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Economic Insight Middle East Quarterly briefing Q1 2014 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 2014: a crossroads for the Middle East Three years on from the onset of the ‘Arab Spring’ protests, the Middle East remains volatile. While the conflict in Syria drags on, elsewhere in the region countries are moving on from the problems of the last six years. Most notably, continuing negotiations between Iran and the P5+1 nations (the US, Russia, China, UK, France and Germany) could finally reach a lasting resolution in 2014. Iran has been under international economic sanctions since 2006, as a result of the country’s nuclear programme. An interim resolution was reached in late 2013 – the first formal agreement between Iran and the US in 34 years. Limited sanctions relief has been provided for six months from 20 January 2014, in return for a freeze in Iran’s nuclear programme and dilution of existing stocks of enriched materials, as well as access to enrichment facilities and power plants for international inspectors. The question now is whether a comprehensive follow-up agreement can be developed. The results of further negotiations will have wide-reaching implications across the region: Iran’s return to international markets would provide yet another supply boost to the global oil market, potentially reducing oil prices and revealing the fiscal vulnerability of other oil-producing states across the region. Elsewhere, Egypt will continue to attempt to rebuild the state, following 2013’s political turmoil, while Lebanon and Jordan will continue to suffer from the influx of Syrian refugees. By contrast, the exportoriented economies of the GCC should perform well as the global economy accelerates to expand at the fastest pace since 2011. BUSINESS WITH confidence icaew.com/economicinsight High oil prices have helped GCC growth soar above most of the world since 2008 The Middle East has benefited from some of the world’s strongest growth rates since the financial crisis hit in 2008. High oil prices have allowed some of the region’s states to post growth rates that advanced economies, dragged down by debt and austerity, could only dream of. A further boost has been provided by significant investment in economic diversification. Over the five years to 2013, the real GDP of GCC countries grew by 24.0%, while that of the UK shrunk by 0.5% and the eurozone by 1.9%. Even the US, which returned to growth much more quickly after the initial financial crisis, only grew by 6.2% over the same period.2 Qatar’s economy performed particularly strongly with double-digit growth in most years adding up to a 66.7% expansion between 2008 and 2013. Saudi Arabia’s economy also grew by 29.6%. Growth was slightly less strong outside the GCC, but still remarkable given the global economic context. Iraq’s economy expanded by 37.7% over the five years, thanks to strong growth in 2011 and 2012 after the destruction of years of conflict. Lebanon’s output also rose by 21.0%, while Jordan and Egypt managed growth of 17.2% and 16.7% respectively despite regional instability. Even Iran managed growth of 9.8% despite the crippling effects of international sanctions and disastrous domestic mismanagement. Rising populations mean wealth has to go further Countries across the Middle East have rapidly rising populations, meaning the economy must grow just to maintain living standards: although the volume of economic resources available across the region is growing, so is the number of people this wealth has to support. Between 2008 and 2013, the population of the GCC rose by 18.9% – more than six times quicker than the rate of growth in the UK or US (2.9% and 2.7% respectively). The population of the ‘+5’ rose 9.4%.3 Population growth across the Middle East is outpacing that across the rest of the globe, and most other emerging markets. While population growth will decelerate over the next decade as birth rates fall, the population of the Middle East as a whole is expected to rise by 17.3% between 2014 and 2024 – amounting to an additional 45m people across the region. Figure 1: Growth of real GDP per capita across the Middle East Living standards set to rise rapidly over next decade Economic prospects for the next decade on a per capita basis are more favourable. As the pace of population increase begins to slow, growth of GDP per capita should accelerate across the region, as illustrated in Figure 1. For the region’s oil-importing economies, including Egypt, Lebanon and Jordan, GDP per capita is expected to rise by more than 10% over the next five years. Iraq is expected to see even more spectacular growth, despite ongoing political instability, as the country begins to make greater use of its natural resources. Here GDP per capita is expected to rise by more than a third between 2014 and 2019, and to continue growing at this pace until 2025. A boost to