MENA region: Two shocks at once put severe liquidity pressure on oil exporters with limited buffers

In January this year, the outlook for the MENA region was one of continued economic growth, albeit at a subdued rate in most countries. The average oil price was projected to remain just below USD 60 in 2020 (average of Brent, Dubai and WTI), and the majority of oil exporters were expected to stabilise their external balance and were close to balancing their fiscal account. Now, three months later, the outlook could not be more different, as COVID-19 deals an unprecedented blow to all countries in the region. The impact of the shock is likely to be larger than that of the global financial crisis as economies come to a standstill under nationwide confinement measures, with a greater impact on growth in oil-exporting countries. Egypt is the only country in the region where the IMF does not expect a recession. However, the deepest contraction in real GDP is expected in Libya (-58.7%), which is evidently related to the ongoing conflict and oil price drop, followed by Lebanon (-12%), where the contraction is related to the impact of the current political and economic crisis on top of the COVID-19 pandemic.

Supply and demand shock affects regional growth

The reason the impact on economic growth is forecast to be this large is down to the fact that some countries, such as Iran, have been at the epicentre of the current crisis. Overall, the entire region is suffering from a significant supply and demand shock.

On the demand side, the confinement measures are significantly weakening consumer demand, notably in tourism and hospitality. These are significant sectors in Bahrain, Egypt, Qatar, Jordan, Lebanon, Tunisia and the United Arab Emirates. Across the region, the retail sector is also significantly impacted. A reduction of demand may be further worsened in countries where public spending cannot be expanded to support the economy, and especially in some oil-exporting countries where it will need to be scaled back in the face of lower oil prices and limited fiscal buffers (Oman and Iraq). In the absence of large fiscal stimuli, significant second-round effects are likely as employment in the private sector is cut back. The more open economies such as Egypt, Morocco and Tunisia, which depend more on the export of goods and services, are seeing a reduction in their exports, which will add to the domestic demand effect.

On the supply side, the closure of borders has interrupted supply chains and manufacturing processes. The specific uncertainty brought about by the current crisis, on top of the already high geopolitical uncertainty and social tensions in some countries, weighs heavily on business confidence in the region and thereby leads to investment projects being put on hold.

For countries in the region that have seen a large inflow of refugees (such as Iran, Jordan and Lebanon) or a large number of internally displaced people (such as Iraq), the COVID-19 crisis brings additional challenges and could further increase pressure on already weak healthcare systems.

A new reality of oil prices just above USD 30 dollars per barrel?

For oil prices, a large supply and demand shock also plays a role, and lockdown measures are having a large impact on demand, with some estimates pointing towards a reduction in oil demand by 33%. In terms of supply, March was marked by strong expansion in the production of oil by Saudi Arabia, the United Arab Emirates and Russia. These three countries then launched a price war after no agreement could be reached to cut production among OPEC+ members in March, but this was finally resolved in early April. However, the planned 10-million-barrels-per-day cut in production that was agreed upon has since not been successful at supporting the price, as the demand shock of confinement measures still outweighs the reduction in supply, and the swelling glut is testing oil storage capacity around the world. This is expected to remain the case as long as the confinement measures are not significantly reduced. As a result, financial markets are currently projecting that the oil price will average USD 30.28 (average of Brent, WTI and Dubai) this year and only USD 33 in 2021.
This price is almost half of what was previously projected for 2020, and USD 5 lower than the IMF continued to project this month for 2020 and 2021. While the price could increase rapidly again in the event that economic activity picks up more swiftly than expected, it is becoming increasingly unlikely that this will happen this year. Hence, it is highly likely that we are entering a period of lower oil prices for the longer term. For all oil-exporting countries, the impact will be pronounced, as for these countries the oil price was the main driver of the economic outlook.

Impact on fiscal balances will be high and difficult to manage

To put the impact of the lower oil price into perspective, the difference between the currently estimated price for 2020 and the currently estimated fiscal breakeven price is shown in graph 1 for a number of countries. Here we can see that all countries have a fiscal breakeven price above the current oil price. The biggest difference is in Algeria, which was already managing a 9.3% fiscal deficit in 2019, which is now likely to become a deficit of a whopping 20% of GDP in 2020. Only Iraq is performing worse, as its fiscal deficit is expected to reach 22% of GDP, compared to only 0.8% in 2019. However, again in the GCC countries, fiscal balances are expected to be strongly negative except for Qatar. For Algeria, Oman and Bahrain, the new oil price drop came at a point when the countries had still not absorbed the 2014 oil price shock, and all three countries have been running significant deficits since then as they did not implement fiscal consolidation measures. For all countries implementing consolidation measures it will be a difficult exercise, as there is a need to support growth during the current crisis. Additionally, countries such as Algeria, Iraq, Kuwait and Oman spend a significant part of their government budget on public wage bills, and they have found it difficult to reduce this. For Bahrain, its expenditure has increasingly consisted of interest payments as the country struggles with unsustainable public debt levels.

