Yearbook 2011: Economic recovery without the fanfare in the Middle East

09 December 2010

The steady economic revival under way in the region will help to restore confidence among policymakers after a tough couple of years, but they would be well advised to also keep an eye on the bigger picture

First, the good news: The Middle East and North Africa (Mena) region’s economies are heading into 2011 showing a solid, if unspectacular, recovery. Strengthening oil prices and expansionary fiscal policies have improved the macro fundamentals in the countries that were hit hardest by the post-Lehman regional downturn.

The UAE, for one, has staged a pronounced improvement in the past 12 months. The International Monetary Fund’s (IMF) Regional Economic Outlook, released in October 2010, raised its 2010 growth forecast for the UAE to 2.4 per cent, from 1.3 per cent in May. It expects growth to accelerate to 3.2 per cent in 2011 – not bad for an economy exposed to crashing real-estate and financial markets in 2009.

Sounder economic growth in the UAE

The UAE’s ongoing rehabilitation is just part of the wider picture. The IMF predicts the region’s output to expand by 4.2 per cent in 2010 – nearly double the 2.3 per cent rate recorded in 2009. This sounder footing provides a robust platform for growth. Almost every country in the region is projected to grow faster in 2010 and 2011 than in 2009, says the IMF.

But analysts warn against expectations of a return to boom times. The bad news is that economies will struggle to grow as strongly as they did in the pre-crisis years and could face new challenges, such as rising inflation. “It’s going to be a recovery – but one without the fanfare,” says John Sfakianakis, chief economist at Banque Saudi Fransi-Credit Agricole.

We are much more in sync with the US than in 2007-08. Any debate about revaluing is completely nonsensical

John Sfakianakis, Banque Saudi Fransi-Credit Agricole

The main Mena oil exporters have shown the strongest pickup in economic activity. With the rebound in worldwide demand, the IMF sees crude oil production growing from 25 million barrels a day (b/d) in 2010 to 26 million b/d in 2011, helping to raise gross domestic product (GDP) growth in these countries from 3.5 per cent to 4.3 per cent over the same period.

The GCC, in particular, has staged a strong revival. The IMF estimates 2010 real GDP growth in the six member states at 4.5 per cent, up from 0.4 per cent the previous year. For 2011, it forecasts growth of 5.9 per cent.

Regional economists believe the momentum for the recovery will be sustained through 2011. “The region’s growth rate will probably be about the same as this year, at around 4-5 per cent,” says Daniel Kaye, senior economist at National Bank of Kuwait.

Total government debt (% GDP)
GCC 14.21218.415.513.3
f=Forecast; GDP=Gross domestic product. Source: IMF

“Although conditions in the private sector are likely to remain subdued, sizeable increases in government spending should help push the economy along. Meanwhile, we can expect further incremental increases in oil production as the Organisation of the Petroleum Exporting Countries (Opec) reverses earlier production cuts.”

Some other Mena economies are well placed to expand. Egypt is on course for a 6 per cent real GDP growth in the 2010-2011 financial year, supported by strong domestic demand and positive net capital inflows.

Consumer price inflation (average %)
GCC 6.310.
f=Forecast. Source: IMF

Lebanon has also reported impressive growth through the recession, again supported by robust capital inflows. Real GDP growth in the country could be at least 8 per cent in 2010, estimates the IMF – putting Lebanon second behind Qatar in the ranks of the Middle East’s fastest growing economies.

Saudi economy bouncing back

Saudi Arabia, the region’s largest economy and a bellwether for the wider Mena region, is on course for real GDP growth to bounce back to 3.9 per cent in 2010, from 0.6 per cent last year, according to Riyadh-based Jadwa Investment Bank. Economic activity picked up strongly through 2010. MEED Projects puts the total value of contract awards for Saudi projects under way over the January to mid-September period at just over $68bn – about twice the value recorded in the same period in 2009.

Nominal GDP ($bn)
GCC 847.41,072.3863.6993.41,100.2
f=Forecast; GDP=Gross domestic product. Source: IMF

As in other Gulf states, it is government spending that will remain a decisive driver of growth in the kingdom. The government applied a fiscal stimulus through 2010 with total spending projected to increase by 11 per cent. So long as oil prices stay above $70 a barrel, the Saudi authorities will keep long-term capital spending projects on track. The Riyadh government unveiled the country’s ninth Five-Year Development Plan in August 2010, projecting spending of $386bn over the five-year period – about 67 per cent higher than planned spending under the 2005-09 plan.

However, there are risks confronting fiscal stimulus programmes in the Gulf. Some states, including Saudi Arabia, are seeing a pickup in inflation, which may call for a tempering of the spending effort.

Despite the spending commitments, most oil-rich economies will register fiscal surpluses in 2011. “For 2011, I don’t see fiscal pressures emerging,” says Sfakianakis. “In the case of Saudi Arabia, we might witness a slight surplus or deficit depending on how much overspending they do this year. Kuwait will probably show a surplus of around 15 per cent of GDP, and the UAE is also likely to show a surplus.”

