The Middle East-Central Asia’s Wayward Aim

Middle East and Central Asian financial markets are under immediate fire from souring emerging economy sentiment and the Turkey crisis in particular, and also lag on commodity diversification, fiscal discipline, and private business support, according to the International Monetary Fund’s November review. It pointed out that sovereign bond spreads increased 100 basis points through August to mirror the broad emerging market trend, with distinct Turkish banking and trade linkages. Parent banks in Qatar and Lebanon control over 5% of local assets, and Azerbaijan suffers from reduced import demand with lira depreciation. The US-Europe-China trade battle more generally hurts oil, mineral, auto and textile shipments from the area, and will aggravate gross domestic product growth and current account deficit worries already weighing on investor confidence, the IMF signals.

Gulf oil exporters will see 2.5-3% growth through 2019, but the medium term price forecast is for gradual decline to $60/barrel. Public infrastructure spending is the main driver, including Expo 2020 and 2022 World Cup preparations in the United Arab Emirates and Qatar respectively. Other petroleum powers Iran, Iraq and Libya are under international commercial sanctions or still experiencing internal conflict. The combined current account surplus is estimated at $120 billion, with the capital account also receiving inflows from $30 billion in sovereign debt issuance and Saudi Arabia’s MSCI stock market index upgrade. However state-owned companies face a large $135 billion maturity hump next year to warrant caution, the report stresses.

In Saudi Arabia, the UAE, Kuwait and Qatar the fiscal position is balanced or slightly expansionary, but sustainability will require public sector salary and subsidy cuts and tax collection such as recent VAT introduction. Bank liquidity is better but private credit is “tepid” with 5% range annual growth, on weak construction and real estate demand. Borrowing rates are higher in line with US Federal Reserve moves under the dollar exchange rate peg, and small business access is limited although fintech is opening new channels. Bankruptcy law, corporate governance, and credit bureau overhauls are overdue and local corporate bond market development should be a priority. More than one-quarter of employment is government-related, triple the emerging economy average, and domestic job creation is subject to numerous costs and distortions and poor professional education and training.

Arab world oil importers have double the growth at 4.5%, with Egypt and Pakistan leading the way as domestic consumption and remittances strengthen. Current account deficits still average 6.5% of GDP despite 15% export expansion, and Egyptian tourism has recovered with heightened security and resumed direct Russia flights. However reserves are under pressure in Jordan, Tunisia, Pakistan and elsewhere, with bilateral and multilateral financing needed for support. Banks are “stable and adequately capitalized,” but portfolios tilt toward government lending with public debt over 90% of GDP in half the group’s countries. More than 50% of the total is foreign currency-denominated, and interest payments take one-fifth of revenue. Energy subsidy reform is “critical,” but will worsen double-digit inflation that could spur further monetary tightening. Per-capita income growth has been lower than peers the past decade, and overriding challenges include reducing informality and raising productivity with “downside risks” to the outlook.

Central Asia and the Caucuses growth is also in the 4% range, but the rate will ebb over time from economic partner spillover and soft private investment. Exchange rates appreciated against the Russian ruble to help contain inflation, and allow easing in Azerbaijan, Georgia, Kazakhstan and Tajikistan. The negative fiscal balance improved to 4%, as stimulus programs like Kazakhstan’s Nurly Zhol housing plan end. Positive terms of trade and increased foreign direct investment help oil exporters, but current account gaps will widen in the Kyrgyz Republic, Tajikistan and Uzbekistan. Highly dollarized banking systems in Azerbaijan and Georgia are vulnerable to capital outflows and currency swings, and the region will not reach middle-income status for at least two decades. Officials pledge to slash government control and ownership but advance slowly, such as with the Kazakhstan stock exchange’s partial strategic company sales to maintain a positive MSCI return through October. Armenia and Georgia are among featured reformers on the World Bank’s Doing Business list and stiffer bank regulation has been promoted, but securities market infrastructure and oversight languish to investor chagrin, the survey warns in foreshadowing likely 2019 and beyond performance.