Middle East: Middel East Economy Profile

Middel East Economy Profile

The Middle East shows tentative signs of recovery in 2010. Developments in the external environment for the region have been generally favorable over the second half of 2009 and into the first months of 2010, as the financial crisis and global recession have given way to hopes of stronger recovery, led by the developing countries. But changes in international financial markets and economic growth developments have also shifted to favor- or have placed at some disadvantage- the region’s diverse set of countries grouped into high-income and developing oil exporting countries, and the more diversified economies. From 2008 through 2010, regional government policies shaped the outlines of domestic absorption growth—depending on the availability of fiscal space and inflation headroom—and the manner in which these measures will be modified or withdrawn over the course of 2010 through 2012 will play a key part in the outlook.

Just as during the decline of regional growth into the global recession of 2009 differed substantially by country, so recovery from the crisis will differ. This will depend on the set of initial conditions, and the intensity of effects flowing though the transmission channels—the price of oil and the balance of payments, reflecting impacts on trade, remittances and FDI flows. But serious headwinds for both oil- and diversified exporters have cropped up in the early months of 2010.
Hydrocarbon revenues increase. As the intensity of global recession began to ease in latter 2009, upward pressure on oil prices emerged, emanating from market expectations of eventual return of strong fuels demand among developing countries, and substantial cutbacks in OPEC crude oil production to restrict growth of global supply and set a floor under prices. Together these developments yielded a gradual increase in oil and gas revenues for the high-income as well as low- and middle-income oil exporters of the region, beginning in late 2009 and continuing into the first months of 2010. The aggregate increase amounted to 25%, carrying total revenues to an annualized rate of $605 billion as of January 2010. This contrasts favorably with total 2009 earnings of $530 billion, offering some scope for optimism looking forward.

Crude oil production cutbacks over 2009 and into 2010, initiated in an effort to reduce massive global stocks, were substantial and economically damaging for the high-income oil exporters, pushing oil-sector GDP well into decline. Generous expenditure of reserves was used as offsets to support the non-oil economy from fallout. Crude oil output declines for the group ranged from 8 to 9 percent from year-earlier levels by mid-2009, registering a 7.8 percent cut for the year. From mid-2009, production declines eased, and crude oil output recouped to stand 2 percent below January 2009 levels by January 2010. Having achieved this modicum of production management (given traditional OPEC quota non-compliance), and with stronger GDP gains in developing countries, oil prices continued to move well above $70/bbl in early 2010 from $50/bbl as of spring 2009.

Indeed, after five consecutive quarters of decline, world oil demand moved into positive territory during the final quarter of 2009, led by strong demand in China—up 1 .3mb/d or 17% (year-on-year). But global crude oil supplies are ample. OPEC’s spare capacity has increased to 6.5mb/d following the recent cutbacks, roughly the level as of 2002 when oil prices registered $25/bbl.
For the diversified economies, there are signs of incipient revival in goods exports, being echoed to a lesser degree in a return of industrial production to stronger growth. Inflation has eased to more moderate rates in these economies, helping to support monetary measures designed to shelter financial systems from distress in the context of crisis. And despite the global downturn, reductions in key remittance-, tourism and FDI flows to the developing region may be considered moderate with respect to how far such flows could have fallen, given the deterioration in economic conditions in source countries. But for oil-and diversified exporters alike, economic headwinds have cropped up during the late spring months of 2010.

Headwinds near. Events in Europe over April to June 2010, grounded in the sovereign debt difficulties of Greece, Spain and Portugal, and the consequent EU/IMF Stabilization Package for the Euro Area, have dampened several of the emerging trends of importance for the Middle East and North Africa. Oil prices plummeted from $85/bbl in the first week of May 2010 to $70/bbl during the third week of the month, on concerns of potentially reduced global oil demand. And the economic outlook for Europe has also dimmed, as austerity measures are in place among the highly-indebted countries of the Southern Euro Zone, as well as in Germany, France, Italy, the United Kingdom and others. These adjustments will work to slow near-term economic activity. Business and consumer sentiment have fallen quickly, while the euro has depreciated sharply against the dollar, with negative implications for European demand and exports from the Middle East and North Africa’s in 2010 and 2011. At this writing, the potential for financial contagion remains high within Europe, and between Europe and its neighboring developing regions, notably Europe and Central Asia, the Middle East and North Africa and Sub-Saharan Africa.
The euro’s decline is a mixed development for the Middle East and North Africa. For oil exporters, where receipts are denominated in dollars, but where the bulk of procurement of capital and consumer goods is transacted with Europe in euros, exporters enjoy a boost to the purchasing power of exports. For the diversified group, the euro’s decline carries less dramatic effects, as both foreign receipts and outlays tend to be euro-based.

