Covid demonstrates growing need to diversify oil-based economies
GDP growth forecast places Kuwait as fifth worst drop for 2020 compared to Gulf peers
Reconnaissance Research has prepared a brief report on the impact of the Corona epidemic on the economies of the Middle East region in general, and Kuwait in particular. This report was prepared by Dr. Matthew Oliver, a professor at the Georgia Institute of Technology, and Turner Stevens, an economics student and non-resident researcher at Reconnaissance Research.
— Editor
he COVID-19 pandemic has had major economic impacts on the Middle East region and demonstrated the growing need to diversify the region’s oil-based economies. International Monetary Fund GDP data illustrates the severity of the situation within the region, as major oil-exporting countries have experienced severe declines in GDP.
The intertwined effects of falling oil demand and falling prices with rising oil inventories have caused a disaster for countries that depend on selling oil to finance the majority of government expenditures. The Coronavirus pandemic led to a significant decrease in Brent crude prices, reaching the lowest level of $23 in April 2020 according to the IMF Primary Commodity Price System. After a brief price war between Saudi Arabia and Russia and subsequent negotiations in April 2020, OPEC+ agreed to production cuts of approximately 23 percent of total production levels.
While the Organization of the Petroleum Exporting Countries (OPEC) has been relatively successful in minimizing some of the financial effects on the region by reducing production in recent negotiations, many Middle Eastern economies have had to expand spending to bridge the deficit and deplete reserves to maintain stability.
Impact of the Coronavirus in Kuwait
Kuwait’s short-term economic outlook prior to the coronavirus pandemic had already been lackluster, with economic growth gradually declining since 2014. Economic growth in Kuwait reached only 0.4 percent in 2019, and the political conditions following the death of Amir Sheikh Sabah Al-Ahmed Al-Jaber Al-Sabah in 2020 brought on more pressure to address steep government deficits.
Interestingly, the negative economic impact of Kuwait was very similar to other (non-oil-exporting) countries, which experienced a decline in GDP. Compared to its Gulf neighbors, the forecast for GDP growth places Kuwait as the fifth worst drop for 2020. Financial Deficit
The rapid drop in oil prices have put Kuwait and its Gulf partners in precarious fiscal positions. Last fall, Moody’s downgraded Kuwait’s bond rating to A1 from Aa2, and more recent changes have caused Standard & Poor’s (S&P) to cut Kuwait’s credit rating from AA- to A+, saying that the government “has yet to put in place a comprehensive funding strategy for these deficits.” The crisis continued until Kuwait’s government deficit reached nearly a third of GDP in March 2021. In addition, Standard & Poor’s expects Kuwait’s deficit to average 17% of GDP during 2021. For Kuwait to meet budget expectations, prices must rise Brent crude to at least $90 a barrel. Oil prices are expected to remain below $50 a barrel through 2022, and mounting liquidity problems have put stress on the funds many of these countries rely on to mitigate fiscal shocks.
The need for diversification
The Oxford Economics Middle East Report estimates that Kuwait’s 2021 GDP growth is 2.5 percent, driven by expansion in the non-oil sector. However, the Kuwaiti economy’s heavy dependence on the oil sector means that the economic recovery will falter until the OPEC + production cuts end later in 2022 and Brent crude prices rise to pre-pandemic levels.
The shock of falling oil prices and the closure of economic activities have weakened the diversification efforts that Kuwait and many other oil-based economies are trying to achieve. In addition, the slow deployment of vaccines in Kuwait compared to its neighbors continues to hinder the reopening of its economy.
Many of the problems with Kuwait and its GCC neighbors’ efforts to expand into non-oil sector expansion stem from the reliance of private sector activity on government contracts and subsidies from the oil and gas sector. The private sector does not depend at all on exports, and the government has not succeeded in attracting foreign capital to bring it attractive revenues.
