MENA: Brexit impact on MENA will be limited
August 3, 2016
While stock markets in the region declined markedly in the aftermath of the Brexit vote, they recovered strongly in July. The impact of the United Kingdom’s exit from the European Union is expected to be relatively limited in the Middle East and North Africa (MENA) yet shockwaves will reverberate mainly via secondary channels.
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While trade links between MENA and the UK are relatively small (the UK accounts for around 1.7% of total shipments from MENA), the effects on the region from the trade channel should be related to the impact of Brexit on growth in the European Union as the bloc accounts for around 12% of total exports from MENA. That said, the impact will be uneven. The exposure of Egypt and Israel to the UK is comparatively high, while the economies of Algeria, Morocco and Tunisia are highly linked to the European Union. Conversely, trade ties between Europe and most Middle Eastern countries are relatively weak.
MENA economies have become increasingly dependent on foreign borrowing since oil revenues began to fall. Therefore, rising volatility in the financial markets due to mounting economic and political uncertainty will have an impact on borrowing conditions. This situation may also delay international bond issuances in the region as appetite for riskier assets will diminish in the wake of rising risk aversion. On the flip side, a cloudy global outlook has the potential to force the United States Federal Reserve to postpone its tightening cycle, thereby improving liquidity and financing conditions in the region
Another significant contagion channel will be through heightened volatility in the oil market. The possibility of a significant slowdown in the European Union will add downward pressure on oil prices due to reduced demand from one of the world’s key crude importers. Moreover, uncertainty will hasten investors to flee to safe-haven holdings including the U.S. dollar and other commodities such as gold. This move will exert further downward pressure on crude prices.
Despite the relatively weak economic links between the region and the United Kingdom, spillovers from Brexit will be felt through the aforementioned channels. A disorderly UK exit from the EU has the potential to exacerbate the negative consequences of the break-up. Therefore, the key factor is how the negotiation process between the EU and the UK will evolve and what the final terms of the agreement are.
Oil market volatility threatens MENA’s growth
Weak global demand, spillovers from the low oil price environment and challenging domestic conditions continued to weigh on economic activity in the Middle East and North Africa (MENA) at the outset of the year, though some tentative signs of improvement have since emerged. According to a more complete set of data, GDP for the region expanded 2.0% annually in Q1, which matched the result tallied in Q4. Although GDP figures for Q2 are not yet available in the region, the gradual recovery in oil prices observed from April to June may have supported growth among oil-export-driven nations. Moreover, strong growth in the United States and still positive dynamics in the Euro area bode well for the region’s external sector.
While economic activity likely improved in Q2, other developments are still clouding the region’s outlook. The consequences of the United Kingdom’s decision to leave the European Union are expected to be limited due to the weak links between the region and the island, though contagion will still stem from secondary channels. Shockwaves will be felt from the financial sector as some countries rely increasingly on external borrowing. Oil market volatility is expected to weigh on oil prices, along with the possibility of reduced demand for black gold in Europe. Nevertheless, the Fed’s intention to postpone its tightening cycle will reduce the pressure on the region’s financial and exchange rate markets.
Although oil prices recovered in the first half of the year from January’s multi-year low, Brexit and fears of oversupply halted the rally. Uncertainty following the referendum in the UK strengthened the U.S. dollar and diverted investments to safe-haven assets. New signs have since suggested that the international crude markets remain overloaded and that the global oil glut is likely to take longer than expected to clear. These factors will exert downward pressure on prices in the second half of the year.
Mounting political uncertainty in Turkey following July’s failed military coup has sparked concerns about a possible impact on the MENA region’s growth due to its geographical proximity, though this is expected to be limited since trade ties between the region and Turkey are small. Only Egypt and Iran have a significant export quota to Turkey. On the investment side, flows from Turkey to the region are also minor.
MENA's 2016 growth prospects stabilize following last month’s downgrade
While the effects of Brexit will be limited, the region faces other sources of uncertainty. If the decline in oil prices continues, it could exacerbate existing macroeconomic imbalances. Although geopolitical risks appear to be receding—as the successful battle against the Islamic State in Iraq and Syria could led to the collapse of the Islamic State of Iraq and the Levant —militants are launching waves of terrorist attacks around the globe, particularly in the region, which are weighing on economic growth. Against this backdrop, our panel of analysts has adopted a wait-and-see approach and kept the 2016 growth projections for the region stable at last month’s 2.3%. If confirmed, this will represent the weakest growth rate since the height of the financial crisis in 2009. For 2017, growth in the region is expected to accelerate to 3.0%.
The stable outlook for this month’s 2016 MENA growth forecast reflects unchanged projections for 7 of the 16 countries in the region, including Iran, Saudi Arabia and the United Arab Emirates. The panel cut the estimates for Egypt, Israel, Qatar and five other countries. Algeria was the sole country for which the panel upgraded its forecast for the economy.
Iran and Qatar are expected to be the best performers in 2016. At the other end of the spectrum, Saudi Arabia and Lebanon are expected to perform poorly, and Yemen, which is entangled in a bloody civil war, will be the worst performer by far. Among the rest of the major economies in the region, Egypt and Israel will likely grow the fastest, with projected expansions of 3.1% and 2.6%, respectively.
