Gulf Gearing up for the New Normal

Gulf Gearing up for the New Normal

A decade of oil driven abundance looks to be fading for the Middle East with the first of what we expect to be a new cycle of rising budget deficits emerging in our forecasts for 2016 in Algeria, Saudi Arabia and Oman, says Simon Williams, chief economist, Central and Eastern Europe, Middle East and Africa, at HSBC. Though they have the wealth to maintain order, they thus far have no convincing model as to how they will generate growth when public spending starts to slow-a troubling prospect for a region with such a large and fast growing population.

“Ten years of sunshine is over. Now the weather is changing. The real questions though are over the longer term, about how the Gulf generates growth without being able to fall back on ever rising levels of public spending. The region has had 10 years of abundance. But that decade of plenty is done. The drop in oil prices will hurt performance in the near term, even if the Gulf’s buffers are powerful enough to ensure there’s no crisis,” he says. Simon Williams along with HSBC’s in-house London- based economists were in Oman recently as a part of the bank’s 17th annual Middle East economist roadshow to discuss the outlook for the region in the light of falling oil prices and strengthening US dollar.

“High oil prices and increased crude oil production supported economic recovery after the global crisis. While Oman’s growth story still has substance, a falling oil price indicates that story has passed its peak. With oil prices hovering around a five-year low, Oman’s budget, in line with that of other major oil producers in the region, looks set to be tipped into the red next year for the first time since 2009. While this is unlikely to trigger direct cuts in the large public investment programme given the years of plenty across the region, and not just in Oman, it does bring questions of future spending restraint and accelerating non-oil revenue growth firmly into view.”

The Sultanate’s economic growth remains healthy, but continues to moderate from its high base as we extend our forecast horizon into 2016, we see a key shift in the Sultanate’s economic cycle. Data for 2014 has been broadly positive with recent heavy investment in the oil sector sufficient to hold output steady at close to 1mb/d. The non-oil economy has been the mainstay of growth driven onward by government-sponsored infrastructure and development spending.

Yet while the growth story has substance, we sense that the cycle has passed its peak. In the oil sector, flat output is insufficient to offset weaker oil prices or continued gains in domestic consumption that led to a drop in export volumes over the first half of the year. More significantly, the oil sector performance looks set to bring the Sultanate’s long run of fiscal surpluses to an imminent close. Public spending in the Sultanate has trebled since 2005 but revenue has remained dominated by oil which delivers close to 90 per cent of total receipts. With oil income now looking set to flat or even contract, we expect the Sultanate to face a budget deficit in 2016 for the first time since 2009. Indeed, the budget could be in deficit in 2015 if oil earnings disappoint.

After such as long run of fiscal surpluses, the deficit is unlikely to lead to outright cuts in public spending. However, we do expect the shift into deficit to temper the government’s ambitious public spending and investment plans, slowing the overall place of growth and bringing greater urgency to the need to diversify the economy where oil and gas still make up 45 per cent of GDP. Given the strength of the Sultanate’s balance sheet after such a long run of surpluses, the deficit is unlikely to constitute a significant funding challenge.

What’s the way forward for the region? Globally, there are worries about deflation, which are increasingly central in our thinking. Deflation sounds nice to some people, but obviously it tends to discourage consumption and investment. The falling oil prices may not be good for the region. The decline in oil prices will add to deflationary pressures. The region however has scope to take the oil price weakness in its stride to some degree. The focus has to be economic diversification. Non-oil growth has been good. Diversification now needs to grow deeper.

In the longer term, the region needs a higher oil price. $70 to $80 per barrel is not enough. Over the next three to five years, oil prices need to be running in three digit level for the region to expect to enjoy the kind of economic growth that it enjoyed in the decade of abundance.

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