Download ECONOMIC INSIGHT MIDDLE EAST Quarterly briefing Q2 2013

ECONOMIC INSIGHT
MIDDLE EAST
Quarterly briefing Q2 2013
The Middle East is slowing in 2013 but
still outpaces the global economy
Welcome to this edition of ICAEW’s Economic Insight:
Middle East, the quarterly economic forecast prepared
directly for the finance profession. 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+5.1
Middle East growth falls to lowest
since 2009
The Middle East economy is slowing from the
breakneck expansion of the last two years. High oil
prices sustained robust growth across the region
but this trend is now turning around, with oil
production contracting this year in Saudi Arabia,
the region’s largest economy. While public spending
and investment continue to drive economic growth,
particularly in the GCC countries, 2013 is likely to
see the slowest expansion since 2009. Meanwhile,
the population continues to expand and demand for
energy rises ever higher.
The slowdown highlights the need to continue
industrial diversification and ensure that
policymakers act to improve the Middle East’s
long-term economic competitiveness and create
conditions for private sector job creation. A key risk
is that public spending on economically inefficient
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policies like subsidised energy distorts the economy,
holding back diversification and building up future
government liabilities. Ultimately, without improving
competitiveness, trend growth will be held back and
the unemployment challenge is likely to become ever
more acute.
Global economy continues to stutter
The overall global economic background remains
mixed. The last few months have seen more turbulence
in the eurozone as the Cypriot banking crisis erupted
and the leading figures in the single currency area
struggled to take decisive action. The eurozone
remains mired in recession with the economy set to
decline by around 0.5% in 2013 and unemployment
among the weaker economies continuing to rise –
indeed, in Spain the unemployment rate has now
surpassed a staggering 27%. In the US there is no such
absence of growth, with the economy expanding at an
annualised rate of 2.5% in Q1 2013 after 2.2% growth
over 2012. However, the need to reduce the world’s
largest economy’s substantial budget deficit means
that government spending cuts will act as a constraint,
limiting growth to around 2.0% and notably beneath
the 3.0% mark that was until now considered the trend
growth rate.
With the so-called advanced economies still short of a
clean bill of health, global economic growth is heavily
reliant on emerging markets managing to sustain their
robust performance. However, growth across many
of the most dynamic emerging economies has slowed
significantly. The pace of expansion in China has
eased in recent years and this downward momentum
continued with 7.7% year-on-year growth recorded
in Q1 2013, down from an 8.1% expansion the same
time a year earlier and average growth at 9.3% over
the previous five years. A similar trend is evident in
India, with growth slumping to 4.5% year on year at
the end of 2012 versus an average 7.6% expansion in
the previous five years. While the Indian economy is
expected to pick up in 2013, growth in both Russia and
China is expected to fall – Figure 1 illustrates the mixed
picture for the global economy.
Figure 1: Real GDP growth, annual percentage
change
%
8
7
6
5
4
3
2
1
0
-1
Eurozone
UK
Brazil
US
2012
Russia
India
China
2013
Source: Cebr Global Prospects Forecasts
Middle East air traffic defies sluggish
global growth
The challenges for the global economy are reflected in
the weakness of world trade growth. The total volume
of goods traded across the globe declined month-onicaew.com/economicinsight
cebr.com
month in February and over the latest three month
period the level of trade is just 1.8% higher than the
same period a year earlier. This compares to long-run
average growth of around 6%, illustrating that global
economic growth is still a long way off the normal pace
before the impact of the global financial crisis.
Regionally, the impact of slow growth in trade has
been reflected in reduced levels of throughput at DP
World operations, which recorded a 7% decline in
cargo handled during Q1 2013 compared with a year
earlier. However, there are also signs that the Middle
East is managing to buck the weak trend in global
trade at least in global air transportation. The latest
International Air Transport Association data show that
the Middle East is experiencing the strongest growth
in both freight and passenger air transport across the
globe, as illustrated in figure 2.
