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30 January 2019

Volatile oil prices pose challenges to GCC’s stable outlook

GCC countries are reliant on oil which accounts for three-quarters of the six-nation bloc’s spending, however, the instability associated with crude prices pose a challenge for the GCC sovereigns in 2019


Economies in GCC are growing at a faster pace compared to their emerging market peers. This is largely attributed to the rise in oil prices reaching $84 per barrel. Heavily reliant on oil, it accounts for three-quarters of the six-nation bloc’s spending. The instability associated with oil prices continue to pose a challenge in 2019. The UAE, Saudi Arabia and Bahrain have begun implementing economic reforms in a bid to diversify their economies.

According to International Energy Agency (IEA), the world record was set in September 2018 when both demand and supply were at 100 million barrels per day—the IEA has since revised down its forecasts for demand for this year and next, stressing that peak oil demand is nowhere in sight.

Higher oil prices during most of 2018 reduced fiscal and external pressures in the short term. It also weakened the impetus for GCC governments to diversify their fiscal bases and rein in expenditure, leaving their credit profiles vulnerable to phases of lower oil prices, asserted Moody’s in a recent report.


Moody’s assumed a WTI oil price of $60-65 per barrel in their base scenario for this year, added Indosuez Wealth Management. Crude oil prices ended 2018 in free fall but reversed course on signs that the Organisation of Petroleum Exporting Countries (OPEC) and other major exporters will follow through on last month’s pledge to slash production.

OPEC+ led by Saudi Arabia agreed to cut oil output this year to support prices. The oil cartel agreed that they would start to trim 1.2 million barrels of daily production in January to stabilise the market--in December they reduced output by 600,000 barrels per day (bpd).

The Emirates  

The UAE has a slightly better public debt outlook compared to its allies in the region. The adoption of economic diversification measures like the implementation of VAT a year ago and the foreign direct investment (FDI) law this year as well as the country’s open market system is expected to boost non-hydro economic growth--which should alleviate the UAE’s dependency on energy prices.

In its Global Outlook 2019 report, Indosuez Wealth Management stated that in terms of monetary policy there is not much divergence due to the peg of the dirham to the greenback. The US Federal Reserve (Fed) is becoming more restrictive and following interest rate hikes this year, the Central Bank of the UAE (CBUAE) has to adopt a tightening bias. The central bank has so far raised its repo rate to 2.5 per cent from one per cent at the beginning of 2017, in six steps of 25 basis points.

The UAE is now using the open market system to lure foreign investors to compete with the local market but at the same time measures are being put in place to protect Emirati firms. The new FDI law which came into effect in January states that a retiree must either have a property investment worth at least AED 2 million ($544,500), savings of no less than AED 1 million or a monthly income of no less than AED 20,000.

The government projected up to 15 per cent FDI growth this year owing to the Federal Law No. 19 of 2018 which was issued by a presidential decree. The granting of long-term visas to the country’s largely expatriate population will benefit investors and people with specialised expertise like doctors, researchers and those in the technology field. The UAE introduced support for the industrial sector by agreeing to reduce electricity fees for UAE factories.

 Under the plans, larger factories would receive a 29 per cent reduction in tariffs while small and medium-sized units would have fees reduced by between 10 and 22 per cent. Tourism, another pillar of UAE’s nonhydrocarbon economy did not expand as expected. Dubai International Airport passenger traffic declined by 0.2 per cent between September 2017 and September 2018--extending a downward trend which started back towards the end of 2015.

Additionally, inflation in the UAE increased to 4.8 per in January 2018, due primarily to the introduction of a five per cent VAT but has since begun to ease. Meanwhile, all of this will not change the debt outlook as assessed by various rating agencies. The current Moody’s rating applied to Abu Dhabi’s long-term debt is Aa2, which means that the Emirate’s bonds are of high quality and are subject to very low credit risk, says Indosuez Wealth Management.

The Kingdom

Although Saudi Arabia is on track to reduce its dependency on hydrocarbon revenue, oil revenue still contributes greatly to the Kingdom. Like its Gulf peers, Saudi is restructuring and opening up its once closed-up economic activities, rethinking the role of foreign direct investment as the authorities look to ease fiscal burden as well as do away with dependence on oil.

The government is targeting a fiscal deficit of 7.3 per cent of GDP this year and a balanced budget by 2023. Economic analysts are saying that the plan defies ‘the laws of arithmetic, this projection may be based on a crude price as high as $80 a barrel in 2019, and it would have to climb to $95 a barrel to balance the budget.

Saudi Arabia recently approved the largest budget in the Kingdom’s history with SAR 1.11 trillion spending in 2019, approximately seven per cent higher than the projected expenditure by the end of the fiscal year 2018. The Kingdom’s oil minister also reassured investors that the OPEC+ coalition would pursue output cuts to balance the market and will do more if it needs to. The 24-member coalition of oil producers is cutting output to stabilise global markets and they agreed to collectively reduce supplies by 1.2 million barrels a day for the first half of 2019.

