Strong public investment spurs Qatar growth

KUWAIT: Despite lower oil prices, high public investment in the country’s $200 billion development plan and gas output gains linked to the launch of the Barzan production facility should see Qatar’s economic performance remain relatively strong through 2016 and 2017. Inflation is expected to edge up slowly, once the deflationary effect of soft international food and commodity prices begins to ease and once rental costs resume their upward trajectory. A stronger dollar should keep imported inflation in check, however.

With oil and gas revenues down by 40 percent, Qatar is expected to record in 2016 its first fiscal deficit since 1999. Consequently, non-essential capital projects are likely to be scaled back amid a drive to rationalize spending and stimulate the private sector. As low energy prices feed through to the banking sector in the form of slowing deposit, credit and asset growth, liquidity has tightened and rates have risen. CDS spreads have also widened. Nevertheless, with strong fiscal and external buffers, including net external assets equivalent to 132 percent of GDP, Qatar is better placed than most of its peers to negotiate the current downturn.

Risks to the outlook center on the trajectory of energy prices, the performance of the global economy, volatility in financial markets and delivery of the authorities’ domestic infrastructure program ahead of the World Cup in 2022. Qatar’s position as the leading LNG exporter in the world is also likely to come under pressure by the arrival of Australia and the US as major LNG competitors in 2016.

Real economic growth

Real GDP is forecast to grow by 5.4 percent in 2016 and 5.1 percent in 2017, from an expected increase of 4.9 percent in 2015. This figure, while down from the 9.2 percent annual average witnessed during 2010-2014, still puts Qatar among the most dynamic economies in the GCC.

Hydrocarbon sector output, having plateaued with the attainment of maximum LNG capacity in 2012, is expected to receive a boost from the commissioning of Barzan in late 2015, which should reach full production of 1.4 billion cubic feet per day (bcf/d) in 2016. Consequently, real hydrocarbon growth is expected to clock in at 0.7 percent in 2015 and 1.7 percent in 2016, before falling to 1.0 percent in 2017.

Barzan was the last project sanctioned before the 2005 moratorium on gas extraction from the country’s giant North Field was put in place. Once fully operational, the facility should supply additional volumes of gas by-products such as condensates and natural gas liquids (NGLs). These took over from crude oil as the dominant liquid fuel products once crude output from Qatar’s maturing oil fields began to decline in 2007. Crude output averaged 0.66 mb/d 2015. (Chart 2.) Output had been as high as 0.85 mb/d in 2007.

In contrast, the non-hydrocarbon sector remains the main determinant of Qatar’s economic growth. Underpinned by government spending, output is forecast to expand by 9.1 percent y/y on average between 2015 and 2017. Financial services, construction and trade and hospitality will continue to drive Qatar’s non-hydrocarbon sector. Economic expansion is also being propelled by burgeoning population growth of 8.8 percent y/y, which is helping to boost domestic consumption.

The authorities have indicated that they remain committed to executing the country’s $200 billion development and diversification plan regardless of the decline in oil prices. The need to roll out World Cup and related infrastructure by 2022 imparts a measure of urgency to government efforts. High profile projects such as the Qatar Integrated Railway ($40 billion), Hamad Port ($7 billion), the Lusail Mixed-Use Development ($45 billion) and the local roads and drainage program ($14.6 billion) look set to proceed apace. Non-essential capital projects, however, will be downgraded and scaled back in the current costconscious environment.

Inflation likely to rise

Headline inflation is projected to rise gradually over the next two years, from an expected 1.7 percent in 2015 to 3.0 percent in 2017 (on an annual average basis). Rising rental costs and slowly rebounding global food and commodity prices are likely to be the predominant inflationary impulses. While rental inflation slowed to 1.8 percent y/y in October, rapid population growth owing to the influx of expatriate workers is expected to continue exerting pressure on the country’s limited residential housing stock. The price of land and buildings, as measured by the real estate price index (REPI), was up 18.2 percent y/y last September, although it has been moderating over the last year. (Chart 4.) A strengthening US dollar-to which the Qatari riyal is pegged-has helped restrain imported inflation.

Fiscal and current account surpluses

Qatar’s fiscal balance is likely to swing into deficit in 2016, for the first time since 1999. With spending levels remaining relatively elevated amid a 40 percent decline in hydrocarbon revenues, the fiscal surplus is forecast to narrow from 16.1 percent of GDP in 2014 to -0.5 percent of GDP in 2016. In 2017, the fiscal account should just about balance. Similarly, the current account surplus is likely to narrow considerably.

On the fiscal side, future spending is likely to be rationalized. While current spending will be restrained, capital spending will need to rise as the authorities make up for previous below-budget outlays, due to delays and capacity constraints, and push ahead with implementing their development plan ahead of the World Cup in 2022. As mentioned, however, non-essential projects will be scaled back.

