MIDDLE EAST AND NORTH AFRICA REGION GCC COUNTRY UNIT GCC Knowledge Note: Global Economic Trends GCC Knowledge Series Sharing Innovative Solutions in RAS Business This note was produced by Dana Vorisek, with contributions from Development Prospects Group’s Global Macroeconomics Team and research assistance from Qian Li and Peter Williams, under the supervision of Ayhan Kose and Franziska Ohnsorge. Disclaimer © 2016 The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org This document is a product of the staff of the International Bank for Reconstruction and Development/ the World Bank. The findings, interpretations, and conclusions expressed in this paper do not neces- sarily reflect the views of the executive directors of the World Bank or the governments they represent. Rights and Permissions The material in this work is subject to copyright. Because The World Bank encourages dissemination of its knowledge, this work may be reproduced, in whole or in part, for noncommercial purposes as long as full attribution to this work is given. Any queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org.  1 G lobal GDP growth remains lackluster, at an estimated 2.4 percent in 2015, down from 2.6 percent in 2014. This performance reflects sluggish world trade, particularly merchandise trade, and persistently weak commodity prices. These trends are contributing to subdued inflation in advanced economies and commodity-importing emerging market and developing economies (EMDEs), while consumer prices are elevated or accelerating in many commodity-exporting EMDEs. Despite the headwinds to growth, financial conditions in EMDEs have improved somewhat since the start of 2016. Asset prices and capital flows have rebounded, while bond spreads have receded. EMDE exchange rates have rallied somewhat against the U.S. dollar after plunging during the past three years. Oil prices have risen from January lows, although they remain low versus historical levels due to both supply and demand factors. Economic performance in large emerging markets—including multiyear contractions in Brazil and Russia and continued rebalancing in China—could set back any improvement in the pace of global growth in 2016. Oil-exporting EMDEs, where fiscal buffers are declining and in most cases inflation is accelerating, are under particular pressure. With their high dependence on the oil sector for government and export revenues, the prolonged period of low oil prices continues to have detrimental impacts on GCC economies. Budget rebalanc- ing is underway, but further fiscal consolidation is likely in the medium term given that oil prices are expected to recover only gradually. Slowing growth in GCC countries stands to generate negative spillovers for oil-importing countries in the Middle East and North Africa through trade, investment, and remittances channels. Global Outlook Global growth: activity lackluster. With the slowing of growth in emerging market economies, the contribution to global growth from advanced economies ticked upwards in 2014 and 2015 (Figure 1A). However, disappointing growth outcomes during the fourth quarter of 2015 in the United States and Euro Area, as well as contracting activity in Japan, contributed to a deceleration of global growth to 1.5 percent (q/q, annualized), from 2.4 percent the previous quarter. High-frequency indicators point to weak momentum carrying over into 2016, as evidenced by subdued industrial production (Figure 1B) and falling manufacturing purchasing managers’ indexes in emerging and advanced economies in February. The weak indicators in February were followed by tentative signs of stabilization in March, however. World trade: sluggish. Global merchandise trade was subdued in 2015, as import demand fell in com- modity exporters, and weakened in China due to slowing activity and economic rebalancing (Figure 1C). Last year’s merchandise trade growth of 1.7 percent almost matched the post-crisis low reached during the Euro Area crisis in 2012. Services trade appeared more resilient, supported by strengthening consumer spending and rising purchasing power among major oil importing economies. The volume 2 GCC KNOWLEDGE SERIES: SHARING INNOVATIVE SOLUTIONS IN RAS BUSINESS FIGURE 1: Global growth, trade, and inflation A. Global GDP