Most leaders in the Middle East will probably be starting the year in a similar frame of mind. Theirs is an uncertain world. The Israeli/Palestinian crisis continues unabated and, although there is no immediate danger of overspill, there are equally no signs of life in any peace process. Dominating more international headlines is the escalation of rhetoric in the US campaign against Iraq. The drums of war have been beating for nine months, and the momentum built cannot be sustained indefinitely. This year it will either explode into conflict or – a scenario most analysts have neglected – be naturally dissipated by the diktats of real politik (see box).
Such regional political issues provide one backdrop for the region’s economic planners. The others come in the form of forecasts over the health of the global economy, with which the Middle East is becoming increasingly integrated, and the price of oil – still the major source of revenue for many of the region’s governments, despite attempts at economic diversification. Of course, the bundle of inter-related variables forms an impossibly complex economic equation. The result is that economic forecasting is less a science and more an art.
In its annual macroeconomic outlook, MEED is mainly bullish: 2003 will be a year of healthy economic growth. Its forecasts are based on the assumption that there will be no war in Iraq or, if there is a conflict, that it will be sufficiently quick, clean and well-managed for the disruption to business activity elsewhere in the region to be reduced to a minimum.
The other key assumption made is that OPEC is well positioned to react to volatility in the global oil market and soften market-fundamental – as well as emotion-driven – swings in the price of crude. This has not always been the case, as the most recent oil price crash in 1997/8 highlighted. But the improvement in relations between Riyadh and Tehran, the surplus production capacity within the group and reasonable internal coherence suggest the organisation will have the flexibility and the confidence to bring comparative calm and stability to the oil market.
The two jokers in the pack are the current political unrest in Venezuela – strike action against the policies of President Chavez has pulled significant supply out of the market in recent weeks, and no reduction of tension seems imminent – and the Iraqi question. A multiplicity of hands could yet be dealt pushing oil prices in different directions, but most scenarios that recognise the importance of OPEC’s internal capacity to manage the market end up forecasting oil prices that will average between $24-25 a barrel this year.
On the back of strong oil last year and in 2001, when oil averaged $24.30 and $23.13 a barrel respectively, there is good reason to expect the region’s well-fuelled oil economies to be firing on all cylinders. The reason for this is twofold. First, government expenditure continues to be a major driver of economic activity throughout the Middle East, despite attempts to stimulate the private sector. Second, most of the region’s largest economies have fixed exchange rates and open capital accounts – which effectively preclude independent monetary policy. As a result, fiscal policy remains the key instrument of macroeconomic management and, with low taxation in the Gulf, the key determinant of fiscal policy on the revenue side is oil.
As a result, many of the region’s economies could be approaching the strong period of a boom cycle. As the table below shows, MEED is forecasting significant increases in government expenditure in 2003 and, as the chart on page 6 shows, this, when added to the stimulation of expenditure over the previous two years, should lead to healthy growth in most regional economies. Of course, the patterns of economic growth are not even.
In Riyadh, the government will spend much of 2003 juggling its urges to spend with the need for fiscal propriety. A number of major infrastructure projects have been stacked up and together form a high wall of spending requirements. In addition, the constant, rapid growth of the indigenous population acts as a powerful attritional force on the budget. The impetus to increase spending will be tempered by the deficit-driven domestic debt pile. Even after the windfall budget surplus of 2000 – which amounted to more than 3 per cent of gross domestic product (GDP) – sovereign debt is thought to stand at about 95 per cent of GDP. The likelihood of a deficit of $5,500-6,000 million in 2002 will add to the pressure for constraint this year. However, firm oil prices forecast for 2003 could allow a marginal fiscal surplus to be posted alongside a 2.5 per cent increase in real spending, which would be equivalent to a 10 per cent overshoot on budgeted expenditure.
Combined with programmes for economic liberalisation and an increasing yield from measures intended to stimulate private sector activity, strong government spending should support a return to more healthy economic growth. Real private sector growth of more than 4 per cent shored up Saudi Arabia last year in the face of decline in the oil sector. With good prospects of the latter being reversed this year and the non-oil sector continuing in good health, real GDP could grow by 3.5-4 per cent in 2003.
Qatar might be resting between massive growth spurts, but it remains in robust good health. The key driver for growth is the expansion of liquefied natural gas (LNG) sales. No major increase will take place this year – exports are slated to rise to 13.1 million tonnes from 12.9 million last year – but a massive jump comes in 2005 when the figure should step up to 22.3 million tonnes. The impact will not only be double digit GDP growth, but a transformation of Doha’s finances. Already the growth of LNG and other downstream hydrocarbon initiatives has brought a reduction in the reliance on oil exports – oil income now accounts for about 75 per cent of government revenues, down from more than 80 per cent a couple of years ago – but the trend will accelerate. By 2005/6, LNG revenue will be vying with oil as the largest line in the budget.
