Middle East set to spend through the downturn

26 June 2009

Although economic growth is predicted to drop sharply in the region this year, governments will continue to invest in much-needed development projects as inflation declines and construction costs fall.

The economic outlook may seem bad in the Middle East and North Africa, but it is far worse in many other parts of the world.

Economic growth throughout the Middle East is expected to drop sharply this year, but at least there will be growth. The economic lessons learned in previous slumps appear to have paid off for Middle East governments, most of which are better prepared for a downturn than they were in the past.

“This part of the world has become significantly better at risk management,” says Jarmo Kotilaine, chief economist at NCB Capital, the investment banking arm of Saudi Arabia’s National Commercial Bank (NCB).

The International Monetary Fund (IMF) estimates that the region’s gross domestic product (GDP) increased by 7.7 per cent in 2008, and will grow by 4.8 per cent this year. This compares with a global economy that will contract by 1.3 per cent this year, led by the world’s most advanced economies.

In the fourth quarter of 2008, the world’s most developed economies experienced an unprecedented 7.5 per cent decline in real GDP. The US has been the hardest hit, but economies in Europe and Asia have also suffered, and the situation has been getting steadily worse.

In its April 2009 Global Financial Stability Report, the IMF estimates that write-downs on US assets by banks and other financial institutions will amount to $2.7 trillion between 2007 and 2010. In January, it put the figure at $2.2 trillion. The sharp rise in the space of just three months highlights the difficult tasks economists and policymakers face in assessing the extent of the problems and how to tackle them.

The IMF now estimates that total write-downs of assets around the world are expected to reach $4 trillion as a result of the downturn, of which two-thirds will be by banks and the remainder by insurance companies, hedge funds and other financial firms.

Conflicting pressures

In this context, most governments in the Middle East could be forgiven for thinking themselves either lucky or wise to have avoided the worst of the crisis. But the overall figures for the region mask significant variations.

At one end of the spectrum, Qatar’s GDP is expected to grow by 18 per cent this year and a further 16.4 per cent in 2010, making it the fastest-growing economy in the world. At the other end of the scale, the GDPs of the UAE, Saudi Arabia and Kuwait are all expected to contract this year.

However, Qatar is an anomaly, with its economy expected to gain from a sharp rise in gas exports as it taps into the fast-growing global market for liquefied natural gas (LNG).

Overall, the region’s hydrocarbons exporters are suffering from lower demand for oil. Despite oil cartel Opec’s efforts to cut output, prices have been far lower than they were last year, although they have recently been showing signs of recovery - in June, prices rose above $70 a barrel for the first time this year.

The economies of the Middle East’s oil-exporting countries - Algeria, Bahrain, Iran, Iraq, Kuwait, Libya, Oman, Qatar, Saudi Arabia, Sudan, the UAE and Yemen - collectively grew by nearly 6 per cent a year between 2004 and 2008, according to the IMF. But given the lower global demand for oil, it expects the collective GDP growth rate will decline to 2.3 per cent this year, from 5.4 per cent in 2008.

Lower oil prices and continued high spending are expected to cause a turnaround in these countries’ external current account positions, from a surplus of $400bn last year to a deficit of nearly $10bn in 2009, based on oil prices averaging $50-55 a barrel.

“This part of the world remains extremely dependent on the oil price,” says Kotilaine. “If we experience a sustained period of weak oil prices that will keep sentiment low. We could have the protracted malaise we saw in the 1980s and 1990s.”

Oil-importing countries - Djibouti, Egypt, Jordan, Lebanon, Mauritania, Morocco, Syria and Tunisia - may gain from these lower prices, but they have other problems to worry about. Tourism revenues and foreign direct investments are falling as international visitors and investors become more cautious about spending their money and stick to their home markets.

Remittances from expatriate workers are also falling as job prospects worsen around the world, and demand for their exports is similarly under pressure from their main trading partners: the US, Europe and the GCC.

Real GDP growth for these countries is projected to drop to 3.2 per cent in 2009, from 6.2 per cent in 2008, according to the IMF, potentially leading to higher unemployment and more widespread poverty.

