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Middle East braced for lower oil prices

When oil prices drop, the obvious question is: How will the Middle East fare?
The short answer is that differentiation is essential, because not all countries in the region feel the same revenue pinch. But the full answer is more complex. Oil importers, for example, are also affected.
Starting with the oil exporters – Kuwait, Qatar, Saudi Arabia and the UAE are fiscally robust. Within this group, some require a higher break-even price (oil revenues minus annual expenditures) than others.
For 2014, the Ashmore Group estimates that Qatar has the lowest break-even price at $58 per barrel (Brent crude), followed by Kuwait at $68 per barrel, UAE at $86 per barrel and Saudi Arabia at $92 per barrel. Still, Saudi Arabia will sustain a respectable surplus in 2014. Brent crude was trading at $88 per barrel last week.
The next consideration is fiscal buffers. The Gulf oil exporters sit comfortably on very strong balance sheets in the form of large Sovereign Wealth Fund (SWF) assets. Saudi Arabia’s foreign reserves cover an estimated 35 months worth of imports. The traditional “rule of thumb” for reserve coverage is the equivalent of 3 months of imports. All central banks and SWFs have accumulated substantial foreign reserves, mostly invested abroad, that would provide secure income for future generations.
In recent years, substantial domestic investments to raise physical and human capital capacity have been implemented. It is often forgotten that since the early 1980s and through the early 2000s, the level of domestic investment was low due to low oil revenues. Much of the capacity building has been compressed within a decade to “catch up”. To outside observers this may appear to be profligate and inter-generationally disruptive spending, but domestic investment across all the Gulf oil exporters has been a very important and deliberate strategy to diversify economies. The mandate of one of Abu Dhabi’s government agencies to help diversify its economy is a good example: The focus is to manage long-term, capital-intensive investments intended to deliver strong financial returns and tangible social benefits for the country.
Many are ready to ring the fiscal alarms unwittingly, but few take sufficient account of the role of policy makers and institutions. The region possesses both the knowledge and institutions to manage lower oil prices. Lower oil prices will be a boon for those policy makers who have over the recent past been calling for greater efficiency and prioritization in spending.
Now is the time for regional policy makers to “walk the talk” about fiscal discipline. The Ashmore Group expects sensible responses if the drop in oil prices becomes more protracted. Policy makers are likely to gradually slow down the pace of fiscal expansion while tapping into reserves. The most probable direction of travel – and the most prudent – would be to contain fiscal outlays. Reserves will only be used during the really rainy days of substantially lower oil revenues for the Gulf oil exporters.
It is worth remembering that the current oil price environment merely takes us back to two years ago, not to the dark ages of the early 2000s when oil prices were below $25 per barrel.
The bottom line is that even with oil averaging $80 per barrel, the robust Gulf oil exporters will do well. Instead of concentrating all capital expenditure in a few years, most Gulf economies will spread spending over longer periods which allows for efficiency and productivity gains.
Fiscal spending for various social programs was scaled up in response to the 2011 Arab Spring. “We don’t expect any social spending (e.g. unemployment benefits, nationalization of the work force, social housing, SME financing) in response to the 2011 Arab Spring to be curtailed in Saudi Arabia or in any of the Gulf countries.”
In Saudi Arabia’s case, the money for social spending has already been allocated from a budgetary perspective.
Away from the Gulf, the Middle East oil exporters who are most exposed in an environment of declining oil prices are Algeria, Iran, Iraq and Libya. None of these countries possess deep fiscal buffers to make necessary corrective moves in due course. With the exception of Algeria, none possess sizable foreign assets to tap into. In Algeria, the fiscal balance as a percentage of GDP has been negative since 2009. This is also the case for Iran since 2011. Libya’s fiscal deficit is estimated to be the largest in the Middle East this year, and Iraq is expected to have a deficit in 2014, the second in a row. Break-even prices range from $140 per barrel in Iran to $108 per barrel in Libya. Not all of them are equally vulnerable at the end of the day. Political instability and lack of institutional depth in Iraq and Libya could put a dent on fiscal resilience and create wider centripetal pressures. The role of the state in both Libya and Iraq is at best tenuous. Historically, Algeria and Iran have demonstrated greater resilience during previous times of crisis.
The Middle East also has a substantial number of oil importers. For those economies, lower oil prices are fiscally positive in some ways and will improve current account balances too. But the picture is not entirely unambiguous. Most oil importers have benefited from the “windfall” in the Gulf oil exporters by receiving bilateral aid and grants (particularly in Bahrain, Egypt, Jordan, Lebanon, West Bank and Gaza, Sudan, Morocco and Yemen). There have also been substantial private investments and remittances into the oil importing states from the Gulf.
The group estimates that some $34 billion was remitted in 2013 from Saudi Arabia, while in percentage terms Qatar’s remittances abroad as a share of GDP were among the highest in the world. Since 2011 more tha n $25 billion was disbursed in financial assistance to nonoil exporting Middle Eastern countries from Saudi Arabia, the UAE and Qatar. Hence the dependence of the nonoil exporters on the oil exporters in the Middle East is vast.
It is important to recognize these linkages: Some oil importers struggle with weak confidence, which hampers growth and job creation. Thus, growth in the Middle East oil importers was only running at a rate of 3 percent in 2013, which is substantially below their trend growth rate of 5 percent. To the extent that commodities prices soften more broadly, this will also adversely impact countries such as Jordan (via lower potash and phosphates mining revenues) and Morocco (phosphates).

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