Standard & Chartered gives the MENA a reality check
Standard Chartered’s latest Middle East and North Africa Focus claims, “Hydrocarbon-based economies are using their fiscal strength to drive near-term growth and diversify their economies to reduce long-term risks. Oil importers are constrained by high domestic subsidy bills and weak investment; this is hampering economic growth.”Among the report’s highlights, the bank identifies a number of key issues:
- Subsidy reform is essential, and countries such as Jordan are taking the necessary concrete steps, despite strong domestic opposition. Stability is key to attracting direct investment flows to support private-sector investment to create jobs.
- Saudi Arabia – the largest economy in the Middle East – has a robust growth outlook, driven by government investment in non-hydrocarbons. This is supporting near-term growth dynamics, and moving in the right direction to meet the kingdom‟s long-term infrastructure needs and create employment opportunities.
- In Egypt, while political transition remains difficult, markets are cautiously optimistic that strong financial support from the oil-rich GCC states will ease the balance of payments pressure and restore investor confidence.
- In the UAE the outlook is positive. Dubai continues to perform well, driven by the core pillars of its economy, and in Abu Dhabi the resumption of strong government investment is driving non-hydrocarbon growth. Dubai‟s measures to ensure healthy pricing dynamics in the property market are a move in the right direction. Meanwhile Abu Dhabi‟s property market is picking up.
Social and political challenges in the wider Levant and North Africa are in stark contrast with the economic boom much of the GCC is enjoying. The GCC economies are benefiting from years of robust hydrocarbon dynamics, although they also face longer-term challenges.
Saudi Arabia is pouring resources into its longer-term development objectives, supporting healthy economic growth. Yet this brings inflation and concerns about productivity. Dubai’s economy, which not long ago faced severe challenges, is performing extremely well against a backdrop of strong investment in the region, benefiting from its role as a trade and services hub. Jordan is now fast-tracking badly needed energy reforms to slow the drain on government finances. Egypt’s political transition is ongoing, and funding from the GCC is supporting the Egyptian pound (EGP) and the balance of payments. Reforms, however, have been delayed and look unlikely as long as social pressures and political uncertainty remain high.
We see three core themes for the region:
1. The need for subsidy reforms to reduce the load on government finances. While these measures may bring near-term pain, they are essential to reduce heavy subsidy burdens in the region.
2. Employment challenges are widespread, even in wealthy economies like Saudi Arabia. Creating sustainable employment opportunities is a priority.
3. The region needs to develop strong and robust legal systems, which are key to sustaining cross-border investment flows that are necessary to support economic growth and create employment.
Reforms – Rationalising subsidies
Subsidies in the region are too high, especially in the energy sector. This creates a fiscal burden on oil importers, and productivity distortions for oil exporters. The MENA region‟s energy subsides are equivalent to USD 236.7bn annually, according to the IMF – 50% of the global total. Some countries are implementing reforms, either by cutting subsidies directly or by developing alternative sources of energy to meet high levels of domestic energy consumption. In other countries more needs to be done.
Jordan is taking decisive steps in the right direction. Having identified energy subsidies as the largest drain on government finances, in August the government raised power tariffs by 15%. This should help to reduce the subsidy bill from 5.3% of GDP in 2012 to 4.3% of GDP in 2013. The government is also accelerating the construction of an LNG terminal at Aqaba, which could reduce generation costs by 20% when it is operational by 2016. Shale oil sources are also being explored. Jordan is both undertaking soft policy reforms and investing to develop domestic and alternative energy resources. This should have a significant positive impact on the long-term economic outlook.
In Egypt, the situation is different. The subsidy bill is ballooning, projected by the government to rise to 9.9% of GDP in FY13 (year ended June 2013) from 8.8% in FY12. This is skewing debt dynamics. Debt to GDP had ballooned to 83% as of March 2013 from 77.7% at the end of June 2012. The government projects that the fiscal deficit will rise to 13.8% of GDP in FY13 from 10.8% in FY12. Increased subsidies have had questionable results in terms of restoring stability, but have clearly resulted in deteriorating fiscal and debt dynamics. We believe the way forward for Egypt is to stabilise its debt dynamics by overhauling the subsidy framework and focusing on pro-growth economic policies. Given social pressures and the uncertain political environment, this looks unlikely to happen in the short term.
Employment remains one of the region’s key challenges. The nature of this challenge varies across the region. In the hydrocarbon-rich GCC, participation rates for GCC citizens in the private sector are very low. On average, less than 10% are employed in the private sector (expatriate workers account for almost 90% of private-sector employment). The public sector remains the largest employer of GCC nationals, reaching almost 90% in some countries. This is an unhealthy balance, and governments are taking steps to address it. In other parts of MENA, the challenge is a weak private sector that is struggling to attract enough investment to create job opportunities.
Saudi Arabia is determined to fight unemployment. The country’s private-sector job market is dominated by expatriates, who number almost 8mn; until recently, the country also had 2mn undocumented workers, according to market estimates. A key challenge is to shift more Saudi nationals into the private sector, where fewer than 10% of Saudis currently work. The government’s ‘Saudisation’ programme has created 600,000 new jobs for Saudi nationals since its launch less than two years ago. Under the programme, private-sector companies must meet a quota for employing Saudi nationals. The government has also been tackling the issue of undocumented expat workers; under an amnesty running until November 2013 1.5mn of the country’s 2mn undocumented workers (market estimates) have received the necessary work permits. The government estimates that 180,000 have left the country. In the longer term, policy makers need to ensure that Saudi nationals have the necessary skills to take on new job opportunities. While a quota-based system has near-term merits in helping create jobs, matching skills to available jobs is a longer-term challenge.
Egypt’s unemployment is on the rise. The government estimates that the unemployment rate rose to 13.3% at the end of June 2013, the highest on record. Educated urban youth face the highest unemployment rate of nearly 25%. With instability affecting core sectors of the economy, growth is proving a challenge. Restoring stability is key in order to attract international investment flows to support private-sector investment and job-creation opportunities.
Creating a macroeconomic environment conducive to investment inflows is an important priority for the region, especially for economies that face funding deficits. Flows to Egypt have come from GCC countries including Saudi Arabia, the UAE and Kuwait. These funds will be used to finance the government’s large subsidy bill for power and food. Nearly USD 2bn of this aid will be in the form of direct oil shipments. While this support is welcome, countries like Egypt must also implement the necessary macroeconomic, legal and subsidy reforms to attract private investment. In challenged pockets of the region, fiscal support from political allies can only go so far. Jordan’s measures to tackle large subsidies show that such reforms are possible, even against a backdrop of strong domestic opposition.