growth and contribution B. Industrial production Percentage EMDE Non-commodity exporters Year-on-year, points EMDE Commodity exporters percent United States Euro Area Japan 5 Advanced economies 20 EME BRICS 4 15 3 10 2 1 5 0 0 –1 –5 –2 –3 –10 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 2005 2007 2009 2011 2013 2015 C. World merchandise trade growth D. Inflation expectations Percent 1992–2000 2000–08 Year-on-year, United States 12 percent Euro Area Since 2010 2015 2.5 Japan 10 8 2.0 6 1.5 4 1.0 2 0.5 0 –2 0.0 World Emerging and Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Developing Source: World Bank, Haver Analytics, CPB World Trade Monitor, World Bank. A: EMDE commodity exporters are countries in the World Bank’s classification of emerging and developing economies (EMDE) where, on average in 2012-14, either (i) total commodities exports accounted for 30 percent or more of total exports or (ii) exports of any single commodity accounted for 20 percent or more of total exports. Countries for which these thresholds are met as a result of re-exports are excluded. EMDE non-commodity exporters are the rest of the EMDE group. B: The last observations are December 2015. Data are seasonally adjusted. D: Inflation expectations are defined as the 5-year ahead 5-year rate of inflation compensation derived from the inflation swaps market in the given countries. The last observations are March 2016. of world trade fell by 0.4 percent (m/m) in January 2016, March rate setting meetings as they seek to avoid inflation and is expected to remain weak in 2016, despite some expectations becoming entrenched at excessively low offsetting effect from services trade growth. levels (Figure 1D). Among commodity-importing emerging and developing economies (EMDEs), as well, inflation is Global inflation: subdued except in commodity exporters. contained, and is below target levels most countries (most In response to weak global growth prospects, softening notably, Vietnam, Romania, Poland, Thailand). For many inflation expectations, and financial market turmoil, central commodity exporters with floating exchange rate regimes, banks in advanced economies have maintained low policy however, inflation is elevated or accelerating (Ukraine, interest rates (United States, United Kingdom, Japan) or Ghana, Kazakhstan, Brazil, Russia). shifted towards further accommodation (Euro Area) at their ADVANCED ECONOMIES 3 Global Financial and Commodity Markets Emerging market assets: rally through March. Emerging currencies and/or moved to manage floating regimes and markets (EM) assets continued to rally through mid-March, some non-commodity exporters have also followed the reversing the losses of the first few weeks of 2016. The same path (Egypt, Turkey). After initial bouts of volatility EM bonds and FX indexes jumped to four-month highs and weakening, exchange rates in these countries appear in March, and EM stocks have turned positive for the year to be stabilizing. after falling as much as 11 percent in just the first three weeks of 2016 (Figure 2A). However, the recent rally in EM Commodity prices: seeking a floor amid abundant sup- assets contrasts with the current subdued outlook for EM plies. The weakness of commodity prices, especially energy, economies. Against the backdrop of persistent concerns persisted into early 2016 (Figure 2D). Oil prices rose from about EM growth, further volatility is to be expected. under $30/bbl in January to $37/bbl during the first half of March on improved sentiment fed by an uptick in China’s Capital flows: rebound. The rally in equity prices has been demand indicators, a weaker U.S. dollar, and supply out- accompanied by a rebound in capital inflows to emerging ages in a number of countries (Iraq, Nigeria, United Arab markets, which in March registered the first net inflows to Emirates). More importantly, December 2015 marked the EM bond and equity funds since December (Figure 2B). first reported year-on-year decline in U.S. oil production in However, a sustained recovery of inflows is likely to require more than four years (Figure 2E). Despite discussion among long-term improvements in economic fundamentals. After producers to freeze output at January levels, the price posting the slowest first two months in over