebanon’s economy will remain severely tested by the spill-over impacts of Syria’s civil war, and inertia within the domestic political environment. Exports fell on an annual basis in 14 out of the last 15 months, underlining the disruptive effect of regional instability to its trade and investment prospects. Jordan also remains challenged by the turmoil in Syria, with the additional strain of Iraq’s continued chaos impacting on its economic climate. It stands to benefit from cheaper oil, as fuels comprise a substantial share of its imports. However, availability remains a concern, with Iraqi supplies having been halted for much of 2014. Egypt has seen private sector activity pick up in recent months, with September’s Purchasing Managers’ Index (PMI) indicating the first expansion in hiring for over two years. We expect annual GDP growth of 2.1% over the year as a whole, rising to 3.3% in 2015, supported by a recovering private sector. Recent oil price movements will help moderate inflationary pressures, which have been elevated as subsidy reforms sharply increased the fuel prices faced by households. However, despite the ceasefire agreement in Gaza, economic confidence will continue to be negatively impacted by the situation in Sinai, as well as ongoing turmoil in neighbouring Libya and Sudan. Kuwait’s oil production has fallen short of projections for this year, leading GDP to grow by less than previously expected. Strong increases in private sector credit over the year indicate the non-oil sector has helped to offset some of this weakness, however, the outlook remains subdued. We estimate GDP to have grown by 1.7% this year, accelerating to 2.5% next year. Iran is among the nations in the region most challenged by the recent oil price correction, with increased fiscal pressures dragging on growth in the coming years. GDP expansion should amount to 1.2% this year, supported by inflation falling back amid limited sanctions relief. We expect subsequent years to see slower growth than previously forecast, amounting to 1.6% in 2015 and 1.9% in 2016. This forecast assumes incremental progress continues during nuclear negotiations with the P5+1 (the five permanent members of the UN Security Council, plus Germany), enabling an extension of talks beyond the 24 November deadline, and further gradual steps towards greater economic integration. Hence, there are substantial risks to this forecast in both directions – a more comprehensive deal being reached would boost growth, while a breakdown leading to tightening of sanctions would choke Iran’s already fragile recovery. The persistent violent conflict across Iraq has shattered its short-term growth outlook. While the threat posed by IS to the Kurdish and Baghdad regions appears less dire after military intervention by the US and fellow Gulf states, the extensive disruption has taken a severe toll. GDP is expected to contract by at least 2.7% this year, alongside oil production interruptions and export pipelines being sabotaged. On the assumption that the fight against icaew.com/economicinsight cebr.com economic insight – middle e a st Q 4 2 014 ENDNOTES 1 Fuel commodities are defined as those recorded under Section 3 of the Standard Industrial Trade Classification (SITC) framework. These include crude oil, petroleum products, natural gas, and coal. Note that these figures refer to external fuel demand, meaning that the values of commodity shipments between GCC+5 nations has been excluded from the total. Cebr The Centre for Economics and Business Research is an independent consultancy with a reputation for sound business advice based on thorough and insightful analysis. Since 1993 Cebr has been at the forefront of business and public interest research. They provide analysis, forecasts and strategic advice to major multinational companies, financial institutions, government departments and trade bodies. ICAEW is a world leading professional membership organisation that promotes, develops and supports over 142,000 chartered accountants worldwide. We provide qualifications and professional development, share our knowledge, insight and technical expertise, and protect the quality and integrity of the accountancy and finance profession. As leaders in accountancy, finance and business our members have the knowledge, skills and commitment to maintain the highest professional standards and integrity. Together we contribute to the success of individuals, organisations, communities and economies around the world. Because of us, people can do business with confidence. ICAEW is a founder member of Chartered Accountants Worldwide and the Global Accounting Alliance. www.charteredaccountantsworldwide.com www.globalaccountingalliance.com For enquiries or additional information, please contact: Lara Khouri, Marketing Manager, Middle East T +971 (0)4 408 0000 E [email protected] ICAEW Currency House Unit 4 Level 4 Dubai International Financial Centre PO Box 506836 United Arab Emirates icaew.ae ICAEW Chartered Accountants’ Hall Moorgate Place London EC2R 6EA UK icaew.com © ICAEW 2014 MKTPLN13602 11/14