I. Middle Eastern Oil Exporters: Continued Spending Supports the Global Economy
- International Monetary Fund. Middle East and Central Asia Dept.
- Published Date:
- May 2009
The global crisis has affected the MEOEs mainly through the sharp fall in oil prices and the tightening of credit conditions. Despite the decline in oil revenues, most countries of the group are maintaining capital spending at a high level. This spending is providing an important stimulus to global demand, but will result in a turnaround in MEOEs’ external positions from a massive collective surplus of $400 billion last year to a deficit of $10 billion in 2009. With credit to the private sector declining and financial risks rising, the authorities have acted swiftly and forcefully to ease domestic liquidity conditions and support banking systems. In view of the downside risks to the outlook, especially of a prolonged global recession and/or deteriorating balance sheets in MEOE financial sectors, countries need to enhance oversight of the financial system and support economic activity while preserving fiscal sustainability.
Middle Eastern Oil-Exporting Countries
The oil exporters comprise 12 countries: the six countries of the Gulf Cooperation Council (GCC—Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates) and Algeria, Iran, Iraq, Libya, Sudan, and Yemen. Together, they account for 65 percent of global oil reserves and 45 percent of natural gas reserves. The countries are mainly exporters of oil, gas, and refined products, with oil and gas contributing about 50 percent to GDP and 80 percent to revenue. They are diverse and differ substantially in terms of per capita GDP, which in 2008 ranged from $1,200 in Yemen to over $70,000 in Qatar. The GCC subgroup is relatively homogenous, however, with similar economic and political institutions and relatively less diverse per capita incomes.
With high oil prices and strong global investor interest in the region, the MEOEs grew on average by a robust 5¾ percent a year between 2005 and 2008. These countries launched huge investment projects to pursue economic diversification and human capital development through investments in oil and gas and infrastructure, as well as in petrochemicals, tourism, financial services, and education. As a result, non-oil growth averaged about 6½ percent a year over the same period. In addition, they saved from their record-high export receipts—the external current account surplus averaged over 21 percent of GDP during 2005–08, enabling these countries to accumulate $1.2 trillion in foreign assets and reduce government external debt. Given these favorable conditions, the financial systems appeared sound: banks made large profits, had high capital adequacy ratios, and reported low nonperforming loan ratios.
Asset prices are down
With the onset of the global crisis, financial sector risks in the MEOEs are rising. During the boom years, banks had lent substantial amounts for real estate and equity purchases. The value of these assets has since fallen sharply. Reflecting a general increase in financial risks, credit default swap (CDS) spreads on sovereign debt and the rollover risk of foreign debt have increased sharply (Figure 1). In addition, in the last quarter of 2008 corporate profits fell significantly. These trends are likely to weaken banks’ balance sheets and feed back to the real economy.
Figure 1.Credit Default Swaps
Sources: Markit; and CMA Datavision.
While the direct exposure of MEOEs to U.S. financial distress has been limited, the process of global deleveraging led to a severe tightening of credit conditions, particularly in countries with financial systems that are more integrated with global markets (for example, the GCC). Countries that were highly leveraged and dependent on foreign lines of credit were affected the most—in Dubai, for example, CDS spreads reached almost 1,000 bps as investors’ concerns about rollover risks mounted. Local real estate and equity prices in the GCC had already begun to correct in the summer of 2008 (Figure 2).1 The correction accelerated with the intensification of the global financial crisis in September 2008. Dubai, where valuations were not aligned with fundamentals, was particularly affected (Figure 3). By the end of 2008, a large outflow of speculative capital took place: a reversal of inflows that had been accumulating since late 2007 in anticipation of an appreciation of the GCC currencies while oil prices were still high and inflation was rising. As oil prices and inflation began to fall, these expectations receded.
Figure 2.Real Estate Price Index
Figure 3.MEOEs: Change in Stock Market Indices
In those MEOEs where financial systems were affected by the global crisis, the authorities responded forcefully to stabilize the interbank market and to restore liquidity (Table 1). Following the tightening of liquidity conditions in the last quarter of 2008, all GCC and some non-GCC central banks provided direct injections of liquidity into the banking system, supplemented by deposits from government institutions and other measures to ease liquidity conditions. To shore up investor confidence, some governments provided guarantees for deposits at commercial banks (Kuwait, Saudi Arabia, and U.A.E.), and sovereign wealth funds (SWFs) were asked to support domestic asset prices and provide capital injections for banks. Despite the policy response, credit markets remain impaired in many countries, largely reflecting global uncertainty, and there is some evidence that even investors with profitable projects are finding it difficult to obtain financing.
|Country||Deposit guarantees1||Liquidity support||Capital injections||Equity purchases||Monetary easing||Fiscal stimulus|
Slower growth, but contributing substantially to global demand
GDP growth rates of the MEOEs are expected to decline significantly (Table 2). Oil production has been cut back, as the Organization of Petroleum Exporting Countries is attempting to stabilize prices in response to the lower demand for oil. The slowdown in non-oil growth should be moderated by plans to maintain public expenditure, as well as by the easing of monetary policy.
|Real GDP growth||5.1||6.4||1.3||4.2||6.8||4.5||3.1||3.4||6.0||5.4||2.3||3.8|
The external current and fiscal account positions of the oil producers are projected to weaken substantially (Figures 4 and 5). With the group as a whole expected to broadly maintain import levels, the combined current account balance is projected to shift from a surplus of $400 billion in 2008 to a deficit of $10 billion in 2009. While some countries (e.g., Bahrain, Oman, Sudan, and Yemen) may need to reduce their imports because their net external asset position is less favorable, their contribution to world demand is relatively small.
