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economic Insight middle east Quarterly briefing August 2011 Mixed picture across the Middle East as oil exporters boom in 2011 – but growth to slow in 2012 Welcome to the second issue of the ICAEW Economic Insight: Middle East, the quarterly economic forecast prepared directly for the finance profession. Produced by Cebr, ICAEW’s partner, and acknowledged experts 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. The global economic backdrop remains uncertain as concerns over the health of eurozone and US economies linger and the European sovereign debt crisis threatens to seriously impact real economic activity. Does this mean the outlook for the Middle East is materially worse? What kind of risk does the ongoing sovereign debt crisis pose to the region? Given concerns over a slowing global economy are oil prices heading lower now and what does this mean for the Middle East? BUSINESS WITH CONFIDENCE icaew.com/economicinsight Middle East to outperform global economy but growth to slow in 2012 Overall our latest assessment is that growth in the Middle East looks set to be stronger than in the global economy as a whole in 2011. However, there are interesting divergences in performance, with particularly strong growth expected in Qatar, Iraq and Saudi Arabia as export growth drives increased economic activity and government investment surges. The ongoing ramifications of political unrest in Egypt, Lebanon and Bahrain lead us to expect far weaker performance in these economies. Looking ahead, it is abundantly clear that there are major risks to the global economic outlook and we expect oil prices and production to ease even without a hard landing for the global economy which is becoming a clear risk. Hence, we project an appreciable slowdown in Middle East growth in 2012. Mixed picture for global oil demand Oil prices fell sharply from a peak in May, with a 12% peak to trough decline in the price of Dubai Fateh, but have since partially recovered and the surge since mid-2010 means prices stand some 52% higher than a year earlier in July. But can prices be sustained over $100 per barrel against a turbulent global economic background? While emerging market growth has been strong, the economic recovery in Europe and the US has generally struggled to gain traction. With sluggish job creation, unemployment above 9% and major public spending cuts ahead, the US looks set for 2011 growth far weaker than trend. Meanwhile, in the eurozone, concerns over the sustainability of large public sector debt continue and the growth performance in large economies like Italy and Spain disappoints. However, this weakness in demand from advanced economies is offset by strong growth among emerging economies. China and India are expected to grow in real terms by 9.4% and 7.9% respectively this year. Indeed, China’s oil demand will grow by 6.6% in 2011 and a further 5.2% in 2012 in contrast to declines across OECD economies in both years.2 Overall, the emerging market thirst for oil will result in global oil demand expanding by 1.4% in 2011, down from 3.3% growth in 2010. Figure 1: Oil price, simple average of three spot prices 3 , $ per barrel Source: IMF, Cebr prospects service forecasts Middle East oil production surging to fill in gap created by Libya conflict Looking at the generally weakening picture in the global economy, one could have reasonably expected to have seen a sharper and more sustained decline in oil prices. While we expect slow growth in the advanced economies and deceleration in emerging markets due to monetary policy tightening to lead to a fall in the average price in oil in 2012 (as shown in Figure 1 above), prices are likely to remain relatively high relative to long-run levels. One of the major factors contributing to the precipitous rise in oil prices earlier in the year was political uncertainty among oil exporting countries of the Middle East. The ongoing conflict in Libya has seen close to 2% of global oil supplies dry up. Interestingly, the decline in capacity seems to have been compensated by growth in production from key Middle East economies. Oil supplies from Libya are down by around 1.6m barrels per day, while production in the GCC countries plus Iran and Iraq is up by around 1.4m barrels. 4 Indeed, over the three months to March, annual growth in oil production across the GCC was the highest since August 2008 and production in Iraq and Iran as a share of global supply reached its joint highest level since 2003. 