Market analysis: GCC economies’ outlook remains positive

The key questions being asked by investors are: Where are markets headed? Have we seen the bottom or it is yet to come? Will current valuations compensate for the difficult global and local environments?

Above, traders at the Dubai Financial Market. Over the past three months, the Dubai index has fallen by 13 per cent. Duncan Chard for The National
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The past year has been a volatile and difficult period for GCC markets, with many markets trading in negative territory.

Key challenges in the region have included a sustained decline in the oil price, a reduction in foreign reserves, questions over the viability of GCC currency pegs, an increasingly likely nuclear deal between Iran and the world powers, and evolving geopolitics.

In the international arena, the Chinese currency devaluation, uncertainty surrounding US interest rate hikes, and concern over global growth, have led to floundering global markets.

Over the past three months, Abu Dhabi corrected by minus 5 per cent, Dubai by minus 13 per cent, Saudi Arabia by minus 19 per cent, Kuwait by minus 7 per cent, Qatar by minus 8 per cent and Oman by minus 10 per cent.

The key questions being asked by investors are: Where are markets headed? Have we seen the bottom or it is yet to come? Will current valuations compensate for the difficult global and local environments?

These are difficult questions in uncertain market conditions when timing the market is not easy or advisable. What is clearly evident is the fact that post-correction market valuations appear compelling. Currently, the Middle East and North Africa market is trading at the lower end of its five-year range, and on a relative basis is trading at close to a 30 per cent discount to the MSCI World Index.

After almost a decade of healthy growth, GCC economies have become geared to higher oil prices, as reflected by increasing oil price budget break-even prices.

The current low oil price environment has clearly posed strategic challenges, but has also provided strategic opportunities. The key challenge lies in rebalancing government spending to a lower oil price. In the near term, regional governments need to continue to spend on development projects and infrastructure. But over the medium term, the reality of lower oil revenue needs to be aligned with lower government spending and increased non-oil GDP growth, leading to slower but still solid economic growth.

Ultimately we see a sustained lower oil price environment affecting capital allocation decisions across the region. Regional governments, however, have a broad range of variables that can be adjusted: taxation, feedstock prices, currency peg, trend and composition of government spend, pace of reforms and private sector participation.

So far there has been a visible shift towards deficit financing, introduction of indirect taxes, government asset sales, evaluation of pricing regulation and subsidy structures, suggesting that there is a strong commitment towards growth and development.

Regional currency pegs are likely to remain over the next few years, as the benefits of a stable currency outweigh the negatives, especially in time of stress. Fundamental factors such as high import dependence, inelastic exports and technical factors related to the cost of defending the peg and mode of financing counter-cyclical spending all favour a status quo. Kuwait has already set a precedent a few years ago by successfully following a basket of currencies, a model that could ultimately be used across the region. We do not foresee an imminent change for regional currency pegs given the weak stimulatory benefit versus the uncertainty that such a move would create.

A low oil price environment also brings opportunity to enhance efficiency, calibrate resources productively and pursue various reforms that would be of benefit in the longer term. The reform process and options available to individual countries differ owing to a unique mix of factors. The demographic of individual countries will shape decisions taken and reforms enacted. For example, it may be easy to impose indirect taxes in the UAE, given its large expatriate population, but that is not true for Saudi Arabia, which has a lower proportion of expatriates.

Continuing in this vein, it may be easier to pass on the healthcare burden to the private sector in Saudi Arabia by enabling higher insurance penetration. However, it may not be preferable at least initially to increase petrol and utility prices in the kingdom. Overall, we expect regional governments to take the path of least resistance, duly taking into account the social acceptability of economically viable measures. We see a low probability of any relapse in reforms, even if oil prices recover, fiscal break-even oil prices are already high. And in the long run, targeting growth without shifting the burden of growth to the private sector is not an ideal solution.

In summary, even though we have witnessed negative sentiment towards global risk assets and a low oil price environment that has posed challenges for many GCC countries, the regional outlook remains positive, as governments have demonstrated a commitment to growth not only through the obvious steps of leveraging strong balance sheets but also through difficult but much- needed reform.

Saleem Khokhar is the head of fund management at National Bank of Abu Dhabi.

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