Gulf countries are in a tight spot. At a time when increased government spending is needed to offset the negative impact of coronavirus, Saudi Arabia has forced oil prices down to $30 a barrel.
For those with strong enough economies, part of the answer to the question 'where will governments find the money to survive?' might be on international markets.
Gulf authorities have announced a swathe of spending cuts in an effort to rebalance budgets this year, but with coronavirus hitting supply chains and inward investment, a fiscal response is now required. That means raiding reserves and increasing deficits to start with.
Saudi Arabia’s move to increase oil production may bring it more revenue – though that is by no means certain – despite or because of the lower price per barrel and allowing it to finance its own response to the virus, but it has made things more difficult for weaker oil exporters.
They will increase their deficit and borrow money and use their cash reserves. Issuing sovereign bonds is very important. They will have a yield curve and markets will mature. It will be a good thing- Ryan Lemand, ADSI
Indeed, Saudi Arabia also has the cushions of large FX reserves and low debt-to-GDP ratios that should allow it to spend its way out of trouble.
For others, however, such as Oman, which is already struggling, the impacts of low oil prices and the coronavirus could be much more difficult to deal with.
The economic effect of Covid-19 will likely reduce global demand for oil and will have a dampening effect on the Gulf’s fledging non-oil sectors, stalling many of the Gulf states’ transformation agendas.
“On its own, [coronavirus] is a very serious financial and economic risk,” says Ryan Lemand, senior executive officer of ADS Investment Solutions (ADSI) and the global head of wealth management at ADSS, an Abu Dhabi-based financial services firm. “We have underestimated it initially. It has serious consequences on the supply chain globally.”
With sustained low oil prices, and the spread of coronavirus, a recession in the Gulf is likely.
Countries face a choice: either cut spending as previously planned and see growth fall even further, or absorb the shock on the balance sheet and run a wider deficit.
The UAE has responded with some limited measures to protect liquidity in the banking sector.
“They have reduced day-to-day funding, but this is not enough,” says Elyas Algaseer, co-head of MUFG’s DIFC branch and head of corporate banking MENA. “At the moment, point-of-sale transactions are drying up. Consumption is negligible and people are in their houses.
“The government will have to do more. They need to find solutions for existing companies to keep pumping money into the cycle, and through rescuing these companies to pay all the wages.”
Saudi Arabia and United Arab Emirates, whose currencies are pegged to the dollar, have both followed the US Fed’s decision to lower rates by 50 basis points.
Kuwait, whose currency is pegged to a basket of currencies, has cut rates by 25bp.
They have reduced day-to-day funding, but this is not enough. They need to find solutions for existing companies to keep pumping money into the cycle, and through rescuing these companies to pay all the wages- Elyas Algaseer, MUFG
However, bankers say that looser monetary policy is not enough to stimulate growth. As in the rest of the world, a fiscal response is also required.
“They will have some serious fiscal packages to put in place to stimulate economic activity,” says ADSI's Lemand.
Much of the Gulf may have low debt-to-GDP levels, but the recent sharp fall in oil prices is expected to hit reserves.
The cumulative current-account balance for the nine MENA oil exporters will shift from a surplus of $64 billion in 2019 to a deficit of $104 billion in 2020, according to the Institute of International Finance, assuming oil averages at $44 a barrel.
The IIF sees the weighted average fiscal deficit for the region widening further from 3.4% of GDP in 2019 and 8.1% in 2020, and expects weighted average non-oil real GDP growth to slow to 0.4% in 2020 from 2% in 2019.
Should oil remain closer to $30, Saudi’s fiscal deficit would widen to 18.6% of GDP for 2020 from 4.6% last year. Economists say that would raise government debt to 40% of GDP this year from 23% in 2019.
Investment flows into the country will also slow.
Saudi leaders have marked economic diversification as essential to growth, but lower inward investment and falling private sector confidence would hamper that. The IIF has slashed Saudi’s non-oil sector growth to 1.4% in 2020 from 3% in 2019.
The UAE, the most diversified of Gulf economies, will suffer.
“We saw signs of economic weakening in the UAE before the coronavirus, so lower oil prices add to the problem,” says Garbis Iradian, chief economist for MENA at the IIF. “In the UAE, Dubai’s economy could contract by at least 1.5%, while Abu Dhabi’s non-oil economy could stagnate.”
Standard Chartered thinks poor non-oil growth will force some economies, such as Saudi Arabia, to defer spending cuts budgeted for 2020.
Before oil price cuts were accounted for, the bank had recently cut its year-on-year GDP growth expectations for Gulf countries, lowering Saudi’s to 1% from 2.3% and the UAE’s to 1.1% from 2.1%.
StanChart sees only limited room to increase fiscal spending because of lower hydrocarbon revenues and rising public debt, thanks to six years of subdued global oil prices.
“They won’t increase spending that much,” he says. “A significant increase in spending would exacerbate the fiscal deficit, so I don’t think we will see much.”
Despite volatile markets, and a likely higher cost of borrowing, bankers say Gulf countries will now need to come to the international markets.
“They will increase their deficit and borrow money and use their cash reserves,” says Lemand. “It is the text-book approach to an economic slowdown. Issuing sovereign bonds is very important. They will have a yield curve, which we don’t have today, and markets will mature. It will be a good thing.”
Greater sales of higher-risk assets has seen spreads widen on Gulf Eurobonds, though Saudi Arabia’s have outperformed their riskier counter-parts.
The yield on Saudi dollar 2030s rose from around 1.18% in early February to 3.17% on Thursday March 12, with a spread of 250bp over Treasuries. Over the same time period, the spread on Oman’s 2029 dollar bonds widened from around 350bp to 400bp, to 900bp or a yield of around 9%.
Despite volatility in the market, a London-based syndicate banker tells Euromoney there would be investor appetite for higher-quality Gulf bonds, providing the issuer chooses the right window and is realistic on terms.
“There’s no time for stretched-out executions, and they need to be more pragmatic on price than they normally would be, but they would have [market] access,” he says, before qualifying, “Oman probably wouldn’t.”
Governments will be calling in favours from their relationship banks. Japanese and more recently Chinese banks are regular lenders to the Gulf.
The banker says that he is seeing requests for bridge to bond loans.
“We’re very active in the region, and I wouldn’t be surprised to see our [lending] appetite tested.”