BMI View: We retain a generally positive view of the GCC's prospects as we h e ad into 2014. While headline growth should slow on account mainly of smaller gains in oil production, the expansion of the non-oil private sector will remain robust. We highlight several themes that will define the region over the coming year , including declining fiscal surpluses; rising rental inflation; continuing diversification; limited increases to private sector employment; and political risks linked to succession issues and sectarianism .
Our macroeconomic outlook for the six economies of the Gulf Cooperation Council (GCC) remains generall y positive as we head into 2014. As has been the case over the past few years, we expect growth in the non-oil private sector to be sustained by low interest rates, large pipelines of public capital infrastructure projects, and rising household incomes . Continued progress in government-driven development plans will support construction and investment activity in most countries, while the prospects for the retail and services sectors remain bright. We have stayed bullish over the more liquid equity markets in the region throughout 2013, and expect this view to hold over the coming quarters (see 'Regional Equity Strategy', August 28) .
| Growth Rates Slowing Down... |
|GCC - Real GDP Growth, % (Brackets Refer To GCC Average)|
That said, headline growth is likely to slow for the GCC as a whole in 2014, on the back of smaller gains in oil production and a mild cyclical deceleration in the non-oil sector following three years of above- average economic expansion . Overall real GDP growth for the GCC is expected to fall to 3.7% - down from an estimated 4.1% this year and 5.2% in 2012 . We forecast Qatar to remain the fastest-growing country for the ninth year in a row (4.8%), followed by Saudi Arabia (4.3%), Oman (3.5%), the UAE and Bahrain (3.4% each), and Kuwait in last place (2.9%). While by no means modest, these rates mark a continued decline in growth after the hectic pace of the mid-2000s, when the hydrocarbon sector was expanding at full steam.
| ... And Converging |
|GCC - Real GDP Growth, %|
We project the OPEC basket price to average US$105.0/bbl in 2013 and US$101.8/bbl in 2014, down from US$109.5/bbl in 2012. Our Oil & Gas research team expects resistance to higher oil prices over the remainder of 2013 and into 2014, reflecting a relatively robust supply picture, a lacklustre demand story, and cautious optimism regarding international efforts over Syria and Iran (see 'Resistance To Remain Strong As Risk Premium Subsides', October 3) . Our forecasts have already priced-in a below-consensus view on China and emerging markets as the growth story slows, translating into less robust global demand for oil. On the upside, prices could be pushed higher by unscheduled maintenance and production disruptions in countries such as Iraq, Libya, and Nigeria .
| Saudi Arabia Retains Swing Producer Status |
|GCC - Monthly Crude Oil Production, mn bbl/d|
We thus expect only low single-digits increases in GCC oil production next year, with Saudi Arabia maintaining its traditional role of swing producer thanks to its large spare capacity. Overall crude output (including refinery gains) across the region is forecasted to expand by 2.4%, after average growth of 3.2% during 2008 - 2012. The tight o utlook for gas is set to endure. A lthough Saudi Arabia and Oman have made some progress in bringing online new supplies, most GCC countries will still need to import gas to meet rapidly rising domestic demand . T he region's collective failure to address energy subsidies and raise gas prices to a level that would incentivise foreign participation (see 'GCC Subsidies: An Untenable System', March 22) , in addition to Qatar's moratorium on the development of new upstream projects at the North Field , limit the potential for LNG output growth in the medium term .
| Medium-Term Fiscal Picture Looks Challenging |
|GCC - Fiscal Account, % of GDP|
Although we project only a relatively soft decline in oil prices over the coming quarters, the subsequent impact on hydrocarbon revenues will complicate the outlook for the most fiscally vulnerable GCC states. We forecast the region's average budget surplus falling to 6.1% of GDP in 2014, from an estimated 7.8% in 2013 and 10.3% in 2012. Bahrain is likely to record a fiscal deficit for the sixth year in a row, while the outlook for Oman is becoming more uncertain (see chart above) . Both countries are reliant on a small and slowly declining oil production base to cover their budgets, although they can also count for now on development aid from the rest of the GCC as well as access to international markets and (if need be) foreign assets.
