Figure I Changes in real GDP growth rates in major Middle East countries

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1 Section 4 Middle East 1.Overview of the Middle East economies First of all, we will look at the economic trends in major Middle Eastern countries in recent years. Subsequently, we will describe the trends in Saudi Arabia and Turkey in more detail. (1) Changes in the real GDP growth rate and nominal per-capita GDP The growth rates of Saudi Arabia, the UAE and Turkey, which were relatively high until the first half of the 2010s, have been slowing down as a trend. On the other hand, Iran s growth rate, which declined from 2012 onwards, rebounded to a high level in 2016, while the growth rate of Egypt, which stayed at around 2 to 3% for many years, has rebounded above 4% since 2015 (Figure I ). Meanwhile, per-capita nominal GDP has been trending downward since 2014 owing to such factors as the crude oil price decline (Figure I ). Figure I Changes in real GDP growth rates in major Middle East countries Source: IMF WEO Database April

2 Figure I Changes in per capita GDP in major Middle East countries Source: IMF WEO Database April (2) Changes in foreign currency reserves as a proportion of GDP Regarding the current account balance as a proportion of GDP, Saudi Arabia and the United Arab Emirates were previously recording a current account surplus equivalent to higher than 20% of GDP, but the figure has steeply deteriorated, to a deficit equivalent to around 5% of GDP for Saudi Arabia and to a surplus equivalent to around 5% for the UAE. On the other hand, Iran s surplus as a proportion of GDP, which was trending downward from 2011 onwards, has resumed growing recently (Figure I ). The level of foreign currency reserves as a proportion of GDP has been trending downward for Saudi Arabia and has remained low for Turkey and Egypt (Figure I ). 362

3 Figure I Changes in account balance as a percentage of GDP in major Middle East countries Source: IMF WEO Database April Figure I Changes in foreign currency reserves in major Middle East countries (as a percentage of GDP) Source: CEIC, IMF WEO Database April

4 (3) Changes in the CDS spread concerning government bonds The CDS spread concerning government bonds in Egypt has remained the highest in the Middle East region, but it has declined to around 300 basis points recently. On the other hand, the CDS spread for Turkey has remained high at above 250 basis points since 2015 as a result of the deterioration of the domestic political situation. The CDS spread for Saudi Arabia remained high, reflecting the weakness of resource prices since 2015, but recently, it has been trending downward at around 100 basis points due to a recovery in resource prices. (Figure I ). Figure I Changes in the CDS in major Middle East countries Source: Thomson Reuters EIKON. 2.Turkey (1) Trends in the Turkish economy (A) GDP Regarding changes in real GDP and contributions by demand item (Figure I ), between 2012 and 2016, Turkey recorded an annual average real GDP growth rate of 5.5%, a high level compared with other countries around the world. Private consumption, corporate capital investment and fixed capital formation made significant contributions to the real GDP growth rate. Turkey recorded a negative real GDP growth rate of 1.3% in the third quarter of 2016 compared with the previous quarter due to a drop in net exports, but it recorded a high positive growth of 3.5% again in the fourth quarter because of a recovery in the growth of private consumption and a shrinkage of the margin of the net export deficit. While Turkey enjoys such advantages as a stable government based on the public s confidence in the president, a favorable fiscal condition relative to European countries 364

5 conditions, an abundant labor force reflecting the low average age of the population and a sound banking sector, it is facing challenges such as lowering its dependency on energy supply from abroad in order to resolve the current account deficit, shifting to industries that create high value added and raising the low domestic savings rate. In the second half of 2016, the depreciation of the Turkish lira dealt a heavy blow to the economy. However, the situation did not become serious as the central bank raised its policy interest rate and the crude oil price remained in a relatively low range, and the Turkish economy is now recovering. Figure I Changes in real GDP growth rates and contribution level by demand item Source: Turkish Statistical Institute (TurkStat), CEIC Database. (B) CPI Turkey s consumer price index (CPI) (compared with the previous year) (Figure I ) repeated ups and downs between 2011 and 2015: it rose steeply, 6.5% in 2011 and 8.9% in 2012, but the growth rate declined to 7.5% in However, the CPI growth rate rose for two consecutive years in 2015 and 2016, recording a rise of 7.8% in 2016, 0.1 percentage points higher than the growth rate in As Turkey is an importer of natural gas and other resources, its CPI is affected by the resource (crude oil) price trend. Turkey has enjoyed the benefits of the downtrend in the crude oil price in recent years, but its deficit will grow if the Turkish lira depreciates because it has been chronically recording net imports in its trade balance. In 2016, net imports expanded as the Turkish lira depreciated significantly. In each of 2015 and 2016, the CPI growth rate has been far higher than the inflation target of 5%. (Since January 2015, the inflation target of the Central Bank of the Republic of Turkey (TCMB) has been 5% with a tolerance of plus or minus 2%.) 365