Nevertheless, while oil exporters are facing a double shock on their fiscal balance, the impact of the COVID-19 crisis for oil-importing countries will also be extensive, as most of these countries have been dealing with very high public debt levels and persistent fiscal deficits in recent years. Egypt, Jordan, Lebanon and Tunisia all had public debt levels above 70% of GDP at the end of 2019, which are already remarkably high figures. Now, as these countries are also expected to run significant deficits in 2020 and as their economies are expected to shrink, debt-to-GDP ratios will rise significantly this year. This will happen most notably in Tunisia, where the debt-to-GDP ratio is expected to rise by 16% to 88.5% of GDP. The relief provided by the lower oil price on the fiscal balance is expected to be limited for these countries, as most of them already took significant steps to reduce energy subsidies in recent years.

Increased external imbalances as a result of the shocks

For all countries in the region, significant pressure on the current account receipts is expected, most evidently due to lower oil receipts in oil-exporting countries. The lower oil price is expected to lead to particularly large current account deficits in Iraq (-21% of GDP), Algeria (-18.3%) and Oman (-14%). However, other countries in the region are also likely to be affected, firstly through lower non-commodity exports (Morocco, Tunisia and Egypt), where Tunisian exports to the EU in particular are likely to be significantly affected. Secondly, many other commodity prices have also dropped in response to lower global economic growth. This impacts the exports of Jordan and Morocco because they are major potash exporters, a commodity which dropped significantly in price. Tunisia is also impacted by lower food prices. Thirdly, the oil-importing countries benefit from lower import payments on oil and gas products, which has a strong positive effect on the balance of payment of countries such as Jordan and Egypt. However, at the same time, these countries will see a lower inflow of remittances from oil-exporting countries, which is a main source of foreign exchange receipts for them. Therefore, countries such as Tunisia and Jordan are expected to run significant current account deficits this year of 7.5% and 5.8% of GDP, respectively. Countries with a flexible exchange rate such as Egypt can benefit from this to absorb part of the current shock.

Is there any fiscal space?

Countries will only be able to mitigate the impact of the current shock on their economy if they have fiscal space, and here we can see large differences between countries. In Kuwait, Saudi Arabia, the United Arab Emirates and Qatar there are substantial external buffers in the form of sovereign wealth funds, reserves and external borrowing capacity. This allows these countries to take significant measures. Up to now, the GCC countries have taken fiscal measures averaging 3.8% of GDP, and these measures are expected to expand in the coming months. For Saudi Arabia, the shock came right when it was implementing its Vision 2030 plan, an ambitious reform programme aimed at expanding the non-oil sector. It is now expected that measures will be taken to mitigate the impact of the crisis on its non-oil sector. The most likely scenario is that the authorities will strive to avoid a situation such as in 2015, when they responded to the lower oil price by freezing payments to contractors, a measure that had a strong negative impact on the wider economy. Instead, the Saudi government now indicates that it plans to borrow extensively (up to USD 58 billion this year according to some reports) to overcome the double shock and at the same time preserve its foreign exchange reserves.
Oman and Bahrain do not have significant borrowing space as public debt levels have already risen significantly since 2014; instead, additional financial support from GCC countries seems increasingly likely for Bahrain. Algeria, on the other hand, has resisted borrowing in the past and has instead relied extensively on its foreign exchange reserves since the oil price dropped in 2014, although this led to a substantial drop in reserves. Current reserves still cover 12 months of import coverage, but they are expected to decrease further at a rapid rate. As a result, this will force the country to start borrowing externally.

The only option for oil-importing countries with limited space will be to redirect spending policies and try to delay non-essential expenditures, as well as looking for external funding support. Nevertheless, while their public debt levels are already high, Egypt, Tunisia and Morocco responded by increasing targeted household spending, increasing unemployment benefits or implementing assistance programmes for affected companies. For a country such as Lebanon, the crisis comes on top of unprecedented public protests and a historic sovereign default, leaving it ill-placed to deal with the shock of COVID-19.

It should be noted that external borrowing to fund the larger government deficits is expected to be increasingly difficult for countries in the region, which have faced large outflows of portfolio investments. This has happened in most emerging markets as investors increasingly fled to safe haven assets. As a result, bond yields have surged in a number of countries (especially in the case of Egypt, Jordan and Tunisia), and this carries the risk that these countries will face higher interest rates or difficulties accessing the financial market.

Outlook: risks on the downside and a further rise in social discontent

The issue with the current outlook is that risk continues to lie firmly on the downside. There is still a large degree of uncertainty over whether we will see a V-, U-, L- or W-shaped recovery. While a U-shaped recovery is becoming increasingly likely, multiple elements will further determine the severity of the crisis. First of all, as in the rest of the world, the further evolution of the COVID-19 pandemic in the region will play a vital role, as this will determine the intensity of confinement measures and thus the size of the supply and demand shocks on the local economies. Secondly, and connected to this, for oil-exporting countries the oil price remains the main driver of the economic outlook. A significant pick-up in the oil price could further support these countries’ economies. However, prolonged subdued prices, as are currently expected, will continue to weigh on the outlooks of these countries. Lastly, a major source of uncertainty is the possible rise in social tensions, and there is a severe risk that social tensions will worsen in countries such as Morocco, Jordan and Tunisia because the current downturn is likely to lead to an increase in unemployment and might force these countries to implement further fiscal consolidation.

Analyst: Jan-Pieter Laleman – jp.laleman@credendo.com