All the same, the issue of fiscal sustainability will become ever more urgent over the medium term: our Oil & Gas research team projects oil prices to continue declining beyond 2014, while the flexibility of budgetary policy has decreased for virtually every GCC state since the onset of the Arab Spring. Despite enjoying a benign macroeconomic outlook over the last few years, the region has thus far not managed to reduce its dependence on hydrocarbon revenues: these accounted for a GCC-average 74.0% of total exports and 83.3% of total government income in 2012. Only in Kuwait, which enjoys a substantial oil wealth relative to its small population, and Qatar, which has managed to partially diversify its revenue streams through foreign investments, are large surpluses likely to continue in the coming years.
| As Dependent As Ever |
|GCC - Reliance On Hydrocarbon Revenues, 2012|
We see the overall growth of government expenditure slowing slightly next year, although fiscal policy will still remain firmly supportive of economic activity. This is in part due to base effects: given the large-scale expansionary policies announced since 2011, GCC economies will in any case find it harder to respond to additional fiscal stimulus . Lower oil prices are also likely to force restraint: for instance, the Omani government signalled in April its intention for budget policy to become more conservative from 2014 onward. The UAE has made efforts to reduce spending, particularly in Dubai (see 'Expenditures To Slow As Cliff Approaches', July 12) . We forecast average public expenditure growth of 5.7% in 2014, down from an estimated 9.4% in 2013 and 8.2% in 2012. Spending in Qatar and Kuwait should continue to rise at a relatively faster pace, as both countries attempt to improve execution rates for their capital infrastructure projects. All countries, however, could end up unexpectedly raising spending commitments in the event of a rise in social tensions.
| Lending Activity Decelerating In Several Countries |
|GCC Commercial Banks - Credit Growth, % chg y-o-y|
Monetar y policy should see few changes in 2014 , and will remain accommodative. I n our view, all GCC countries will opt to retain the exchange rate peg to the US dollar over the medium term (or the basket peg in the case of Kuwait) , leaving limited scope for policy rates to diverge from the US benchmark rate . While we expect that the US Federal Reserve will begin to normalise monetary policy either in late 2013 or early 2014, our baseline forecasts see no changes to US interest rates until 2015 (see 'Policy Normalisation Ahead', October 7) . GCC banks will continue to enjoy ample liquidity, and we expect commercial banks' credit growth to remain robust , averaging approximately 11% . The pace of lending activity should continue to converge over the region, with a mild slowdown for Qatar after several years of rapid growth, and a pick-up for Kuwait and Bahrain.
Headline c onsumer price inflation (CPI) will increase slightly next year, but should remain fairly restrained. We forecast average CPI of 3.4% across the GCC in 2014, from 2.6% in 2012 and an estimated 3.0% in 2013. However, we expect a continuing divergence between food and housing prices, which have traditionally acted as the two main drivers of inflation in the region . International food prices have declined sharply over the last few months, and with our Agribusiness research team forecasting lower wheat prices in 2014, (see 'Wheat To Average USc650/bushel In 2014 ', October 9 ), GCC food inflation is likely to trend lower over the coming quarters . Government food subsidies will also isolate consumers from any upside shocks.
| Housing Prices Fly Out Of Deflation |
|GCC - Consumer Price Inflation In Housing Component, % chg y-o-y|
By contrast, the housing component is likely to act as the principal source of price pressures over 2014, having emerged out of deflationary territory in many countries this year (see chart above) . Tight housing stocks and high demand are placing a heavy burden on the residential market. Growing and young populations, urban migration, poor land utility and insufficient infrastructure, and a lack of financing schemes in the region suggest that any tangible improvements are unlikely over the near term (see 'Affordable Housing On The Forefront', January 4) . Governments have attempted to address the issue through policy fixes, including housing subsidies, anti-inflation allowances, and greater access to housing loans. However, these cannot resolve the fundamental supply-demand mismatch, and the lack of affordable housing will remain a key social and political pressure for GCC monarchies in the coming years.
Attempts Towards Economic Diversification Will Continue...
All GCC countries will continue to pursue the ultimate goal of economic diversification, with varying degrees of success. Aside from the development plans pursued by every government across the region, individual countries have taken active steps to claim leadership roles in lucrative economic sectors . Taking advantage of their rapidly growing banking sectors, Abu Dhabi, Doha , and Riyadh are aiming to replace Dubai and Manama as the region's dominant financial centres . Oman and the UAE are developing their tourism industry: the countries rank 57th and 27th respectively in the WEF's Travel & Tourism Competitiveness Report 2013. Saudi Arabia is laying the foundations for a regional manufacturing base (see 'Domestic Production Offers Mutual Opportunities' ), while undertaking extensive business environment reforms, raising expectations for an opening of the stock market to foreign direct investment (see 'What Will The Opening Of The TASI Look Like?', September 24) . In Oman, we expect momentum towards privatisation to rise over 2014 (see 'Privatisation A Long-Term Imperative', September 27) .