6 Figure I Changes in consumer price indices in Turkey (year-on-year rate) Source: IMF WEO Database, April (C) Current account balance As for the trend in Turkey s current account balance, the services account balance has been in surplus, while the trade balance has been in deficit. Between 2012 and 2016, the current account balance has continued to be in deficit, with the deficit amount averaging 44 billion dollars (Figure I ). The current account deficit as a proportion of nominal GDP was 5.6% on average. The trade balance has been chronically in deficit as a result of net imports due to factors specific to Turkey s economic structure. 366

7 Figure I Changes in account balance in Turkey Source: Central Bank of the Republic of Turkey and CEIC Database. (a) Tourism revenue supporting the services account balance Tourism revenue accounts for most of receipts in the services account balance. Turkish Airlines, the state-owned national flag carrier, covers most European cities with its flight services using Istanbul as the hub (Turkish Airlines number of countries served, at 105 countries, is the largest in the world (2014)) (Turkey is the global No. 6 in terms of the number of international tourist arrivals, after France, the United States, Spain and other countries, according to the rankings shown in Table I (UNWTO 2016)), and the airline accounts for a large portion of Turkey s tourism revenue (Table I ). Table I Rankings of the number of international tourist arrivals Source: UNWTO. 367

8 Turkey has set various goals in the runup to the centenary of its foundation as a republic in One of the goals is becoming the fifth largest tourism country in the world by the centenary year of 2023 by taking advantage of Turkey s geopolitically important location at the cross-section of Asia and Europe. 117 (D) Budget balance Turkey s budget balance (revenue and expenditure) recorded a large deficit of 38 billion Turkish liras in 2010 because of the deterioration of the current account balance into deficit that was caused by the after-effects of the global financial crisis in 2008 and a steep increase in imports due to the expansion of domestic demand driven by the country s high growth (Figure I ). In order to shrink the current account deficit while curbing speculative capital inflow, the government implemented monetary tightening through a combination of policy interest rate hikes and an increase in the deposit reserve ratio, resulting in a significant decline in the deficit amount to 7.8 billion Turkish liras in Subsequently, the deficit amount stayed at around 20 billion Turkish liras until 2015, before growing in 2016 to 42 billion Turkish liras, a level similar to the deficit amount in 2010, due to the effects of the Turkish lira s depreciation, as was mentioned earlier. Figure I Budget balance (revenue and expenditure) and proportion of budget balance to GDP in Turkey Source: IMF WEO Database, October (2) Status of foreign investment in Turkey Regarding changes in the value of inward foreign direct investments in Turkey (on a flow basis) 117 The year 2023 marks the centenary of the founding of the Republic of Turkey, and the Justice and Development Party, the country s single ruling party, mentioned various projects to be implemented in the run-up to the centenary, including joining the global top 10 in terms of GDP. 368

9 (Figure I ), the annual value stayed at around 20 billion dollars between 2005 and Although the value dropped to only 8.6 billion dollars in 2009 due to the effects of the global financial crisis, it subsequently stayed at around 14 billion dollars until The number of companies with foreign capital in Turkey (cumulative number) (Figure I ) continued to rise from 2000 onwards except in , immediately after the outbreak of the global financial crisis, in 2012, when the Turkish lira appreciated, and in 2013, when the domestic economic growth slowed down. In 2016, the number fell by 20 from the previous year to 5,581 companies. Figure I Changes in the volume of inward foreign direct investment in Turkey (on a flow basis) Source: Ministry of Economy / Ekonomi Bakanlığı, CEIC Database. Figure I Changes in the number of companies with foreign capital (total) Source: Ministry of Economy / Ekonomi Bakanlığı, CEIC Database. 369

