economic Insight Middle East Quarterly briefing Q3 212 Global economy stutters into the second half of 212 as euro crisis drags on Welcome to the sixth issue of ICAEW s Economic Insight: Middle East, the quarterly economic forecast prepared directly for the finance profession. Produced by Cebr, ICAEW s partner, and acknowledged experts in global economic forecasting, it provides a unique perspective on the prospects for the Middle East region as a whole and for individual economies against the international economic background. We focus on the Middle East as being the Gulf Cooperation Council (GCC) member countries (United Arab Emirates, Bahrain, Saudi Arabia, Oman, Qatar and Kuwait), plus Egypt, Iran, Iraq, Jordan and Lebanon (abbreviated to GCC+) 1. It has been another turbulent few months for the global economy. The second quarter of 212 saw many key economic indicators deteriorate and a plethora of growth forecasts downgraded. The key result of this for the Middle East which holds 48 of the world s proved oil reserves 2 has been the sharp decline in oil prices seen through May and June. The biggest issue for the global economy remains the seemingly never-ending eurozone crisis. Despite more bail outs, summits and central bank government bond buying, a clear way forward remains elusive. This profound uncertainty continues to plague the world economy. Meanwhile, recent months have also seen the emerging market stars of the global economy slow down notably, hitting global growth. On top of these global developments, political uncertainty and security concerns remain prevalent in the Middle East to complicate the economic outlook further still. BUSINESS WITH CONFIDENCE icaew.com/economicinsight
Suez Canal figures point to weakening global economic activity Through the second quarter of 212 the broadbased slowdown in the global economy has become increasingly clear. The amount of trade passing through the Suez Canal is a rather useful economic indicator, being closely linked to overall changes in global economic activity; around 8 of the world s international trade passes through the Suez Canal. 3 The data on the tonnage of goods passing through offer timely indicators of real economic activity. The June data illustrated in Figure 1 show that the number of vessels passing through the Suez Canal stood 9.4 lower than in June 211, the steepest annual decline in vessels travelling through since November 29 when the effects of the 28 9 global recession were still impacting the figures. The figures on net tonnage are also disquieting because they fell for the first time year on year since the financial crisis June 212 net tonnage was down 2.4 from 12 months earlier. Figure 2: Middle Eastern equity markets hit by weakening global economic outlook; percentage change in key equity indices between 3 March 212 and 3 June 212 - -1-1 Saudi Stock Exchange, Tadawul All Share Index Dubai Financial Market, General Index Egyptian Exchange, EGX1 Index Doha Securities Market Index FTSE World Index Kuwait Stock Exchange Tehran Stock Exchange, All Share Index Abu Dhabi Securities Exchange, General Index Muscat Securities Market, MSM 3 Index Figure 1: How global growth has faltered yearon-year percentage change in net tonnage and number of vessels transported on the Suez Canal -2 3 3 2 2 1 1 - -1-1 -2-2 -3 Net tonnage Source: Suez Canal Authority Number of vessels Source: Macrobond Oil prices in sharpest drop since global recession of 28 9 The weaker global economic picture has of course resulted in a lower price of oil too crucial as always for the Middle East economy. The price of crude dropped sharply from early April through to late June. The average of the three main oil spot prices declined from $117.79 in March to $9.73 in June. Figure 3 illustrates that this was the steepest decline in oil prices over three months since January 29 the lowest point of the 28 9 global recession. However, since late June oil prices have rebounded; the price of a barrel of Brent Crude reached a low at $9.34 dollars at close on 26 June but has risen through July to surpass $17 a barrel, still some way short of the recent peak at $126 a barrel in mid-march. Middle Eastern equity markets sink as economic outlook worsens Markets were hit by the weaker economic picture through the second quarter of 212. Figure 2 illustrates the decline in key equity indices across the Middle East between the beginning of April and July. The Muscat MSM 3 was the only one of the key benchmarks to avoid a decline through the quarter with equity markets generally weakening. The steepest decline over the quarter was on the Saudi Tadawul index, dropping in value by 1.4 while the Dubai Financial Market index also experienced a double-digit decline of some 11.9 over the quarter. The declines in indices in Saudi Arabia, Dubai, Egypt and Qatar all surpassed the 7.1 decline on the FTSE World index. The declines in stock prices reflect falling profit expectations as well as perceptions of higher risks for businesses in the region. Figure 3: Weaker global economy hits oil prices although downward trend reversed in July, change in average of three spot prices 4 from three months prior, $ per barrel $ 3 2 1-1 -2-3 -4 - -6-7 Source: IMF, Cebr analysis icaew.com/economicinsight cebr.com