living standards is also expected in GCC economies, as investment in downstream industries and diversification begins to bear fruit. The most dramatic improvements will be seen in Qatar, where GDP per capita should double between 2014 and 2025, thanks to the low costs of producing natural gas and the country’s hosting of the 2022 football World Cup. Other countries will see slightly slower growth, held back by a fall in global oil prices. This will mean GDP per capita growth in Saudi Arabia will be slightly slower in the coming years than over the last five, but the UAE, Kuwait, Qatar and Bahrain are all expected to see further acceleration. High savings to fuel investment in diversification GDP per capita is just one measurement, however, of the prospects for an economy. While this is the average resources available for each person in the population, the measure tells us little about how these are distributed among the population. Across the GCC, less than half of all GDP is consumed, either by government or households. In Saudi Arabia, for example, just 38.6% of GDP was used to finance domestic consumption in 2012, while the UAE consumed only slightly more of its GDP – 46.2%. Qatar consumed just 19.9% of its GDP, allowing 23.0% of what it earned to be invested.4 2008–2013 2014–2019 forecast Iraq Saudi Arabia Egypt Qatar Lebanon US Iran Bahrain UK Jordan Oman Kuwait Instead, much of the earnings of oil exporters are saved, providing finance for investments in other industries to guard against dependence on hydrocarbons. UAE % 40 35 30 25 20 15 10 5 0 -5 -10 -15 -20 -25 This population growth means that despite robust economic expansion, living standards (measured by GDP per capita) have not increased across the board in the Middle East. Indeed, despite the rapid growth of their economies over the last five years, the UAE, Kuwait, Oman and Jordan have all seen real GDP per capita fall. Although output is rising quickly, a combination of high birth rates and immigrants hoping to take advantage of the opportunities created by economic expansion mean that living standards have struggled to keep pace with GDP growth. 2020–2025 forecast The International Monetary Fund (IMF) estimates that Qatar’s gross national savings accounted for 59% of GDP in 2013 – more than even the 51.4% famouslythrifty China put aside. Kuwait also saved 55.2% of its earnings, and other GCC nations were not far behind – Saudi Arabia’s national savings account for 47.6% of GDP, while the UAE’s are worth 40.1%. GCC countries have among the world’s highest gross national savings per capita on a US dollar basis, as illustrated in Figure 2. Source: United Nations World Population Prospects: The 2012 Revision, International Monetary Fund World Economic Outlook, Cebr analysis icaew.com/economicinsight cebr.com economic insight – middle e a st Q1 2 014 Figure 2: National savings per capita, US$ current prices Figure 3: Consumer Price Index (CPI) inflation, annual percentage change 2013 and 2018 US$ % 60,000 14 50,000 12 10 40,000 8 30,000 6 20,000 2020 forecast Source: United Nationals World Population Prospects: The 2012 Revision, International Monetary Fund World Economic Outlook, Cebr analysis In Qatar, gross national savings per person were equivalent to nearly US$55,000 in 2013, while the equivalent figure in Kuwait was over US$30,000. Saudi Arabia and the UAE also have relatively high levels of savings per capita – both above the US’s level of just under US$9,000. These high savings rates, a result of strong exports and a persistent current account surplus, can be used to finance investment, providing these economies with a boost in their efforts to diversify. By 2020, as populations begin to age and middle classes continue to grow, savings per capita will fall across many of these countries – most notably in Qatar, but also in Kuwait, the UAE and Saudi Arabia. Middle Eastern economies will become less reliant on hydrocarbons in future as prices fall and diversification efforts bear fruit. Once this is achieved, the pattern of economic growth across the region is likely to shift away from the current emphasis on investment towards consumption – a natural sign of a maturing economy. Determination to reform subsidies places pressure on inflation rates Rising GDP per capita should bring benefits to people across the Middle East in coming years. Although they may not feel the benefits directly in pay packets, quality of life should also be improved by access to better public services and improved transport networks as the benefits of strong economic growth trickle down. At the same time, however, households across the region will be feeling the pinch of rising inflation. After many years in which daily essentials such as food and power have been heavily subsidised by governments, fiscal pressures mean that many are now seeking to cut the amount they spend on supporting household consumption. The immediate impact of