How long can the Middle East withstand the low oil price?

At current oil prices, Middle East economies are under pressure. Governments of the major oil producers in the Middle East are all running fiscal deficits and we estimate their 2016 fiscal breakevens – the oil price needed to balance the government budget – to range from a low of $57/bbl in Kuwait to $92/bbl in Saudi Arabia. How sustainable are these government's fiscal positions?

The decline in oil price since mid-2014 has decimated oil revenue for Middle Eastern governments. Saudi Arabia's government revenue from oil fell by an estimated $120 billion between 2014 and 2015, a 54% year-on-year decline. This is a shock for any economy that generates 90% of its government revenue from oil.

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How are governments responding?  

In response, governments in the region are trying to ease the fiscal pressure. Cutting expenditure is an important strategy – deferring investments, reducing subsidies (including energy), and curbing welfare payments and public sector wages among other things. However, the cuts made to date have been outweighed by the fall in oil revenue. This has led to a growing fiscal deficit for all.

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All five of the major oil-producers in region – Iran, Iraq, Kuwait, Saudi Arabia and the UAE – will run a fiscal deficit in 2016. Deficits will range from 4% of GDP in Iran, to ~20% of GDP in both Saudi Arabia and Iraq by our estimates. Given the size of fiscal deficits, these economies face years in the red unless there is a sustained recovery in prices. It will be 2020 before all are back in the black or running a fiscal surplus, based on our expectation for the oil price to return to $85/bbl (real) in 2020.

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What are the key factors for sustainability?

The key to fiscal sustainably is access to capital – either a cushion of reserve assets, or the ability to issue government debt in international markets. Kuwait and the UAE have vast reserve assets allowing them to comfortably sustain fiscal deficits well beyond 2020. While Saudi Arabia has a healthy cushion of reserve assets, these are being eroded fast. According to official data from the Saudi monetary authority (SAMA), the kingdom burned through SAR 716 billion ($191 billion) in reserve assets between August 2014 and September 2016. Iran, on the other hand, has limited reserves but a relatively small deficit to finance. Indeed, the 2016 shortfall could be covered eight times over by their reserves.

Iraq is facing the greatest test. Having depleted most of the $18 billion Iraq Development Fund, Iraq is relying on emergency loans from the IMF and the central bank to purchase short dated government debt. Access to international capital markets is limited. And the country's debt stock is already elevated. Iraq cancelled an auction last year because of the high yield demanded by investors.

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What are the expected actions? 

We expect other countries to allow debt to play a greater role in deficit financing. To stem the depletion of reserve assets, Saudi Arabia issued $4 billion in local bonds and $17.5 billion in international bond markets this year. Abu Dhabi issued $5 billion in bonds in April, the first issue for seven years. And even Iran is considering debt issuance in international markets after a 14-year hiatus.

Over the longer term, to achieve fiscal sustainability these economies need to diversify away from oil. Low oil prices, while highlighting the need to diversify, unfortunately risk stalling diversification, because governments are disproportionately cutting investments to ease fiscal pressure. The investments that will help economies diversify away from oil over the longer term are reliant on oil revenues – a troubling paradox.

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ReportIran economic outlook H2 2016

 

ReportUnited Arab Emirates economic outlook H2 2016

 

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