Market analysis: Cautious optimism for year ahead

Relatively healthy non-oil sectors and the commitment to ambitious infrastructure projects should provide some grounds for optimism that a steady pace of growth in the GCC can be maintained. Kamran JeShow more

Although 2016 will begin with the usual degree of apprehension, there is a little more certainty about some of the key issues facing the world and the region. This provides some confidence that 2016 could actually be a year of progress despite headlines again being dominated by risks.

In particular, with the path of US interest rates this year looking more certain and “lift-off” now behind us, the question becomes how much the Federal Reserve will raise rates instead of whether it will.

The fact that the era of zero rates is behind it may well create confidence in the US economy, but it might also translate into better overseas activity, too, as uncertainty is reduced, especially with euro-zone crises also diminished.

Markets are now likely to find an anchor in accommodative monetary policy in other parts of the world and from recovering US-led global economic growth.

This year is still expected to be a challenging one in the GCC, with low oil prices, uncertain geopolitics and higher US rates weighing on the macroeconomic outlook.

A halving of oil revenue since 2014 is likely to lead to a more cautious approach to spending by governments, with some countries, such as Saudi Arabia, already announcing spending cuts for this year. Moreover, measures to boost non-oil revenues, such as a value added tax or corporate income tax, may also be announced next year, although implementation is unlikely before 2018.

With governments in the region needing to borrow more to fund expenditure, some businesses may find it more difficult, and more expensive, to obtain credit, particularly as the costs of bank funding rises. Higher US interest rates will also feed through to increased borrowing costs in the region. Against this background, it is unsurprising that businesses might be wary.

Regional outlook

Nevertheless, there are several reasons to remain cautiously optimistic about the GCC, and the UAE in particular. The resilience of the UAE’s and Saudi Arabia’s non-oil sectors last year bodes well for this year. Oil production is expected to remain elevated, despite the price outlook, underpinning activity in the manufacturing sector in particular. Fiscal reserves accumulated over the past decade will allow governments in the region to manage the pace of fiscal consolidation in a measured way. The UAE and Qatar have committed to ambitious infrastructure projects, which must be delivered by 2020 and 2022 – in time for the Expo and Fifa World Cup – respectively, which will continue to underpin growth and activity in the non-oil sectors.

Outside of the GCC, it is setting up to be another year of below-trend growth for most of the Middle East’s smaller oil importing economies. Continuing conflicts in Libya and Syria are likely to have negative spillovers for into neighbouring countries, which are all struggling to restore investor confidence and boost moribund tourism industries. While these economies can theoretically benefit in an environment of weaker global commodity prices, they are also likely to suffer to the extent that lower oil prices begin to curtail aid, investment and remittances from the Arabian Gulf.

Fortunately, as these economies tend to have limited reliance on short-term portfolio flows, they will be somewhat insulated from any market turmoil that might hit other emerging markets around the world caused by rising interest rates in the US, while financial support from institutions such as the IMF will help cover their external financing requirements. For the oil exporters, there is likely to be a sharp slowdown in growth through the year, including Iraq and Algeria, as governments slash public spending to rein in ballooning budget deficits.

Most attention, however, is likely to be focused on Iran, as a potential lifting of international sanctions in the first quarter paves the way for the country’s reintegration into the global economy.

Commodities

After a brutal year in commodities markets, it might be thought that they should be in a position to improve next year. However, there are several major headwinds that could disrupt markets for a while.

The dominant factor is oversupply. The overarching reason behind the collapse in oil, metals and agricultural prices last year is simply that there is too much of nearly everything. The oil market oversupply will narrow but not disappear as major Opec members produce crude oil at elevated levels to preserve market share, all while demand expands at only a muted pace.

There is also the prospect of Iran potentially returning to oil markets, worsening the glut. This situation is being mirrored nearly exactly in iron ore, steel, copper and aluminium, albeit with China exerting an even greater influence on the surplus conditions.

Currencies

The trajectory of the US dollar will also affect the path of commodities next year. The strong performance of the dollar last year helped to worsen the fundamentals-led slide in commodity prices and further gains next year will act as a brake on any rallies in commodity markets.

However, with the pace of dollar appreciation likely to be less pronounced than that of the past two years, this may provide the basis for the correlation between commodities and the dollar to weaken a little. While the euro-dollar exchange is still expected to fall below parity in the coming year as monetary policies between the US and euro zone diverge, the relationship between the dollar and commodities can be different during rate rising cycles.

In particular, with US rate rises being driven by economic strength, this could be viewed as a force for a more constructive commodity price trajectory. So while the performance of the dollar may have a bearish effect on the commodity prices in the short term, fundamentals should begin to exert a greater positive influence further out.

The year begins with a number of challenges, many inherited from previous years that remain unresolved. The Fed’s December rate hike shows us, however, that progress is finally being made with some of the intractable legacies of the financial markets crisis of 2008/09, and at least 2016 begins without the threat of an imminent euro-zone break-up.

The GCC faces many of the same issues that dominated throughout last year, particularly in relation to oil prices, requiring fiscal consolidation. However, relatively healthy non-oil sectors and the commitment to ambitious infrastructure projects should provide some grounds for optimism that a steady pace of growth can be maintained.

Tim Fox is the group head of research and chief economist at Emirates NBD.

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