this will be to increase the prices of these goods, raising inflation, as illustrated in Figure 3. icaew.com/economicinsight cebr.com 2013 Egypt Lebanon Jordan Saudi Arabia Qatar Kuwait Oman Bahrain Iraq Qatar UAE Kuwait US Saudi Arabia Oman UK 2013 Bahrain Iran China Iraq Jordan 0 Egypt 0 Lebanon 2 UAE 4 10,000 2018 forecast Source: International Monetary Fund. Iran data excluded from figure due to distortionary effect on scale – Iranian CPI inflation was 42.3% in 2013, and is expected to fall back to 20.0% by 2018. Most hard hit by attempts to reduce subsidies will be households in Egypt, where a third of all government spending (13% of GDP) is on reducing costs of consumption. In the initial aftermath of political upheaval in 2013, relief was increased to reduce the prices of subsidised goods by 10-15%, but in the long run policies such as these are simply not sustainable. Reducing the subsidy bill here is a condition of further IMF relief. The withdrawal of state support, however, will hit household budgets hard, pushing consumer price index (CPI) inflation up from 6.9% in 2013 to 12.3% by 2018. The proportional rise in inflation will be even higher in Iraq, as the removal of subsidies combines with the accelerating economy and greater demand for resources to leave inflation at more than double its 2013 level by 2018. Price rises in the UAE, Kuwait and Qatar will be more limited, but inflation is still expected to rise. By contrast, households in Jordan and Lebanon are expected to see some relief from inflationary pressures by 2018, as a reduction in the violence overspilling from Syria (if not an end to the civil war) reduces demand for essential items and lowers the pressure placed on resources by large populations of refugees. What if sanctions on Iran are lifted? Iranian oil production has dropped dramatically since 2012, when sanctions imposed as a result of the country’s nuclear programme were tightened. Over the 12 months to September 2013, production was nearly 1m barrels a day lower than over the same period two years earlier,5 representing the loss of almost a fifth of Iranian oil output. As negotiations continue between Iran and the P5+1, what would the consequences of a deal be for other countries around the Middle East? Increased oil supply pushes prices down To date, sanctions have provided yet another supply restriction which has kept global oil prices elevated. Combined with the US ban on exports of crude oil, disturbances in other major oil producing states, and security concerns across the Middle East, sanctions against Iran have kept average oil prices6 persistently above $100 a barrel since early 2011. This is despite an increase in global oil production of 2.5% over the same period.7 economic insight – middle e a st Q1 2 014 30 20 2002 2004 2006 2008 2010 2012 2014 2016 2018 Baseline forecast Forecast if an agreement is reached by 20 July 2014 Source: International Monetary Fund and Cebr analysis We expect that the immediate impact of a full-scale international agreement between Iran and the P5+1 would be minimal, as it would take some time for production to restart. Countries such as India and China, who are already purchasing oil from Iran under waivers from the US, may immediately increase their purchases from this source, reducing prices slightly across the rest of the market. If a deal is reached within six months of the implementation of the interim deal on 20 January 2014, Iran could increase production by 1m barrels a day within months. Under this scenario, international average oil prices could fall to $100 a barrel this year – slightly lower than the $101 otherwise anticipated. By the end of the forecast period, the combination of increased Iranian production and spare capacity in other OPEC states, particularly Saudi Arabia, could drive prices down to $88 a barrel – where they would otherwise be expected to remain around $96 a barrel. The pace of price decreases would likely be moderated by a fall in production from ‘tight oil’ sources. Our baseline forecast – assuming that a deal is not reached by 20 July 2014 and sanctions on Iran are tightened once again in late July – also shows prices falling, albeit less quickly, mostly as a result of increased oil supply from shale sources. However, as the cost of recovering this oil is much higher than that of drilling conventional icaew.com/economicinsight cebr.com Figure 5: Annual real percentage change in GDP, assuming Iran and the P5+1 fail to reach an agreement % 9 8 7 6 5 4 3 2 1 0 2014 2015 Iraq 40 Qatar 50 Saudi Arabia 60 UAE 70 Bahrain 80 Oman 90 Even without a full international agreement, we believe that the economic prospects for Iran are looking better than they have over the last few years. Poor domestic policies have deepened Iran’s economic troubles in recent years; the combination of expansionary policies and falling revenues thanks to international sanctions have left the country battling