five years, bond rally stalled as the market remains oversupplied with large issuance activity also picked up in March, as the persis- stocks, particularly in the United States. Crude oil stocks in tently low yield environment in advanced economies and the OECD as a whole reached a record high of 1.2 billion stabilization in commodity prices have pushed borrowing barrels in early 2016 (Figure 2F). Metal prices have also risen costs significantly lower (Figure 2C). However, the market from January lows on expectations of firming demand and environment is likely to remain volatile as rating momentum production cuts. Markets remain oversupplied with large in emerging markets continues to trend downward. stocks, however, and capacity continues to rise, especially for iron ore and copper. Agricultural prices continued their Exchange rates: strengthening. Emerging market curren- downward trend in early 2016, mainly due to ample supplies cies have rallied recently as stabilizing commodity prices that reflect surpluses accumulated during the past two sea- and a more dovish tone from the U.S. Federal Reserve sons, along with a balanced market in 2015–16. In addition boosted investor appetite for riskier assets. A gauge of to well-supplied markets, the weakness in agricultural prices 20 developing-country currencies against the dollar rose has been aided by lower energy prices (agriculture is an to a four-month high in mid-March, led by the Brazilian energy intensive sector) and the plateauing of demand for real and the Colombian peso. The index is up more than biofuels. Fears that El Niño could disrupt food supplies did 3 percent this year after plunging by more than 30 percent not materialize, apart from some local supply disruptions, during the past three years. Several commodity export- especially in Latin America and East Asia. ers (Azerbaijan, Kazakhstan, Russia) have devalued their Advanced Economies United States: mixed signals. Strong job gains continue rate rose to 63 percent, the highest since March 2014, while to accompany lackluster real GDP growth. Payroll employ- the unemployment rate rose marginally, to 5 percent, from ment increased 215,000 in March, following an upwardly 4.9 percent in February. High-frequency data point to mod- revised 245,000 gain in February. Net hiring during the first erate GDP growth in the first quarter, currently tracking at quarter averaged 209,000 per month, close to the robust job around 2 percent. Consumer spending started the year on growth of 229,000 per month during 2015. As more people a relatively subdued note, but a stabilization in industrial returned to the labor market, the labor force participation production in January-February and a pick-up in the PMI 4 GCC KNOWLEDGE SERIES: SHARING INNOVATIVE SOLUTIONS IN RAS BUSINESS FIGURE 2: Capital flows, oil prices, and other emerging market indicators A. Emerging markets financial assets B. Flows into EM bond and equity markets Index (Jan. 2 2015 =100) $ billion EM equities EM equities 115 EM bonds 5 EM bonds 110 EM FX 3 105 1 100 –1 95 –3 90 –5 85 –7 80 Jan-15 May-15 Sep-15 Jan-16 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 C. Emerging market bond spreads D. Commodity prices EM sovereign bond yields, percent US$ nominal, 2010=100 Agriculture 8 150 Energy Metals 130 110 7 90 70 6 50 30 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 5 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 E. U.S. oil production F. OECD crude oil stocks Year-over-year change, kb/d Million barrels 2000 1,200 OECD crude oil stocks 1500 5 year average 1000 1,100 500 0 1,000 –500 –1000 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 900 2007 2009 2011 2013 2015 Sources: World Bank, Haver Analytics, Bloomberg, International Energy Agency. A: The last observations are March 2016. B: The last observations are the week ending March 16, 2016. Weekly net inflows into EM equity and bond funds. C: The last observation is March 2016. D: Grain includes maize, wheat and rice. The latest observations are February, 2016. E: Shaded area (last 11 observations) are a forecast. F. The last observations are January 2016. EMERGING AND DEVELOPING ECONOMIES 5 in March suggest that conditions could be gradually bot- the influx of asylum seekers and the uncertainty