Middle East and Central Asia
The world economy’s centre of gravity is shifting from the US towards China. The leading developed nations will grow by 3.6 per cent, predicts the IMF, but emerging and developing economies will grow by 6.6 per cent on average. The Middle East is caught between the two extremes, but its fortunes are closely tied to both. There is no doubt that the weakness of the dollar is making life harder in the region. The IMF is upbeat about the year ahead for the Middle East but other economists warn that the region is ‘insulated, not isolated’ from the problems.
According to a latest report published by the International Monetary Fund, high oil prices are boosting region’s oil revenues as a result of which fiscal and current account surpluses in oil-producing countries are projected to remain large despite stronger imports and further fiscal expansion. In most non-oil-producing countries, the policy stance will likely aim to rein in fiscal and external deficits, thereby reducing further vulnerabilities. Risks to the outlook are broadly neutral, with some upside risks from domestic demand likely to be balanced by downside risks from the external sector.
High oil prices and further cuts in US interest rates could lead to a stronger-than-expected increase in domestic demand in the GCC countries, comprising Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE). Furthermore, the growing surplus in oil producers, combined with concerns about asset quality in advanced economies, may well lead to increased inflows to the other countries in the region, fueling stronger credit and domestic demand. However, a protracted slowdown in advanced economies would hurt growth in most Middle Eastern and Central Asian countries, depressing exports and commodity prices.
Tighter credit in advanced economies and lower risk appetite, as evidenced by widening sovereign spreads, could also curtail the capital inflows that have supported growth in many countries in the region. All countries in the region have been largely unscathed by the recent financial turmoil in developed countries, except Kazakhstan, where the banking sector relied heavily on foreign borrowing. As in most other emerging markets and developing countries, this resilience owes much to the region’s strengthened macroeconomic position and progress with structural reforms.
Notwithstanding continued strength in import growth (20 percent in dollar terms), high oil prices will keep the region’s current account surplus above 18 per cent of GDP in 2008, leading to a further accumulation of international reserves, now close to the $1 trillion mark. The key macroeconomic policy challenge in the short run for most countries in the region, however, is to contain rising inflationary pressures, and for countries with large external debts and current account deficits to protect their external stability in the context of high oil prices and slowing world growth.
In oil-exporting countries with currencies pegged to the dollar, demand management policies will face challenges in controlling inflation, given the continuing bias toward monetary easing in the United States. The burden of the adjustment may well have to fall on fiscal policy, particularly in the GCC countries, where a change in the exchange rate regime would be disruptive in the run-up to the planned monetary union.
According to the IMF staff, policymakers need to remain focused on strengthening policy frameworks, promoting sound financial deepening, and supporting the growth potential of the private sector. In particular, countries need to continue strengthening their fiscal policy frameworks tailored to address specific issues in their fiscal outlook, most notably the efficient and sustainable use of oil revenues in oil exporting countries, and high public debt in some low-income and emerging market economies.
For countries where greater exchange rate flexibility is desirable over the medium term, it is important to continue to lay the foundation of an independent monetary policy. Despite the difficult challenges ahead, GCC countries are encouraged to keep the agenda of the proposed monetary union on track, including reaching consensus on the appropriate exchange rate regime.
Helped by continuing high oil and non-oil commodity prices, and despite increased uncertainties in global financial markets, growth in the region is projected to stay in the 6-7 per cent range in 2008. All parts of the region are doing well, with growth in the Caucasus and Central Asia projected to be especially strong at 11 per cent, the fourth year of double-digit growth. Unemployment remains a big concern, however, especially in the Maghreb countries, where more moderate growth of 5-6 per cent is expected.
But inflation is on the rise in many countries. Fueled by strong demand growth, large external inflows, and generally accommodative monetary policies, average inflation in the region has picked up to 8-9 per cent. For oil exporters, the increase has been particularly sharp, to nearly 10 in 2007, from seven per cent in 2006. In the context of pegged or heavily managed exchange rates, higher inflation is resulting in significant real exchange rate appreciation in many countries, as would be expected in response to rising oil prices. With no major changes in the policy stance envisaged, inflation is likely to ease only slightly in 2008.
As oil producers have ramped up their spending, saving in the region has declined. With imports of investment and consumer goods increasing rapidly, oil exporters’ current account surplus has dropped to about 17 per cent of GDP, from 21 per cent in 2006, even though oil prices remain at record highs. Higher private and public sector spending has contributed to this. In the Gulf Cooperation Council (GCC) countries, investment spending plans amount to at least $800 billion over the next five years, with major projects in the oil and gas sectors (funded largely by national oil companies), infrastructure (mainly under public-private partnerships), and real estate (financed primarily by the private sector).
Saudi Arabia
Saudi Arabia commands a pivotal position in the global economy. As both the world’s largest oil producer, and the only one with significant spare capacity, the Kingdom has a substantial influence on the supply and hence price of this most crucial resource. In addition, Saudi Arabia is an important exporter of capital. Although an increasing amount of the country’s oil earnings are invested at home, such is the scale of these earnings that the country has continued to accumulate foreign assets.
In 2007, the Saudi Arabian Monetary Authority (SAMA) increased its foreign assets by $80 billion. Most of this is likely to have been channeled into US dollar-denominated assets, representing significant support for the greenback at a time when the US external current account remains in large deficit and there are growing uncertainties about US economic prospects.
Finally, the Kingdom’s economy has been growing rapidly in recent years, doubling in nominal terms since 2002.
With nominal GDP projected at around $465 billion this year, Saudi Arabia’s economy is now on a par with that of Switzerland. It accounts for a little more that half of the total output of the GCC and is twice the size of the second largest GCC economy, the UAE. It is a major trading nation, and the second largest global source of outward remittances after the US. Economic expansion and diversification continue apace in Saudi Arabia and this momentum should be maintained in the period ahead.
Global oil prices are expected to remain high, investment in domestic oil and gas production capacity is being ramped up, and the enormous potential of the private sector is being unleashed by fundamental improvements to the business environment. As a result, robust public and private sector investment should underpin real economic growth of 6 percent or more annually over the coming years.
Hydrocarbons will remain the cornerstone of the economy. The sector’s contribution to real GDP is expected to rebound this year in line with a pickup in crude oil output and investment in productive capacity. In nominal terms the sector is expected to grow by as much as one third, as global oil prices are buoyed by market demand, supply concerns, and speculative activity.
The surge in Saudi oil revenue will support further brisk growth in government spending (around 15 per cent both this year and next). Much of this will be directed towards basic infrastructure, but spending on salaries and other benefits, as well as subsidies, will also be raised in a bid to offset the social costs of rising inflation. Despite the economic stimulus coming from rising government spending, the expanding private non-oil sector is increasingly becoming the driver of growth.
Inspired by properly sequenced and thorough-going economic reforms, both private and foreign investment is surging ahead, most notably in utilities, manufacturing, telecoms, financial services, and the Economic Cities. With economic reform momentum likely to be maintained, the prospects for sustained private investment growth are excellent. The growth in government spending will prudently continue to lag that in oil revenue, keeping the budget in surplus by as much as 20 per cent of GDP both this year and next.
The balance of payments position is also exceptionally strong and current account surpluses averaging some 25 per cent of GDP in 2008-09 will further boost foreign asset holdings. The major risk to this buoyant outlook stems from inflation, with consumer price growth likely to average around eight per cent this year.
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