Whatever the precise up or down movements, an increase in the volatility of commodity prices has become evident since the mid-2s. Rising speculative activity in this formerly sleepy corner of the financial markets may have a role to play; large shifts in demand to emerging markets are another. The injection of large amounts of cheap money through central bank quantitative easing into global markets may have exacerbated this trend as money moves out of the economies it is intended to support to chase returns in the globalised financial marketplace. While the fluctuations around the average have become increasingly unpredictable, the next section looks at expected future prices. But oil prices rebound in July as political uncertainty escalates This most recent market trend could partly be a function of central banks responding to the weaker growth environment with a range of monetary policy measures; we have seen rates cut from China to the eurozone to South Korea, Brazil and India. Meanwhile in the UK the Bank of England has once again increased its quantitative easing programme by bn and there are growing calls for further quantitative easing from the Federal Reserve in the US. However, given the sharp, abrupt nature of the recent price rises and no particular sign of a significant change from the weakening trajectory of the global economy in recent weeks, it seems likely that a large part of these price movements can be explained by increased political uncertainty. This ongoing political uncertainty means that, despite weaker economic fundamentals, the oil price remains high. Figure 4 shows an analysis of futures market contracts for delivery of oil over the next four years. This suggests that the price of Brent Crude will remain above $1 a barrel in 213, although increased supply will put slight downward pressure on prices for the following three years. Not surprisingly, given prices far above the cost of production in the Middle East, moves to boost production are already evident as the following sections illustrate. Figure 4: Oil prices to remain above $1 a barrel in 213? Brent crude futures $ per barrel $ 12 1 8 6 4 2 Brent crude Source: IMF, Macrobond, Cebr analysis Brent futures Iranian oil production slumps while Kuwaiti, Saudi and Iraqi output booms Hand in hand with the higher oil prices, oil production in the Middle East has grown strongly over the last couple of years especially after the Libyan crisis knocked around 3 out of global oil supplies. With Libyan oil production back up to around 84 of its pre-crisis level and global economic growth slowing, the robust growth in the oil economy seems almost certain to slow in the second half of 212 and into 213. Figure shows that oil output growth has been especially robust in Iraq, Kuwait and Saudi Arabia through 212, while the trade sanctions imposed on Iran are causing steep cutbacks in production. Despite the falls in Iranian production, the strong growth in oil production across the region has seen the Middle East s share of global oil output reach almost 31 over the latest 12-month period. Within that, the Gulf Cooperation Countries share of output reached 22.7. Both these figures are near record highs. Figure : Percentage change in oil production volume over three months to May compared with same period a year earlier 2 2 1 1 - -1-1 Kuwait May 212 Saudi Arabia Source: IEA, US EIA, Cebr analysis Iraq UAE Qatar But Middle East oil surge will slow as 212 goes on Emphasising the strong growth and record production figures leaves a clear danger of looking too much in the rear view mirror. There are obvious signs that the oil economy and the wider regional Middle Eastern economy will slow as 212 goes on. Figure 6 shows that while the last two years have seen a prolonged period of robust growth in Middle East oil production, the last few months have seen a trend decline in the annual pace of output growth starting to emerge. While clearly the declines in Iranian production play a significant role in this, given the weakening global economic backdrop captured in the Suez Canal data in Figure 1, this weaker pace of growth is likely to continue into the second half of 212. Supply is only one part of the market equation determining prices and volumes traded. Demand, of course, is the other. We now turn to look at events in major world regions to gauge the drivers of oil markets from that perspective. Iran
Figure 6: Percentage change in total Middle East oil production over time, three month annual change Figure 7: Middle East exports to eurozone, share of total goods exports 14 12 1 8 6 4 2-2 -4-6 -8-1 -12 Middle East World 3 2 2 1 1 Oman Bahrain Jordan United Arab Emirates Kuwait Total Qatar Saudi Arabia Lebanon Iran Iraq Egypt Source: US EIA, Cebr analysis 21 211 The ongoing eurozone crisis and its impact on the Middle East and world economy It is clear that global economic growth is straining as the eurozone current and future performance remains in question, but how bad are things likely to get and what impact will it have in the region? A contraction in the eurozone economy through 212 seems all but certain. Economic output in the single currency area is expected to decline by.8 in 212 and struggle to achieve