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A $ 267 billion budget deficit is expected in the Gulf States in 2020

A recent report issued by Arqaam Capital expects that the economies of the Gulf countries will suffer a large deficit for the fiscal year 2020, in light of the great pressures resulting from the sharp decline in oil prices and the consequences of the spread of the Corona virus. The report recommended that those countries should work on the needed average prices of a barrel of oil to achieve balanced budgets in the long term in light of expectations that oil prices will continue to fluctuate in the future. However, the report emphasized that the governments of the Gulf countries will not change their strategies that they followed during the period of oil price recessions during the period 2014-2016 to address their budget deficits when they proceeded to issue new debt bonds, withdraw from reserves and liquidate some of their deposits with the banking system.

Oil challenges

The report highlighted a set of challenges facing the economies of the Gulf States as follows: The exit of some shale oil companies from the market requires that oil prices to remain below $

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25 a barrel for a long period. In the event of market adjustment and the return of oil prices to levels of $ 50 a barrel, shale oil will return to competition. The agreement to reduce production addresses the supply side of the market, but the problem remains in the low rates of demand and its unpredictability in the future. There are fears that the continuous production cut agreements without coordination with the United States may trigger a trade war with OPEC countries.

In light of this, the report expected that the average price of a barrel of oil during the current year would reach about $ 25, and that the total expected deficit for all Gulf countries would reach about $ 267 billion, equivalent to 16 percent of the gross domestic product of all six countries combined.

Reduced equalization rates

Based on these challenges, which confirm that the fluctuation of oil prices is not an emergency, but rather that it can extend to the long term, the report recommended that the Gulf countries should seek to reduce the average oil prices that they need to achieve balanced budgets.

The report divided the Gulf States into two groups, the first includes Saudi Arabia, Bahrain and Oman, and the three countries need to reduce the average oil prices needed to achieve equalization to about $ 35 a barrel. The report expects those countries to achieve a budget deficit ranging from 4 to 8 percent of GDP, even if the average oil price reaches $ 60 a barrel.

As for the rest of the Gulf countries consisting of the UAE, Kuwait and Qatar, the report recommended to reduce the average price of a barrel of oil to achieve balanced levels with varying proportions ranging from 5 to 15 dollars per barrel. The report expected that the UAE would achieve a deficit with all oil prices, though it would reach only 2 percent of the GDP if the average price of the barrel reaches $60.

Kuwait will not achieve a surplus in its budget except with these levels, because the deficit may reach about 20 percent of the GDP if oil price reaches $30 dollars a barrel during the current year. As for Qatar, the report expected that it would achieve a surplus with any oil price, even if its average fell to $ 30 a barrel during 2020.

Financing the deficit

Arqaam Capital research indicates that the strategies to finance the expected budget deficit for the Gulf countries during the current year will not differ much from what these countries did during the period of low oil prices 2014-2016. In particular, the following strategies will be adopted. First, withdrawal from the general reserves and foreign exchange reserves, as it was the main tool to finance the deficit during the period 2014-2016, especially in Saudi Arabia. Second, withdrawals from government deposits in the banking sector, a less likely option, indicated the report, in light of the fear that this would affect the liquidity of the banking sector, which could expose it to a shock given the Coronavirus crisis. Third, the issuance of sovereign debt locally and abroad, a measure that has been implemented by Qatar already, which issued international bonds worth 10 billion dollars. Among the strategies also is the imposition of taxes such as value-added tax, excise tax and taxes on corporate income, which may be done differently across countries with a lower possibility of implementation, though.

The banking sector

The report emphasized that the banking sector in the Gulf countries will be clearly affected, but it is able to withstand the consequences of lower oil prices and the spread of the Corona virus, with an expected increase of non-performing loans by 10 percent during the next two years.

The report pointed out that Gulf banks will increase their capital through issuing bonds and increasing capital, which may result in an increase of 4 to 5 percent of total loans, and an expected growth of average operational profit during the next two years of 3.5 percent.

And under the pressure of low interest rates and their impact on the interest income of Gulf banks, the report expected that cash dividends for the year 2020 to Gulf banks would decline sharply or be canceled completely. With regard to the policy of linking the exchange rate to the US dollar, the report expected it to continue in light of the huge monetary reserves, stressing that any change is associated with the depletion of those reserves.

Questions

1. Based on the report highlighted in the article, what is the nature of the main economic crisis facing Qatar and the Gulf states in general, and what are the main causes of this crisis?

2. What is the importance of oil prices and the budget balance in the countries of the Gulf Cooperation Council? Using the concepts of supply and demand for oil, and based on what was stated in the report, explain why the Gulf countries should reduce the average expected oil prices that they need to balance their budgets.

3. Analyze

   1. The impact of low oil prices on the banking sector in the Gulf countries,

      and

   2. Why the Gulf governments that suffer from budget deficits, did not withdraw their deposits in the banking sector?

4. If you were the CEO of a commercial bank in the Gulf countries, and in light of low oil prices and worsening budget deficits in these countries, would you recommend expanding credit facilities (giving more loans to individuals and companies) or reducing that? Explain your answer.