10 As for the share of inward direct investments in Turkey by country in 2016, European countries such as the Netherlands, the United Kingdom, Germany and Austria had large shares, while the Middle East region as a whole accounted for nearly a fifth, 18%, of the overall investments, indicating the presence of a close economic relationship between Turkey and countries in its geographical proximity (Figure I ). The value of foreign direct investment in Turkey from Japan fell to 260 million dollars in 2014 from 440 million dollars in 2013, but it increased moderately in (Figure I ). The number of Japanese companies officially registered in Turkey surpassed 200 in 2015 (Table I ). Figure I Share of inward foreign direct investment in Turkey by country (2016) Source: Ministry of Economy / Ekonomi Bakanlığı, CEIC Database. 370

11 Figure I Direct investment value in Turkey by Japan Source: Central Bank of the Republic of Turkey. Table I Year Number of Japanese companies developing business in Turkey (on a registration basis) Number of Japanese companies registered in Turkey Source: Ministry of Economy / Ekonomi Bakanlığı. In August 2016, a major Japanese construction machinery company opened a representative office in the Turkish city of Izmir. Explaining the reason for opening the office and the background factors, the company stated: In terms of agricultural GDP, Turkey is No. 1 in Europe and No. 7 in the world, 371

12 so we can expect an increase in sales of agricultural machinery, which is our main product. In addition, against the backdrop of maritime trade for which there is robust local construction-related demand, we can expect stable demand for small construction machinery and engines for ships as well in the future. Therefore, Turkey is a promising country which is expected to continue to provide significant business opportunities in the future. In November 2016, a major Japanese food company acquired all the shares in a major Turkish food company. Explaining the background to the acquisition, the company stated that the needs for seasonings and processed foods of high convenience have expanded owing to women s growing social participation in urban areas that has come with economic development as well as the underlying economic and social factors, such as Turkey s large population, a population mix in which half of all people are aged 30 or younger, and stable GDP growth. Turkey has a large population, million people (in 2015), relative to neighboring countries in the Middle East and North Africa, and the proportion of the dependent population (which refers to a population of people aged 14 or younger and people aged 65 or older; people outside the dependent population are referred to as the working-age population) is small at 49.7% (Tables I and I ). Because of its geographical proximity to Europe and Africa, Turkey has potential as an export or production base. The country is also geopolitically important as a hub of transportation of energy (oil and natural gas) from Central Asia, the Caucasus region and the Middle East to Europe. It is noteworthy that since 2016, Japanese companies, while exercising calm judgement and discretion, have continued to invest in Turkey from the long-term perspective in consideration of the country s records of economic growth, its advantage as a market (a large population with a significant proportion of young people) (Tables I and I ) and its promising role as a base for export to the Middle East, Europe and North Africa. 372

13 Table I Changes in population in Turkey and neighboring countries (Unit: 10,000 people) (Increase in ) Egypt 6,833 9,151 11,710 2,559 Turkey 6,324 7,867 8, UAE , Saudi Arabia 2,139 3,154 3, Middle Eastern countries 37,743 50,149 61,649 11,500 Worldwide 612, , , ,130 Source: World Population Prospects: The 2015 Revision, JETRO. Table I Comparison of dependent population between Turkey and neighboring Dependent population (%) Aged 15 or Aged 65 or younger older Egypt countries Proportion of Dependent population (%) dependent Aged 15 or Aged 65 or population younger older Turkey Proportion of dependent population UAE Saudi Arabia (People aged 15 or younger + those aged 65 or older) Proportion of dependent population= 100 (People aged 15 to 64) Source: World Population Prospects: The 2015 Revision, JETRO. (3) Risks requiring careful attention in the future Effects of the attempted coup d état and the future outlook on the economy Although some elements of the Turkish military attempted a coup d état on July 15, 2016, the government suppressed them and brought the situation under control within several days. The Turkish people s support for the government led to the early resolution of the emergency situation, reaffirming their strong confidence in the president. As for the impact immediately after the attempted coup d état, the foreign exchange market reacted strongly, with the lira temporarily depreciating 4.5% against the U.S. dollar to 3.05 liras per dollar. The yield on 2-year and 10 years Turkish government bonds rose by around 0.3 percentage points and by around 0.6 percentage points, respectively. At the monetary policy meeting, the upper limit of the interest rate corridor was lowered. Despite the lira s temporary plunge in the financial 373

