A measured approach to far-reaching economic reforms

In February, oil prices continued to fall as news that a number of Opec oil ministers recommended freezing production at already-elevated January levels dashed hopes of a more serious effort to curb oversupply. Oversupply issues in the US, with inventories approaching full capacity, continued to drive a widening of the pricing differential between Brent crude (-0.7 per cent in February) and WTI (-4.3 per cent in February).

In line with a weaker dollar, the rise in risk aversion and flight to safety, the price of gold rose by 10.7 per cent.

In contrast to global trends, equity markets in the MENA region performed well in February, with the S&P Pan Arab Index up 4.01 per cent for the month and most major markets recording gains.

The strongest performing market by far was the UAE, which surged by a spectacular 9.6 per cent. Rather than any market-specific news, much of the strong performance was driven by a recovery from very low levels, supported largely by local investors and by a partial return of foreign investors.

Most heavyweight stocks posted gains in the mid- to high teens. The purchasing managers’ index (PMI) for the UAE fell to 52.7 in January, from 53.3 in December and 59 in January 2015, largely due to a slowdown in manufacturing.

Loan growth also slowed from 7.8 per cent in December to 7.4 per cent in January. The International Monetary Fund cut its 2016 growth forecast for the UAE economy from 3 per cent to 2.5 per cent. In other positive news, ratings agency Standard and Poor’s (S&P) affirmed Abu Dhabi’s rating at AA with a stable outlook.

Saudi Arabia’s market rose 2.2 per cent over the month. Foreign participation continued to drop, reaching 0.97 per cent in February, down from 1.18 per cent in May 2015 when the market first opened up to foreign investors. Foreign investment has been slow in part due to regulatory issues, which are now being addressed.

As such, the exchange believes that the inclusion in the MSCI Emerging Markets Index may be further off than previously expected, likely in 2018.

The government passed several regulations to boost the economy, increasing the ceiling of banks’ loan-to-deposit ratio from 85 per cent to 90 per cent and the loan-to-value for home mortgages from 70 per cent to 85 per cent. Credit growth in January increased by 9.1 per cent year-over-year while deposit growth rose 3.4 per cent.

Although the PMI dropped from 54.4 in December to 53.9 in January, a number above 50 still indicates expansion. Meanwhile, S&P downgraded the sovereign rating of Saudi Arabia to A-.

Kuwait’s market gained a modest 1.9% in February. S&P affirmed Kuwait’s sovereign rating at AA, citing the ample reserves. The country announced plans to raise its crude oil production capacity from 3 million barrels per day (bpd) to 3.15 million bpd by the third quarter of 2016, with the goal to reach production of 4 million bpd by 2020.

Kuwait Petroleum Corporation plans to sell all of its loss-making assets, which should help improve its finances. After another round of discussions, the National Assembly and the government decided on further subsidy cuts, especially for fuel and electricity, with petrol prices set to increase anywhere between 42 per cent and 83 per cent, depending on the type and grade of fuel.

Credit growth was strong in 2015, with system lending up 8 per cent, beating expectations.

The market in Qatar also performed well, rising 5.6 per cent over the month. FIFA confirmed plans to hold the World Cup in 2022 was welcome news to Qatar, which has already undertaken significant spending related to the event. The government increased gasoline prices as part of reform measures to shore up the deficit, and announced plans to issue a sukuk in March-April 2016 in further efforts towards this end.

Oman’s central bank confirmed its commitment to keep the rial’s peg to the dollar. Meanwhile, the government continued its efforts to finance the deficit, announcing plans to issue $5 billion to $10 billion of debt and cut select benefits for employees at state-owned institutions.

In addition, the Ministry of Communications started the process to sell a license for a third mobile operator, which will also generate funds to reduce the deficit. In addition to health and succession concerns for the Sultan, another factor weighing on sentiment was S&P’s decision to downgrade Oman’s sovereign rating to BBB-.

We continue to remain somewhat cautious about the outlook for the global economy. We are monitoring the impact of the significant reform measures announced in the budgets of many Gulf countries, especially the impact on the costs and earnings of corporations.

Overall, we are reassured by the serious commitment and proactive approach taken by these countries in recognising the need to reform, reduce deficits and accommodate for low oil prices. These measures have removed uncertainty regarding the deficits and drag on foreign exchange reserves that market participants were worried about in the aftermath of the drop in oil prices.

While these measures are considerable enough to ensure that reserves will not be substantially depleted if oil prices stay under pressure, governments have been careful that the measures are also reasonable enough to not have a dramatically negative impact on economic growth or consumer demand.

The writer is CIO, MENA Equity, Franklin Templeton.