21 January 2016

Gulf Arab states will require more than USD 250 billion over the next two years to plug budget deficits.

Gulf Arab economies will continue to face pressure from weak oil prices and rising geo-political tension in 2016 with crude oil prices near 12-year lows and a further deterioration in relations between regional rivals Saudi Arabia and Iran.

Economic growth in the Gulf Cooperation Council (GCC) region is expected to slow to 3.25 percent in 2015 and further to 2.75 percent in 2016, compared with 3.5 percent in 2014, according to the International Monetary Fund (IMF). It said fiscal deficits are expected to be 13 percent of gross domestic product in GCC countries in 2015.

Gulf Arab states are expected to require more than USD 250 billion over the next two years, according to Moody's, and are likely to tap bond markets to raise the money and could also sell some state assets.

Saudi Arabia, the largest Arab economy, announced an austere state budget for 2016 and said it plans to privatise some government-owned assets. The 2016 budget projects spending of SAR 840 billion (USD 224 billion), down from SAR 975 billion actually spent in 2015, and forecasts revenues at SAR 514 billion riyals, down from SAR 608 billion riyals. The projected deficit is SAR 326.2 billion, around 13.5% of GDP.

"This is by far the largest fiscal deficit that the Saudi authorities have budgeted for, and suggests an oil price assumption in the low USD 40 p/b (per barrel). This would be a second successive double-digit budget deficit, after the Ministry of Finance said that the 2015 deficit was expected to reach SR367bn, or 15% of GDP - the largest ever Saudi deficit, albeit below our forecast of 16.8%," ratings agency Fitch said last week.

Qatar announced a 2016 budget which projects a deficit of QAR 46.5 billion (USD 12.7 billion), its first in 15 years. The United Arab Emirates has approved a balanced budget for 2016 with cuts to federal spending after at least seven straight years of rises, according to Reuters.

Analysts at Barclays, Macquarie, Bank of America Merril Lynch, Standard Chartered and Societe Generale cut their 2016 oil forecasts earlier this month, with Standard Chartered saying oil could fall as low as USD 10 a barrel, according to Reuters.

Oil prices remain below USD 30 a barrel, partly on concern about a global supply glut as Iran prepares to ramp up exports after the lifting of nuclear sanctions. The United States and other powers have revoked international sanctions after Tehran's compliance with terms of a nuclear deal reached last year.

Barjas Albarjas, a former advisor for strategic planning at Saudi state oil giant Saudi Aramco, said oil prices are expected to stabilize at a slightly higher level but that a major recovery was not expected.

"This [sharp rise in prices] will not happen unless one of the oil exporting countries faces political problems that would force it to reduce its agreed-upon production share for 2016. Without such a scenario, oil prices would remain stable and would rise slightly," he told Zawya.

Several Gulf states have embarked on fiscal reforms to curb spending and diversify sources of revenue, including taxation and subsidy reforms, mainly on energy subsidies. GCC states are preparing draft laws on value-added taxes (VAT) that could be imposed from 2018 and officials have told Reuters that the tax can be introduced as soon as two GCC members are ready to implement it.

MARKET SENTIMENT

Saudi-based NCB Capital said that while austerity measures taken by the Saudi government would improve efficiencies in the public and private sector, they could have a negative impact on the profitability of listed companies on the Saudi market, the region's largest.

"We expect the profitability of listed companies to decline 8-10% on higher direct costs, specifically at the petrochemical sector. Moreover, lower disposable income and increased average prices will limit overall consumption," it said in a December report.

Gulf stock markets have largely been tracking oil prices and global equity markets. Saudi Arabia's main stock market index lost 20.57 percent in 2015 compared with the previous year, while Dubai shed 19.7 percent and Qatar fell 17.8 percent, according to Zawya calculations.

Market sentiment has also been impacted by regional conflicts in Yemen, Iraq and Syria and rising tension in the region following the diplomatic row that erupted between Riyadh and Tehran after Saudi Arabia executed a prominent Shi'ite cleric in January. Riyadh severed ties with Tehran after protesters set fire to the Saudi embassy in the Iranian capital, and other Gulf allies withdrew their ambassadors.

"The political situation in the Gulf region in addition to the drop in oil prices, [combined with] the increase in interest rates will have a negative effect on the volume of foreign direct investments in the region, as well as the government's tendency to borrow to cover their budget deficits," banking expert Ahmed Adam, former research director at National Bank for Development, told Zawya.

But a Reuters' survey of Middle East fund managers in December showed a more positive stance on regional equities, with many favoring the UAE, due to the global markets' positive reaction to the Fed rate hikes and improved regional valuations.

When the U.S. Federal Reserve hiked interest rates by 25 basis points in December, most Gulf states, whose currencies are pegged to the U.S. dollar, followed suit. The prospects of further rate hikes in 2016 could raise the cost of borrowing for corporations at a time of tight liquidity in the banking sector.

"Not raising interest rates would have pushed investors to sell their assets in the Gulf region and employ their revenues in high return dollar-evaluated investments, which would put strains on Gulf currencies," Mohammad Barakat, chairman of the Union of Arab Banks, told Zawya.

He said that while the hike in interest rates would have a limited effect on Arab banks, they could affect stock and bond markets in 2016.

FISCAL BUFFERS

Several Gulf governments are looking to top international bond markets instead of drawing down reserves or borrowing domestically. Gulf oil exporting countries have built healthy fiscal buffers over the past years that provide a strong cushion in the short-term and enable governments to maintain investment to drive economic growth.

"In the GCC, adjustment over the medium term is expected to come mainly from a reduction in investment and an unwinding of one-off spending items," the IMF said in an economic outlook report issued in October. "Apart from Kuwait, Qatar and the United Arab Emirates, countries would run out of buffers in less than five years because of large fiscal deficits."

Saudi Arabia withdrew USD 100 billion of its foreign reserves in 2015 and issued government bonds worth SAR 95 billion for the first time since 2007 to cover the budget deficit. The kingdom's finance minister said in remarks published by local media that Saudi Arabia plans to issue international bonds in 2016 to help maintain solvency of the banking system.

In January, Saudi Arabia said it would sell a stake in state giant Saudi Aramco's downstream operations. The kingdom also plans to set up a new sovereign fund to manage part of its oil wealth and diversify its investments, sources familiar with the matter told Reuters.

Qatar -- whose foreign reserves stand at QAR 138.671 billion (USD 38.1 billion) according to latest Central Bank data -- has asked banks to provide a USD 5.5 billion loan to help reduce its domestic borrowing as the government continues to invest in infrastructure in preparation for hosting the FIFA World Cup in 2020.

Kuwait has ample assets to cover medium-term spending needs, with total assets managed by sovereign wealth fund Kuwait Investment Authority to reach USD 472 billion, or 377 percent of gross domestic product, in the 2015/2016 fiscal year, according to a report issued by Fitch Ratings in December.

Amany Shaheen and Mohammad El Agamy contributed to this report .

Zawya 2016