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economic Insight Middle East Quarterly briefing February 2012 Uncertainty pervades the Middle East; region set for weakest growth in 2012 since global recession but ties to emerging markets give hope for resilience Welcome to the fourth issue of ICAEW’s Economic Insight: Middle East, the quarterly economic forecast prepared directly for the finance profession. Produced by Cebr, our partner and acknowledged expert in global economic forecasting, it provides a unique perspective on the prospects for the Middle East region as a whole and for individual economies against the international economic background. We focus on the Middle East as being the Gulf Cooperation Council (GCC) member countries (United Arab Emirates, Bahrain, Saudi Arabia, Oman, Qatar and Kuwait), plus Egypt, Iran, Iraq, Jordan and Lebanon (abbreviated to GCC+5) 1. It remains a highly uncertain outlook as the eurozone debt crisis hangs over the global economy like a dark cloud that could conceivably turn into a thunderstorm with severe consequences in the coming months. In this edition, we evaluate what another recession in the eurozone could mean for the global economy and, more importantly, the Middle East. There are several questions to consider: how exactly will the Middle East be affected by the changing global macroeconomic environment? Is weaker growth in 2012 inevitable or will the region’s ties to emerging markets give it some insulation? Political uncertainties in the region seem to be bubbling away once more – what does this mean for oil prices and will the oil economy grow at the robust pace it did in 2011? BUSINESS WITH CONFIDENCE icaew.com/economicinsight Figure 1: Economic growth across countries, percentage change in country/region annual GDP 7 % 100 6 5 4 3 2 90 80 70 60 50 40 30 20 Egypt Eurozone downside Lebanon Global Global downside 0 World Eurozone Iran Middle East 10 Non GCC Middle East 2014 Jordan 2013 Qatar 2012 Oman 2011 Kuwait 2010 Saudi Arabia 2009 GCC average 2008 Bahrain 2007 United Arab Emirates 1 0 -1 -2 -3 -4 -5 Figure 2: Exports as a share of country GDP across the Middle East – 2010 or latest year for which data are available Source: IMF, Cebr analysis Source: World Bank Development Indicators, Cebr analysis Global economy to experience slowest growth since recession as eurozone poses downside risk The region is closely tied to global trends The Middle East economy, like the rest of the world, will grow more slowly in 2012, the key question is: how much slower? The answer depends substantially on the extent of the weakness in global economic performance. The world economy is expected to grow by just 2.5% in 2012; the weakest expansion since the global recession of 2009, and there are significant downside risks to this from the ongoing eurozone crisis 2. Indeed, many eurozone countries are likely to be in recession as of the first quarter of 2012 and, as a whole, the euro area is expected to shrink by around 1% in 2012. However, there is a real risk that the euro debt crisis leads to an even sharper drop in real economic activity, having a ripple effect on the global economy and sending global growth down towards the 1% mark in 2012. In its January update to the World Economic Outlook, the International Monetary Fund (IMF) sketched out a downside scenario for the eurozone in which the euro area economy would be around 4% smaller than in their central forecast by the end of 2013. In such a scenario, global output would be around 2% lower than in their already relatively modest projections for growth. The Middle East’s fortunes will ultimately be tied to the outcome for the world economy, but its own growth potential and strong interdependence with fast-growing emerging markets means it is expected to outperform the global economy, as shown in figure 1. What would an escalation of the eurozone crisis mean for the Middle East? While figure 1 illustrates that the Middle East is expected to grow faster than the global economy as a whole, how seriously could the region be affected were the downside scenario to materialise with a deep recession in the eurozone? How globalised is the Middle East and to what extent is it going to be insulated by slower growth or contraction in the advanced economies of the West? icaew.com/economicinsight cebr.com Most countries in the Middle East are major exporters and this is a key driver of the overall level of economic activity; this is especially the case in the GCC countries. Figure 2 illustrates country exports as a share of total economic output (as measured by Gross Domestic Product (GDP)). In general exports are more important for the region than is typically the case across the global economy; on average exports make up 52% of GDP in the Middle East compared with 25% across the whole global economy. Across the GCC, exports account for between 47% (Qatar) and 97% (Bahrain) of GDP; so on the face of it the GCC countries in particular are heavily reliant on export markets. So does this mean the Middle East – and especially the GCC countries – are heavily exposed to the downturn in global growth in 2012? The region is increasingly geared towards fast-growing emerging markets The answer to this question is: yes, but it is complicated by where the demand for Middle East exports comes from. Exports to resource-thirsty emerging markets have grown enormously over the last decade or so. Over the last year, goods exports from the Middle East to emerging and developing economies totalled some $455bn compared with $521bn to advanced economies. Over the last 10 years, exports to India in dollar cash terms from the region have grown by over 32 times while exports to China have increased by 15 times. Middle East cash exports (of course, partly reflecting increases in the price of goods) to emerging markets have grown by 723% over the last 10 years, compared with 305% growth in exports to advanced economies. Emerging market exports to overtake exports to West by 2014 Hence, the Middle East’s links to emerging markets have been expanding enormously in recent years. Exports to China and India now add up to three times the value of exports to the world’s largest economy, the US, and are double those to the eurozone. This is despite the