Figure 2: Annual change in air freight-tonnekilometres and revenue-passenger-kilometres,
March 2013
%
20
15
10
5
0
-5
-10
North Europe
America
Asia/
Pacific
Global
Freight
Latin
Africa
America
Middle
East
Passengers
Source: International Air Transport Association
Global growth broadly flat in 2013 but
scope for pick up in 2014
From current trends, it looks like the global economy
will remain stuck near the 2.5% growth level recorded
in 2012.2 However, with massive monetary loosening
in Japan, a commitment by the US Federal Reserve
to keep interest rates on hold at rock bottom levels
until unemployment declines substantially, and signs
that emerging markets should start to recover from
their recent slowdown, we expect that growth rates
will improve in 2014. But even given these factors,
global growth is unlikely to accelerate rapidly and the
most likely scenario is a modest pick-up in the pace of
expansion.
Figure 3 illustrates how the Middle East, and in
particular the GCC’s oil-exporting countries, bucked
the trend of relatively weak growth in 2012, with a
robust expansion just short of 4.0% across the region3
and 5.8% in the GCC. Primary factors were the oil
sector and a substantial boost in public spending.
An enhanced level of government investment in
infrastructure and increases in spending including
substantial pay increases for public sector workers,
in turn translating into higher consumer spending,
boosted growth in Kuwait, Qatar, Saudi Arabia and the
United Arab Emirates in particular.
Figure 3: Real GDP growth, annual percentage
change
%
10
With the oil economy weakening and regional
economic growth taking a dive, the question is
whether the boom of 2011 and 2012 was just a flash
in the pan driven by high oil prices. Also, there are
more fundamental questions over the sustainability
of the current economic model in the Middle East. As
the population grows and energy demands rise, the
region needs to ask itself whether or not oil supplies
can provide for domestic energy needs and continue to
drive economic growth through export earnings.
8
6
4
2
0
-2
-4
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Middle East
World
GCC
Source: IMF, Cebr analysis
Oil economy moves from tailwind to
headwind
As Figure 3 shows, while the rate of expansion in
the Middle East economy will continue to outpace
that across the globe as a whole, growth is slowing
appreciably in 2013. The regional growth rate is being
held back by the pronounced weakness in the Iranian
economy as a consequence of economic sanctions.
However, even the high-spending economies of the
GCC face far slower growth, expected to come in
marginally above 4.0% in 2013.
The oil economy is a key cause. Following a 7.5%
increase in GCC oil production in 2011, supplies grew
a further 3.1% in 2012 but this is likely to turn negative
in 2013. Indeed, Saudi Arabia, the region’s largest
producer, cut production in December 2012 and
again in February 2013. Consequently, over the year
to March, oil production in Saudi Arabia declined by
0.2% on the previous 12-month period; the first drop
since October 2010. Weakness in the oil economy will
curtail growth in the region’s biggest economy.
Across the other big producers in the region there
are contrasting stories. In Iran, oil production is now
running 41% lower than at its peak before the global
recession, with the decline exacerbated by the impact
of international trade sanctions. In Iraq, oil production
has slipped from the peak achieved in August 2012.
As shown in Figure 4, the overall picture is that the
oil economy will make a far weaker contribution to
economic growth in 2013.
Figure 4: Annual percentage change in oil
production in the 12 months to the date shown
%
25
20
15
10
5
0
-5
-10
-15
-20
Can the oil economy meet growing
energy demand as well as driving
export-led growth?
Iran
Qatar
Source: IMF, Cebr analysis
Saudi
Arabia
March 2012
UAE
Kuwait
March 2013
Iraq
Energy consumption across the region has nearly
tripled since 1990, as illustrated in Figure 5, and grew
by 72% between 2000 and 2010 – about three times
faster than the rate of growth across the world as
a whole. In every country across the region energy
consumption grew faster than the 26% average global
increase: it more than doubled in Oman and Qatar,
rising by 147% and 116% respectively. Similarly, the
UAE, Egypt and Kuwait saw increases of more than
75%.
Figure 5: Index of energy use growth in the
Middle East, kiloton oil equivalent (1990 = 100)
400
350
300
250
200
150
100
50
0
1990
2000
US
Eurozone
2010
2020
(expected)
Middle East
Source: World Bank, Cebr analysis
Population growth and industrial
development drive huge increases in
energy demand
Increased demand for energy has partly been driven
by substantial population growth – the number of
people in the Middle East increased by 52% between
1990 and 2010.The region’s industrial structure also
plays a role in that, ironically, the process of oil and gas
extraction is energy intensive. Nearly a tenth of Saudi
Arabia’s energy output is consumed by Aramco, the
state oil company. The geography of the Middle East is
not kind either – the climate and topography requires
significant energy for air conditioning and water
desalination to provide modern living standards.