Qatar is rapidly becoming a vast surplus economy: current account surpluses, budget surpluses and, if such a thing is imaginable, surplus growth have become the norm. With slightly lower oil production negating some of the benefits of higher oil prices, much of the impetus for GDP growth in 2002 came from the non-oil sector. The trend is likely to be continued this year. It will be supported by stimulating government expenditure. The 2002/3 financial year, which comes to a close in March, is expected to see a 9 per cent increase in actual expenditure. No figures for the 2003/4 budget have yet materialised, but the government is expected to be comparatively liberal in its capital expenditure. With a broad range of civil and industrial projects on the drawing board, Qatar will be attracting more than its fair share of headlines over the next 12 months.
On the other side of the Gulf, the macroeconomic picture in Iran is also looking benign. Unsurprisingly, high oil prices over the past three years have done much to improve the Islamic republic’s financial situation. The trade balance and current account are in the black, while external debt has been reduced to its lowest levels in years. In financial year 2003/4, this trend is likely to continue. But the country remains highly dependent on developments on the international oil market as crude exports still generate about 50 per cent of government revenues and 80 per cent of export receipts. A first draft of the 2003/4 overall budget presented in December earmarks an 11 per cent increase in expenditure induced by rising inflation, increased defence spending and investment in the country’s infrastructure. The government has also vowed to allocate significant amounts to job creation programmes in an attempt to reduce unemployment, which officially stands at 16 per cent. As a result of increased spending, the government budget is forecast to feature a deficit of nearly 4 per cent in fiscal 2003/4. GDP growth is anticipated to reach 3.5 per cent, also boosted by another year of non-oil sector growth. Another round of reform initiatives, in particular the liberalisation of different economic sectors and the privatisation of state-owned companies and banks could provide yet another boost to the economy in 2003/04.
Kuwait has been less successful in stimulating its economy. Oil revenues still account for about 45 per cent of GDP, 70 per cent of government revenues and 90 per cent of export values. One of the main results is that the Kuwaiti economy has little protection from swings in oil prices and production levels. Production cuts and a series of oilfield accidents hurt last year – average production dropped to 1.89 million barrels a day (b/d) from 2.04 million b/d in 2001 – and there was little protection offered by the non-oil sector. Official figures point to only marginal growth and despite substantial increases in government expenditure, there is little reason for optimism in 2003. However, increases in oil production in 2003 could reverse real GDP decline and high government expenditure in the tail of the 2002/3 fiscal year followed by further hikes in 2003/4 could prove stimulating to the non-oil sector. However, with elections looming this year, and strained relations between the government and parliament producing stalemate in a number of reform programmes, the possibility of further economic stagnation remains real.
The Middle East’s largest economy outside the Gulf is showing signs of recovery after a difficult period. Real GDP growth rates in Egypt are likely to rise to 3.5-4 per cent in the 2003/4 fiscal year from an improved 3 per cent in 2002/3. The devaluation of the Egyptian pound is set to continue, possibly unwinding to $1=£E 5.25 by the end of the year. The process will bring further support to Egyptian exports, and contribute to the establishment of a current account surplus. However, Egypt remains particularly exposed to regional political instability due to the size of its tourism industry and its inherent volatility. The other cloud comes in the shape of a growing debt pile: external debt stands at about 38 per cent of GDP and expanding domestic obligations are likely to be nudging 60 per cent of GDP by the end of the next fiscal year.
For all the national differences, there is one macroeconomic variable followed closely across the region. Although not the result of active monetary policy in most Middle Eastern countries, the comparatively low interest rate environment – which is likely to persist throughout the year – provides two boons. First, it brings welcome relief to the more heavily indebted governments and gives greater flexibility on the expenditure side of their budgets. Second, the lower cost of borrowing should encourage the private sector to take on debt for investment purposes. Whilst credit demand in many of the Gulf countries has historically been unrelated to interest rates, the correlation is growing.
While the interest rates are unlikely to spring major surprises in 2003, political events rarely unfold as foreseen. For those doing business in the Middle East, it is a difficult year to forecast but there is no doubt that opportunity abounds. And it is worth remembering that economic growth in the region is set to outstrip growth throughout the developed economies of the West.