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Global Economic Outlook
Middle East and North Africa (MENA): Q3 2010 Outlook
By Ayah El Said and Rachel Ziemba
- Stronger oil prices will boost revenues and economic growth, but the need to ensure domestic finance will contribute to a downshifting of growth from pre-crisis levels.
- The GCC is weighed down by recovering banks and will underperform other regions in 2010 while accelerating in 2011 when the EU-exposed Maghreb again lags.
Fiscal policy is beginning to be less accommodative, and oil importers are beginning to implement cuts, including to subsidies.
Outlook Update: In Search of a New Equilibrium
The MENA region will record strong growth in 2010 of about 4.4% before accelerating slightly in 2011 as domestic credit unlocks, particularly in the Gulf Cooperation Council (GCC). Strong oil prices, government spending, global restocking and rising incomes pushed up growth in H1, but economic growth is stabilizing in H2 largely below its 2005-2008 peak. Waning external demand, the threat of higher financing costs and constraints in local banking systems will keep growth below recent trend as it continues to find a new equilibrium after the overheating earlier in the decade. In 2011, an improvement in global trade and global demand, continued government expenditure, infrastructure investment, robust domestic demand, higher oil prices and a more robust recovery of the region’s export partners will boost growth to closer to 5%.
Although growth patterns are largely converging in 2010 among the three main sub-regions, there are exceptions, particularly within the GCC. Qatar, with gas production, will return to double digits, growing twice as fast. It should outperform the rest of the region, while a contraction in Dubai will keep the UAE a growth laggard. Domestic demand will be a major driver for the region’s large, relatively closed economies, especially Egypt and Saudi Arabia. Israel and the Maghreb will bear the brunt of EU austerity. 2011 will witness stronger growth rates across all the MENA countries, but growth rates—especially among oil importers—will remain beneath potential and will be shaped by the extent of the global recovery.
For the GCC, economic prospects remain oil-dependent, as oil contributes most of its export and government revenues and is highly correlated to investment and consumer confidence. The gradual recovery of the sub-region’s economy stems largely from bank stabilization, and recovery from the excesses of 2004-2008 has left an overhang of bad debts . RGE’s expectation of slightly higher oil prices in 2011 boosts the GCC as well as the Maghreb’s oil exporters.
Figure 1: With Some Exceptions, Growth Converging
Source: IMF, RGE
Figure 2: Strong Growth Across the Region
Growth Dynamics: Hydrocarbons and Domestic Demand Supporting Growth
Economic activity picked up across the MENA region in H1 2010 aided by the rise in oil prices and oil output, continued government expenditure, the global restocking cycle and—in countries like Egypt—an increase in domestic demand. However, on a real sequential basis, growth started to cool as credit conditions remained tight. Moving forward, government-influenced investment and domestic demand will be the main drivers of growth in H2 2010 and 2011. Oil output will continue to increase in both 2010 and 2011 due to commodity intensive growth in the emerging world and in spite of the slowdown in the global economy.
Outside of the oil exporters, the external sector will dampen growth prospects. In 2011, the revival of external demand will add further momentum to the region’s growth. Yet, growth in the MENA region will be below the trend observed in the pre-crisis (boom) years, in part as the economic base has grown. RGE believes that the trend growth of the next decade will likewise be below the credit-bubble-fueled record pace of the last half decade. Outside the GCC, a revival in global trade boosted Egypt’s Suez Canal revenues and supported growth in Morocco, Tunisia and Israel. Slower global trade, due to retrenchment of advanced economies, will slow the contribution going forward.
Subdued credit growth continues to be a constraint on growth, particularly private sector growth, as RGE has noted in the past. Credit markets are beginning to unlock in Saudi Arabia and Qatar but remain constrained in the UAE and Kuwait. Across the MENA region, the public sector rather than the private sector is still attracting most of the capital. A modest improvement in the region’s financial and banking sector should prompt lending growth in 2011.
A rise in domestic investment—aided by unprecedented government support—was the main driver of growth across the region in 2009, a trend that will continue in 2010. This pattern was strongest in the GCC but was also seen in the Maghreb and to a much lesser extent in the revenue-constrained Levant. Government funds, some raised through bond issuance in global markets, offset weaker funding from banks and equity markets.
