Middle East Economics

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The MENA countries may be divided into two groups: (1) oil-exporters which include the six GCC countries (Bahrain, Kuwait, Qatar, Oman, Saudi Arabia, and the UAE), Algeria, Libya, Iraq, and Iran; and (2) net oil-importers which include Egypt, Jordan, Lebanon, Morocco, Syria, and Tunisia. SGE will report on the key policy challenges facing MENA’s economies and provide sound policy recommendations.

Our analysis and research are aimed particularly at asset allocators and financial companies as well as any other companies with interestsin the Middle East and North Africa.                   

Economic Briefing

Geoplotical Risks Hampering The Recovery

October 29, 2014

Underlying Themes and Fundamentals

 

  • The collapse of long-standing regimes in important parts of MENA region, coupled with weak institutional structures, has opened the way for chaos, civil strife and social disintegration in the affected countries.

 

  • Important parts of the region, notably the GCC and much of North Africa, remain stable and have cushioned the impact of the spreading violence in Syria, Iraq, Lybia and Yemen.

 

  • Economic performance has reflected this divergence, with the GCC countries maintaining solid growth and other economies showing varied performance, but all being burdened by the direct or indirect impact of the turmoil in the region.

 

  • Two overarching geopolitical risks have cast a shadow over the region: spillovers from intensifying conflict across wide areas of Syria and Iraq, and the continued alienation of Iran from the international community as its role in fragile parts of the region deepens.

 

  • Largely independently, oil prices have continued to weaken despite these risks as market fundamentals prevail.

A return to stability and high growth across the region will require tangible amelioration of these risks and a refocus on fundamental reforms. The prospects for that to happen in the near future are small.

                             

Regional Overview

Saudi Arabia

Growth in the Saudi Arabian economy appears to have stabilised in Q3, as a pick-up in activity in the non-oil sector offset a further slowdown in the oil sector. But in spite of the relative strength of the recent figures, we expect growth to slow further over the coming quarters.

Real GDP growth is expected to remain relatively strong in 2015-19, at an average of 3.8%, supported by rising investment, and the maintenance of elevated oil output. However, with fiscal policy steadily tightening, we expect growth to dip below 3% in 2019.

 

Risk assessment

Sovereign risk

The sovereign's creditworthiness is not in question, given the large stock of financial assets, the small public debt stock and the fiscal and current-account surpluses. The main constraint on the rating remains the dependence of the public finances on oil and significant public-sector liabilities.

 

Currency risk

Monetary union between Saudi Arabia and three neighbouring states is not expected in the forecast period. If the riyal were to come under downward pressure, the Saudi Arabian Monetary Agency (the central bank) has more than US$750bn in foreign assets with which to support the dollar peg.

 

Banking sector risk

Banks remain well capitalised and have increased provisions for bad loans accumulated prior to 2009. Equally, the sector is buttressed by ample liquidity and benefits from implicit government backing. However, continued rapid lending growth, especially in the real-estate sector, raises the risk of an uptick in future non-performing loans should the commercial property market soften.

 

Political risk

Although the Al Saud family is expected to remain in power, stability could be threatened by a spillover of the chaos in Iraq and nearby Syria. The rule of the Al Saud also faces other challenges, with the reins of power likely to pass soon to the next generation.

 

Economic structure risk

Despite efforts to diversify the economy, oil accounts for around 90% of export and government revenue. As a result, the economy is vulnerable to shifts in world oil prices and geopolitical risk, especially in the event of any resumption of tensions over Iran's nuclear programme.

 

Egypt

We expect growth to reach 3.5% in 2015 and to accelerate thereafter, as political stability improves, economic reform progresses, and investment recovers. However, the state finances will remain heavily reliant on foreign aid and vulnerable to external shocks.

 

Risk assessment

Sovereign risk

Despite large Arab aid inflows, a large public debt stock (over 90% of GDP), weak growth prospects and a persistently high fiscal deficit will continue to impair Egypt's creditworthiness. The Economist Intelligence Unit forecasts that the external debt stock will rise in 2015‑16, to an average of US$63.5bn, but remain manageable at 17.5% of GDP. Ongoing security uncertainties pose additional downside risks to the sovereign rating.

