Non-oil growth gains momentum

More countries in the region are making headway on economic diversification, especially in the Gulf. Published in MEED, 22 April 2014

Economic diversification has been a policy ambition with which most oil-exporting countries in the Middle East and North Africa region have long struggled. The benefit of having mixed economies that are less susceptible to the vagaries of oil prices on international markets is clear enough, but it has proven to be a difficult policy goal to achieve.

This has been particularly true in recent years, when oil prices have been at historically high levels. Even if the broader economy is growing at a healthy pace, hydrocarbons revenues easily overwhelm everything else when they are pouring into the public coffers.

Even so, some countries have managed to create a better balance than others. Over the past four years, statistics from the Washington-based IMF suggest Algeria, Iran and Oman have all managed to secure higher rates of growth in their non-oil GDP than in their oil GDP.

In the case of Iran, much of this can be attributed to the successive layers of international sanctions that have severely curtailed its ability to sell hydrocarbons abroad and to attract investment to develop its energy industry. But for Algeria and Oman, it may simply be that the authorities have been better at encouraging more activity in a wider range of industries.

Faster economic growth

All the other energy-rich countries in the region have stumbled from time to time, but the projections from the IMF for 2013 and 2014 suggest more states are enjoying faster non-oil GDP growth these days, particularly in the Gulf. Bahrain, Kuwait, Qatar, Saudi Arabia and the UAE are all expected to see non-oil GDP growth outpace the rate of hydrocarbons across the two years.

Among the GCC countries, Saudi Arabia has had the best track record in non-oil expansion in recent times. The kingdom saw non-oil activity rise from 61 per cent of GDP in 1990 to 80 per cent in 2012, according to a research paper published in July 2013 by Pascal Devaux, Middle East economist at France’s BNP Paribas. From 2007 to 2012, non-oil growth was averaging an impressive 8 per cent a year.

In contrast, Qatar has had the worst record among the six GCC countries and its non-oil activity has shrunk from 60 per cent of GDP in 1990 to 56 per cent by 2012. However, the IMF’s projections for last year and this year suggest that trend could now be reversed, no doubt helped by the investment being poured into preparations for the 2022 Fifa World Cup and the end of its liquefied natural gas investment programme.

It is worth noting that delineating the border between oil and non-oil activity is more of an art than a science. The petrochemicals sector is often classed as non-oil, although it could just as easily be seen as a downstream part of the hydrocarbons industry. Many other activities continue to be indirectly dependent on the oil and gas sector. To take just two examples, the World Cup stadiums in Qatar could not be built without the huge wealth that comes from the country’s gas exports, and the GCC aluminium industry has only been able to grow to its current size because of the cheap energy available.

Despite this, industries such as construction and aluminium will continue to play an important role in the diversification of these countries’ economies. But the most important area of non-oil activity in the GCC over recent decades has been the services sector. According to Devaux, between 1991 and 2009, the services industry grew by an average of 2.8 per cent a year, compared with less than 1 per cent for the manufacturing and construction sectors.

Unemployment factor

The services sector is particularly important because it could help to solve one of the major challenges facing the oil-rich countries in the region: unemployment. The oil industry is capital-intensive but not labour-intensive, so it cannot provide a solution, and manufacturing industries often have a similar profile. The IMF estimates that 1.6 million locals will join the labour force in the GCC between now and 2018, so developing industries that create lots of jobs is vital.

Alongside building up new industries, governments also need to find ways to boost the private sector’s role. In many of the Gulf countries, the public sector plays a large and sometimes dominant role in the non-oil economy. There are some exceptions, such as the financial services sector in Bahrain and the UAE, and the logistics and tourism sectors in the UAE and, to a lesser extent, Oman. But for the economies to thrive in the long term, these examples will have to become the norm.

The situation in Saudi Arabia offers some reason for optimism there. According to the local Jadwa Investment, non-hydrocarbons private sector growth outpaced both the oil and the government sectors in 2012 and 2013, and is projected to do so again this year. The firm estimates that non-oil private sector GDP will increase by 5.2 per cent in 2014, compared with 4 per cent for the government sector and a contraction of 1.4 per cent for the oil industry.

Saudi deceleration

These growth levels are promising, but they are far below where they were just a few years earlier. In four of the five years from 2006 to 2010, non-oil activity was growing by more than 10 per cent a year in Saudi Arabia.

The signs of a deceleration are reinforced by recent data from the Saudi purchasing manager index (PMI) compiled by the UK’s Markit, which offers an insight into the level of activity in the non-oil private sector. In March, it fell to 57 points from 58.6 points in February, its lowest level since October last year. The current figure is still well above the 50-point mark, which separates expansion from contraction, but provides a contrast to 2010 and the first half of 2011, when the index was well above 60 points.

Meanwhile, the UAE’s PMI figure is rising; from 57.3 points in February, it reached 57.7 points in March and is now at its second-highest level since its first calculation in August 2009, according to Markit.

In any case, both countries are well above the HSBC Emerging Markets Index, which incorporates PMI data from 17 countries around the world. In March this year, it stood at 50.3 points, indicating a tiny amount of growth and marking a drop from the prior month’s figure of 51.1 points.

There is a danger in some countries that the rush to expand non-oil activity too quickly could result in unwelcome problems. That is probably most apparent in Qatar, which is pressing ahead with massive infrastructure projects to prepare for the World Cup. Jake Jolly, Middle East economist at US research firm IHS, says Doha’s expansionary fiscal policy should continue to support healthy growth across the economy, but it could be forced to prioritise.

“We expect that these large spending initiatives run a moderate risk of resulting in high inflation and economic overheating in the medium term,” he says. “We also expect the authorities will, as in the past, actively manage the economy’s liquidity situation, dampen acute price pressures when needed and generally take a pragmatic approach to developing the country’s infrastructure.”

Oil importers

GDP growth in the region’s oil-importing states has generally trailed behind that of the oil exporters in recent years. The importers enjoyed average growth of 5.7 per cent a year from 2006 to 2010, compared with 5.1 per cent for oil exporters, but the going has been tougher since then.

The strongest performance has come from Mauritania, helped by a strong mining sector and public spending. However, the country also has the smallest economy in the region and the lowest GDP per capita. Larger economies such as Egypt continue to struggle, even with the huge financial flows from sympathetic Gulf governments. The most recent PMI data suggests things are getting worse for Egypt’s non-oil sector: in March, its index fell to 49.8 points, indicating a small contraction in activity.

The situation is even worse in Lebanon, where the PMI figure for March stood at just 46.2 points. Beirut has been making efforts to develop its oil industry, but political inertia is hampering progress with such projects.

While the region’s oil exporters would welcome more non-oil growth to help their economies become more diverse, for other countries the prospect of a vibrant hydrocarbons sector is one they would gladly welcome.