These factors combine to make the region very energy
intensive: in the GCC the amount of energy consumed
per capita is between three and four times the global
average. Figure 6 illustrates that energy use per capita
is highest in the region in Qatar and Kuwait. The oil
exporters are huge energy guzzlers by global standards
and it is likely they will consume even more energy in
future.
Expected population growth of 33% between 2010
and 2030 is going to drive a rapid rise in energy needs
which, combined with continued economic growth,
will increase the consumption needs of the population
and their consequent demand for energy. Furthermore,
many Middle Eastern countries are developing energyintensive industries, such as petro-chemical and
aluminium production, as they attempt to diversify
their economies away from hydrocarbon extraction.
Taken together, these factors mean energy demand
will grow by a further 36% between 2010 and 2020 to
nearly four times its 1990 level, as shown in Figure 5.
The question for the region is whether or not this trend
is sustainable. What alternative development strategies
could be adopted?
Figure 6: Energy use per capita in 2010, billion
kilotons of oil equivalent
Figure 7: Percentage change in energy
production and use across the Middle East,
2000–2010
200
150
100
50
14,000
6,000
Change in energy use
2000–2010
4,000
Oman
Qatar
UAE
Kuwait
Saudi Arabia
Bahrain
Iran
Iraq
Egypt
-50
8,000
Jordan
10,000
Lebanon
0
12,000
Change in energy production
2000–2010
Source: World Bank, Cebr analysis
Qatar
UAE
Kuwait
Oman
Bahrain
USA
UK
Euro area
Iran
Saudi Arabia
Source: World Bank, Cebr analysis
World
Lebanon
Iraq
Jordan
Egypt
2,000
0
policymakers’ focus on the need to diversify energy
production and ensure that consumption is being
driven by sustainable industrial policy. While it is
understandable that Middle Eastern countries are
seeking to maximise the benefit obtained from their
abundant natural resources, further diversification is
needed if an energy crisis is to be avoided.
Energy consumption is growing faster
than production
The phenomenal growth in energy consumption is
outstripping that of energy production across the
region, as illustrated in Figure 7. Although oil-rich
countries continue to invest in new fields and those
countries without oil are increasingly exploring natural
gas reserves, neither source can quite compete with
the growth in domestic and industrial thirst for energy.
The Middle East has the highest energy intensity of
GDP in the world – it takes more fuel to produce a unit
of GDP here than anywhere else. Diversification could
reduce the energy intensity of these economies over
time, as production becomes less dependent upon oil –
but this will only work if the new industries introduced
are less energy intensive. Many of the industries being
developed in the Middle East at present rely heavily on
substantial energy inputs, so as of now, that required
trend is not evidenced by current new business
developments.
Saudi Arabia already consumes all of the natural gas
production domestically, and Kuwait has even begun
importing liquefied natural gas from Russia. With their
reliance on energy exports and consumption growing
so much faster than production, these countries
face a difficult economic outlook unless something
changes. Forward-thinking countries in the region
have already acted on this and have put in place plans
to develop diversified energy sources; for example
the work of the Emirates Nuclear Energy Corporation
and the development of the huge Shams solar power
station in Abu Dhabi. But the reliance of the region
on energy and the growth in demand should sharpen
Substantial energy subsidies distort
energy demand even further
Socio-economic policies across the Middle East have
failed to encourage such efficiencies or the need for
diversification. Fuel and electricity are very cheap
in the region – a litre of petrol costs just $0.50 on
average, compared to a world average price of $1.904.
This is in no small part because both oil exporting
and importing countries in the Middle East have
a long history of providing households and firms
with subsidies on energy. On average across the
region, 7.8% of GDP is spent on pre-tax subsidies
on petroleum products, natural gas and electricity.
By comparison, pre-tax energy subsidies account
for less than 0.1% of GDP in the UK, US, Germany,
France and Spain. The breakdown of the subsidies is
illustrated in Figure 8. Spending on subsidies accounts
for more than 10% of GDP in Egypt, Iran and Iraq.
In contrast, oil exporters Qatar and the UAE have the
lowest share of energy subsidisation. Across the globe
25% of all energy is consumed by households, but in
the GCC residential use accounts for 47% of energy
consumption, illustrating how subsidies contribute to
particularly energy-intensive household consumption
patterns. In oil-exporting countries, subsidies are often
justified as simply reflecting the abundance of natural
resources, the low costs of production, and as a way
of ensuring that mineral wealth is shared among the
population.