Any deficits should, in any case, be comfortably financed through either debt issuance or reserves. “So long as oil prices remain close to their current levels, the budget positions of most other governments should remain comfortable,” says Kaye. “This does not preclude the need for longer-term fiscal reform, however, which can be justified both in terms of sustainability and boosting the role of the private sector.”

The main challenges going forward will be for governments to execute the large capital projects associated with higher spending, and for the private and corporate sectors to continue the process of deleveraging and normalisation in the aftermath of the real estate and stock market crashes, says Kaye. “Progress in these areas will have a positive impact on the macro economy. Policymakers will also have to keep an eye on inflationary conditions in light of high food prices and the recent decline in the US dollar, both of which are putting upward pressure on consumer prices.”

Revaluation pressure limited in GCC

Inflation is one challenge that could loom large in 2011. With a further weakening of the US dollar, in light of the US Federal Reserve’s wave of quantitative easing, the vulnerabilities of Gulf states with currencies pegged to the greenback could be exposed. However, revaluation pressure in the dollar-pegged economies may be limited.

“The forces at play today – both domestic and external – are quite different from 2007-08, as Gulf economies are on a recovery path, as is the US economy, leaving little damage in following the US policy rates,” says Sfakianakis.

Inflation is not a major issue with the Gulf’s main trading partners, such as the US and Asia. “We are much more in sync with the US than in 2007-08. Any debate about revaluing is completely nonsensical at the moment,” argues Sfakianakis.

But there may be more structural drivers of inflation that could emerge more powerfully in 2011, particularly affecting food commodities. Echoing the global food crisis of 2007-08, NCB Capital says soft commodity prices are once again developing momentum, with a risk that speculative buying and efforts to contain food exports will lead to severe supply shocks.

“The GCC authorities say they’ll stick to the dollar for right or wrong. My view is that when the pain starts, and if the dollar continues to fall, then they might have a different view,” says Angus Blair, head of research at Cairo-based Beltone Financial.

Another major focus of economic policy debate in 2011 is the need to galvanise the region’s private sector, and enable regional governments to wind back their stimulus spending.

In Saudi Arabia, barely SR30bn ($8bn) in credit was extended to the private sector in the January-July 2010 period, compared with SR126bn in the corresponding period in 2008.

Despite the generally anaemic private sector credit supply, some of the larger projects, backed by credible, solvent sponsors, will continue to attract bank lending.

Yet there is some way to go before conditions in the financial sector normalise, says Kaye. Until then, credit may well grow at a fairly modest pace. “Not only do banks, as a whole, remain quite cautious in their approach to fresh lending, but the demand environment is much weaker than before. Major projects have been cancelled, real-estate prices remain soft and consumer incomes grow less strongly. There could also be changes to financial regulation for banks to contend with, although I would expect any such regulation to have a fairly small impact on the Gulf region,” he says.

Much will depend on private sector confidence levels. “The private sector is not growing as we were hoping,” says Blair. “Banks are still not lending. The story in 2011 is what is going to be the role of the private sector … I think growth is going to be better than this year, but nowhere close to 2007-08. The issue is one of gradual recovery over faster recovery and it will take a lot longer than we expect.”

Regional stock markets have staged a partial recovery from the lows reached during the first quarter of 2009, but Gulf equity markets are lagging behind their global equivalents. Whereas the S&P 500 had, by the final quarter of 2010, climbed back to 88 per cent of its level as of August 2008, in the GCC this has ranged from just 47 per cent in Kuwait to 72 per cent in Qatar and Saudi Arabia, according to the October 2010 IMF Regional Economic Outlook.

Greater confidence

There are signs of a rebound in fixed income markets. The number of GCC conventional bond offerings doubled to 25 in the third quarter of 2010, compared to the second quarter, with volumes issued increasing by 141 per cent to $10.8bn. Much of that is down to greater confidence in the wake of the resolution of Dubai World’s debts in September 2010.

Governments and corporates will face significant debt refinancing needs in the near future, estimated by NCB Capital at about $60bn in 2011. But don’t expect a flood of debt and equity deals, warns Blair. “I think you’ll see a marginal improvement in new paper coming to the market, but it won’t be a rolling wave. You can see there is money looking to come into the Mena region and you would expect some more new issuance, fixed income as well as equity.”

With recovery the driving narrative, economic policy makers may struggle to focus on economic reform. Key structural changes are nonetheless needed to ensure the region’s economies meet pressing long-term challenges.

Efforts toward financial sector development and economic diversification are at the top of the in-tray, while creating jobs for expanding populations is another key issue that will need to gain serious traction in 2011. 

All Middle Eastern economies need to raise growth to provide employment for the fast-growing working-age population. As the IMF points out, in order to absorb those currently unemployed and new entrants into the labour market over the next decade, annual growth would need to reach 6.5 per cent – 2 percentage points more than during the past decade.

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