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Higher Growth Outlook for Arab Economies
As elsewhere in the world, the global financial and economic crisis has taken a toll on the Middle East, the IMF says in its latest Regional Economic Outlook report for the Middle East.
Oil exporters were directly hit by the global financial crisis through a sharp decline in oil prices and a sudden drying up of capital inflows, but the impact has been greatly mitigated by countercyclical government spending, the report says.
The oil exporters, covered in the survey, comprise 12 countries: the six countries of the Gulf Cooperation Council (GCC—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates) and Algeria, Iran, Iraq, Libya, Sudan, and Yemen. Together, they account for 65 percent of global oil reserves and 45 percent of natural gas reserves.
The countries are mainly exporters of oil, gas, and refined products, with oil and gas contributing about 50 percent to GDP and 80 percent to government revenue. They are diverse and differ substantially in terms of per capita GDP, which in 2009 is estimated to range from US$1,108 in Yemen to more than US$76,000 in Qatar. The GCC subgroup is relatively homogeneous, however, with similar economic and political institutions and relatively less diverse per capita incomes.
The decline in oil prices, combined with an expansionary fiscal stance, is leading to a substantial drop in current account surpluses for oil exporters, from more than US$380 billion in 2008 to just over US$50 billion projected for 2009. Combined with the sharp outflows of capital and given the authorities’ commitment to maintaining fixed exchange rate regimes, this also led to a significant drawdown of the large stocks of international reserves built during the oil boom years.
From a peak of US$807 billion in September 2008, total reserves of oil exporters fell by nearly US$40 billion in six months.
These numbers exclude movements in sovereign wealth funds, for which only limited function is available. Sudan and Algeria—the two countries that allowed some degree of exchange rate flexibility—experienced downward pressures on their currencies as well.
The sudden drying-up of foreign funds and the decline in domestic asset prices also put severe strains on the balance sheets of banks that had both borrowed externally and were heavily exposed to real estate and equity markets. This led to a striking slowdown of credit expansion in most countries; the deceleration ranged from more than 40 percentage points in Qatar to about 5 percentage points in Algeria.
A decomposition of the changes in the sources and uses of funds in the banks’ balance sheet helps shed light on factors that have likely contributed to the marked deceleration in bank credit in individual countries.
The main factors were the sharp decline in the growth of deposits, banks’ limited ability to raise capital, and a withdrawal of foreign financing.
Particularly notable were the decelerations in deposits in Algeria, Bahrain, Qatar, and the UAE, as well as reduced foreign financing in Kuwait.
Governments responded swiftly to the deteriorating conditions in the financial sector, undertaking a variety of extraordinary steps to mitigate the credit crunch and the impairment of capital by injecting funds in stressed financial institutions. Part of this policy move took the form of expanding central bank credit to the banking system, particularly in Kuwait, Saudi Arabia, and Sudan.
All of the GCC governments injected funds directly into the banking system. In addition, central banks in some countries (Libya, Yemen, and most GCC countries) lowered policy interest rates.
The banking systems have so far absorbed the stress, buffered by the authorities’ actions and strong profitability in the pre-crisis years. By and large, banks have remained solvent and profitable at end-2008, albeit at a lower level.
Capital adequacy ratios have continued to be well above the required regulatory norm, and in many countries, the ratio of nonperforming loans has remained low, with more than 100 percent provision coverage (Oman, Saudi Arabia, and the UAE).
Within the banking of the GCC, Islamic banks have grown at very high rates in previous years and seem to be in a better position to withstand the shock, as a result of their larger capital and liquidity buffers.
The external environment is gradually improving: oil prices are rising, external financing conditions are easing, and an incipient global recovery is under way.
After fluctuating between US$30 and US$40 per barrel in early 2009, oil prices rose to about US$70 per barrel in August and, based on futures markets, are projected to remain over US$75 per barrel in 2010.
Spreads on sovereign credit default swaps in the region have fallen continuously since their peak in the first quarter of 2009—by more than 650 basis points in the case of Dubai, from a high of 944 basis points on February 13.
Despite uncertainties surrounding the strength of the global recovery, oil demand is expected to rebound, with OPEC well positioned to meet a near-term rise in demand.
On the domestic front, housing markets in a number of hard-hit GCC countries are starting to stabilize, and financial markets have begun to turn around, with the Qatari stock market gaining as much as 72 percent from their trough.
Price-earnings ratios are increasing, reflecting a sign of renewed optimism over the region’s economic outlook. For instance, price-earnings ratios in Abu Dhabi, Dubai, and Saudi Arabia have more than doubled since the beginning of the year and are approaching, or have already surpassed, their early-2008 levels.
International reserves are also rising, partially reversing previous losses—recent gains in Kuwait, Oman, and Qatar have been particularly large at 35 percent, 14 percent, and 63 percent, respectively.