5 Hence, Middle East oil production is surging in 2011 and this will contribute to boosting overall economic growth in the region this year. However, we think that weaker global growth fundamentals – and the assumption that Libyan production comes back online at some point in 2012 – imply that growth in production will ease appreciably in 2012. 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 International Energy Agency Oil Market Report, 13 July 2011. 3 Brent crude, West Texas Intermediate and Dubai Fateh. 4 Cebr analysis of US Energy Information Administration (EIA) data. 5 Cebr analysis of US EIA data. Figure 2: Oil production, annual percentage change Figure 4: Export value index; three month moving average; May 2009 = 100 20% 170 15% 160 10% 150 5% 140 130 0% 120 -5% 110 World GCC Iran and Iraq Asia Advanced MEA May 11 Mar 11 Jan 11 Nov 10 Sep 10 Jul 10 May 10 Mar 10 Jan 10 Nov 09 Jul 09 100 90 Sep 09 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 -15% May 09 -10% World Source: EIA Source: CPB Netherlands Bureau of Policy Analysis, Cebr analysis Political turmoil sees real economic activity hit in the wider MEA region But Middle East – especially GCC more insulated from drop off in trade Despite the surge in oil prices and production levels in the Middle East, the ongoing conflict in Libya and political disruption has had a palpable effect on real economic activity in the wider region. As shown in Figure 3, traffic through the Suez canal over the three months to June was 2.2% lower compared to the same period a year earlier and the month of May saw the largest year-on-year decline since November 2009. The volume of traffic on the canal still stands some 25% below the peak level before the recession. At first inspection, the trade volume data suggest that real economic performance in the Middle East has weakened appreciably in 2011. However, this interpretation needs to be treated with caution for two reasons. First, the disruptions to economic activity caused by political unrest and conflict affected different parts of the wider region quite differently; for example events in Egypt and Libya are likely to have distorted the overall MEA trade volume figures downwards. Second, when we analyse the figures in terms of values, i.e. in dollar cash terms, and consider the importance of oil trade to the region, a different story emerges. While the Suez canal figures are likely to have been particularly influenced by the political disruption in Egypt, the latest trade volumes for the wider Middle East and Africa (MEA) region bear witness to evidence of a weakening in real economic activity in 2011. Annual growth in the volume of exports from MEA over the quarter to May 2011 has fallen to 1%, compared with rampant 12.6% annual growth as recently as December 2010. The 1% growth compares with 7.2% growth in trade volumes across the world and 13.5% growth in Asia over the same period, suggesting weaker performance in MEA. Figure 3: Suez canal traffic, quarterly annual percentage change in total number of vessels 30% 20% Figure 4 illustrates that MEA trade, in dollar terms, has boomed since Q3 2010. Over the three months to May, the value of exports stood 28% higher than the same period a year earlier, compared with 15% annual growth in the value of total world exports. The value of MEA imports grew by 18% in the same period – suggesting a substantial boost to trade surpluses among those economies benefitting from the export boom. The obvious explanation for this is that the surge in oil prices has driven robust growth in the value of MEA exports. With the GCC plus Iran and Iraq making up around 73% 6 of total MEA oil production, this suggests that large parts of the Middle East will experience a stronger 2011 than trade volume data suggest in isolation. 10% 0% -10% -20% Jun 11 Jun 10 Jun 09 Jun 08 Jun 07 Jun 06 Jun 05 Jun 04 Jun 03 Jun 02 Jun 01 -30% Source: Suez Canal Authority, Cebr analysis 6 Cebr calculation based on latest EIA oil supply data. icaew.com/economicinsight cebr.com economic insight – middle e a st August 2 011 Figure 5 illustrates that combined exports from across the Middle East to the eurozone and US as a share of total exports declined from near 30% in 1990 to 15% in 2010. Notably, the countries in the GCC have the lowest export reliance on the US and eurozone at just 12% in 2010. Hence, while Middle East exports to the eurozone and US are still huge in value terms at $66bn and $52bn respectively in 2010, the data show that fast-growing emerging markets are an increasingly important source of demand for exports from the region. 