With the exception of Qatar, Yemen and Mauritania, all countries in the region are expected to suffer a drop in GDP growth this year. For some countries, such as Egypt, Iran, Iraq, Syria and Yemen, this will continue into 2010.

This latter group is predominantly made up of countries that are poorly integrated with the global economy. While their relative isolation has shielded them from the worst of the downturn, it also means they will be less able to take advantage when the global economy revives.

One of the main difficulties preventing a rapid recovery in any market remains a lack of credit for both banks and companies. Restoring the ability of banks to lend money, and of businesses to borrow, will be critical to a revival of all sectors of the region’s economies.

Economic diversification

For the GCC, one of the most important areas is the construction sector, the longer-term economic health of which requires growth across the industrial and services industries. As a result, economists in the region say they expect governments will continue with their diversification policies throughout the downturn.

The policy responses of governments around the world to the current crisis have often been found wanting. Many were slow to react, and the succession of bank bail-outs by governments and capital injections by central banks that followed have yet to fully restore confidence and revive activity.

Economists estimate that the Saudi government deposited SR30bn ($8bn) with local banks in the six months to 31 March 2009, in an effort to encourage them to lend more. In the UAE, the government has made AED120bn ($32.6bn) available to support its banks. Such figures pale in comparison to what is happening in Europe and the US. The IMF estimates that US banks could need $275-500bn in extra capital and European banks up to $1.2 trillion.

But Middle East governments are grappling with the same problems as their European and US counterparts in trying to stimulate economic activity. Many are in the fortunate position of having large reserves, which means they can afford to support struggling businesses and invest in much-needed infrastructure. Kuwait, for example, has put in place a $5.2bn package to encourage bank lending.

As governments maintain spending levels, many are being forced to run budget deficits. They include Saudi Arabia, which has set a budget including SR475bn in spending for this year, despite expecting revenues of just SR410bn. Even Qatar, with its large gas revenues, is forecasting a budget deficit of QR5.8bn ($1.6bn) for the year running from 1 April 2009 to 31 March 2010, although that is based on a conservative oil price of $40 a barrel.

“Policymakers have done well maintaining stability,” says Simon Williams, a Dubai-based economist at UK-based HSBC bank.

“They have stopped the slowdown becoming a derailment. There were some very unrealistic expectations around the region that the governments could take measures to keep the good times going.”

Amid all the gloom, there have been some positives to the downturn. Inflation has, in most cases, been falling from very high levels, due to a combination of slower domestic economic growth and lower food and commodity prices.

In 2008, Jordan, Kuwait, Lebanon, Libya, Oman, Qatar, Syria and the UAE all struggled with double-digit inflation - ranging as high as 14.9 per cent in Jordan’s case. But this year, inflation will fall to far more manageable levels in all these countries, dropping to 7.5 per cent in Syria and just 2 per cent in the UAE.

Delaying recovery

There is a danger that some economies could suffer from deflation for at least part of the year, which could set back hopes for a recovery as it tends to prompt businesses and consumers to delay spending. However, this is unlikely to be a significant concern for most economies.

As always, there are some losers. Iraq’s inflation is expected to rise from 3.5 per cent in 2008 to 13.8 per cent this year - an inevitable consequence of the high levels of spending required to rebuild the economy. It is also struggling to fund a massive infrastructure investment programme at a time of far lower oil revenues. But the overall picture for inflation across the region is a positive one.

A secondary benefit of the reduced level of activity has been the opportunity it offers governments to catch up with projected demand growth. While prices were high and contractor availability was at a premium, utility providers across the region had been struggling to deliver new power and water plants.

But with costs now lower and more slack in the contractor market, they have the chance to put in place long-term expansion plans at a reasonable price.

The main question for the region is whether it is now at the low point of the crisis, or if there is further to fall.

According to Williams, “it still seems early” for any recovery. However, “I am increasingly confident that we have at least seen the bottom,” he says. “Even if it proves to be a while before any upturn comes, we have at least seen the floor.”

NCB Capital’s Kotilaine agrees. “We have come down to levels where it is not possible to keep declining at the same pace,” he says.

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