Figure 4.MEOEs: Current Account Balance
Sources: Data provided by country authorities; and IMF staff estimates and projections.
Figure 5.MEOEs: Government Fiscal Balance
Sources: Data provided by country authorities; and IMF staff estimates and projections.
By keeping up their imports, the MEOEs are thus contributing importantly to global demand and acting as stabilizers during the global downturn. Their contribution to global demand is reflected in the doubling of the GCC share in world imports during 2003–10, and most notably the sharp increase in this share during 2009–10 (Figure 6).
Figure 6.Imports of Goods and Services
Sources: Data provided by country authorities; and IMF staff estimates and projections.
Significant downside risks to the outlook
A major risk to the economic outlook is the possibility of a prolonged global recession. This would keep oil demand and prices low. If MEOE governments come to believe that oil prices will remain depressed for a prolonged period of time, they are likely to reduce their spending to maintain fiscal sustainability. A prolonged economic slowdown in the MEOEs would in turn translate into lower growth in neighboring trading partners (notably Egypt, Jordan, Lebanon, Pakistan, and Syria) because of less trade and regional tourism; lower demand for foreign labor and, consequently, lower remittances; and a decline in foreign direct investment (FDI) flows to other countries in the region.
Another key risk that would delay economic recovery is a sharp deterioration in the balance sheets of financial institutions. A key driver would include further asset price deflation, particularly in countries whose banks have large direct or indirect exposures to equity and real estate markets. This could result in a negative feedback loop between the real and financial sectors: limited access to credit and declining aggregate demand affect loan repayments, falling loan repayments weaken banks’ balance sheets, banks react by curtailing credit to the private sector, aggregate demand falls further, and the number of nonperforming loans increases.
Indeed, financial risks may be higher than observed so far. Capital adequacy ratios in most countries were high going into the crisis. And there have been improvements in supervisory and regulatory frameworks of many countries, but they could fall short in some countries, including where credit growth was very high. Available financial soundness indicators (FSIs) (Table 3) show healthy banking systems in GCC countries, but these indicators may not fully capture risks posed by high credit growth and concentration in real estate. FSIs are available with a lag, tend to be backward looking, and the averages mask the distribution across banks. In the non-GCC MEOEs, the relative weakness in the indicators predates the crisis and reflects structural factors, for example, the use of moral suasion to induce banks to lend to government-sponsored entities (e.g., Iran). As the availability of financing decreases, the likelihood of more directed lending increases, with potentially adverse effects on the health of the banking system.
Where there is fiscal space, use it
By keeping fiscal spending up where there is the fiscal space to do so, despite falling revenue, most MEOEs have been able to mitigate the effect of the crisis on their domestic economic activity. This has helped avert an exacerbation of the negative feedback loop between financial conditions and the real sector and has supported growth elsewhere in the region and globally. Fiscal policies will need to strike a balance between supporting domestic demand and adjusting to lower oil revenue (for an uncertain period of time). Most countries of the group envisage maintaining investment expenditure, although some have indicated they would reduce outlays if faced with further revenue shortfalls. Saudi Arabia has announced the largest fiscal stimulus package among the G-20 for 2009–10 and a $400 billion investment plan over five years. In general, countries with adequate fiscal space should continue to stimulate domestic demand. Expenditures should be limited to reversible measures and focused on high-quality investment. Capacity expansion decisions in the oil sector should continue to be based on the long-term outlook for global demand, in order to minimize large fluctuations in oil prices, serve the strategic interest of exporters, and contribute to global economic stability.
In countries with more limited fiscal space, expenditure prioritization will be necessary to maintain fiscal sustainability, especially if oil prices remain at their current level for a prolonged period. A few countries have taken measures to consolidate their fiscal positions, especially in view of the scarcity of external financing. Some countries—notably Iran, Sudan, and Yemen—were already in deficit in 2008 and are planning to significantly reduce expenditures to preserve fiscal sustainability. For example, the Iranian administration has proposed to parliament a significant increase in energy prices. In Yemen, the authorities issued a decree cutting many expenditure items and have reduced energy subsidies to industry. In Sudan, transfers to the provinces have declined, reflecting lower oil receipts, and the authorities are considering increasing excise taxes on luxury items and rationalizing value-added tax and tariff exemptions. Sudan is also facing binding financing constraints, having official foreign reserves coverage of about one month of imports.