growth in 213, but this is highly uncertain. Steep drops in economic activity are occurring in Italy and Spain with GDP likely to decline by at least 2 in both cases while Greece and Portugal are mired in recession and even Europe s economic powerhouse Germany is suffering from weaker growth as business sentiment indicators have been declining. But what bearing will this have on the world economy and the Middle East region? The eurozone accounted for around 19 of the global economy at the end of 211, measured at market exchange rates, so the ongoing crisis acts as a major drag on global economic growth. Indeed, in current dollar terms, the forecast decline in eurozone economic GDP will knock around $bn off global GDP in 212. So there is a serious impact on the global economy, oil prices and hence the Middle East. However, on the upside for the region trade with the eurozone is, in relative terms, quite small. Figure 7 shows that across the regions goods exports to the eurozone total around 9 of total Middle East exports and this export share has been declining; back in 21 eurozone exports totaled 11 and going back further it was larger still. For some Middle Eastern economies the proportion of exports to the eurozone has declined notably, including the region s two biggest economies: Saudi Arabia and Iran. Global economic growth to fall again in 212 and remain muted in 213 Across the AtIantic the US has been far stronger than the eurozone but there have been clear signs of weaker performance in the US too, with employment growth disappointingly weak through the second quarter of 212. Hence, economic growth below 2 is expected in the US in 212 and, with fiscal tightening likely to set in through 213, growth is likely to remain impaired. Source: Macrobond; IMF Direction of Trade Statistics & Cebr analysis With the large economies of the West subdued, the onus is increasingly on emerging economies to drive global growth. Indeed, previous editions of Economic Insight: Middle East have highlighted the importance of emerging economies to the region s economy as a major trade partner and driver of Middle East export growth. Moreover, growth in the Middle East is strongly correlated with emerging market growth. While emerging market expansion is still going to significantly outstrip growth in the advanced economies of the West, the outlook has become more challenging. In China there have been clear signs of a slowing economy as investment expansion eases after years of booming growth. The rate of growth is expected to ease back towards 7 over the next few years, having averaged 1.3 from 2-21. In India, growth is also weakening considerably in 212, forcing the Reserve Bank of India to loosen monetary policy by cutting benchmark interest rates. Overall, Indian economic growth is expected to fall below 6 and is not expected to surpass this level in 213 either. What this all means for global economic growth is illustrated in Figure 8: in 212 the world economy will slow to its lowest rate of growth since 29 and remain below 3 in 213. Figure 8: Economic growth outlook for key economies, annual percentage change in real GDP 12 1 8 6 4 2-2 -4 China India Source: IMF, Cebr analysis Eurozone US Global economic insight middle east Q3 212
Emerging markets slowing too, posing downside risks for the Middle East in 213 As the global economy slows, growth across the Middle East is expected to fall back. Growth is slowing from nearly 6 in 211 down to 4.4 in 212. This is still some 1.8 percentage points higher than across the global economy as a whole as the strong growth in oil production boosts the overall level of economic activity. However, with key export markets slowing down and weaker oil demand growth resulting in a lower rate of expansion in oil production, the pace of growth is set to fall further in 213, with expansion the smallest since 29. Beyond that, policy intervention and the turning of the global economic cycle will see Middle East growth rise again towards 4 in 214. In all years of the forecast period growth in the Middle East outpaces the world as a whole, but in 213 the gap will close as the effect of lower oil production growth hits the Middle East harder then. Figure 9: Comparison of regional annual GDP growth forecasts 8 7 6 4 3 2 1-1 -2-3 Middle East Source: IMF, Cebr analysis Global What policy tools are available for the Middle East? As the global economy slows and the Middle East feels a cooler breeze from the rest of the world economy, policy-makers across the region may need to assess what options they have to mitigate weaker external conditions. A weakness for the region has traditionally been its dependence on the hydrocarbon economy. Measures to diversify economic structures have long been a policy objective in the region, but the overwhelming importance of the petrochemical industry makes progress in this direction a challenge why change a winning formula? In addition, the financial crisis exposed a construction boom in some countries as unsustainable, teaching the Middle East a lesson that many other regions of the world have also had to learn the hard way: buildings in and of themselves don t make things. Once the boom fizzles out, a large part of the economy slumps in the ensuing