surround- toming out in manufacturing. Conditions remain in place ing a referendum on the United Kingdom’s membership for a continued recovery, supported by resilient consumer in the European Union) could weigh on confidence in the spending amid improving labor market conditions. Core months ahead. inflation (excluding energy and food prices) has gradually increased recently. Japan: more weakness. After contracting by 1.1 percent in the final quarter of 2015, the economy showed further Euro Area: weak trade offsetting solid domestic demand. signs of weakness in early 2016. Surveys generally remain Growth for the fourth quarter of 2015 of 1.3 percent (q/q downbeat, with the manufacturing PMI dropping to a saar) was consistent with average growth for the full year nine-month low in March, and the service sector PMI fall- of 1.6 percent. Domestic demand for the fourth quarter ing to an eight-month low. Real consumption, domestic was solid, with consumer spending up 0.9 percent (q/q machinery orders and real exports, however, showed saar), government consumption up 2.2 percent (boosted some signs of stabilization at the start of 2016. Despite by refugee-related spending), and capital spending up weak and volatile growth, labor market conditions con- 5.4 percent (helped by mild weather). This was partly offset tinue to tighten against the backdrop of a shrinking and by sluggish export growth (0.9 percent during the second aging population. The unemployment rate declined fur- half of 2015) and robust import growth (4.3 percent). High- ther to 3.3 percent in February, the active job openings- frequency data for the first quarter of 2016 suggest mod- to-applicants ratio has risen steadily, and the perception estly strengthening activity in manufacturing and services of labor shortages has heightened to levels last seen in (industrial production growth rebounded to 2.8 percent 1992. Headline inflation continues to hover around zero, y/y, retail sales growth to 2 percent y/y in January, and and there are concerns that annual wage negotiations services PMI increased to 54 in March). Rising uncertainties may result in limited gains in base pay amidst persistently in recent months (including the terrorist attacks in Brussels, low inflation expectations. Emerging and Developing Economies Growth: softening. Growth in emerging and developing February, decelerating from 5.9 percent in December, economies (EMDEs) slowed in 2015 to 3.4 percent, the and manufacturing PMI has been below the expansion- weakest showing since 2009, and a pace well below the pre- ary level of 50 for the past year, at 49.7 in March. Retail crisis average. Both Brazil and the Russia are experiencing sales and fixed investment continue to grow robustly, deep contractions, above-target inflation, and deteriorating expanding at double digit rates in the first two months of public finances. The contraction in Russia is having substan- 2016 (even as domestic credit eased from January highs). tial spillovers for other countries in the region, especially While consumer price inflation accelerated to 2.3 percent in Central Asia and the Caucasus, through trade, remit- (y/y) in February, producer prices declined further, but tances, and capital flow channels. Falling activity in Brazil at a slower pace (Figure 3B). Efforts to move towards is expected to weigh on growth in other South American greater exchange rate flexibility and capital account lib- economies, including Argentina, Paraguay, Ecuador, and eralization continue to pose complex policy challenges. Peru. Growth in South Africa continues to be bottlenecked Foreign exchange reserves fell by $28.6 billion to $3.2 tril- by infrastructural challenges. India’s economic growth lion in February 2016, considerably less than the declines remains robust, although the outlook for 2016 is slightly less of around $100 billion in January and December, sug- optimistic than expected in January. An expected second gesting that capital outflows have moderated. year of contraction in Brazil and Russia in 2016 will help delay a meaningful recovery in growth in EMDEs until 2017. Oil exporters: under pressure. Many oil-exporting countries entered the oil price plunge with significant reserves and China: continued rebalancing. Indicators in the first