total size of the Chinese and Indian economies being equivalent to only around two thirds the size of the eurozone economy in dollar terms. Figure 3 illustrates this disparity between exports to various regions and the relative size of their economies – pointing to the region’s growing interdependence with emerging markets. The share of Middle East exports to emerging markets is expected to surpass those to the advanced economies within the next two years, as shown in figure 4. Figure 3: Export destination as a share of total exports in the Middle East over the 12 months to Q3 2011 and share of global economy in 20113 % 70 60 50 As emerging markets have become increasingly important trade partners for the Middle East, growth in the Middle East is becoming less linked to growth in the West. Figure 5 below shows the correlation between growth in the Middle East and other parts of the global economy over the period 1993–2011. Quite simply, a higher number implies that the Middle East moves more closely with the economy in question. As the graph shows, the strongest correlation with Middle Eastern growth is with the emerging and developing economies. Importantly, this analysis illustrates that the region is less tied to macroeconomic outcomes in the euro area and the advanced economies more generally. However, there is a significant correlation with the performance of the global economy. So, while growth in the emerging markets can provide insulation in the case of a severe contraction in the eurozone and the region is less directly dependent on the euro area, the drag on the global economy from a severe recession in Europe – as shown in figure 1 – would still have serious implications for growth across the Middle East. Figure 5: The correlation of Middle East regional 40 GDP growth with the global economy (1993–2011) 30 0.9 20 0.8 10 0 Reasons to hope for resilience: growth in the Middle East is more closely linked to emerging economies than the West 0.81 0.7 0.6 United States India China Euro Area Share of Middle East exports Emerging & Advanced Developing Economies Economies Share of global economy 0.53 0.5 0.4 0.31 0.3 0.3 0.2 0.1 Source: IMF Direction of Trade Statistics, Cebr analysis 0.0 Figure 4: Middle East exports to emerging markets as a proportion of exports to advanced economies World Correlation coefficients % 120 Source: IMF, Cebr analysis 100 80 60 40 Middle East exports to emerging markets as a share of exports to advanced economies Cebr estimates Source: IMF Direction of Trade Statistics, Cebr analysis 2015 2014 2013 2011 2012 2010 2009 2008 2007 2006 2005 2004 2003 2001 2002 20 0 Emerging & Developing Economies Euro Area Advanced Economies But downside scenario sees Middle East growth slowing to nearly 3% Looking at a scenario in which sovereign and bank funding pressures in the euro escalate, leading to a major credit squeeze and a decline in real economic activity in both the eurozone and global economies, modelling can assess the impact on growth in the Middle East. Figure 6 shows that recession in the eurozone and a weaker global growth outturn – with the pace of expansion across the world dropping to 1% in 2012 – would likely lead to growth in the Middle East falling back to 3.3%, compared with 4.4% on the central forecast. Other than when recession swept across the globe in 2009, this would result in the weakest performance of the Middle East economy since 2001–2. Political uncertainties complicate the outlook Economic forecasts are of course often shrouded in uncertainty, but at present this is especially pronounced due to political developments in the region. With the continuing concern over Iran’s nuclear programme, tensions between the West and Iran have escalated in early 2012. In January, the EU imposed economic sanctions on Iran that will come into full force in July, while Iran has mooted the possibility of blocking the key trade route of the Strait of Hormuz. It is likely that the economic sanctions will knock back growth in the Iranian economy through the second half of 2012 but the blockade of this key trade route could have a profound impact on regional trade and economic activity. In such a scenario, one would expect economic activity in the region to be hit. However, while all of this uncertainty continues, one thing seems certain: the ongoing uncertainty is helping to prop up oil prices. Oil prices defy logic of economic gravity – as political uncertainty works in the opposite direction Indeed, the price of oil has so far defied the global economic slowdown. While the outlook for growth in 2012 is rife with uncertainty – and there are major downside risks – the forces of economic gravity have been offset by the question marks over Iran’s apparent collision course with the West. In addition, there has been speculation that more members of the Organization of the Petroleum Exporting Countries (OPEC) are shifting towards a target price for oil of closer to $100 a barrel. This could mean that production levels are eased if the slowdown starts to have more effect (as one could reasonably expect) on prices in the coming months, following massive increases in production across the Middle East through 2010–11. Indeed, production across the Middle East rose to a recent peak of 27.4m barrels per day – up some 16% from a trough in the 2009 recession; across the GCC production is up by a fifth. This robust growth in production contributed to the strength of economic growth in the last two years and there are some signs of the pace of growth easing. This trend could become more pronounced moving through 2012, so the oil economy contributes less to growth across the region – and in particular in the GCC countries – this year than the previous two. Summing up, as shown in figure 7, the projections for oil prices in 2012 and 2013 have been upwardly revised; while prices are still expected to fall in 2012, political factors will prop prices up more than previously anticipated. Figure 7: Oil price average across calendar year, average of three spot prices 5, $ per barrel $ 120 100 Figure 6: Modelling what the eurozone crisis could mean for the Middle East economy, annual percentage change in Middle East real GDP4 80 60 % 9 40 8 20 7 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2002 