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 2011 Qatar The US and eurozone account for more than two fifths (43%) of global economic activity, but how reliant are Middle East export markets on them? 7 The answer to this, interestingly, is less than they used to be. Figure 7: Real GDP growth across Middle East economies, annual percentage change Iraq A key theme of 2011 has been the eurozone sovereign debt saga as member countries with large public sector deficits and liabilities struggle to convince markets that they will be able to service their debt. Meanwhile, the US recovery has disappointed, with quarter-on-quarter growth at just 0.1% and 0.3% in Q1 and Q2 2011 respectively. This is far below the long run trend at 0.8% quarterly growth. Saudi Arabia How big a risk does weak growth in Europe and the US pose to the Middle East? Kuwait Source: IMF Direction of Trade Statistics, Cebr analysis Oman 2010 UAE Total (GCC+5) Jordan 2000 GCC Iran 1990 Iraq and Iran Bahrain Egypt, Jordan and Lebanon Growth across the Middle East as a whole looks set to outpace global growth in 2011, but there are major divergences in performance across the region. Growth across the GCC could reach its highest level since 2004 and to be far stronger than in Egypt, Iran, Jordan and Lebanon, while growth in Iraq is likely to be its strongest since the US-led invasion in 2003. Growth across the GCC is being bolstered by some exceptional factors. First, oil production is surging, partly to making up for reduced capacity elsewhere. In addition, government spending and infrastructure investment is growing strongly. However, growth rates are expected to normalise in 2012 as the global economy slows. In contrast to the GCC, the group of Egypt, Jordan and Lebanon are experiencing weaker growth conditions, partly due to the consequences of turbulent political circumstances – we expect growth across these three countries to come in at its weakest level since 1992, but expect some improvement in 2012 as political turmoil subsides; but clearly this remains relatively uncertain. Lebanon 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Mixed picture across the Middle East as the GCC powers ahead in 2011 Egypt Figure 5: Exports to the eurozone and US as a share of total exports by country group in the Middle East 2012 Source: Cebr analysis Qatar’s incredible growth continues; growth across GCC to fall in 2012 WC: 1090 (2790) Figure 6: Real economic growth in the groups, annual percentage change 8 8% 6% 4% 2% 0% -2% 2005 2006 GCC 2007 2008 Iran and Iraq 2009 2010 2011 2012 Egypt, Jordan and Lebanon Source: Cebr analysis and IMF World Economic Outlook Database April 2011 In 2011, for the sixth successive year, the strongest growing economy in the region will be Qatar. We expect the economy to grow by 19% as booming liquefied natural gas (LNG) production drives growth. In current dollar terms, the size of the economy has more than tripled since 2006 – a performance rivaling any economy across the globe. Despite the exceptional growth rate, inflation remains well contained, standing at 1.8% in June but likely to accelerate and come in around 3% for the year as a whole. Growth is expected to ease in 2012 to around 7%, but with 13.5% of proved natural gas reserves, investment will continue to pour in, with the government expected to spend $125bn over the next five years on major developments. 8 Weights derived from current dollar GDP share. 7 Calculation based on 2010 current dollar GDP estimates from IMF World Economic Outlook April 2011. icaew.com/economicinsight cebr.com economic insight – middle e a st August 2 011 For Saudi Arabia, the Middle East’s largest economy, we expect a rate of expansion that ranks alongside fast-growing emerging markets in 2011. Oil production is growing robustly this year; over the quarter to June, Saudi oil output stands some 13.7% higher than during the same period a year earlier, which is the strongest annual pace of growth since the quarter to January 2005. At the same time, government current expenditure and investment is booming; government expenditure is likely to fall in the 40–45% of GDP range in 2011 and is likely to be structurally higher than the 34.9% average over the 10 years to 2008. As the global economy cools, we expect growth to fall to a more normal 4% in 2012. In the United Arab Emirates, the GCC+5’s third largest economy, we have upwardly revised growth – expected to come in at 3.8% in 2011. The buoyant economic performance is partly being driven by the flow of labour and capital from countries experiencing political unrest and, in particular, robust performance in Abu Dhabi where oil production also booms. Annual growth in production across the UAE reached its highest rate since 2005 in 2011. In Dubai, the hospitality and retail sectors have shown promise and while the real