With deposit growth and capital inflows regaining strength, funding conditions in the banking systems are also improving. Private sector credit, however, has remained sluggish in some countries, reflecting increased risk aversion, difficulties in raising sufficient capital, and increased supervisory scrutiny. It could also reflect concerns about the recent credit problems faced by large family businesses in the GCC, and an expected deterioration in asset quality.
Outlook for 2010
With the rebound in the global economy in 2010, oil and non-oil GDP are projected to grow at 4.4 percent and 3.9 percent, respectively, on average across the region. Given current projections for domestic spending, the pace of non-oil sector activity will remain well below the growth rates reached in 2005–07.
Despite expansionary macro-economic policies and an increase in international commodity prices since the beginning of 2009, inflation rates have continued to fall since August 2008, and are forecast to remain in the 5–10 percent range in most countries.
The current account balance for oil exporters as a whole is projected to show a surplus of about US$171 billion or 9.5 percentage points of GDP in 2010.
Imports are projected to increase to more than US$750 billion in 2010, lifting the region’s share of world imports from 3.9 percent in 2008 to 4.7 percent. Thus, Arab oil exporters will continue to contribute to sustaining global demand.
The countercyclical fiscal policy pursued in several GCC countries in response to the crisis is expected to be maintained (especially in Saudi Arabia and the UAE), with
a focus on large public investment projects.
Projections for fiscal balances vary noticeably between GCC and non-GCC countries. For the first group, fiscal surpluses are projected to decline in 2009, and then recover in 2010. For the second, a slight improvement is forecast for 2009, with little change in 2010. Given the uncertainty regarding the pace of global recovery and in light of the anticipated increase in oil prices, continued spending in 2010 is both warranted and feasible in countries with ample fiscal space.
In due course, as guided by developments in the global and domestic economies, an exit strategy from the recent exceptional measures to support the financial sector would need to be considered.
In fact, in cases where commercial banks have been building up their reserves in the central bank and clear signs of a sustained recovery emerge, the authorities should assess when government funds in the banking system would no longer be needed.
Caution is needed in some low-income oil exporters to ensure that debt does not rise to unsustainable levels. As a result of the substantial widening of their fiscal deficits—by about 2½ percentage points of GDP in 2009—Sudan and Yemen are likely to record troubling increases in their ratios of public debt to GDP in 2009 and 2010.
Key improvements in financial regulation and supervision already in place in some oil Exporting countries will continue to be crucial for safeguarding the financial system against future shocks. The spillover among GCC financial markets—where difficulties faced by large businesses in one country affected the banking system in another—also underscores the need for these countries to harmonize their regulatory efforts.
Furthermore, to reduce vulnerability to external sources of funding, domestic financial systems should be further developed. Most businesses are concentrated in retail, trade, construction, and real estate—sectors that have been hit hard by the crisis and borrow from banks that rely heavily on external funding.
Looking ahead, ongoing initiatives to diversify financing channels away from banks need to be pursued. In particular, GCC policymakers increasingly see value in developing alternatives to bank financing, such as local debt markets for large corporates, thus allowing banks to concentrate more on financing small and medium size enterprises that create private sector jobs and more diversified economies. At the same time, this would attenuate the adverse impact of banking distress on the provision of credit and help enhance corporate governance as debt issuance will demand more rigorous financial disclosure and transparency.
Maghreb countries
Oil importers in the Maghreb (Mauritania, Morocco, and Tunisia) have been highly exposed to the slowdown in the European Union—their main partner for trade and remittances.
In Morocco, however, an exceptional agricultural harvest has mitigated the impact of the global economic slowdown on overall output.
For 2010, a slow recovery in partner country economies, combined with limited scope for further countercyclical policy action, imply that growth—projected at 3.8 percent—will remain relatively flat.
High debt levels among most oil importers limit the space for fiscal stimulus, and the scope for monetary easing will be constrained by an anticipated increase in global interest rates from current historical lows. With narrowing room for continued stimulus, policymakers need to focus more on supply side reforms that will help boost private sector activity and employment and enhance competitiveness. In countries without fixed exchange rate regimes, greater flexibility in exchange rates will facilitate these goals.
Role of Private Sector
While the crisis has highlighted more immediate needs, countries should be careful not to lose the momentum on structural reforms, especially those that deal with the problem of protracted unemployment. To support this goal, the creation of an environment more conducive to private business needs to remain an overarching priority. This may involve broadening privatization and liberalizing the energy sector. While limited openness and lack of competition may have shielded regional oil importers from the risks associated with the global economic downturn, these countries’ lack of international integration also implies forgone opportunities to boost economic growth and employment over the longer term.
The region is projected to return to higher growth by 2011. If the global recovery fails to take hold, however, continued strong headwinds could prove problematic, the report says. Few, if any, countries in the group are in a position to provide stimulus for an extended period. Continued poor growth could therefore have more serious consequences, including for poverty and social stability. Sharply higher oil prices would also be a concern for the countries with no hydrocarbon resources of their own.
David Morgan
Global Arab Network