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    Return to a stable Economy for the GCC will take time

    February 2021

    The pandemic dealt a severe blow to the economies of the Gulf due to the collapse of the local tourist industry and all the associated hospitality, travel, entertainment businesses subject to social distancing or even closures.

    With the arrival of several vaccines at the close of last year, what are the prospects for 2021? In my view the outlook depends on the evolution of several main factors: progress in dealing with the virus, the growth of money and credit beyond that and most important for the Gulf states, the outlook for the oil market.

    The rollout of vaccines to a sufficient proportion of the world population to enable consumers and businesses to return to a certain level of normality will probably take at least until the third quarter of this year – and possibly far longer for some countries. As they usually do, financial markets have moved ahead of events – in this case the successful production and widespread distribution of multiple vaccines – with the Dow Jones Industrial Average and other key indices surging to new highs.

    But even as global markets react positively to vaccine-related news, investors sentiment in the GCC remains cautiously optimistic of how quick economies in the region can recover to pre-pandemic levels, even after the reconciliation between Saudi Arabia and Qatar, which could see GCC relations restored. GCC equity markets underperformed their global peers and witnessed mixed performances across individual stock exchanges in the region for the most part of 2020.

    The MSCI GCC Index reported yearly decline for the first time in five years, hurt predominantly by the entire region imposing COVID-19 restrictions with an expected 2.7% decline in GDP rates for the GCC region, as per the International Monetary Fund (IMF).

    Recovery from this recession in the GCC is expected to be slower and more uneven this year as compared to developed economies, despite the positive news on COVID-19 vaccines. We have to recognize that governments in the oil producing GCC were constrained in their ability to provide additional fiscal support by the sharp decline in oil revenues as a result of the pandemic. The fact also that there is largely a “tax-free” regime in place makes it a very different model to most other economies where government revenue is largely derived from taxes. The extent of monetary and fiscal support to economies undergoing waves of the pandemic is critical in ensuring a rapid bounce-back once the virus subsides in important economic sectors. In the developed economies, the financial support from governments to firms and individuals required to suspend their normal economic activity has been quite astonishing in scale and speed of delivery.

    Saudi Arabia’s cumulative spending in the year to September 2020 was 3.4% lower than in the same period In 2019, when in contrast, the US’s spending rose 50% in the second quarter of 2020. With only a modest rebound in oil prices expected in 2021, most governments in the GCC region will in my opinion for 2021 and 2022 likely prioritized deficit reduction over growth.

    Saudi Arabia has already hiked VAT to 15% from 5% previously, and increased customs duties on a range of goods, including food items to boost government revenues. This move has led to inflation acceleration of 6.1% in July 2020, compared to 2019, when the tax increase came into effect.

    Many emerging economies have not been able to provide as much support to their economies since their debt markets do not have the capacity of their developed economy counterparts. Also, the data on the fiscal side is hard to assess because government programs have consisted of a whole range of grants, loans, tax determents, rental holidays and loan guarantees – actual and contingent expenditures that may or may not ultimately be a burden on the state.

    It is much easier to assess the support on the monetary side. The most straightforward way to measure the stimulus is to look not at the declines in interest rates, but at the rates of growth of broad measures of money and credit.

    In the US, for example, ML has grown by an extraordinary 23% over its level a year ago – the highest growth rate in US peacetime history – thanks to the Fed’s asset purchase an loan programs. Normillay nominal GDP – GDP in current prices – grows at a rate that is close to the average annual broad money growth over the previous two years.

    However, on this occasion although the injection of money was very large, it was also very brief – between March and July 2020. Since then it has returned to a more normal growth rate of 5-10% per annum.

    This implies that over two years the net boost to current spending in the US will be much more modest than the 23% figures suggest, perhaps in the region of around 12%. Nevertheless, this suggests a stronger recovery in the second-half of 2021.

    Applying these considerations to the GCC I find that broad money growth is around 10% per annum, but credit to the private sector has grown much more slowly at around 3-4%, both very much less vigorous than they were prior to the global financial crisis of 2008 – 2009.

    With the domestic boost to activity from money and credit remaining subdued, the recovery in the Gulf area in 2021 will be highly dependent on external factors such as tourism and the recovery of the airline business.

    The most important factor is the oil market – 2020 has been a tumultuous year for oil. Prices began last year by drifting lower, driven primarily by recessionary worries, trade anxieties, and excess supply stemming from LNG production in the US.

    The pandemic arguably has its largest effect on consumer spending and aggregate demand, to which the oil market is highly sensitive. Consequently, when it became opponent that COVID-19 would spread globally oil prices plunged.

    Incredibly, due to logistical constraints in storing a large supply of oil and severely suppressed demand, oil futures contracts turned negative on April 20, 2020, over the course of the day. To see a further healthy upswing (not through output cuts by OPEC +) in oil prices will require that key economies return to roughly normal growth rates and consumers to something close to previous lifestyles, raising the demand for oil.

    In sum, with an expected oil price of around 50 US dollar for 2021, these factors imply that the economic recovery in the Gulf area in 2021 will be most probably a modest one, still constrained by the hangover of the pandemic, rather low credit growth and a slow recovery in the oil market.