two fiscal surpluses. The duration and magnitude of the price months of 2016 point to further slowing and rebalancing slump means these buffers are eroding rapidly, however. Key in China, calibrated by policy stimulus. Industrial produc- challenges include weakening current accounts (Azerbaijan, tion growth was 5.4 percent (y/y) in both January and Colombia, Kazakhstan, Russia) and depreciated exchange 6 GCC KNOWLEDGE SERIES: SHARING INNOVATIVE SOLUTIONS IN RAS BUSINESS FIGURE 3: Macroeconomic conditions in major advanced and emerging economies A. U.S. job creation and unemployment B. China’s consumer and producer prices Percent 1000s Percent, year-on-year 9 Non-farm payroll gains (RHS) 400 9 Producer price index Unemployment Rate 8 350 7 Consumer price index 7 300 5 6 3 250 5 1 200 4 –1 150 –3 3 2 100 –5 1 50 –7 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 0 0 2012 2013 2014 2015 2016 Source: World Bank, Haver Analytics. B. The last observations are February 2016. Data are seasonally adjusted. rates (Angola, Azerbaijan, Colombia, Kazakhstan, Nigeria, balances have improved among several oil importers Russia), which in some cases have been met with the impo- (Bangladesh, Egypt, India, Pakistan, Turkey), as budget- sition of foreign exchange controls (Azerbaijan, Nigeria). ary outlays on subsidies fall. In this context, several coun- Other challenges include accelerating inflation, tighter tries, both oil exporters and importers have sought to monetary policy (Colombia, Kazakhstan, Russia), falling eliminate or reduce fuel subsidies. government revenues, and tighter fiscal policy (Angola, Colombia, and to some extent Mexico). Weakened fiscal BRICS spillovers. Since 2010, a synchronous growth positions may be challenged further by oil price assumptions slowdown has been underway in emerging and devel- in 2016 budgets that exceed the $37 average projected oping economies, including in all of the largest ones oil price in the World Bank’s January 2016 Commodity (the BRICS—Brazil, Russia, India, China, South Africa) Markets Outlook. with the exception of India. Given their size and integra- tion with the global economy, a slowdown in the BRICS Oil importers: narrowing vulnerabilities, lagged ben- could have significant global spillovers through trade efits to growth. In oil importers, pressures on external and finance. Specifically, the World Bank’s January 2016 balances, inflation, and government budgets are easing. Global Economic Prospects finds that a 1 percentage The lower price of energy imports has helped narrow point decline in BRICS growth is associated with lower persistent trade deficits (Egypt, India, Turkey) and reduce growth in other emerging markets by 0.8 percentage stress on exchange rates. The pass through from lower point, in frontier markets by 1.5 percentage points, and oil prices has slowed inflation, and in many countries in the global economy by 0.4 percentage point over the provided the scope for monetary easing in support of following two years. faster growth, including in high income countries. Fiscal GCC Economies Reflecting high dependence of the oil sector for export growth in 2015 is estimated to have slowed, and in Kuwait’s and fiscal revenues, the sustained drop in oil prices under- case contracted, across the region (Figure 4B). way since mid-2014 has had profound impacts on Gulf Cooperation Council (GCC) economies (Figure 4A). GDP With fiscal breakeven oil prices well above current market prices (particularly in Bahrain, Oman, and Saudi Arabia), GCC ECONOMIES 7 FIGURE 4: Macroeconomic conditions in GCC economies A. Oil dependence, 2014 B. GDP growth Percent Government revenues Percent Goods exports 2013 2014 2015 100 6 90 80 4 70 60 50 2 40 30 0 20 10 0 –2 Bahrain Kuwait Oman Saudi Arabia UAE Qatar Bahrain Kuwait Oman Saudi Arabia UAE Qatar C. Government finances D. 5-year sovereign CDS spreads Revenue (LHS) $ billions Percent of GDP Basis points Expenditure (LHS) 160 Fiscal balance 30 450 Current 120 20 12-month low 80 12-month high 40 10 300 0 0 –40 –10 150 –80 –120 –20 –160 –30 0 2014 2015 2016e 2014 2015 2016e 2014 2015 2016e 2014 2015 2016e 2014 2015 2016e 2014 2015 2016e Saudi Arabia Bahrain UAE Qatar BHR KWT OMN QAT SAU ARE E. Foreign exchange reserves F. Gap between spot exchange rate and 