For economic diversification programs to succeed, oil-exporting countries such as Kuwait must focus on producing goods and services that do not depend on the sale of oil and petroleum derivatives. Unfortunately for Kuwait, this challenge was a nearly impossible task even before the pandemic, and it is now more difficult than it used to be, with hydrocarbon production accounting for 90 percent of total exports in Kuwait and Qatar, more than 80 percent of total exports in Saudi Arabia and the Sultanate of Oman, and more than 50 percent of total exports in the United Arab Emirates and Bahrain, according to the United Nations Merchandise Trade Statistics database.
Prior to the pandemic, global oil demand had fallen from 100 million barrels per day in the fourth quarter of 2019 to 83 million barrels per day in the second quarter of 2020. Combined with the failed OPEC+ negotiations in March 2020 between Russia and Saudi Arabia, the decline in travel and movement due to the epidemic, and a large glut in global oil supplies, the price of Brent crude dropped to less than $30 a barrel.
After global shutdowns in March and April 2020, West Texas Intermediate (the US crude oil benchmark) turned negative for the first time in history as suppliers reached maximum storage capacity in the absence of demand. After OPEC production cuts were later agreed to by about 10 million barrels per day, oil prices remained nearly 30 percent below pre-pandemic levels.
With the global economy gradually reopening, oil prices returned faster than expected, with Brent crude reaching more than $70 as of June 2021. As the economic effects of the Corona epidemic recede over time, the countries of the Middle East will remain at risk, and their economic problems will not subside in the short-term without proper fiscal and monetary measures. The way they conduct their fiscal and monetary policy operations will be critical as the global economy reopens.
During the pandemic, countries in the Middle East underwent major changes in fiscal and monetary policy to adapt to the decline in economic output. Several GCC countries have provided liquidity support to maintain credit flows, and central banks in these countries have cut interest rates by an average of nearly 140 basis points.
Despite the positive reaction from global financial markets to these expansionary policies, financial risks such as the budget crisis in Kuwait present a real challenge. High debt and low reserves will constrain the policy options available to these countries in the event of future shocks. A key indicator of success will be their ability to diversify their economies.
Saudi Arabia Experience:
Long-term investments such as Saudi Arabia’s Vision 2030 have resulted in bold plans that have gone from paper to reality for energy production, manufacturing, trade and alternative energy investments. Saudi Arabia’s plan has already demonstrated clear benefits for its citizens, including increased participation of women in the workforce, non-oil revenues, and the growth of small and medium businesses.
Saudi Arabia’s plan to be powered by 50 percent renewable energy by 2030 is commendable, but the economic effects of the pandemic have hampered further development despite signs of a serious desire to achieve further successes.
Al-Anjeri raises questions about the future of Kuwait:
Abdulaziz Al-Anjeri, Founder and CEO of Reconnaissance Research, said that during the discussion of the axes of this brief study with the specialized research team, several questions about the future of Kuwait surfaced, which he thought to share with the readers, namely:
1. How will structural and economic stability be ensured?
2. What is the probability that Kuwait will lose the wealth of future generations?
3. Is Kuwait immune to the possibility of a major political conflict resulting from financial mismanagement?
4. How will Kuwait act if the Kuwaiti bonds rating continues to decline, and what is the impact of this on its ability to borrow and finance its debts?
5. If renewable energy is the future, what is the way forward for a country like Kuwait?
“I do not think that there are those who disagree that the above questions are logical and need clear and honest answers” he said., he continued: “The research team was shocked when they were unable to obtain official Kuwaiti governmental public sources that addressed those matters in either an interview, an article or a general meeting for these important questions!”
“In light of the available facts and figures within local and international special analyzes on the reality of Kuwait’s economic future, I do not hide my deep concern about the continued absence of transparency among government leaders, their lack of clarity of vision, and the apparent lack of coordination between them due to the many conflicting statements published in the press releases to the public. Their vocal presence to the people is overcome by emotional reassurances and recycling plans and promises without implementation and follow-up. As if the goal is only to seek to buy more time.”
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