SWFs have played a significant stabilizing role domestically and abroad.2 They have been called to play a more prominent role in their domestic economies as economic and financial conditions have deteriorated and home bias of foreign investors has increased, underscoring the need for SWFs to maintain an adequate degree of liquidity in their investment portfolios to facilitate short-term stabilization goals and long-term saving objectives. A more active role for SWFs (in their domestic economies) and the increased emphasis placed globally on strengthening regulations and oversight highlight issues of transparency, integration with national budgets, and sustainability of overall macroeconomic policies (Box 2).
Keep a close eye on the banking system
In light of financial sector risks, countries should strengthen financial supervision and risk management. Key steps would include the following:
Box 2.Middle Eastern Oil Exporters’ Sovereign Wealth Funds: Impact and Implications of the Global Crisis
The role of Sovereign Wealth Funds (SWFs) in supporting domestic macroeconomic and financial stability has increased with the global crisis. As a result, implications for their investment strategies, overall transparency, and consistency with domestic macroeconomic frameworks are receiving attention.
Deteriorating domestic financial conditions have warranted more prominent roles for SWFs in their home countries. For example, the Kuwait Investment Authority (KIA) and the Abu Dhabi Investment Authority have repatriated part of their foreign assets and deposited them in domestic banks to provide liquidity. SWFs’ resources in Kuwait and Oman were used to set up funds investing in local equity markets. In addition, the Qatar Investment Authority and the KIA bought domestic bank shares to help boost bank capitalization and confidence. At the same time, SWFs in the region continue to pursue profitable investment opportunities abroad in real estate, retail, and finance.
The crisis has shown that, notwithstanding their long-term focus, SWFs have a domestic stabilization role with implications for their investment objectives and strategies. In times of financial stress in the domestic economy, SWFs’ domestic investments may temporarily deviate from pure profit maximization to support broader macroeconomic and financial stabilization objectives. Going forward, SWFs need to ensure that they hold sufficient liquid assets to take on their stabilization role without realizing losses.
The scope for SWFs’ stabilizing role in international capital markets will remain substantial. The sharp downturn in asset prices since early 2008 has likely resulted in losses for MEOE SWFs. This is not surprising given the marked declines in major indices (the S&P 500 and World Equity Index lost, respectively, 39 percent and 42 percent in 2008). Despite their losses and greater domestic focus, SWFs’ relative size and influence in the global market will remain large. They are also likely to continue to maintain a longer-term investment strategy than most other investors.
International financial markets are likely to face increased regulation and demand greater transparency and accountability, which may affect SWFs’ cross-border operations. Increased regulation may alter the relative attractiveness of some asset classes or industries that SWFs invest in. More directly, SWFs could be affected by requirements that all financial institutions and investment vehicles improve transparency and disclose more financial information.
Furthermore, as SWFs have become more active in their domestic economies, it is important that their domestic operations also support, and be consistent with, the country’s macroeconomic framework. Well-designed policies and procedures for adding to or withdrawing from SWFs’ resources would ensure consistency with their policy objectives.1 Spending of SWF resources should be transparent and not undermine budgetary control. Moving SWF assets from abroad should take account of balance of payments and liquidity implications and be closely coordinated with monetary and exchange rate policies to prevent undermining the macroeconomic management of the domestic economy.Note: This box was prepared by Yinqiu Lu and Iva Petrova.1See International Working Group, 2008, Generally Accepted Principles and Practices: Santiago Principles, GAPP 4.
conducting comprehensive stress tests to identify potential sources of vulnerability;
assessing the size of possible recapitalization needs;
putting in place contingency plans to deal with systemic risk;
ensuring effective powers of intervention in banks deemed at risk; and
reviewing resolution mechanisms for financial institutions placed under administration.
In view of the financial links across countries, it is also important to coordinate policies, particularly among GCC members, and develop a clear and effective strategy to articulate publicly policy measures to bolster investor confidence and secure political support.
Global deleveraging and more limited access to foreign financing could provide the necessary impetus for the development of domestic debt markets. Some countries face an ongoing need to raise financing to cover budgetary deficits. Other countries do not require budgetary financing, but would benefit from building their financial markets, with a view to further enhancing financial intermediation, stability, and growth prospects. In this regard, the IMF and the Arab Monetary Fund have launched the Arab Market Development Initiative to improve the efficiency and functioning of debt markets in Arab countries. The project aims to identify supply-side policies for developing and enhancing a liquid bond market and strengthening the framework for effective management of associated debt.
Note: This chapter was prepared by Abdelhak Senhadji, Khaled Sakr, and Joshua Charap, with research support from Arthur Ribeiro da Silva.
For a discussion of real estate markets in the MCD region, and the risks associated with the rapid price increases observed through the spring of 2008, see the MCD Regional Economic Outlook, May 2008.
For a discussion on the role of SWFs, see the MCD Regional Economic Outlook, May 2008.