Middle East suffered less disruption than most developing regions in the crisis. As background to recent developments, it should be noted that—contrasted with other developing regions which may carry tighter integration with global financial markets; and for those with trade linkages that may be more extensive—the adverse effects of the global crisis and recession on the Middle East have been moderate. A loss of 1 point of growth during 2009 (from GDP gains of 4.2 percent for the developing region in 2008 to 3.2% in 2009), contrasts favorably with the 9.5 point decline in growth for Europe and Central Asia; a 6.4 point falloff for Latin America and the Caribbean, and 4 point drop for developing countries in aggregate.

Within the broader region, the high-income Gulf Cooperation Council economies were hardest hit by crisis, due to the huge terms of trade shock associated with the plunge in oil prices, and a financial shock which destabilized overextended domestic banks, in part leading to a bursting of real estate bubbles. The debt problems of Dubai, United Arab Emirates, first brought the possibility of—sovereign default‘in the region onto the global radar screen. Equity markets across the oil exporters plunged at the outset of crisis, and recovery has been exceptionally sluggish, underscoring continuing market uncertainties regarding the financial underpinnings of these economies.
A decline in the group‘s GDP growth in 2009 to 0.2% from 5.3% in the preceding year, tied to loss of oil revenues and scale-back in oil production, carried confidence across the broader region lower, and set the tenor for weaker growth. The high-income oil exporter‘s current account surplus plummeted to 10% of GDP from 30 percent in 2008, while the fiscal surplus narrowed by 20 % points.

Remittances, and especially flows of foreign direct investment (FDI) from the group to the developing region—which had become an import source of financing and for investment—slowed, removing an important factor for growth in the developing region.

Growth of per capita income for the developing region declined by almost a percentage point in 2009, increasing just 1.5 percent, following two consecutive years of stronger gains. Household spending grew at a slower pace in 2009 and is likely to remain subdued through 2010 (in historic comparison), suppressed by potential job losses, reduced government support, lower confidence levels and a decline in worker remittances. Trade performance has reflected the decline in hydrocarbons and goods exports, with some recovery expected in 2010.
Against this background, the current account surplus for the developing countries of the region shifted to deficit of 1.4% of GDP in 2009, a sharp correction from peaks nearer 10 percent in 2007. But the regional surplus is anticipated to improve moderately in 2010 to 0.4% of GDP on higher oil revenues. Public consumption in support of domestic demand picked-up to nearly 11 percent growth in 2009, in turn, pushing the fiscal balance from surplus of 1.6 percent of GDP in 2008 to deficit of 5%. And fiscal shortfalls are anticipated to continue through 2012.

Low- and middle-income oil exporters’ revenues halved. Iran, Syria and Yemen collectively suffered a halving of hydrocarbon revenues in 2009, as exports declined 40 percent from $212 billion in 2008 to $125 billion in 2009. On this massive drop in revenue, the current account surplus of the group fell from 18%to 3 % of GDP. For countries highly reliant on oil revenues to finance longer term infrastructure and housing projects, subsidize current consumer outlays (Iran), or build and maintain the capacity for exporting larger quantities of LNG (Yemen), the virtual collapse of incomes carried a toll on economic growth. But much stronger activity in non-oil sectors (Algeria) helped to soften the overall impact of the downturn. Though public spending in these countries is typically pro-cyclical, in the current crisis, both Algeria and Iran used monetary easing and fiscal stimulus to encourage economic growth. As is the case for the high-income exporters, oil revenues for the group have been on the rise of late, as oil prices firmed to near $80/bbl in early 2010 and hydrocarbons production in Algeria breached to positive growth as of February 2010.

