Despite the Opec decision to slash production and growing confidence that the oil price crash is over and may even be partly reversed this year, the Middle East’s largest economies will suffer a substantial setback in 2009.

According to analysis in A Short, Sharp Shock, a new report by MEED Insight about the economic outlook for the GCC, the dollar value of the GCC’s gross domestic product (GDP) at current prices will probably contract by about 20 per cent in 2009.

The forecast is based on the assumption that the price of West Texas Intermediate (WTI) crude oil will fall by no more than one-third, to an average of $60 a barrel in 2009, from more than $96 a barrel in 2008, thanks to Opec’s decision to cut production. GCC oil production will be cut by about 10 per cent to 14.6 million barrels a day (b/d) next year.

GCC economies will also be affected by the volatility of the dollar, to which five of the six GCC states peg their currencies, the equities crash, the liquidity squeeze, the global real estate crash, the aviation and tourism slump, and lower volumes of world trade.

Video:

A Short Sharp Shock: GCC Economic Outlook 2009-10 presentation

Increasing uncertainty

However, the report anticipates increases in non-oil activity, based on the assumption that governments will maintain spending. Lower oil prices and reduced oil production, coupled with falling demand for goods and services, will translate into a crash in the region’s export income, trade surplus and overall current account surplus. The latter will effectively fall to zero from the 2008 record level of more than $350bn.

Bahrain, Oman and Saudi Arabia are expected to record budget deficits in 2009 as government income tumbles. The GCC fiscal balance is expected to fall into the red for the first time since 2002.

However, oil prices below $60 a barrel cannot be ruled out. Convinced that the sharp economic downturn in advanced economies will spread to Asian economies, which were previously seen as recession-proof, pessimists believe world oil demand will fall in 2009 – the first time this has ever been recorded for a full year. If oil averages $40 a barrel this year, the dollar value of current GDP in the GCC will fall by at least one-third, and there would be pervasive budget deficits. Whichever way the figures are manipulated, the economies of the GCC are about to be dealt a bitter blow.

The region’s governments have accumulated aggregate budget surpluses of more than $500bn in the past five years, well in excess of any conceivable income shortfall in 2009. The financial reserves of Bahrain and Oman are limited, but those of Kuwait, Qatar, and the UAE are worth at least 100 per cent of their annual national incomes.

Private investment

In contrast, few actual businesses are well capitalised and they have tended to depend on short-term bank credit. This was richly abundant, often at negative real interest rates due to inflation, until the summer of 2008.

But the collapse in confidence in US banks has spread to the GCC. By the end of 2008, borrowing had become more expensive and far harder across the region. In some markets, new borrowing was almost impossible. The bank credit freeze has compounded the challenges facing Gulf companies from the shut down of GCC equity markets as a source of capital.

The new worry is that private investment, which tends to move with oil prices, will drop precipitately. Business is therefore relying on governments to maintain and even increase spending, particularly in the projects sector. Saudi Arabia has signalled that it intends to maintain spending in 2009, despite the oil price slump, and Kuwait has announced a huge increase in spending. Qatar is also likely to keep government spending high.

The situation in the UAE is mixed: Abu Dhabi has the resources to maintain expenditure, but Dubai is almost certain to cut public investment, unless a cash injection from Abu Dhabi is provided.

Price slump

By 2010, however, the GCC will see a radical improvement in macroeconomic conditions, for two reasons. First, the conviction that Opec will act to reverse the price slump. The clearest evidence that it is getting serious came in late November when Saudi Arabia’s King Abdullah said that $75 a barrel was “the right price” – a startling reassertion of the price target policy Opec abandoned in 2005.

The kingdom could slash production close to 8 million b/d, but other Opec states and Russia will need to take supportive measures too. A larger uncertainty is how consuming nations, particularly the US, will react to Opec acting to raise oil prices at a time of global recession. In 1980, Opec was berated in the West for cutting production and lifting prices when the world economy was retreating. The West’s response was to focus massive efforts on reducing oil demand and imports, and in 1986 the price of oil crashed to below $10 a barrel.

The second reason why 2010 should be a big improvement on 2009, is due to the enormous stimulus the US has had to its economy since the summer of 2008.

This is partly due to the sharp appreciation of the dollar, which has increased the purchasing power of US consumers, and also the crash in oil prices, which has sent the price of gasoline in the US down to less than $1.50 a gallon. At $60 a barrel, America will spend at least $100bn less on oil imports in 2009 than it has in 2008. Another positive factor is President George W Bush’s $700bn Troubled Assets Relief Programme, passed by Congress in October. On 15 December, it was revealed that president-elect Barack Obama also plans to inject $600bn into the economy through capital spending and tax cuts.

Comfort

Between them, these package are equivalent to almost 10 per cent of US GDP. They constitute the largest government financial injection in economic history and should start delivering higher growth by this time next year. As the US economy accounts for 25 per cent of the world economy, America’s recovery will stimulate a global economic rebound in 2010. Saudi Arabia has signalled that it intends to maintain spending in 2009, despite the oil price slump, and Kuwait has announced a huge increase in spending. Qatar is also likely to keep government spending high.

The situation in the UAE is mixed: Abu Dhabi has the resources to maintain expenditure, but Dubai is almost certain to cut public investment, unless a cash injection from Abu Dhabi is provided.

By 2010, however, the GCC will see a radical improvement in macroeconomic conditions, for two reasons. First, the conviction that Opec will act to reverse the price slump. The clearest evidence that it is getting serious came in late November when Saudi Arabia’s King Abdul- But how can the GCC economies cope with the shocks likely to hit them in 2009?

There is comfort to be found in the figures in MEED Insight’s A Short, Sharp Shock. Even with a 20 per cent fall in GDP, the GCC economy will be about the same size, in money terms, as it was in 2007. The difference is that every Gulf company has assumed that the growth since 2003 would continue without interruption.

Government aid

The problems most companies will face are employing too many people and difficulties in finding finance. For businesses, the answer is simple: restructure and downsize to the scale that was appropriate in 2007, and wait for the recovery. The key decision that companies will have to make is how to reduce payrolls without losing the skills they will need when growth resumes.

But businesses cannot do this on their own. Governments will have to do more to ensure the GCC banking system provides the finance that they will need. The official response, so far, has been modest and uncertain. Some critics believe GCC governments are in denial about the problems businesses are likely to encounter in 2009.

Governments must also reject the conventional response to oil-price falls of cutting spending. Young businesses that could play a vital long-term role, particularly in creating jobs for nationals, are in jeopardy because they may be starved of cash because of the failure of the banking system, and payment delays, some by government.

There is light at the end of the tunnel, but it will not be reached without government and business recognising the seriousness of the challenge 2009 presents, and grasping the fact that there are options that will help them ensure the GCC emerges from the year ready for the next phase of the long Gulf boom.

This information is taken from the MEED Insight report A Short, Sharp Shock: Economic Outlook for the GCC in 2009-10. To order a copy, download the order form (PDF) or email MEED Insight for more information, quoting reference EC2.

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