Posted on November 23, 2016

The report Economic Insight: Middle East Q4 2016 – produced by Oxford Economics, ICAEW’s partner and economic forecaster – was launched yesterday evening in a joint briefing session conducted by ICAEW and the Saudi Organization for Certified Public Accountants (SOCPA) in Riyadh. The report warns oil prices will not return close to the US$100 per barrel averaged in 2010–2014. Brent crude is forecast to average US$50.3 per barrel in 2017 and remain below US$60 per barrel until 2019. While GCC countries can cover the revenue shortfall in the near term by borrowing as well as drawing down sovereign wealth funds and foreign exchange reserves, they will not be able to do so in the long term without raising taxes.

The projected 2016 breakeven prices – at which oil must sell in order to balance the budget – put Qatar and UAE in the most preferable position at US$44 and US$57 per barrel respectively, followed by Kuwait at US$60 and KSA at US$77 . Oman and Bahrain are under the greatest pressure with breakeven prices at US$104 and US$97 per barrel respectively. Tom Rogers, ICAEW Economic Advisor, and Associate Director of Oxford Economics’ Macroeconomic Consultancy for Europe, Middle East and Africa (EMEA), said: “The need to significantly increase non-oil government revenues to maintain financial steadiness is clear. But few tax policies are free of wider economic consequences, so it will be important for governments to ensure that tax policies are considered as part of broader economic diversification strategies, such as those in Saudi Arabia’s Vision 2030.”

A GCC-wide VAT of 5% is already due to be implemented in 2018 and IMF estimates suggest this could raise GDP as much as 1.5% –2% across the region. While this presents a start to addressing deficits, it also contributes to a rise in cost of living, which in turn could raise wage demands and thereby undermine organisations’ competitiveness. Other possible tax measures include the broader application of corporation or profits tax, or personal income tax, the latter of which is typically the major contributor to government revenues in high-income economies. However, since social security systems treat nationals and non-nationals differently, it seems unlikely in the near term that personal income tax would be applied unilaterally. The report highlights that raising non-national workers’ wage demands as a result of personal income tax could be consistent with government targets to ‘nationalise’ workforces, and might be preferable to quota systems that force companies to employ locals regardless of the availability of suitable employees.

Michael Armstrong, FCA and ICAEW Regional Director for the Middle East, Africa and South Asia (MEASA), said: “Businesses in the GCC need to brace themselves for a long-term effort by governments to close fiscal deficits and raise much more substantial revenues from the non-oil economy. In addition, they can expect the implementation of other offsetting populist policies like the drive to increase the national share of the workforce, especially in the private sector. “To ensure that the adjustment in public finances is consistent with ongoing growth, businesses should make the case for accompanying measures that will allow tax increases to be absorbed with minimal impact on activity. Offsetting measures could include welfare reforms to incentivise more citizens to compete for jobs with migrants, more flexibility to negotiate wages, and deductions from profit taxes to protect investment spending.”

Pressure on oil prices is also a key worry for business from the perspective of exchange rate stability. Beyond Kuwait which manages its rate against a basket of other currencies, all GCC economies operate a pegged exchange rate regime. Over 2015-2016, all GCC countries have seen current accounts deteriorate sharply, requiring central banks to draw upon foreign exchange reserves to meet demand for foreign currency. While across the GCC weaker exchange rates look to be a necessary part of any longer-term plan for diversification, any depreciation will have a short-to-medium term impact on business costs, output prices, and ultimately household spending power.

According to the report, the GDP in GCC+5 (Egypt, Iran, Iraq, Jordan and Lebanon) is expected to grow 2.6% in 2016, improving very modestly to 2.7% in 2017 due to weak oil prices and associated fiscal consolidation programmes.

The report also shows:

  • GDP in Saudi Arabia is expected to rise 1.2% in 2016 and a similar rate in 2017, due to flatter oil production next year. The Kingdom’s inaugural bond issue in October, at US$17.5bn, was the largest emerging market bond in history; with its high demand underlining Saudi Arabia’s ability to source cheap credit (the bond carried an average interest rate of just 3.25%). This should relieve some austerity pressure, allow non-oil growth to recover to 1.5% in 2017 from -0.2% this year, and support investment in pursuit of the Vision 2030 agenda.
  • While one of the most diversified economies in the Gulf, the UAE economy is still influenced by oil price developments. The country is expected to see GDP growth of 2.3% this year, rising to 2.7% in 2017 as both oil and non-oil sectors improve. Output in the oil and gas sector, which makes up around one third of the economy, is expected to rise by only 1% in 2016 after growing 5% last year. Non-oil growth is also expected to slow a little further this year to 2.9% as the cumulative impact of low oil prices, tighter fiscal policy and liquidity feeds through.
  • GDP growth in Bahrain should hold up in 2016, unchanged from 2015 at 2.9%, thanks to GCC support and higher oil production. However, with oil output expected to fall, prices remaining low and spending dropping back, growth is expected to slow to 1.7% in 2017.
  • GDP growth in Oman is expected at 2.3% in 2016, slowing further in 2017 to just 1.7%. This reflects fiscal consolidation, stagnant wage growth, lower subsidies and tightening financial conditions. The budget deficit remains the highest in the GCC, forecast at 20% of GDP in 2016. Cuts in subsidies, together with measures to raise non-oil revenues, should see the deficit fall to 11% of GDP next year.
  • With government spending forecast to drop 10.2% in 2016, non-oil GDP growth in Qatar is expected to slow to 5.8% this year, but pick up to 6.6% in 2017. This will leave overall GDP growth at 2.6% in 2016 and 3.7% in 2017. Liquidity remains fairly tight despite sovereign bond issues in May, August and September.
  • Thanks to government investment, continued employment growth and subsidy cuts, overall GDP in Kuwait is expected to grow by 2.8% in 2016. However, GDP is expected to dip to 2.3% in 2017 due to a slowdown in the hydrocarbon sector and political challenges, with Parliament being dissolved in October.

The full Economic Insight: Middle East report can be found here: