Middle East Economic Review 2011: Concerns over instability in the Middle East return

After the global economic crisis, the fiscal forecast for the Middle East was upbeat. Then political unrest swept the region. Growth for most countries now looks to be an even longer uphill struggle. Published in MEED, 9 June 2011

After several years in the doldrums, 2010 was a promising year for the economies of the Middle East and North Africa. Almost every country in the region saw growth accelerate and trade levels improve, while budget deficits became increasingly rare.

Qatar was the standout performer, with a rise of more than 16 per cent in its gross domestic product (GDP), but every country’s economy expanded to some extent, even if it was by just 0.8 per cent, as in the case of Iraq.

Then came the political unrest. The turmoil that began in Tunisia in December 2010 and then spread throughout the region, has created both winners and losers. In place of the usual easy division of the region’s economies into oil importing and exporting ones, these days the most significant factor is whether or not a country has witnessed crowds of protestors on the streets and a violent response by the police and army.

Sharp slowdown in some Middle East economies

Early estimates predict a sharp slowdown in the economies of Tunisia, Egypt and Bahrain. Making any sort of credible forecast for the fate of Libya’s economy has become all but impossible.

“There has been an impact [from the political unrest], but the degree of impact varies considerably,” says Simon Williams, chief economist at HSBC Middle East. “In those economies that have been directly impacted by severe unrest – Bahrain, Egypt, Libya, Yemen, Tunisia – growth has slowed very sharply indeed. In Egypt, I had been looking for growth in the first half of this year, but I’m now expecting negative growth. In Bahrain, similarly, I had been looking for decent growth, but I’m now expecting flat growth or even a contraction.”

The political turmoil has led the Washington-based IMF to cut back its growth forecasts. Until the protests began, it had expected the region’s economy to grow faster in 2011 than in 2010, led by the oil producing states of the GCC, Iraq, Libya and Sudan. However, in April, it issued revised estimates for 2011, trimming the GDP figures for 13 of the 19 countries in the region and omitting Libya entirely.

In the case of Egypt, for example, it slashed its previous estimate of 5.5 per cent GDP growth to just 1 per cent. It was a similar story for Tunisia, Syria and many others.

However, that still leaves five countries, which have bucked the trend, with higher GDP growth predictions than previously expected. Mauritania, which is benefiting from strong phosphate and iron ore prices on world markets, is one, with its growth rate creeping up from the previously anticipated 5.1 per cent to 5.2 per cent. The others – Kuwait, Qatar, Saudi Arabia and the UAE – are all benefiting from the fact that the unrest has helped to keep oil prices high.

In addition, Qatar and the UAE, which have remained immune to the disturbances so far, are benefiting from being seen as a safe haven for tourists and businessmen.

“There will be three main winners: Dubai, Abu Dhabi and Qatar,” says Marios Maratheftis, regional head of research at the UK’s Standard Chartered Bank. “They are politically and socially stable. Dubai has been able to benefit from the flight to quality. Abu Dhabi and Qatar have been able to export more oil at high prices.”

But whether they have witnessed protests or avoided them, all governments around the region are having to reconsider their economic strategies. The unrest has highlighted the fact the health of an economy cannot be judged solely on the basis of macroeconomic indicators, such as GDP growth. Instead, more attention will need to be paid to issues such as unemployment, housing and income inequality.

Distributional effect

Dominique Strauss-Kahn, former managing director of the IMF, acknowledged the problem when speaking on 6 April, in advance of the Spring meeting of the IMF and World Bank in Washington.

“You may have rather good results at the aggregate level, [but] still have a large problem of inequality in the country,” he said. “This leads to political unrest, which in turn leads to macroeconomic problems. If really we want to look at the region in terms of growth, then we have to take into account the fact that what could be destabilising for growth is not only the situation of the banks, inflation, the asset bubble, the fiscal deficit, the current account deficit, but also things that have to do with the distributional effect. And that’s clearly seen these days in Tunisia and Egypt and in other countries.”

Inclusive state policies

The IMF now plans to take greater account of measures, such as unemployment and income inequality, when assessing the health of a country’s economy in the future. Governments around the region will have to do something similar, with more inclusive economic policies to lift people out of poverty and into jobs.

The IMF estimates that if the job market is to absorb all those that are currently unemployed, as well as new labour market entrants over the next decade, annual growth will need to reach 6.5 per cent – well above current levels. Only three countries are expected to surpass that benchmark this year: Qatar; Iraq; and Saudi Arabia. The region as a whole will grow by just 4.1 per cent, well below the rate needed.

“There’s a recognition that structurally growth has been too slow and things have to change if these Middle East economies are going to deliver the kind of growth rates necessary to keep unemployment low and to turn the wealth offered by high oil prices into genuine prosperity,” says Williams.

“Some of the work that has been done has been correct in terms of infrastructure build-out, but there’s a whole set of issues around the business environment, capital markets and fiscal and monetary policy that have to be addressed if the region is going to go from one with a trend growth rate of 4-5 per cent to one that can generate growth of 7-7.5 per cent and they are issues that take some time to work through.”

Many, particularly the economies of North Africa, have not been helped by the relatively weak economic performance of their key trading partners in Europe in recent years. The Gulf countries, by contrast, direct far more of their efforts to the economically vibrant regions of south and southeast Asia and in particular India and China, which in turn helps their economies grow more quickly.

Inflation also continues to be a problem. It is expected to average 10.2 per cent across the region this year – up from 7 per cent in 2010 – with Iran, Yemen and Egypt the worst affected. This will put further pressure on household and national budgets alike. Governments know that, unless they take action to counter the high costs of food and fuel, they could have even more protests to deal with.

Financial assistance for many Middle East countries

In the short term, governments have been using a combination of cash handouts and price subsidies to placate their poorer citizens, as well as creating more public-sector jobs.

However, such measures will lead to higher budget deficits for many countries, further weakening their fiscal position. Some are likely to need greater financial assistance from allies or international organisations to get through this period. For a more enduring solution, they will need to face the long-running issue of diversifying their economies.

“The unrest highlights the need for diversification,” says Maratheftis. “A lot of the responses, such as higher salaries in the public sector and creating more public-sector jobs might be good in the short term, but in the long term, these countries need to create jobs in the private sector to have a sustainable economic model.”

Old concerns about private investment

In the current environment, however, many countries will find it hard to persuade private sector companies to invest heavily in creating new jobs. Foreign direct investment levels are expected to be down significantly in Egypt this year and there will be fewer tourists to provide employment in the services sector.

It is still too early to say what long-term damage may have been done to the reputation of individual countries and their economies, but overall investment levels are unlikely to pick up until stability returns.

“The unrest has brought a lot of the old concerns investors had about the region back to the fore,” says Williams.

“It’s likely some investors will stand back and wait for the dust to settle. They’ll need to be persuaded that the environment they’re looking at is stable, robust and unlikely to be subject to marked change. Once those concerns have begun to pass, I expect to see investment pick up again, but it’s going to take a while. The shock of the events of the first half of the year is bound to reduce the appetite investors have.”

While the region waits for the investors to return and their economies to recover, the reality is the disparity between oil-producing and oil-importing countries will widen as a result of recent events. The countries directly affected by political unrest might come from both groups, but only one group has the ability to cope easily with the economic consequences.

Fiscal cushion

“Oil producers will if anything be growing stronger than we expected six months ago and oil importers will find things harder, so disparities around the region will increase,” says Richard Fox, head of Middle East sovereign ratings at the US’ Fitch Ratings.

“For oil exporters, not only have they large earnings, they also have large savings. The only thing that could blow them off course is a large and sustained fall in the price of oil.”

As long as unrest continues, oil prices are likely to remain relatively high, providing the fiscal cushion these countries have become used to. For other economies, which rely on importing oil, the outlook is far less bright.