high inflation8 and unemployment as well as contracting output. President Rouhani made clear when presenting his first budget in December that he intends to move away from the populist policies of his predecessor and focus on turning Iran’s economy around. Additionally, the limited relief provided under the interim agreement will give the Iranian economy some positive momentum. Given this, Iran’s GDP is expected to rise by 1.3% over the course of 2014 – a stark contrast to the 1.3% reduction in output experienced last year. Nevertheless, without an international agreement which will allow Iraq to export its hydrocarbons, it will remain the region’s weakest performer, as illustrated in Figure 5. Jordan 100 Scenario 1: Iran and the P5+1 fail to reach agreement on a full-scale deal Kuwait 110 This price fall would obviously have consequences for oil exporters across the Middle East. Many states have implemented dramatic programmes of government spending in the aftermath of 2011’s protests, raising the ‘break-even’ oil price needed to pay for these outgoings and balance the budget. The reduction in oil prices will have an impact on the fiscal decisions of these states, and also their decisions to invest in additional oil production capacity – with Iran back in the game, the incentive to invest in new wells and take advantage of historically high prices would be reduced. Charts 5 and 6 below compare the growth forecast for these two scenarios. Egypt US$ How would falling oil prices affect economies across the Middle East? Lebanon Figure 4: Oil price forecasts: the effect of an Iranian return to market. US$ per barrel, simple average of prices of Brent crude, West Texas Intermediate and Dubai Fateh wells, the steeper price decrease expected if Iranian oil returned to markets would have the potential to reduce supply growth from these sources. By reducing the scale of the increase in the global oil supply, this would counteract some of the negative price pressure of Iran’s return to global markets. Iran If a deal is reached and sanctions on Iran are lifted fully in the next 12 months, this would certainly have an impact on global oil prices – assuming that other factors do not change significantly. President Rouhani’s decision to re-appoint former oil minister, Bijian Zanganeh who brought in billions of dollars of international investment between 1997 and 2005, suggests that Iran is serious about re-entering the international oil market. Furthermore, although Iranian production has been curtailed by sanctions, wells are likely to have been closed in an orderly fashion, making the prospect of re-starting production much simpler than the task faced in neighbouring Iraq, where infrastructure has been damaged by years of conflict. While Iranian oil would not return to market as soon as a deal is reached, the prospect of additional supply within a few years could be significant enough to bring oil prices down in the short term as much oil is traded through futures markets. 2016 Source: Cebr analysis economic insight – middle e a st Q1 2 014 Elsewhere, Lebanon and Egypt will both continue to be held back by political instability. Lebanon is not expected to find a permanent government until late 2014, and with no end to the Syrian civil war in sight, the country will continue to pay the price in lost tourism and the overspill of violence. Prospects for 2015 onwards are a little bit brighter in Egypt, where growth is expected to rise to 4.0% by 2016 as the political situation settles down. The Middle East’s brightest growth prospect is Iraq, where growth is expected to accelerate in 2014 to 6.7%, up from 4.4% in 2013. Although the region continues to be dogged by outbreaks of violence, there is nonetheless evidence that companies are increasingly keen to operate there. International banks are moving in – Standard Chartered opened a Baghdad branch in 2013, and Citibank is expected to follow suit shortly – as are business services firms including Deloitte. Strong growth will become self-reinforcing, as international firms seek a piece of the action and invest. With other emerging markets, including China, Russia and India, looking less attractive than they have in recent years, Iraq will be tempting to investors despite instability. With a third of the population on the public payroll, increases in government spending will also have a significant effect. Growth is expected to rise to 8.6% by 2016. Across the GCC, a slight acceleration in output growth is anticipated in 2014, from 4.0% in 2013 to 4.4%. High levels of fiscal spending will continue to provide an impetus for growth in the UAE, Qatar and Saudi Arabia, although this will fall slightly later in the forecast period as governments grapple with the difficult problem of reducing spending on subsidies. Scenario 2: Iran and the P5+1 reach a deal, and Iranian oil returns to markets Figure 6: Annual real percentage change in GDP, assuming