Complex Made Simple

Q1 economic outlook: The Gulf Region faces the headwinds of “the perfect storm”

The ongoing pandemic is leading to an unprecedented decline in global GDP during the first half of 2020.

The COVID-19 pandemic has radically changed the prospects of the global economy for the short-, the medium- and potentially for the long-term The Conference Board currently estimates global GDP growth to fall at -4.8 percent for 2020 compared to 2019, which is an unprecedented decline for the post WW-II period The Gulf countries face a somber outlook as well, with the GDP of the region expected to contract by 5.9% in 2020 compared to 2019

Article by: The Conference Board Gulf Center

The Conference Board Gulf Center for Economics and Business Research released its quarterly update on the Gulf Economic Outlook for the year 2020. The report presents the impact of the COVID-19 pandemic on the GCC economies.

COVID-19 pandemic has radically changed the prospects of the global economy for the short-, the medium- and potentially for the long-term. In the short-term, as governments throughout the world introduce stringent measures limiting physical mobility and social activity to slow the spread of the virus and avert a health crisis, economic activity seriously contracted. 

This is leading to an unprecedented decline in global GDP during the first half of 2020. The Conference Board currently estimates global GDP growth to fall at -4.8 percent for 2020 compared to 2019, which is an unprecedented decline for the post WW-II period.

The Gulf countries face a somber outlook as well, with the GDP of the region expected to contract by 5.9% in 2020 compared to 2019. The Gulf countries whose economies remain highly dependent on hydrocarbon are ahead of “perfect storm” like scenario: a humanitarian crisis, that morphed into a global demand shock and pushed oil prices into a free-fall. A historical oil production cut agreement barely managed to improve prices. 

Fiscal deficits of the region are expected to widen significantly in 2020 and remain in the negative territory in the short term with most of the countries still trying to recover from the 2014 oil price collapse. To make things worse, the gulf authorities had to generously intervene through fiscal and monetary support packages to alleviate some of the pain caused by this crisis, adding more pressure on their budgets. 

With foreign reserves quickly depleting and raising pressure on their pegged currencies, the Gulf countries would have to tap the international markets and their sovereign wealth funds to fund the fiscal deficits, highlighting once more the eminent need to decouple the region’s budgets from hydrocarbon revenues.

Oil Dynamics

The containment measures imposed in more than 180 countries curtailed mobility, aviation and trade which account for nearly 60 percent of global oil demand. As per the International Energy Agency (IEA), by the end of March, global road transport activity was almost 50% below the 2019 average and aviation 60% below. 

Oil demand is set to decline by 29mb/d in April and by a smaller magnitude in May as most countries will remain under restrains. As such, by end of 2020, the oil demand gap (oil demand minus oil supply) would remain large. In fact, global oil demand is expected to fall by more than 15 mb/d year-on-year in 2020.

Figure 1 Oil demand gap (consumption minus production) and oil prices (Brent and WTI)

Sources: Historical data from EIA for; forecast from The Conference Board

Following the drastic fall in global oil demand, OPEC+ countries agreed on a historic output deal to cut production by 9.7 mb/d for May and June, equivalent to a 23% cut from an agreed production level (October 2018), and a further 18% cut for the rest of 2020 and 14% cut in 2021. Saudi Arabia recently pledge to increase further its production cut in June to support oil prices. Additional reductions are set to come from other Non-OPEC countries mainly the US and Canada. The production cuts will slightly help alleviate the pressure on oil prices and oil storage capacities, but they are definitely not enough to erase the oil glut.

In fact, the ripple effect of the simultaneous demand and supply shocks is causing a continuous wave of shocks to oil prices. During the first 30 days of the pandemic (Feb 17= day 0) oil prices fell by 54% prior to inching up slightly post OPEC+ agreement. Oil prices are now in Contango, meaning that storage capacities are full or might become full very soon, pushing producers to sell at “distressed price”. This has pushed the maturing WTI May futures contract price to fall into negative territory, an unprecedent event caused by the inability of investors to find buyers for their contracts. The price gap has subsided thereafter with the global production cut coming into effect, although insufficient, and expectations of sluggish oil demand, would keep prices bearish for longer.

Contraction in the Gulf region GDP in 2020 followed by a mild recovery in 2021.

The Gulf countries are currently facing not only one but two seismic shocks:

  • A demand shock that has halted most sectors as the coronavirus turned into a pandemic.
  • Quickly followed by a supply shock with oil prices losing more than 50% in a matter of weeks, and significant decline in global oil demand.

The significant cut in oil production results in a 2.5-3.5% cut in headline GDP growth in 2020, especially for countries that are more dependent on oil revenues like Kuwait and Oman. The scenario used for the Gulf economies is a U-shaped recovery with a gradual and slow opening of the economy and return of social activities. The region’s GDP is forecasted to decline by 5.9% in 2020 and then to recover by 2.2% in 2021. This is in line with the IMF Longer Outbreak Scenario and not their baseline scenario which is a V-shape recovery.

Figure 2 Annual GDP Growth 2020 – 2021

Depending on the efficiency of the containment measures and the number of new COVID-19 cases, the region is subject to three possible scenarios for 2020 and 2021; however, all three would result in a significant GDP contraction in 2020. 

Under the U shape recovery scenario in 2020 (extended contraction, slow recovery), Q2 is set to witness the sharpest GDP decline, with the OPEC+ agreement going into effect. Economic weakness would stretch into Q3 and Q4 would see a shy return of non-oil activity, especially for the services sectors. 

The V shape recovery scenario (deep contraction, fast recovery) is more of an optimistic scenario, where the deep economic contraction is in Q2 only, followed by a stronger recovery in Q3. 

However high uncertainty reigns if the economy gets opened up too fast leading to a second wave of COVID-19 cases. Then we are faced with a W-shape (2nd contraction in Q4 due to new peak).

GDP of the gulf region is expected to recover modestly in 2021 as oil production increases slightly and non-oil GDP improves by 2.1% y/y.

Figure 3 Gulf GDP index scenarios