| Attractive Business Environments, Despite Challenges |
|MENA - Ease Of Doing Business 2013 Rankings And Global Competitiveness Index 2013-14|
... But Getting Nationals Into The Private Sector Will Remain A Challenge
Despite long-standing efforts by GCC governments to promote private sector employment amongst their nationals, progress will stay limited throughout 2014 and beyond. In line with our view, workforce nationalisation programmes picked up pace throughout 2013: Oman's government has announced a long-term goal of limiting the number of foreign workers to 33% of the population from 43% currently ; Kuwait aims to reduce the number of foreigners by 100,000 a year (from an expat population of 2.6mn) ; and Saudi Arabia is due to resume a crackdown on illegal foreign workers in November. Over 2014, these policies could complicate efforts to progress with infrastructure construction programmes and cause disruptions to economic activity, and will have regional ramifications through their effects on remittances (see ''Saudisation' To Have Widespread Effects', April 17) .
Moreover, structural weaknesses will continue to delay the effective entry of GCC nationals into the private sector. The region-wide preference for government positions, which benefit from greater job security and more favourable working conditions and remuneration, has been further entrenched by the public sector wage increases of the last few years. D espite substantial progress in promoting education over the past decade, skills mismatches in nationals remain a concern for private sector employers. Opposition to workforce nationalisation efforts is mounting from businesses and (in limited cases) the governing elite: in September 2013, Saudi Arabia's education minister publically stated that " Saudisation and employment is not the solution " , a view backed by the Riyadh Chamber of Commerce .
Succession Risks Will Remain Key
The GCC countries rank at the top of our proprietary political risk ratings for the MENA region, having proven relatively resilient to the turmoil of the Arab Spring. Yet their monarchical nature (and the advanced age of most of the rulers) means that succession issues and leadership changes perpetually loom large on the horizon. Only the UAE and Qatar, now ruled by the 33-year old Sheikh Tamim bin Hamad Al Thani after a successful and peaceful transition in June 2013, appear fully stable for now.
| Relative Havens In Terms Of Stability, But Substantial Risks |
|MENA - Breakdown of Political Risk Ratings (max = 100)|
Elsewhere, the outlook is more complex, and complications could flare up at any stage over 2014. Saudi Arabia, where King Abdullah is set to turn 90, is the most obvious risk: although recent leadership changes at the t op of echelons of government suggest that the reins of power are increasingly shifting towards a younger generation , the current system of succession (adopted in 2006) remains untested. In Oman, the 72-year old Sultan Qaboos has no children and has never publically anointed an heir. Kuwait's Emir Sheikh Sabah al-Ahmad al-Jaber al-Sabah (84) likewise has no obvious successor. Bahrain's Khalifa bin Salman Al Khalifa (77) is the longest-serving current prime minister in the world, having held office since 1971 - yet as an emblem of the regime's hardliners, his position has come into question over the past two years, as the country's political crisis has continued .
Sectarian Tensions On The Rise
The religious divide between Sunni and Shi'a Islam, the largest and oldest schism in the history of Islam, is one which traditionally re-emerges during periods of increasing political instability ('Sunni-Shi'a Divide Heightening Political Risks', May 24). Sectarian tensions across the MENA region have been fuelled throughout 2013 by the military stalemate in Syria, and the growing participation of militias from neighbouring countries (such as Hizbullah and Iraq's Abu Fadl al-Abbas). In June, Saudi Arabia's grand mufti praised a fellow Sunni cleric for attacking Shi'a-affiliated Hizbullah, and declared that "in this historic moment, we declare our support for the sheikh and call upon all Muslim clerics to take steps to stop the aggression of this hateful, sectarian party - and whoever is behind it."
Sectarianism is likely to intensify throughout 2014, particularly given our view that the Syrian civil war will continue indefinitely. This constitutes a key geopolitical risk for GCC countries, notably in view of their large Shi'a minorities (and in Bahrain's case, majority). Saudi Arabia's Shi'a population accounts for approximately 10% of the total, and is concentrated in the east of the country, home to nearly 90% of oil production. In Bahrain, we expect the ongoing political crisis to continue, posing a key downside risk to the economic outlook (see 'Rising Radicalisation And Limited Odds Of Breakthrough', August 16) .