a deal between Iran and the P5+1 % 9 8 A fall in oil prices would push many GCC countries perilously close to their break-even oil prices. As countries including Bahrain, Kuwait and Saudi Arabia have boosted social spending in the wake of the Arab Spring, they have raised the amount they need to earn from oil revenues to fund this spending. The Arab Petroleum Investments Corporation (APIC) estimated in August 2013 that Saudi Arabia’s break-even price had risen to $98 a barrel from $94 in 2012, while the UAE’s break-even price is also edging closer to $100 a barrel.9 While most GCC countries are already expected to reduce fiscal spending within the forecast period, the fall in oil prices anticipated if Iranian oil was to return to international markets would bring forward the date at which these countries would enter fiscal deficits and make efforts to trim subsidy spending and public wage bills more pressing. Lower prices would also reduce the incentives to invest in new oilfields elsewhere in the Middle East, knocking a few percentage points off the growth forecasts for the UAE, Oman, Kuwait and Saudi Arabia. Production limits in OPEC states, in an attempt to support international prices, could have the effect of capping growth in these countries. The main loser from a deal between Iran and international powers would be Iraq. Iran, with the second-largest proved oil reserves in the Middle East, would be a very attractive destination for many international firms. Several international carmakers have already spoken of their willingness to produce in Iran if a deal is reached. Given this, we expect that free access to Iranian markets may significantly reduce the attractiveness of investment in Iraq, where violence is expected to continue throughout the forecast period. An international agreement with Iran would thus cut forecasted growth in Iraq in 2016 from the 7.3% envisaged in our baseline scenario to 6.9%. It is possible that the reintegration of Iran into the international community could also speed along the resolution of the conflict in Syria. Given that this slightly improves the prospects for surrounding countries, we expect that growth in Lebanon and Jordan would be slightly stronger in the event that an agreement was reached between Iran and the international community. 7 6 A deal would hasten diversification across the GCC 5 4 3 2 2014 2015 Iraq Qatar Saudi Arabia UAE Bahrain Oman Jordan Kuwait Egypt Iran 0 Lebanon 1 2016 Source: Cebr analysis The impact of a deal between Iran and the P5+1 which resulted in a loosening or retraction of international sanctions would not have an immediate impact on oil prices. The impact on expectations of future prices would be felt much more quickly, however, and would influence decisions on government spending and investment in new oil production capacity. Figure 6 presents forecasts which take these changes, and their consequences for economic growth, into account. icaew.com/economicinsight cebr.com The impact of a deal on GCC economies would be mitigated in the medium term by existing efforts to diversify economies away from reliance on hydrocarbon production. As long as investment in transportation networks, improving education and building downstream industries continues, these countries will escape the worst consequences of a sharper fall in the international oil price than if no deal is reached. The negotiations to reach a deal will doubtless be long and arduous, with the US particularly struggling to balance domestic calls to treat Iran harshly with the desire to improve the stability of the region. However the cards fall in 2014, oil prices will fall as supply grows in coming years. Countries within the GCC must continue to confront their fiscal situations and the need to diversify if the economic success of the last five years is to be sustained in a world of lower oil prices. economic insight – middle e a st Q1 2 014 ENDNOTES 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 if we refer to wider definitions of the region, we will try to point this out explicitly. 2 Estimates of GDP growth rates 2008-2013 are based on IMF historical data for 2008-2012 and Cebr forecasts for 2013. 3 United Nations, Department of Economic and Social Affairs, Population Division (2013), World Population Prospects: The 2012 Revision. 4 Cebr analysis of data from the UN National Accounts Main Aggregates Database 5 Cebr analysis of Energy Information Administration data. 6 IMF, simple average of market prices of Brent crude, West Texas Intermediate and Dubai Fateh. 7 Cebr analysis of Energy Information Administration data. 8 See comment below Figure 3. 9 APICORP (2013), Modeling OPEC Fiscal Break-even Oil Prices: New Findings and Policy Insights, Economic Commentary 8(9-10). Available online at http:// www.apic.com/Research/Commentaries/2013/Commentary_V08_N09-10_2013.pdf 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 MKTPLN12929 02/14