SAUDI ARABIA | Growth remains subdued in Q2 despite higher crude prices
The economy slowed to a three-year low in Q1, due to a combination of austerity measures designed to rein in the Kingdom’s fiscal deficit and a negative base from one-off spending measures stemming from the coronation of the new king in January 2015. While more recent data suggest that growth remained relatively subdued in Q2 in the non-oil sector, the economy benefited from higher crude prices and stronger production. However, recent volatility in the international oil markets due to Brexit spillovers and concerns about oversupply have the potential to weigh on growth going forward. Other than that, the impact of Brexit on the Saudi economy will be minimal due to its limited exposure to the UK and the Eurozone.
While low oil prices will continue to dampen growth and increase the country’s massive fiscal deficit, Saudi Arabia has ample fiscal and financial buffers to weather the storm. In the longer term, if Saudi Vision 2030—the government’s economic diversification plan to reduce dependence on oil—is successfully implemented, it could boost the Kingdom’s potential for growth. FocusEconomics Consensus Forecast panelists forecast that the economy will expand 1.0% in 2016, which is unchanged from last month's projection. In 2017, the panel sees the economy growing 1.7%.
UAE | IMF praises UAE efforts to rein in fiscal deficit
The UAE’s economy has continued to fare relatively well this year despite comparatively low oil prices and the adverse external environment, thanks in large part to its being diversified. Nevertheless, the slowdown has strained the public purse. The IMF’s Article IV review of the Emirati economy, which was concluded in July, focused on the government’s chosen fiscal strategy in the low-oil-price environment. The Fund welcomed the steps taken to address the budget shortfall, but cautioned against steeper consolidation in the near term in order to preserve growth and recommended that further fiscal tightening should be implemented the medium term. Looking at short-term economic indicators, the PMI signaled expansion in June, although it remained below its long-term trend, which was in large part due to the earlier start of Ramadan this year.
The gradual improvement in oil prices should alleviate some of the pressure on growth. So too will large-scale investments in the run-up to Expo 2020, which are expected to start materializing this year and will help to continue diversifying the economy. FocusEconomics Consensus Forecast panelists expect that the economy will grow 2.4% this year, which is unchanged from last month's projection. Next year, the panel expects GDP growth to accelerate to 2.9%.
EGYPT | EGP drop in parallel market suggests another currency devaluation is on the horizon
An acute shortage of U.S. dollars is taking its toll on Egypt’s economic activity and is restricting vital imports. Expectations that March’s 13% devaluation of the Egyptian pound would alleviate the dollar crunch were short-lived and a widening gap between the official and black market exchange rates suggests that another devaluation will be needed to resolve the liquidity shortage. PMI readings underline the view that economic performance was subdued from January to June as the indicator remained in contractionary territory during this period, with survey respondents often mentioning the dollar shortage as the main hurdle for business activity. That said, Egypt’s recent announcement that it was close to reaching an agreement with the IMF over a three-year conditional credit line sparked hopes that the deal could help ease the foreign currency shortage, restore confidence and oblige Egypt to implement its economic reform plans, which include the long-delayed introduction of a Value-Added Tax (VAT).
The economic outlook is clouded by the acute dollar crunch, weak fiscal accounts and political instability. Downside risks to Egypt’s GDP growth increased with the UK’s Brexit vote as the two countries have relevant trade and investment connections. Our panelists expect GDP to have expanded 3.1% in FY 2016 and forecast growth of 3.7% in FY 2017.
ISRAEL | Parliament passes two-year budget to assure political stability
Israel’s economy decelerated in Q1 due to depressed external demand and a strong currency. Conversely, domestic demand supported overall growth and both private consumption and fixed investment recorded expansions. More recent indicators show that economic activity likely gained strength in the second quarter. In June, business confidence improved notably and exports contracted at the softest rate in five months. Last month, the Knesset approved a two-year budget for 2017 and 2018 following lengthy negotiations between the opposition and coalition parties. The two-year budget structure was proposed by Prime Minister Benjamin Netanyahu in order to minimize the odds of potential disagreements among political parties over the government’s proposed fiscal policies and thus avoid early elections before they are due in 2019. The government has also set aside funds that will serve as a safety cushion if the fiscal deficit grows faster than expected or in the event of unexpected economic developments in the next two years.
The economy is expected to accelerate marginally this year. However, external risks from a slow recovery in global demand are weighing on the country’s economic outlook. FocusEconomics panelists expect the economy to grow 2.6% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, the panel forecasts that GDP will expand 3.1%.
INFLATION | Inflation stabilizes at high levels in June
Inflation in the Middle East and North Africa region stabilized at last month’s 4.2% in June, thereby remaining at the highest point since September 2015. The print mainly reflected higher inflation in Algeria and Egypt, which was compensated by lower prices in Iran and Iraq. The increase in commodities prices is gradually feeding through to oil-dependent economies. This situation has been exacerbated in Egypt by the exchange rate pass-through from March’s devaluation and a shortage of hard currency, which is sharply weakening the Egyptian pound traded in the parallel market. While the Gulf countries started to remove subsidies this year, a strong U.S. dollar and the region’s currency pegs are helping to alleviate upward pressures on prices.
Given the balanced risks to the inflation outlook, FocusEconomics panelists decided to maintain their 2016 inflation forecast for the MENA region at last month’s 4.6%. In 2017, inflation is expected to increase to 5.0%.
Written by: Ricard Torné, Head of Economic Research