5 2003 0 6 4 3 Source: IMF, Cebr prospects service forecasts 2 1 2014 2013 2012 2011 2010 2009 2007 2008 2006 2005 2004 2003 2002 2001 2000 0 Central scenario Downside scenario Source: Cebr analysis economic insight – middle e a st february 2 012 Iraqi oil economy to continue boom despite weaker production growth across the region Scope for Middle Eastern economies to stimulate economic growth in coming years While global oil production could slow this year as exporters react to weaker growth in global demand, in Iraq it is a different story. Oil production is expected to continue its expansion as investment pours into the resurgent Iraqi oil economy. There are ongoing ambiguities surrounding production in the Kurdistan Regional Government-controlled areas, but on the whole production across the country continues to expand. In 2011, output was around 10% up on the average level in 2010 and the highest level since 1989. Although the rate of expansion in production may not match this level in 2012, we still expect further growth in the coming years (as shown in figure 8) which will take the overall level of output to almost 90% of the peak level of production achieved in 1979. As output expands, this will help to fuel strong growth in the Iraqi economy and maintain its status as the fastest growing country in the Middle East. However, there are ongoing concerns about the weak non-oil economy and the lack of investment in the non-oil manufacturing and service sectors. With oil prices set to remain high despite a weaker global outlook and even with softer growth in oil production, the public finances of many of the Middle East’s key economies remain very healthy, especially when compared with the heavily indebted advanced economies. As discussed above, slower growth in the global economy will necessarily affect the region and retard growth, which is of course necessary to create jobs and keep unemployment low. With most Middle Eastern countries effectively having monetary policy determined out of their control due to their dollar pegs, the other key policy option available is using fiscal policy to keep overall demand growing robustly. Figure 8: Oil production in Iraq, calendar years index where total production in 1970 = 100 250 200 150 100 50 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 0 Oil production in Iraq Forecast Source: IMF International Financial Statistics, Cebr analysis Figure 9 illustrates how low the public sector debt burden is in the region’s largest economies relative to the advanced economies of the West. Furthermore, Saudi Arabian public debt is expected to drop to just 3% of national income by 2016. This compares with 109% in the advanced economies – suggesting there is plenty of scope for governments in the region to use expansionary fiscal policy; that is, lower taxes or public spending programmes on, for example, infrastructure, education and other key public services. From an economic viewpoint, policies that help to stimulate productivity growth would be most beneficial – investment in high quality education and skills. However, figure 9 also illustrates that it is not one story for all in the region. While Saudi Arabia and the United Arab Emirates have very low public debt burdens and Iraq’s is expected to continue falling as oil production increases, in Egypt total public debt and the current level of government borrowing is far higher. Weakness in economic growth and bond market nervousness provide major constraints to Egypt’s ability to rapidly expand public spending despite high unemployment, particularly for the youth population, and much needed improvement in public services. Notwithstanding the Egyptian situation, on the whole there is plenty of fiscal room for manoeuvre across the Middle East – which is another reason to believe in the region’s resilience against slower growth across the globe in 2012. Figure 9: General Government Gross Debt in 2012 (% of GDP) 120 100 80 60 40 20 0 Saudi Arabia United Arab Emerging Emirates Economies Iraq Egypt Advanced Economies Source: IMF icaew.com/economicinsight cebr.com economic insight – middle e a st february 2 012 FOOTNOTES 1 The phrase ‘Middle East’ is often used to cover different parts of the region. Much of the internationally-available economic data relates to the Middle East and North Africa region which we call MENA (this covers the seaboard countries in North Africa from Somalia to Mauretania and all the states in the Arabian peninsula including Israel plus Iran and Turkey in the north). Political discussions often treat the Middle East as synonymous with the Arab world. But where we refer to wider definitions of the region we will try to point this out explicitly. 2 Global GDP weighted at market exchange rates. 3 Share of global economy calculated using nominal GDP at current exchange rates from IMF October World Economic Outlook dataset. 4 Middle East GDP weighted at market exchange rates. 5 Brent crude, West Texas Intermediate and Dubai Fateh. ICAEW ICAEW is a professional membership organisation, supporting over 138,000 chartered accountants around the world. Through our technical knowledge, skills and expertise, we provide insight and leadership to the global accountancy and finance profession. Our members provide financial knowledge and guidance based on the highest professional, technical and ethical standards. We develop and support individuals, organisations and communities to help them achieve long-term, sustainable economic value. Because of us, people can do business with confidence. Cebr Centre for Economics and Business Research ltd is an independent consultancy with a reputation for sound business advice based on thorough and insightful research. Since 1992, 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, agencies and trade bodies. For enquiries or additional information, please contact: Deborah Amara Regional Marketing and Business Development Manager, Middle East Currency House, Unit 4, Level 4 Dubai International Financial Centre PO Box 506836 United Arab Emirates T +971 (0)4 408 0000 E [email protected] ICAEW Chartered Accountants’ Hall Moorgate Place London EC2R 6EA UK icaew.com ICAEW and Cebr work in partnership to deliver monthly economic briefings © ICAEW MKTPLN11130 02/12