12-month forward rate $ billions $ billions 100 2015H1 average 700 Points Bahraini dinar –14% 2015H2 average +11% 600 1800 Kuwaiti dinar 80 Latest month Omani riyal 500 1400 Qatari riyal 60 400 Saudi Arabian riyal 1000 –11% 300 UAE dirham 40 +26% 600 200 20 –5% 100 200 0 0 –200 1/2/2014 3/2/2014 5/2/2014 7/2/2014 9/2/2014 11/2/2014 1/2/2015 3/2/2015 5/2/2015 7/2/2015 9/2/2015 11/2/2015 1/2/2016 3/2/2016 Kuwait Oman UAE Saudi Arabia (RHS) Qatar Source: World Bank, IMF, Haver Analytics, Bloomberg. A: For 2015, growth rate is actual Saudi Arabia and estimates for other countries. B: e= expected. C: For Saudi Arabia, bars for revenue and expenditure show half of actual amounts. D: UAE reflects the simple average of spreads for Abu Dhabi and Dubai. For all countries, the last observation is March 30, 2016. E: Latest month is February 2016 for Kuwait, Qatar, and UAE; January 2016 for Saudi Arabia; and December 2015 for Oman. Percentages reflect difference between current level and average in the first half of 2015. 8 GCC KNOWLEDGE SERIES: SHARING INNOVATIVE SOLUTIONS IN RAS BUSINESS government finances in GCC countries have deteriorated resources have been used to help defend pegs (Figure 4E). rapidly. Fiscal deficits widened to double-digit levels in The risk of strong upward inflationary pressure following most countries in 2015, reflecting sharp revenue losses, large currency devaluation (consumer goods are largely although they are expected to recede modestly in 2016 with imported in GCC countries) will factor heavily into central procyclical budgets planned. Rebalancing in 2016 will come banks’ decisions about exchange rate regime. Markets predominantly through planned or already-implemented have in recent months increasingly expected policymakers reductions in spending on infrastructure projects, fuel and to defend their pegs for the time being, as reflected in a utility subsidies, and government wage obligations (Figure declining gap between spot and forward exchange rates, 4C). A GCC-wide agreement to implement a value-added following a spike at in early 2016 (Figure 4F). Maintaining tax of an expected 5 percent at the start of 2018 was fixed exchange rates implies that interest rates will likely be announced in March. Further consolidation is expected adjusted with shifts in U.S. monetary policy, as suggested in the medium term given that oil prices are expected to by the rate increases in Bahrain, Kuwait, and the United recover only gradually. Arab Emirates that followed the December hike by the U.S. Federal Reserve. Increasing pressure on government finances was reflected in sovereign rating downgrades in early 2016 for Bahrain, With fiscal austerity underway and the oil price outlook Oman, and Saudi Arabia and a spike in sovereign credit lower for 2016 than for 2015, growth will likely slow in GCC default swap (CDS) spreads. Although spreads have since countries this year. Although still above the threshold of receded, they remain high versus levels of the past 12 50, composite (manufacturing and services) PMI in Saudi months in Saudi Arabia and Bahrain (Figure 4D). Large Arabia and the United Arab Emirates has been broadly buffers in the form of foreign exchange reserves and declining for the past 18 months, reaching an all-time low sovereign wealth funds in most countries continue to in Saudi Arabia (since surveys began in August 2009) of provide a considerable amount of cushion for public 53.9 in January. Slowing growth in GCC countries stands finances, however. to generate negative spillovers for oil-importing coun- tries in the Middle East and North Africa through trade, Together, the plunge in oil prices and an appreciating U.S. investment, and remittances channels. Indeed, growth in dollar have raised concerns about the sustainability of oil-importing countries in the region is expected to weaken long-standing currency pegs.1 Declining foreign exchange in 2016, although there are also domestic challenges at reserves in Saudi Arabia, Oman, and Qatar reflect that these work in these countries. 1 Kuwait pegs to an undisclosed basket of currencies, while all other GCC countries maintain conventional pegs against the U.S. dollar. MIDDLE EAST AND NORTH AFRICA REGION GCC COUNTRY UNIT GCC Knowledge Note: Global Economic Trends