downturn. Therefore, investment in skills and technology appear to be the way forward. The opening of campuses by foreign universities as well as the construction of innovative projects such as the zero emissions city in Abu Dhabi, and the growing international profile of regional businesses are steps in the right direction. To build a diverse industrial base will require deeper changes, however, with more inclusive education policies and greater opportunities for minority groups such as recent migrants another part of the policy mix. Only a universally high level of skills and economic opportunities can provide the level of labour productivity growth required for lasting success in the 21st century. Those long-term policies which require an extended period both to be implemented and to bear full fruit are crucial for living standards in the coming decades, but the shaky state of the global economy also points to the need for more immediate measures to safeguard livelihoods. A possible fall in oil prices amid a global recession that might be caused by a eurozone implosion or a China slump could depress oil prices substantially. That suggests the need to be prepared for a more immediate policy response if the economy sours. With a dollar peg common in the Middle East, exchange rate volatility is eliminated. But on the other hand it also cuts states capacity to set interest rates and effectively outsources monetary policy to the US Federal Reserve. In other words, the Middle East has less policy flexibility than countries with floating exchange rates and has to look to fiscal policy for management of the business cycle. However, large spending increases implemented during the Arab Spring have already boosted the role of the state in the economy in many countries. Further stimulus from the public purse runs the risk of creating imbalances, resulting in wasteful spending with a low multiplier impact on the rest of the economy and also increasing the reliance on oil and gas revenues at a time when the underlying resource is losing value. In this context, a potential crisis in the Straits of Hormuz may benefit the oil-dependent countries more than it may hurt them by driving up prices. The other risks to the global economy, which appear to be firmly weighted on the downside, suggest that the Middle East would feel the effects of a downturn as strongly as other parts of the world. However, if the above-mentioned economic diversification is made a priority and oil and gas revenues are invested to boost the long-term growth potential, the outlook for the region is bright. Growing populations that are raising their skill level, a strategic location between rising stars Africa and Asia as well as an insatiable need for energy all promise a bright future even if the path to lasting prosperity may be a bumpy one in the aftermath of the global financial crisis. icaew.com/economicinsight cebr.com economic insight middle east Q3 212
FOOTNOTES 1 The phrase Middle East is often used to cover different parts of the region. Much of the internationally-available economic data relates to the Middle East and North Africa region which we call MENA (this covers the seaboard countries in North Africa from Somalia to Mauretania and all the states in the Arabian peninsula including Israel plus Iran and Turkey in the north). Political discussions often treat the Middle East as synonymous with the Arab world. But where we refer to wider definitions of the region we will try to point this out explicitly. 2 According to the latest BP Statistical Review of World Energy, June 212 3 The Economist; Running Aground http://www.economist.com/blogs/dailychart/211/9/world-economy 4 Brent crude, West Texas Intermediate and Dubai Fateh When the central bank buys up government bonds through the creation of new central bank reserves. ICAEW ICAEW is a professional membership organisation, supporting over 138, chartered accountants around the world. Through our technical knowledge, skills and expertise, we provide insight and leadership to the global accountancy and finance profession. Our members provide financial knowledge and guidance based on the highest professional, technical and ethical standards. We develop and support individuals, organisations and communities to help them achieve long-term, sustainable economic value. Because of us, people can do business with confidence. Cebr Centre for Economics and Business Research is an independent consultancy with a reputation for sound business advice based on thorough and insightful research. Since 1993, Cebr has been at the forefront of business and public interest research. It provides analysis, forecasts and strategic advice to major multinational companies, financial institutions, government departments and trade bodies. For enquiries or additional information, please contact: Sarah Jane Carter Regional Marketing and Business Development Manager, Middle East Currency House, Unit 4, Level 4 Dubai International Financial Centre PO Box 6836 United Arab Emirates T +971 ()4 48 2 E sarahjane.carter@icaew.com ICAEW Chartered Accountants Hall Moorgate Place London EC2R 6EA UK icaew.com ICAEW and Cebr work in partnership to deliver quarterly economic briefings ICAEW 212 MKTPLN1114 8/12