After exhausting all efforts to contain the impact of the global financial crisis, GCC governments' response is now gradually shifting from monetary to fiscal measures. There is also the willingness to continue spending, setting the scene for the resolution stage.
However, the drastic drop in oil prices will still put a big constrain on fiscal spending, as almost 90 per cent of the region's revenues come from oil, a report sent to Emirates Business said. And, while not at the top of the agenda, the macro-backdrops in the GCC countries also have some implications for the planned monetary union.
According to the GCC quarterly report from Banc of America Securities-Merrill Lynch, the GCC governments have been proactive in smoothing the downturn by resorting to monetary measures.
Initially, the governments undertook a liquidity management that aimed at reducing the impact of the global credit crunch and falling asset prices on the domestic financial systems. This involved a number of measures including cutting interest rates, lowering reserve requirements, giving blanket deposit guarantees and injecting liquidity into the banking sector.
Then comes the second stage, which involves bank recapitalisation. The UAE, for example has made Dh120bn ($32.7bn) of funds available to the banking sector with Dh70bn earmarked for deposit injections and Dh50bn as an emergency borrowing facility. Qatar, on the other hand, has chosen to strengthen the sector with purchases of up to 20 per cent of domestic banks by the Qatari sovereign wealth fund.
The third stage has been selective bailouts. While Kuwait was a latecomer to the GCC investment frenzy, it has not escaped the comedown.
"Not only has the country had to bail out Gulf Bank, the fourth-largest lender by value, but it has already seen its biggest investment bank, Global Investment House, default on most of its debts," the report said. "A KD4bn (Dh50bn) fund to help local investment companies pay off their debts is currently under discussion by policymakers but it faces some opposition in parliament."
Fourth, the governments have also propped up collapsing asset prices at home. Kuwait's sovereign wealth fund, KIA, has shifted its focus inwards, having been called on to prop up the falling stock market.
These measures – liquidity management, bank recapitalisation, selective bail-outs and propping up asset prices – are viewed as the containment phase, as the GCC authorities focused more on damage control and adopted the responses simultaneously when needed.
The next phase is fiscal stimulus, says the report.
Together with the announced 2009 budgets, governments' professed willingness to continue spending despite lower oil prices to smooth the downturn is gradually turning into action, setting the scene for the resolution stage, it said.
"Saudi Arabia's 2009 budget, for example, assumes a seven per cent contraction in spending vs the realised 2008 expenditure and a 16 per cent rise on the 2008 budget," it said. "However, as the Saudi authorities have historically overspent by about 20 per cent vs the planned budgets, it is safe to assume they might do so again in 2009, given the various infrastructure investment commitments."
As GCC governments have loosely adhered to their budgets, which often assume a conservative oil price, Banc of America Securities-Merrill Lynch expect their fiscal expansion to be more pronounced.
Given the reversal of previous years' favourable trends, the report says GCC governments are well justified in taking bolder action going forward via both strengthening of the banking sector and the introduction of fiscal stimulus.
Oil price constraints
From a macro point of view, the region has saved almost 70 per cent of the oil windfall, giving the region plenty of savings to carve out a credible exit plan.
However, while the governments have been pro-active in dealing with the crisis, low oil price will remain a constraint on fiscal spending as almost 90 per cent of budget revenues come from oil.
Thus, it is expected that a further slide in oil prices is likely to push the fiscal and current balance into double-digit deficits.
And this will call for faster consolidation with more project delays/cancellations, lower non-oil growth and higher default rates in non-strategic private sector businesses, the report said.
The US-based bank estimates the GCC 2009 budget breakeven oil price at $52 per barrel but given the expected overspend and its base oil price assumption of $45/bbl, it expects actual breakeven $60/bbl for the GCC states.
"On this basis, we expect a budget deficit of five per cent of GDP in 2009 vs an estimated surplus of 30 per cent in 2008," it said. "We expect a slight current account surplus of 1.5 per cent of GDP, mainly thanks to Kuwait, and almost flat GDP growth on average in the region despite contractions in Saudi Arabia, Kuwait and the UAE as the hydrocarbon sector in Qatar is still growing strongly.
"Until there is a sustained oil price recovery, GCC governments' ability to cope with the recession and the credit crunch is therefore likely to be discounted," it said.
GCC monetary union
Due to the crisis, many countries will likely fail to meet the budget deficit criteria in both 2009 and 2010, providing another reason to delay the monetary union goal, says the report.
"Meeting the five per cent of GDP budget deficit criteria seems unlikely to us if oil prices remain depressed for much longer," it said. "Also, fighting against very strong headwinds, governments with strong savings and large hydrocarbon sectors would prefer to run wider budget deficits until oil prices recover."