14 market, the situation gradually calmed down as a result of the early resolution of the emergency situation and the central bank s market stabilization measures. S&P, a credit rating agency, downgraded foreign currency-denominated long-term bonds issued by Turkey from BB+ to BB while upgrading domestic currency-denominated long-term bonds from BBB- to BB+. As for the economic outlook, the Turkish economy has recently been driven by domestic demand, mainly private consumption, against the backdrop of the inflow of immigrants. Amid a decline in companies appetite for capital investment, the deterioration of the security situation as exemplified by the attempted coup d état and terrorism incidents curbed direct investments from abroad. In April 2017, in a referendum on whether or not to amend the constitution in order to expand the president s powers, a majority supported the amendment, indicating the people s confidence in President Erdogan and the stability of the government. The proposed constitutional amendment would abolish the post of prime minister, have the president concurrently serve as the head of state and government in place of the existing parliamentary system of government, and empowers the president to declare a state of emergency, appoint and dismiss cabinet members, and formulate budgets. As a result of the constitutional amendment, the next presidential election is scheduled to be held in 2019 and President Erdogan could remain in office until As Turkey depends on imports for most of its supply of crude oil and other energy sources, the trade deficit is expanding and the inflation rate is gradually rising as a result of the currency devaluation. The IMF revised upward its estimate of the growth rate in 2017 to 3.8% and the World Bank projected a growth rate of 3.5%, but these figures may be revised downward. In Turkey, there are three policy interest rates. The Central Bank of the Republic of Turkey is conducting a somewhat complex monetary policy based on the guidance of market interest rates using a corridor (interest rate range) comprised of three policy interest rates: the one-week repo rate, which is the main policy interest rate; the overnight lending interest rate (equivalent to the uppermost interest rate); and the overnight borrowing interest rate (equivalent to the bottom interest rate). In the future, the central bank aims to unify these policy interest rates. In January 2014, the Central Bank of the Republic of Turkey decided to raise the policy interest rate steeply (from 4.5% to 10.0%) at an emergency monetary policy meeting. The direct cause of this bold policy interest rate hike was the rapid depreciation of emerging countries currencies triggered by risk aversion activities attributable to concerns that capital flight from the countries may occur because of the tapering of the United States quantitative monetary easing policy and the slowdown of the Chinese economy. Like the Argentine peso and the Brazilian real, the Turkish lira continued to fall against the U.S. dollar, so the policy interest rate was raised steeply in order to arrest the currency depreciation. In November 2016, the one-week repo rate, which is particularly important among the three policy interest rates was raised from 7.5% to 8% in order to curb inflation. This was the first interest rate hike in two years and 10 months. In a statement issued after the monetary policy meeting, the Central Bank of the Republic of Turkey observed that although the inflation rate is slowing down amid signs of the Turkish economy bottoming out, the current rapid depreciation of the lira is an upside risk on the 374

15 inflation outlook, indicating the view that it was necessary to curb inflation expectations through monetary tightening. Figure I Total government debts in Turkey (as a percentage of GDP) Source: IMF WEO Database, October Figure I Recent changes in exchange rates of Turkish lira (against the dollar) Source: Thomson Reuters EIKON. 375

16 Figure I Changes in policy interest rates in Turkey Source: Central Bank of the Republic of Turkey, Thomson Reuters. 3.Saudi Arabia (1) Macroeconomic trends The GDP growth rate declined steeply (a decline of 2.1%) in 2009 because of the effects of the global economic crisis (2008) but it subsequently increased gradually and reached 10.3% in Mainly, exports and capital formation made significant contributions to the growth rate. That was because crude oil demand decreased temporarily in 2009 due to the deterioration of the global economic conditions and also because the crude oil price rose and stayed at around 100 dollars per barrel in From 2012 onwards, the contribution of exports declined due to a drop in the crude oil price and turned negative in 2014 (-0.9%). Figure I shows that instead, government consumption and private consumption are making significant contributions to the growth rate. 376