The prospect of a sustained period of low energy prices has prompted the government to proceed with reforming the state’s finances. New measures include: the introduction of a QAR 600 billion ($165 billion) spending cap on new investment projects for 10 years; the creation of a macro-fiscal unit and public investment management department (PIM); the shift to a calendar rather than a fiscal year budget (effective in 2016); the withdrawal of subsidies to certain state institutions; and the privatization of semi-government institutions. The last two measures were announced by the Amir in November 2015 and form part of an effort to shrink state monopolies and boost the economic contribution of the private sector.

Sufficient fiscal buffers

With $39.6 billion in international reserves (excluding the $256 billion SWF)-equivalent to 7.4 months of imports-and strong credit ratings, however, Qatar has sufficient assets to finance capital spending and weather the fall in energy prices-certainly over the forecast period. Were oil prices (and gas prices by extension) to remain in the $40-50 range for longer, then, like Saudi Arabia, the authorities would probably envisage stepping up bond issuance, perhaps with a view to attract international investors, given domestic liquidity concerns. Gross central government debt had dropped to 31.0 percent of GDP in 2014 from a high of 42.0 percent of GDP in 2010 after the authorities paid back maturing public debt. This trend could reverse, however.

Banking sector

Credit growth has been moderating over the last year owing to a slowdown and contraction in public sector borrowing. The most recent data showed overall bank credit growing by 12.0 percent y/y in September, with credit to the public sector contracting by -6.6 percent y/y. In contrast, credit growth to the private sector has averaged 22.0 percent y/y for most of the year (compared to 15.6 percent in 2014), as banks continue expanding credit lines to the real estate, industrial and retail sectors of the economy. Foreign lending has also proceeded apace, with growth averaging 45.2 percent y/y in 2015. In view of the government’s commitment to continue spending on infrastructure and expand private sector participation in the development plan, the outlook for credit growth remains positive.

Lower deposit flows

Reduced government deposits in the banking system resulting from lower oil and gas prices have slowed overall deposit growth considerably over the previous year. Total banking sector deposits grew by 7.1 percent y/y as of endSeptember, down from the average annual growth rates of 13.8 percent and 30.6 percent in 2014 and 2013, respectively. Public sector deposits were down by -13.9 percent y/y last September-the steepest contraction since the financial crisis. Public sector deposits, as a share of total bank deposits, stood at 25.0 percent, which is a decline from their high of 32.0 percent in 2013 and 2014. (Chart 11.) Private sector deposit growth has remained in double digits, however.

With deposit growth slowing and trailing credit growththe loan-to-deposit ratio (LDR) remained elevated at 111.4 percent last September-banks are increasingly facing funding pressures. In response, banks are increasing their exposure to the costlier and more volatile interbank funds as well as to the debt markets; interbank funds as a share of total funds was back up to 21.4 percent in September 2015.

Interbank rates tacked sharply upward since July, reflecting once again concerns over tightening liquidity. In order to alleviate potential liquidity constraints, the International Monetary Fund (IMF), in its Article IV Consultation, suggested that the authorities reallocate deposits from government and related institutions, including from the overseas SWF, and reduce the size of the central bank’s T-bill and bond auctions.

Government securities form the bulk of commercial banks’ liquid assets, and, along with deposits at the central bank, provide some measure of liquidity cover. While liquid banking assets accounted for 27.0 percent of total tangible assets in December 2015, this figure looks likely to fall to between 22.0-25.0 percent by the end of 2015.

With the Qatari riyal pegged to the US dollar, domestic interest rates tend to be closely aligned with US interest rates. The US Federal Reserve is expected to raise its benchmark Federal Funds rate by the turn of 2016, which will likely mean that Qatar’s key lending and deposit rates will follow suit, possibly with some lag.

Qatari equities roiled

With the oil price slump continuing to negatively affect market sentiment, the benchmark Qatar Exchange Index (QE) had been in negative territory (ytd) for close to 7 months by mid-November 2015. This is despite the fact that Qatari corporates had posted the highest earnings growth in the GCC, of 13 percent, during the first 6 months of 2015. As of 20 November, the index was down -8.1 percent to 10,860. Low trading volumes have reflected weak buyer interest. Investors have also been concerned that the government would be forced to rein in spending, including cutting subsidies, and consider corporate tax increases in a bid to boost state coffers.

The trajectory of energy prices

With its sizeable fiscal buffers and AA credit rating, Qatar remains well positioned to weather the current period of low energy prices. Nevertheless, the longer oil and gas prices remain depressed, the more pressure Qatar will face on its finances and banking sector. Growth will undoubtedly be affected. In a sign of rising pressures, along with a rise in the forward currency curve, the 5-year sovereign credit default swap spread widened significantly, by 14 bps, during the second half of the year. The likely arrival in 2016 of Australia and the US as LNG exporters is another concern, as it will challenge Qatar’s position as the world’s largest LNG exporter. Qatar’s low gas production cost base, however, should enable it to compete effectively in this new environment.