Economic developments in Iraq have been fast moving in the last months. The country’s fiscal position deteriorated substantially in 2009 to 22 percent of GDP, a result of the sharp falloff in oil prices affecting revenues, from modest surplus positions during 2007–08. At the same time, GDP growth fell from a 9.5% jump in 2008 to 4.6% for 2009 tied once more to the oil price slump. A new two-year Stand-By Arrangement with the IMF, as well as a Fiscal Sustainability Development Policy Loan from the World Bank were approved in February 2010.
The diversified economies were hit hard by the recession in Europe. The more diversified economies of the region, including Egypt, Jordan, Lebanon, Morocco and Tunisia, were directly affected by the recession in key export markets in the European Union, and to a lesser degree, the United States, carrying exports to sizeable decline over the course of 2009. Signs of some recovery are now apparent in the early months of 2010. Industrial production has largely followed the decline in exports. Though these (largely) oil-importing economies enjoyed reprieve on import bills, with a substantial improvement in terms of trade, they are also suffering severe indirect consequences of the financial crisis and recession. These include reduced remittance inflows from Europe and the high-income oil exporters, a cutback in FDI flows from the latter group, and tourist arrivals diminished by the crisis.
Fiscal policy for the diversified economies is expected to continue to be expansionary, as countries use various measures to stimulate demand. But these will carry adverse consequences for fiscal balances—for some economies, including Lebanon, Jordan and Egypt, for which fiscal space is limited—and the fiscal position could become a longer-term growth constraint.

Among the more prominent exporters of the group, Egypt‘s merchandise exports peaked at more-than 100 percent growth (y/y) during summer 2008 (the effects of oil exports coming on stream), before slipping to decline of 30 percent a year hence. In broader fashion, the sharp falloff of import demand in Europe yielded a growth path for the aggregate of diversified exporters—which peaked near 70% in summer 2008—fell to nil by year-end before recovery set in. Production in the diversified economies was directly affected by the downturn in exports, as well as by softening domestic demand, in turn adversely affected by several important indirect channels of the crisis.

Industrial production for the group moved from gains of 10% in early 2008 (y/y) to trough at nil in spring 2009, though with much diversity across countries.
There are early signs of recovery, which have carried the group‘s merchandise exports to growth of 18 % by January 2010 (y/y), with advances for Egypt bettering these figures at 45% and 23 % respectively during February. Production has not yet responded to the new impetus, as business may be using existing inventories to meet demand, a sign of caution under current global circumstances.

For the developing MENA region, worker remittance inflows reached an all time high in 2008 at $33.8 billion representing 4 percent of regional GDP. Egypt was the largest recipient of remittances at $8.4 billion, with the importance of such flows highest for Lebanon at close to 20% of GDP. Given deterioration of employment conditions in the European Union, and notably among the high-income oil exporters, remittance flows declined 6% in 2009 to $31.8 billion, or to 3.8% of regional GDP. And estimates for 2010 look less than promising due to continuing uncertainties in the European economy. The knock-on effects of such decline are especially important for consumer spending and private investment in the diversified economies of the Middle East.

Tourism revenues also established all-time highs in the region during 2008 at $35.1 billion, or 4.2% of GDP. Highest in Egypt, at near $11 billion during 2008, and of greater importance for Jordan at 14.4% of GDP, tourism represents an important source of job growth, with many “multiplier” effects in local communities. Analysis from the United Nation’s World Tourism Organization and the World Travel and Tourism Council, indicate that tourism was exceptionally hard hit by the global slump after a strong showing in 2008. During the former year, global tourist arrivals grew 2 percent, but were sharply affected during the second half of the year by the financial crisis, declining 1.5 percent over the like period of 2007. The Middle East however, saw strongest gains in international arrivals, moving up to 55 million persons in 2008 or 18 percent growth.
Travel conditions in 2009 and early 2010 deteriorated sharply, and the World Tourism Organization estimates that global arrivals declined by a heady 4% in the year. Tourism revenue estimates for the Middle East in 2009 suggest a downturn of about $3 billion, a decline of 8.5 percent, especially affecting Egypt, Jordan. The falloff in tourist income from Europe and the OECD has been offset to a degree by increased arrivals from within the region, a trend in development over the last years. Still, receipts are likely to decline further in 2010 against a less -than hospitable global environment for growth, notably in Europe.

Given the adverse developments in economies that serve as the main source for FDI flows to the developing region, such flows are estimated to have declined sharply in 2009, by 32 percent to $19.2 billion in the year. Recent developments in Europe and the high-income oil exports suggest that FDI may continue its decline through 2010. The implications of the decline in FDI are important for the region, as the dynamism of private investment growth of the last years, largely spurred by FDI, is waning in 2009 and 2010. Moreover, as fiscal positions deteriorate into 2010, FDI as an external financing source will be more keenly missed.

Capital flows to the developing economies of the Middle East, outside of foreign direct investment, are quite small both in dollar terms and as a proportion of GDP. Developments during 2009 reflect the downturn in FDI noted, with a $3.2 billion pickup in net debt flows, comprised of $2.7 billion from official sources and $0.5 billion from private creditors. Short term flows shifted to net inflow of $4.4 billion in the year from outflow of $3.5 billion in 2008.