In the longer term, attracting more private investment both portfolio debt and equity flows as well as direct investment is needed to diversify revenue streams. The freezing of privatization plans has exacerbated the lack of investment assets. The shallowness of most local markets and persistent corporate balance sheet concerns make these reforms imperative. In 2010, some GCC countries began lifting restrictions on foreign ownership (Bahrain and Qatar) and improving financial regulation (Kuwait) which could help in the medium term. Political trends in Egypt could defer investment until 2011.
Figure 3: Sources Shifting Drivers of Growth
Source: World Bank
The property market is another area of divergence. While the fastest growing GCC countries (UAE and Qatar) now have slack that is pushing down rents and prices, activity is now picking up in Kuwait, Saudi Arabia and especially the Levant. In Lebanon, some of the funds that fled to its banking system are now flowing to the property market, pushing up prices.
Risks: Fluctuations in Oil Prices
The region as a whole remains vulnerable to fluctuations in oil prices. A reduction in oil demand and prices could weigh on the region’s oil exporters and capital flows more broadly, since oil is correlated with risk appetite. Lower oil prices imply lower hydrocarbon receipts, which will adversely affect both output and the GCC fiscal position. Oil importers in the region could receive a reprieve from high oil prices as the dollar strengthens against the euro.
Spillover effects from eurozone weakness to the MENA region include lower trade volumes (and revenues in USD terms), tighter credit conditions should risk aversion return, as well as equity market volatility. Slowing of global growth poses a risk to oil prices. Fiscal austerity measures will lower consumption and their imports from the MENA region, which would hit oil importers more than oil exporters.
The MENA region’s banking sector was fairly resilient to the global financial crisis, particularly outside the GCC. GCC banks are still recovering from excessive lending financed by easy global credit, and credit growth is likely to remain subdued. Outside the GCC, the relative isolation of the banking sectors meant that the sector was relatively unscathed, although the growth rate of deposits slowed down (except in Lebanon). NPLs will continue to rise in 2010, as will provisions weighing on banking sector profitability.
Dubai Inc.’s debt restructuring process has helped to stabilize sentiment in the UAE. However the process is yet to be finalized and RGE still believes that several Dubai government-owned companies still have unsustainable debt levels. This implies that more restructuring may be needed, particularly if property prices remain weak. With the revenue outlook clouded, there will be a need to write down this debt, which will weigh on local markets. Regional markets were hard hit in the global selloff in May 2010, with the exception of Morocco and Tunisia, and the constraints on equity financing are raising concerns. Moves to consolidate local markets could at least help channel liquidity more efficiently, but ultimately, the deleveraging process will continue into the near future.
Policy struggles and political transitions could weigh on several economies, particularly their ability to attract capital. Iraq’s inability to form a workable government is the most extreme, but policy battles could defer implementation of reforms and fiscal policy in Egypt, Lebanon and Kuwait. Meanwhile the geopolitical stresses emanating from Iran and its nuclear program weigh on the region, including the UAE whose trade ties with some Iranian entities have been curtailed.
Policy Implications: Still Accommodative
For 2010, fiscal policy will continue to be expansionary across the region, but the pattern will diverge in 2011 as some countries begin to implement fiscal consolidation (Maghreb, Jordan, Israel and Bahrain) and others step up government spending (Kuwait, Algeria and Libya). Even in the most supportive countries, the net contribution of new spending could ease in 2011 (Saudi Arabia and the UAE). The fiscal positions of many countries have become more precarious. Many oil exporters now rely on oil prices well above US$60 per barrel. Bahrain, Iran and Iraq have some of the highest requirements. The region’s oil importers are constrained in their fiscal position and cuts may be necessary, especially in Lebanon and Jordan and even oil-poor Bahrain. Fiscal pressures are contributing to a withdrawal of subsidy programs across the region, which should help reduce future vulnerabilities.
While inflationary pressures should remain muted, allowing monetary policy to remain on hold, there are some countries—Saudi Arabia and Oman—where some overheating pressures could re-emerge as credit growth and housing prices rise. Israel will defer further hikes for some time as growth decelerates from the overheating pace of late 2009.
Many countries in the region are restrained by dollar pegs. Moreover, with some notable exceptions (Lebanon and Saudi Arabia) rents, a major driver of inflation, are not climbing. In the UAE and Qatar housing prices are contributing to deflationary pressures. Even in the Levant, rents are not climbing fast enough to indicate a housing bubble. Lower oil prices and effectively tighter credit markets relative to the pre-crisis years imply lower liquidity in the region.