But subsidies distort price signals and fail to allow
the market to allocate resources in the most efficient
manner. This will act as a constraint on productivity
growth, which ultimately determines the standard of
living in the long run. For example, subsidised energy
can make capital and energy-intensive production
processes relying on machines rather than workers,
limiting job creation. This is a particular concern in the
Middle East where unemployment is a big problem
and likely to be made even worse due to forecast
ECONOMIC INSIGHT – MIDDLE E A ST
Q2 2 013
population growth. The region could have a significant
advantage through the availability of labour, but
distortions in relative prices created by subsidies will
prevent this from being fully realised.
term. While a subsidy may initially be affordable,
increases in international energy prices or currency
movements can drive the cost of the policy up
dramatically in a very short space of time.
Ultimately, resources used to subsidise energy cannot
be used to improve competitiveness in other ways.
Subsidies on fossil fuels encourage more wasteful
methods of energy production, for example generating
electricity using oil. This inefficient practice has long
since been discarded elsewhere, but is still prevalent
in the Middle East where new oil-fired power stations
continue to be built. These power stations will remain
in service for years, making it difficult to develop
alternative energy sources.
These subsidies have the potential to store up major
future challenges to government budgets. For
instance, along with high unemployment, reduced
tourism, depressed foreign investment and the falling
value of the Egyptian pound, the need to finance
energy subsidies has led Egypt into dangerous fiscal
territory. With foreign currency reserves running low,
the country requires support from the International
Monetary Fund.
While the specific political circumstances of Egypt
obviously played a significant role in bringing it to
this point, it serves to illustrate the distorting impact
of subsidising energy. Moreover, the more countries
across the Middle East increase current public
expenditure, the more they store up fiscal liabilities
for the future. This creates the risk that a shift to less
favourable circumstances – falling export earnings for
instance – could lead to a substantial deterioration in
public finances. By encouraging domestic consumption
growth, reducing export availability and potentially
endangering fiscal stability, energy subsidies pose a
serious risk to the economic health of the Middle East
in the medium term.
Figure 8: Pre-tax energy subsidies as a
percentage of GDP in 2011
World
Qatar
Lebanon
UAE
Jordan
Oman
Kuwait
Bahrain
Saudi Arabia
Promoting competitiveness issues is
key to the region’s success
Egypt
Iraq
Iran
0
2
4
Petroleum
products
6
8
Electricity
10
12
Natural gas
Source: International Monetary Fund (2013), Energy Subsidy Reform:
Lessons and Implications
Energy subsidies store up future liabilities
without improving competitiveness
As outlined above, subsidies impose a significant cost
burden on governments. Across the region, pre-tax
energy subsidies account for 23% of government
spending. In Iran, energy subsidies amount to more
than half of government revenue. Egypt is not far
behind and energy subsidies account for more than
20% of government revenue in Jordan and Bahrain.
For the oil importing countries Jordan and Lebanon,
energy subsidies lead to balance of payments volatility
and cannot be financed at current levels in the long
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14
Reduced energy subsidies, energy source diversification
and competitiveness promotion across the economy
are vital in order to create good long-term growth
prospects. In the UAE and Qatar, governments have
made successful strides towards diversifying both
energy production and the wider economy. Both
have experienced a remarkable era of growth and
established the region’s leading financial centres: Dubai
and Qatar, with Abu Dhabi following close behind.
While fiscal surpluses continue, it is important that
governments invest in the long term. Creating first
class infrastructure is crucial and huge progress has
been made across the region; the world-leading
growth in air transportation traffic is testament to this.
However, alongside physical infrastructure, investment
in human capital will also be essential in providing
the growing populations with the skills needed to
contribute productively to the economy. In the long
run, growth will be held back unless distortions to the
economy are removed and the private sector is allowed
to flourish.
ECONOMIC INSIGHT – MIDDLE E A ST
Q2 2 013
ENDNOTES
1The 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 if we
refer to wider definitions of the region, we will try to point this out explicitly.
2 Based on economies weighted at market exchange rates.
3 Defined as the ‘GCC +5’ as explained at the start of the report.
4 World Bank data, Cebr analysis.
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.
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© ICAEW 2013 MKTPLN12258 05/13