In addition, there is the issue of meeting the convergence criteria which states inflation should not be higher than two percentage points above the average rate of all the states; interest rates should not be higher than two percentage points above the average of the lowest three countries' rates; FX reserves greater than the equivalent of four months of imports; budget deficit lower than three per cent of GDP, or five per cent during periods of low oil prices and public debt-to-GDP lower than 60 per cent.
The goal of entering monetary union by 2010 was adopted in 2001 – though the agreement to establish a joint currency has been in place since 1982 – and was seen as a means of increasing the region's attractiveness to foreign investment, lowering transaction costs, and promoting growth, intra-regional trade and integration and investment.
The body has adopted five convergence criteria, which are essentially based on the Maastricht criteria. The project faced a setback when Oman pulled out in 2006, citing divergent economic policies, and Kuwait dropped its dollar peg and adopted a currency basket back in 2007.
The GCC adopted a common customs tariff in 2003 (reducing it to 5 per cent of all imported goods) and a common market was launched in 2008, implementation of which is largely complete.
In December 2008, GCC finance ministers finalised a draft document for the establishment of an executive monetary union council, which will be tasked with establishing a central bank. And although the official GCC line remains that they will stick to the 2010 deadline for adopting a single currency, this is likely to prove optimistic and many GCC leaders have dismissed the feasibility of this timetable, it said.
GCC in a nutshell
As the world's largest oil producer, Saudi Arabia bears the brunt of mandated production cuts, which will see the oil sector contract in 2009, leading to a contraction in overall growth of -0.2 per cent YoY from 4.2 per cent growth in 2008. The non-oil sector growth will remain positive and will be supported by continued fiscal stimulus, as the government remains committed to its development plans. Despite the dimmed global outlook, Saudi's large, closed and under-penetrated market is a stable source of growth. Still, as oil prices fall, this will lead to deficits in the current account and budget. Inflation will come down in 2009 to to six per cent YoY due to slowing economic activity and stronger USD.
The UAE is the GCC's most-diversified, open and most-leveraged economy, which leaves it the most vulnerable in the region. Domestic credit expansion, high population growth, infrastructure spending and the vibrant non-oil sectors supported growth in the UAE in 2008. In 2009, tight USD liquidity and less available external financing will pull down credit expansion, reduce infrastructure spending and ease real estate sector growth. As a result, the domestic credit crunch, global downturn and cuts in oil output will result in economic contraction. Inflationary pressures will subside in 2009 to about seven per cent YoY along with reduced economic activity.
Qatar will remain one of the fastest growing economies despite lower oil prices, thanks to its status as the largest exporter of LNG, which has long-term, fixed contracts in the world. Still, as a result of Opec mandated cuts, the hydrocarbon sector growth will fall to single digits. The non-oil sector will also slow as the investment driven, capital-intensive growth is capped by the credit crunch and global economic downturn. Budget and C/A surpluses will be eroded in line with oil prices. Inflation will prove sticky in 2009 (10 per cent) but will come down in 2010 to 7 per cent.
The Kuwaiti macro story continues to be driven by oil, which has afforded the state the largest surpluses in the GCC. Despite the fall in oil prices, the current account and budget will remain in surplus owing to limited investment and spending commitments. The lack of political determination for diversification has caused Kuwait to lag most of its GCC neighbours so far and economic activity will be further hit by contraction in the oil sector in 2009. Still the sovereign's large pile of cash should help smoothen the landing with strong government spending. Inflation as elsewhere continued to climb in 2008 but will come down as growth slows in 2009 and will average at 7.5 per cent YoY.
As a small, open economy with limited surpluses, Omani growth will have less cash to ensure a smooth landing in the face of the global downturn. The economy was heavily reliant on high oil prices and boosting its hydrocarbon output to diversify away from oil and secure the revenues necessary for its plans. A $15bn investment plan for the oil and gas sectors may be reconsidered due to high recovery costs, limited reserves and low oil prices. Non-oil growth will also stall given dependence on the services sector, especially tourism. Inflation pushed up by food and rent prices, along with negative real interest rates, will come down with lower commodity prices, rents and credit expansion to eight per cent.
While the non-oil sector is the main driver of the Bahraini economy, growth will come under pressure as financial services, the country's largest sector, faces global headwinds. With limited petrodollars the country will struggle to maintain a strong fiscal stimulus to boost non-oil growth as lower oil prices push the budget into deficit. Real estate, construction and finance accounts for 50 per cent of non-oil growth in Bahrain, and the outlook for all these sectors have turned negative. Inflation should ease in 2009 at four per cent.