estate sector is still relatively weak, there are signs of stabilisation. Overall, growth in Abu Dhabi is likely to be stronger than Dubai, while growth across the emirates will ease to 3.4% in 2012, less than half the 7.9% average growth for the five years through to 2008. Similarly, Kuwait is expected to record solid 5% growth in 2011 as oil production grows strongly and the government approved the largest budget since 2003 at $71bn. Inflation remains a concern at 5.4% year-on-year in June. We expect growth to moderate slightly in 2012 but fiscal policy will continue to contribute strongly to growth in economic activity in the near term. Growth in Oman is expected to be a touch weaker than Kuwait, at 4.2% in 2011. Oil production growth has been generally weaker while government spending growth is less ambitious than in some of the other GCC states. Growth is expected to moderate to 4% in 2012. The weakest performing economy within the GCC is Bahrain, with ongoing concerns due to political instability. The uncertainty over political developments has impacted investor sentiment and is affecting real economic activity. Real GDP growth is expected to come in at 1% in 2011; the weakest since 1994. Stronger growth, although still weaker than the GCC as a whole, is expected in 2012 but it is a particularly uncertain outlook. Iraq economy to record post-war growth high while Iran navigates economic reforms since March 2008. While inflation remains high – surpassing 6% earlier this year – investment has poured into the economy and growth is expected to be as high as 10% in 2011; second only across the Middle East to Qatar. Growth is expected to moderate slightly in 2012, but increased trade links with China and infrastructure investment is expected to result in Iraq recording the highest growth rate across the Middle East in 2012. In Iran, the picture is less clear. Evidence on recent real growth performance is ambiguous, with estimates ranging between 1–3%. The removal of some $60bn of government subsidies is thought to have been relatively successful as inflation has remained lower than recent years, although at 19.7% in April, is still the highest rate of price growth across the Middle East. There is a large degree of uncertainty around growth estimates but we expect growth to rise from 1.5% in 2011 to 2.5% in 2012. Sluggish growth in Egypt and Lebanon due to political instability In Egypt, the political turbulence through 2011 is having a discernible negative impact on real economic performance. Industrial production fell as much as 25% year-on-year in February and May saw a 6% annual decline. Overall, the economy declined by nearly 4% compared with a year earlier in Q1 2011. Against this background – and with the annual rate of inflation running at 11.8% in June, squeezing real disposable incomes – growth across the year is likely to be its weakest since 1992. Growth is estimated to come in at 1% as the Central Bank of Egypt keeps interest rates on hold at 8.25%, where they have been since September 2009, but growth could be even lower than this. The pace of expansion is expected to increase in 2012 as the relatively low interest rates and weak exchange rate help to boost external and internal demand. In Lebanon, political uncertainty remains and economic performance continues to underwhelm. We expect GDP growth at just 1% in 2011, the weakest since 2006. Inflation remains above 5%, squeezing consumer purchasing power while the government is running a large budget deficit, so fiscal consolidation is likely to be around the corner. In Jordan, the economy is expected to post reasonable growth at 3.4% in 2011. Although unemployment stands high above 13% of the labour force, annual growth in industrial production returned to positive territory in Q2. The real estate sector shows signs of promise while the country’s information and communications technology sector can capitalise on the government’s aim to increase internet penetration from just 11% in 2007 to 50%. Overall, growth is somewhat less stellar than the GCC, but is stronger than economies adversely affected by political unrest. Similarly to the GCC, Iraq is benefitting from high oil prices and corollary double digit annual growth in oil production volumes. Over the three months to June, oil production rose by 18.3% compared with the same period a year earlier, the strongest rate of expansion icaew.com/economicinsight cebr.com economic insight – middle e a st August 2 011 ICAEW ICAEW is a professional membership organisation, supporting over 136,000 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. 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