The Kingdom’s new bankruptcy law, which was introduced in August 2018 will act as a conduit to investment growth is the latest development in a string of reforms under Crown Prince Mohammed bin Salman’s Vision 2030. Among other economic transformation measures, the bankruptcy law will encourage foreign direct investment (FDI) by structuring the business legal framework.

Moreover, the bankruptcy law clarifies provisions that are related to the liquidation, settlement and financial reorganisation. The law will protect creditors’ rights, reduce the costs and timeframe of the bankruptcy procedures and encourage SMEs to invest in the commercial market. The new law has since been put to test in the case of Ahmad Hamad Algosaibi & Bros (AHAB)- -which applied to the Commercial Court in Dammam for protective settlement.

In an audit report, Dallas-based DeGolyer & MacNaughton stated that the Kingdom’s vast oil reserves are at 268.5 billion barrels since it nationalised its energy industry about 40 years ago, slightly more than the 266.3 billion barrels that the Government published previously. The audit comes at a time when the Saudis are trying to generate interest in Aramco ahead of a potential initial public offering (IPO).

Aramco IPO stalled last year but the Crowne Prince insisted plan to sell shares in oil giant will go ahead by 2021, sticking to his view the state-run company is worth $2 trillion or more. Similarly, the Saudi Arabia Stock Exchange (Tadawul) was upgraded to an emerging market from a frontier market by the MSCI index in June 2018—together with the bankruptcy law the move is expected to attract billions of dollars of passive funds.

Earlier on in March, FTSE Russell had upgraded the Saudi index to the emerging market status which was followed by launches of other services essential for a modern stock market, such as a central clearing system. Saudi Arabia also started the year by announcing that construction at the Crown Prince Mohammed bin Salman’s ambitions for life after oil NEOM city, a proposed $500 billion futuristic city, will start in the first quarter of 2019.

The planned megacity, which is being financed by the Kingdom’s sovereign wealth fund unveiled more than a year ago, is part of MbS’ grand plan to bolster non-oil revenue and attract FDI. According to Bloomberg reports, the area will have its own airport, 2,500 luxury hotels as well as 200 retail establishments and 700 villas.

Bahrain, Kuwait & Oman

Lower than expected oil prices would dent fiscal positions in the other small GCC economies to varying degrees. Moody’s currently assumes Brent crude to average $75 per barrel in 2019, $65 in 2020 above the $54/bbl level at which spot prices started the year. Oman and Bahrain are most exposed to persistently weak oil prices from a fiscal perspective, given their much higher initial debt burdens.

Oman is the only one out of the six-nation bloc to be rated with a negative outlook. According to Moody’s, with oil at 2017 levels, Oman and Bahrain would run budget deficits of 12 and four percentage points of their GDPs, respectively. Bahrain’s bailout package from the UAE, Saudi Arabia and Kuwait in October last year reduced near-term liquidity pressures, with oil prices at these levels, the situation implies larger borrowing needs than assumed in the arrangement, potentially raising government liquidity risks again.

The Kingdom of Bahrain promised its rich-oil neighbours to implement steps to repair its strained finances which include the introduction of VAT. The country also plans to cut public expenditure, voluntary retirements for government workers and redirecting state subsidies. The planned reforms are expected to save BHD 800 million annually, as the Government looks to curb its debt after years of lower oil prices.

In Oman, if the government does not take additional steps to reduce the budget deficit, funding costs would likely rise in the event of weak oil prices weighing on fiscal strength. Low oil prices pushed spreads on the Government’s 10-year bonds above 450 basis points, however in the event of low oil price the Sultanate is said to be looking for alternative financing means.

Kuwait, unlike Oman and Bahrain, has vast sovereign assets under the Kuwait Investment Authority, in the event of a slump in oil prices these would act as a buffer to absorb such shocks comfortably. According to Moody’s, there are remote prospects for further removal of gasoline subsidies in Kuwait.

The GCC 2019 outlook is stable in general and higher oil prices in 2018 reduced fiscal as well as external pressures for the short term. However, higher oil prices also weakened GCC governments’ motivation to diversify their fiscal bases and rein in expenditure, leaving their credit profiles exposed to phases of lower oil prices like in the case of Kuwait.

Bahrain’s aid from its wealthier allies helped to reduce credit risk to the lowest level in five months on optimism following the confirmation from the tripartite agreement.There is a need for the Kingdom to fully commit to its pledge to reform the economy. The UAE and Saudi Arabia, as the strongest economies in the Gulf, are safe in the event of a decrease in oil prices this year.





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