17 Figure I Changes in real GDP growth rates and contribution level by type of industry in Saudi Arabia Source: Ministry of Economy and Planning, Saudi Arabia, and the CEIC Database. Figure I Changes in consumer price indices (CPI) in Saudi Arabia (year-on-year rate) Source: Ministry of General Statistics Agency, Saudi Arabia, and the CEIC Database. 377

18 The consumer price index (CPI) in January 2016, which was announced by the Saudi General Authority for Statistics (former Central Agency for Statistics), rose 4.3% compared with the same month of the previous year, the largest growth rate in five years. According to an analysis by Jadwa Investment, a major Saudi investment bank, this was attributable to the effects of energy price increases implemented after the end of Some economists have warned that a steep price increase may have a considerable negative impact on the middle class. As for the trade balance, the value of exports was 1.37 trillion riyals and the value of imports was billion riyals in However, the value of exports fell to billion riyals in 2015, while the value of imports increased to 655 billion riyals. This means that the trade surplus declined due to the effects of the crude oil price decline. The current account surplus, which was 66,751 million dollars in 2010, grew 2.5-fold to 164,764 million dollars in Subsequently, the surplus gradually declined, and in 2015, the current account balance deteriorated significantly and turned to a deficit of 53,478 million U.S. dollars (Figure I ). Regarding the policy interest rate, Saudi Arabia is adopting a dollar-peg system, 118 and the policy interest rate remained unchanged since Figure I Changes in trade balance in Saudi Arabia Source: Ministry of General Statistics Agency, Saudi Arabia, and the CEIC Database. 118 The dollar peg system refers to the system of keeping the domestic currency at a fixed exchange rate relative to the U.S. dollar through monetary adjustments and exchange interventions conducted by the government and the central bank. Saudi Arabia and the UAE can avoid large fluctuations in the exchange rate by linking their domestic interest rates to U.S. interest rates. 378

19 Figure I Changes in account balance in Saudi Arabia Source: Saudi Arabian Monetary Agency, CEIC Database. Figure I Changes in budget balance and proportion of budget balance to nominal GDP in Saudi Arabia Source: Saudi Ministry of Finance and Economy, CEIC Database. 379

20 Figure I Changes in crude oil prices between 2006 and 2015 Source: Thomson Reuters EIKON. (2) Effects of the oil price decline on the budget balance As for the budget balance, revenue increased gradually from 2009 onwards and peaked at 1,440 billion riyals in 2012, and it decreased to 615 billion riyals in Expenditure continued to increase from 596 billion riyals in 2009 until peaking at 1,109 billion riyals in 2014, but it declined slightly to 978 billion riyals in The WTI crude oil price stayed high after surpassing 100 U.S. dollars per barrel in February 2008 and rose to 140 U.S. dollars per barrel in June of the same year. However, in October 2008, when the global economic crisis broke out, the oil price fell to the U.S. dollars range. Subsequently, the oil price stayed between 40 and 70 U.S. dollars per barrel in The average oil price in 2009 was 63.9 U.S. dollars per barrel. After repeating fluctuations, the oil price fell to the U.S. dollar range in November The average oil price in 2015 was 49.3 U.S. dollars per barrel, down as much as 14.6 U.S. dollars from The Saudi Vision 2030, 119 which has set the national goal of reducing the dependency on oil, was announced in April 2016, so the budget was compiled while policy measures to increase non-oil revenues were being developed. Revenue was projected at 692 billion riyals (approx. 20,760 billion yen; 1 riyal = approx. 30 yen), an increase of 31.1% compared with the revenue in fiscal 2016 (estimate). On the other hand, expenditure is projected at a record high of 890 billion riyals, an increase of 7.9% from the previous year s expenditure. Oil revenue is projected at 480 billion riyals 119 The economic reform plan for the period until 2030 advocates the vision of economic diversification, including reducing dependency on oil and increasing investments and improving and developing tourism, manufacturing and logistics for the purpose of nation building based on investment returns. 380

