Lower oil prices will slow growth and increase budget deficits in oil-exporting Gulf Cooperation Council (GCC) countries this year, eroding their fiscal reserve buffers and increasing debt, according to a report.

 

The Moody's Investor Service report pointed out that the fiscal deterioration is expected to be faster in Saudi Arabia, Bahrain and Oman than in the UAE, Qatar and Kuwait, where reserves cushion the short-term negative impact and allow a more gradual adjustment, prompting a divergence in the GCC sovereigns' credit profile. 

 

Most sovereigns have outlined short-and medium-term policy measures in response to the dramatic fall in oil prices, including renewed diversification plans, new taxes and the privatisation of state-owned companies, it said.

 

The firm is conducting a review for downgrade of all GCC sovereign ratings, to be concluded by the end of May, which will examine how these policy actions could mitigate the steep decline in their fiscal accounts.

 

It will analyse the extent to which lower oil prices will impact GCC sovereign credit profiles. The likely impact, not just this year, but over the medium-term horizon given that the baseline scenario for oil prices is based on a structural break between supply and demand that will depress oil prices for an extended period of time will be assessed.

 

The oil price drop will test the strength of each country's institutions, and in particular their capacity to restrain expenditure increases now that the period of fiscal surpluses is likely at an end, and to formulate effective policy responses to absorb deficits. 

 

It will also test the availability of financial buffers in times of stress. 

 

Based on these criteria, Kuwait, Qatar and the UAE sovereigns have a larger room for manoeuvre, but this could also lead to fiscal laxity. Saudi Arabia, Oman and Bahrain have larger borrowing requirements. 

 

Their respective policy roadmaps will determine their ability to attract external funding, maintain investor confidence and to minimise the impact of adjustment measures on growth and domestic liquidity.

 

Meanwhile, Moody's expects oil prices will remain lower for longer than it did at the same time last year. 

 

Following continued falls in the price of oil through the end of 2015, it has revised the oil price assumptions downwards once more to $33 on average this year and $38 next year, which is $20 less than in 2015 and $10 less than we assumed only three months ago.

 

This revision was driven by a range of factors, including lower demand in emerging markets and higher-than-expected supply from the US and, going forward, Iran and Iraq. This has far-reaching implications for all oil exporters, including Gulf countries.

 

Shifts in supply and oil prices have major implications for exports and public finances

 

The GCC economies are largely exposed. Hydrocarbons make up roughly 50 per cent of GDP, 70 per cent of government revenue and 80 per cent of goods exports in the GCC region.

 

While GCC countries represent 20 per cent of global wellhead production, they have among the lowest marginal costs of production of all producers, ranging from $4.4 to $6.8 per barrel. 

 

This insulates them from the risk that oil prices will fall below their marginal cost of production – thus, oil production activity is not threatened by the drop in oil prices, unlike many African and Central Asian producers.

 

OUTLOOK

 

Countercyclical stance in 2015 ensured stable growth, but 2016 will see more marked slowdown, said the report.

 

GCC government cost cuts will result in lower albeit still positive growth. 

 

They have started to cut costs and raise new revenues in response to the oil price shock, after initially maintaining their spending plans last year and using their buffers to finance short-term deficits.

 

While the cost cuts are likely to constrain 2016 growth to levels below those recorded in 2011-14, with the largest drop in Saudi Arabia, growth will remain positive as oil production is sustained and cuts are implemented gradually. 

 

The Purchasing Managers' Indices (PMI) for Saudi Arabia and the UAE show that growth is still positive but fell to the lowest in the series' history. 

 

Non-oil growth will also suffer from the strong dollar, further Fed rate hikes and the repricing of assets in the region. 

 

The nominal effective exchange rate for Saudi Arabia and the UAE shows that their currencies appreciated by 18.6 per cent and 17.5 per cent in the three years to January. 

 

Large deficits will impact reserve and debt metrics

 

Oil price drop will cause deficits to widen substantially this year, while it hit GCC government revenues and led to a sizable fiscal deficit of around nine per cent of regional GDP last year.

 

This year, the deficit will likely reach around 12.5 per cent of regional GDP.

 

GCC budgets for this year, however, point to a quick start with fiscal reforms, including cuts in subsidies, halts in new and existing infrastructure projects and hiring freezes in the public sector. But the fiscal response is only gradual and imbalances will remain considerable because the spending cuts will barely compensate for the renewed oil price slump in 2016, which will lead to a more rapid increase in debt levels in 2016 than in 2015.

 

The deficits will be funded via both reserve draw-downs and debt issuance. Funding these sizable deficits will lead to a rise in government debt and a decline in government financial assets.

 

Bahrain and Oman are expected to record the largest increases in debt, with government debt-to-GDP ratios rising by 35 and 18 percentage points, respectively, from their 2014 levels, followed by Saudi Arabia, which will see its government debt ratio to rise by at least 15 percentage points. 

 

For the other three GCC countries, a 11 to 13 percentage point increase has been forecast.

 

Medium-term reform plans have so far not relieved pressure on government balance sheets

 

Persistently low oil prices have spurred unpopular medium-term policy adjustments. In contrast to 2015, GCC countries have been more proactive so far this year in making policy adjustments in response to lower oil prices.

 

Weakening external positions place additional strain on buffers, but pegs are unlikely to be revised.

 

The external accounts are weakening, albeit from a strong starting point. A further weakening is expected in the external positions of Bahrain, Oman, and to a lesser extent Saudi Arabia, all of which posted current account deficits in 2015.

 

Although Kuwait, Qatar and the UAE maintained surpluses in 2015, all six GCC countries experienced a weakening in their current account balances. In 2016, all six countries are expected to record current account deficits for the first time since the 1998 oil price shock.

 

Geopolitical event risk will persist, exacerbated by Saudi-Iran rivalry

 

The geopolitical event risks are expected to remain high, driven in part by intensified tensions between Saudi Arabia and Iran. 

 

Based on ideological and structural differences, this rivalry has become more explicit in recent years through proxy conflicts in the region, including in Yemen and Syria. 

 

Meanwhile, the effects of the nuclear agreement between Iran and the P5+1 is expected to remain mixed. From a political standpoint, the rapprochement between the US and Iran has detracted from Saudi Arabia's position in the Persian Gulf, which partly explains the escalation of tensions between the regional rivals just as Iran reintegrates into the global community. 

 

From an economic standpoint, the deal and the subsequent lifting of sanctions are viewed as more positive for countries such as Iraq, the UAE and Oman, which will benefit from trade flows as economic linkages are restored. - TradeArabia News Service