COVID-19 impact: GCC faces biggest economic challenge in history

Dubai: Shocked by COVID-19 and the plunge in oil prices, the six GCC states will experience their biggest economic challenge in history in 2020, according to the Institute of International Finance (IIF).

“Restrictive containment measures and fear of contagion has weakened consumer confidence and demand. The depth of the contraction for this year and the speed of the expected recovery in 2021 is subject to a high degree of uncertainty,” said Garbis Iradian, Chief Economist, Middle East & North Africa, IIF.

While there are some reports partial containment of virus outbreak in the region, latest Purchasing Managers’ Index (PMI) for the UAE, Saudi Arabia and Egypt indicate as these economies relax COVID-19-related lockdown, businesses are picking up. However, analysts said economies will remain in contraction this year.

“We expect overall real GDP to contract by 4.4 per cent in 2020. Oil GDP is projected to contract by 5.3 per cent due to the OPEC+ production-cut agreement. The non-oil GDP could contract by 3.8 per cent due to virus-containment measures, the plunge in oil prices, and lower public spending,” said Iradian.

Recovery in 2021

While the service sector activity will be hit the hardest due to containment efforts and social distancing, private and public investments will be delayed. Growth could resume in 2021 supported by the partial easing in oil production cuts and gradual pick-up in private sector non-oil activity.

GCC authorities have resumed fiscal adjustments despite the recession. Wide range of measures such as cuts in public spending, slashing salaries of government employee and tripling of value added tax in Saudi Arabia, postponing of VAT in Kuwait and Qatar. The belt tightening across GCC are expected to offset part of the revenue losses from oil production cuts.

Fiscal deficit

The IIF expects the aggregate fiscal deficit of the GCC to widen from 2.5 per cent in 2019 to 10.3 per cent of GDP in 2020, equivalent to $144 billion, assuming an average Brent oil price of $40 per barrel.

“We project a decline in hydrocarbon revenue from $326 billion in 2019 to $200 billion in 2020. Saudi Arabia, Kuwait, Qatar, and the UAE, with large public foreign assets, are better placed to accommodate large deficits than Bahrain and Oman,” said Iradian.

Foreign assets

Lower hydrocarbon exports will also weigh on the external current account, which the IIF expects to shift from a surplus of $88 billion in 2019 to a deficit of $33 billion in 2020 despite the projected 15 per cent fall in imports. Capital outflows from the GCC, while moderating, will continue to exceed nonresident capital inflows. As a result, the GCC’s consolidated official reserves will fall by $133 billion in 2020.

The gross public foreign assets of the GCC to remain substantial at around $2.6 trillion, about 70 per cent of which is managed by Sovereign Wealth Funds (SWFs) with diversified portfolios of public equities, fixed income securities, and shares in global companies.

Monetary easing

Lowering of rates and financial support to private sector are expected ease the pain in short term. Key policy rates have been reduced by 125 bps across most of the region. The authorities have also introduced liquidity support measures amounting to 4 per cent of GDP (about $54 billion) to help alleviate stress in the financial system and support the private sector, particularly SMEs.The central banks have set up mechanisms to encourage commercial banks to postpone private sector loan repayments for six months.

The banking systems remain sound, with strong capitalisation, adequate liquidity, and relatively low NPLs. Nonetheless, prolonged low oil prices could lead to deterioration in the asset quality of banks in the region.

The IIF do not expect a change in the exchange rate regimes in the short term.

“Indeed, the plunge in oil prices has led to no significant pressure on the peg to the dollar, reflecting investor confidence underpinned by large GCC public foreign currency assets,” said Iradian.