 

Currency risk

Continued financial support from the Gulf underpins the stability of the currency rating despite persistently high inflation and low foreign-exchange reserves. However, with the external financing requirement staying wide, we expect import cover to remain modest, at around three months, and the currency to continue to depreciate.

Banking sector risk

Domestic banks' profits should be bolstered by the expected increase in returns on government debt instruments following the increase in Central Bank of Egypt interest rates in July. However, the commensurate rising exposure to sovereign risk places the  banking sector increasingly at the mercy of the country's combustible political scene.

 

Political risk

Progress with the military-backed transitional roadmap culminated with the election of the former defence minister, Abdel Fattah el-Sisi, as president of Egypt in June. A new parliament is expected to be elected by early 2015 but a lack of will for political reconciliation between the government and the deposed Muslim Brotherhood threatens the long-term stability of the country.

 

Economic structure risk

The economy is well diversified, but nevertheless security uncertainties pose a great risk to earnings from hydrocarbons and the tourism sector, as well as to domestic and foreign investor appetite.

 

United Arab Emirates

We forecast that real GDP growth will average 4% in 2015-19, supported by gains in both the oil and non-oil sectors. The Expo 2020 award adds to this strong outlook. However, implementing tighter banking and property sector regulation is necessary amid a new cycle of risk taking and potential over-exuberance.

 

Risk assessment

Sovereign risk

The UAE's sovereign risk rating, which The Economist Intelligence Unit upgraded at the end of 2013, has remained at BBB in the current assessment, supported by strong economic trends in the federation and progress made in debt restructuring since the Dubai debt standstill in 2009. Fiscal surpluses and large sovereign wealth fund assets also support the rating. Nevertheless, the UAE's debt-financing needs continue to weigh on the sovereign risk rating.

 

Currency risk

The UAE dirham will be susceptible to fluctuations in the US dollar, to which it is pegged. However, with the dollar not expected to suffer major weakness, there is no risk of the dirham being de-pegged. The large current-account surplus supports the currency.

 

Banking sector risk

Banks' profits have picked up strongly in the last 18 months, with slower growth in provisioning for non-performing loans and faster loan growth. Never‑theless, the outlook for banks remains challenging, owing to still high debt ex‑posure to government-related entities and tighter domestic lending regulations initiated by the Central Bank of the UAE to improve credit management.

 

Political risk

The UAE's location presents some political risk. Geopolitical tensions over Iran's nuclear programme will persist, although these have eased as Iran and international powers have extended an interim agreement until November 2014 in order to provide more time for negotiations over Iran's nuclear programme. The UAE is at some risk of blowback from participating in international air strikes against the jihadi Islamic State group in Syria.

 

Economic structure risk

High oil prices and earnings from foreign assets will continue to support the economy. However, its openness makes it susceptible to external shocks. Domestic risks stem from potential difficulties regulating Dubai's resurgent property market.

 

Middle East and North Africa Charts

 

 

Implications for Investment

  • In reality, the economic dividend will take time to materialise, with fiscal sustainability and pro-growth policies targeted at stimulating the private sector the best way to encourage wealth-creation. Yet such a strategy will require leaders both brave and authoritative enough to explain this to their populations and implement the necessary changes. It may be many years before suitable and credible leaders emerge, and the new political organs of state mature.
  • The broader investment climate also remains difficult. Political turmoil has had a significant impact on corporates, tourism earnings and jobs, dramatically increasing the risk perceptions of foreign investors. Overall, corporates seem to be adopting a "wait and see" approach. This has been confirmed by evidence from the private political-risk insurance market, which is finding it very difficult to sell coverage in seemingly stable authoritarian regimes. That said, investors should return fairly quickly once stability improves given the vast opportunities in these markets, particularly in Egypt.