21 (an increase of 45.9%), while non-oil revenue is projected at 212 billion riyals (an increase of 6.5%). Following the agreement on the reduction of crude oil production reached among the OPEC member countries, Saudi Arabia is expecting a revenue increase due to a crude oil price rise and growth in non-oil revenue in fiscal Saudi Arabia intends to cover the budget deficit of 198 billion riyals, which is equivalent to 7.7% of GDP by issuing government bonds and by using foreign currency reserves. The projected expenditure amount includes 42 billion riyals allocated to the National Transformation Program (Table I ). Table I Revenue and expenditure between FY2016 and FY2017 (Unit: Billion Saudi riyal) FY2016 FY2017 Budget Estimated achievement Budget Revenue Petroleum Non petroleum Expenditure Education Military affairs Health and social welfare Public program defense and regional administration Infrastructure and transportation Services by municipalities Economic ties (including public projects) Public policies Notes: The total expenditure in FY2016 was billion riyals, including that unpaid in FY2015 (105.0 billion riyals) Source: Ministry of Finance, Saudi Arabia, and the JETRO. Education, defense, and health/social welfare expenditure Figure I shows the breakdown of the expenditure. Of the total expenditure, 23% is allocated to education, 21% to the military and 14% to health/social welfare. 120 This sets forth specific targets that should be achieved by 2020 in order to realize the Vision Among the targets are increasing non-oil revenue to 530 billion riyals, reducing the total amount of salaries for civil servants from 480 billion riyals to 456 billion riyals and increasing public debts from 7.7% to 30% as a proportion of GDP. 381

22 Figure I Breakdown of expenditure under the FY2017 budget Source: Saudi Ministry of Finance and Economy, JETRO etc. Crude oil price on an uptrend since the second half of 2016 Regarding changes in the crude oil price in 2016 through the first half of 2017 (Figure I ), the WTI price, which is the global benchmark of crude oil futures prices, trended upward after the agreement on coordinated production reduction reached between the OPEC and non-opec countries in November 2016, and it has recently stayed at around 50 dollars per barrel. Figure I Changes in crude oil prices between 2016 and the first half of 2017 Source: Thomson Reuters EIKON. 382

23 (3) Risks requiring careful attention in the future (A) Crude oil price trend Crude oil accounts for 80% of the overall value of exports from Saudi Arabia. Regarding the trend in 2017, many experts expect that the price will gradually rise, with a fall below 40 dollars unlikely. However, the possibility of a global excess supply of crude oil cannot be entirely ruled out. If the price stays above 50 dollars per barrel, shale production is likely to increase (Figure I ). The key will continue to be whether Saudi Arabia and other countries can successfully ensure cooperation between OPEC and non-opec countries in oil production adjustment. Figure I Increase in the number of rigs for crude oil in the United States Source: Thomson Reuters EIKON. As most exports are mineral fuels, the economic conditions tend to deteriorate when resource prices drop. The challenge is reforming the economic structure to reduce the dependency on mineral fuels and promoting measures to foster and diversify domestic industries, such as developing industries other than oil, such as manufacturing, and infrastructure in addition to domestic refining facilities while receiving cooperation from foreign companies. (B) Effects of fiscal consolidation reform on companies in Saudi Arabia Under the budget-balancing program (action plan for fiscal consolidation), which was announced at the same time as the budget, the government indicated the policy of continuing to raise prices (reduce governmental subsidies) of domestic energy, including gasoline, which was announced one year ago at the same time as the fiscal 2016 budget, and cited the following measures to increase non-oil revenue. Measures already introduced included a visa fee increase, a fee increase for local government services, revision of energy and water prices (Phase 1) and revision (reduction) of salaries 383

24 for civil servants). Measures to be introduced by 2020 included a further revision of energy prices, strengthening of taxation on foreign nationals and introduction of the value added tax (VAT). In this way, the government is promoting revenue diversification at the same time as rationalizing various subsidies. At the time of the reduction of subsidies for gasoline and other items that was implemented in January 2016, a heavy burden was imposed on the Saudi people through a rise of higher than 4% in consumer prices in the January-June period compared with the same period of the previous year, which was caused by increases in retail energy prices and water prices. Although the government considers further reduction of energy-related subsidies as essential to fiscal consolidation, it intends to provide allowances to low-income people in order to reduce the burden on them. While strengthening support for the Saudi people, the government intends to ask foreign nationals to bear an increased burden. However, this may be considered to be in conflict with the policy of promoting privatization and invigorating the private sector by attracting foreign investments, so a careful watch needs to be kept on what effects may ensue. 384