Tuesday , October 24 2017

High public investment underpins growth

Relatively high public investment will continue to underpin Qatari economic growth, especially in the non-hydrocarbon sector. Coupled with output gains in the hydrocarbon sector related to the launch of the Barzan gas production facility in 2016, economic activity is expected to remain rather buoyant. In an effort to control public expenditures, ministries have been merged, infrastructure projects have been reprioritized, and subsidies on domestic fuel and utility prices have been cut. Nevertheless, the country is likely to record this year its first fiscal deficit since 1999; this will be financed through debt issuance rather than asset drawdowns. With state revenues impacted by low oil prices, government deposits have contracted and trailed credit growth, leading to a tightening in banking sector liquidity and a rise in interbank rates. Banks’ foreign liabilities have increased as banks have sought to borrow from overseas.

With strong fiscal and external buffers, including its sovereign wealth fund, Qatar is better placed than most of its peers to negotiate the current energy downturn — a fact that was reflected in the AA credit rating status recently affirmed by rating agencies such as Standard & Poor’s (S&P) and Moody’s. The latter’s negative outlook assessment, however, reflects the risks stemming from a continued buildup of public debt and weak implementation of structural reforms. Also, the arrival of Australia and the US as major LNG exporters could herald a new era of price competition.

The government’s $200 billion development plan remains the lynchpin of Qatar’s economic growth. Investment spending on a range of public projects, including the Qatar Integrated Railway ($40 billion), the new Hamad Port ($7 billion), the Lusail Mixed-Use Development ($45 billion) and the local roads and drainage program ($14.6 billion) as well as 2022 World Cup-specific infrastructure i.e. stadia, will continue to facilitate the expansion of the non-oil economy and provide employment for Qatar’s expanding population. Real non-oil growth is forecast to clock in at 6.3 percent and 6.4 percent in 2016 and 2017, respectively. This will continue to be supported by gains in the construction, financial services, manufacturing and tourism sectors.

Meanwhile, hydrocarbon sector output, having plateaued with the attainment of maximum LNG capacity in 2012, is expected to receive a boost from the commissioning of the Barzan gas production facility this year. Barzan should reach its full production capacity of 1.4 billion cubic feet per day (bcf/d) in 2017. It should also supply additional volumes of condensates and natural gas liquids (NGLs) for export and to the country’s refineries — including the upcoming Ras Laffan 2 refinery. These lighter hydrocarbon products took over from crude oil as the dominant liquid fuel products, once crude output from Qatar’s maturing oil fields began to decline in 2007. Crude output averaged 0.66 mb/d in 2015 and should hold steady over the forecast period as Qatar Petroleum and its international partners look to conservatively manage production at the country’s ageing fields. Real hydrocarbon GDP is forecast to grow by 1.3 percent in 2016.

Inflation, as measured by the consumer price index (CPI), is projected to rise gradually over the next two years, from 1.6 percent in 2015 to 2.9 percent in 2017 (on an annual average basis). As of April, the headline rate was up by 3.4 percent y/y, with rising rental costs and rebounding global food and commodity prices the primary triggers.

Inflation in rental prices (5.2 percent y/y growth in the housing and utilities component of the CPI in April) has been a long-standing issue in Qatar given the limited supply of residential housing and the rapid increase in the country’s population — 9.2 percent y/y in April — as a result of expatriate immigration. Real estate prices were rising at a rate of 13.3 percent y/y in March.

The recent fuel price hikes that were instituted as part of the government’s subsidy reform proposals are expected to feed through into the CPI. Their impact is not likely to be significant or long-lasting, however. Furthermore, a strengthening US dollar, to which the Qatari riyal is pegged, should help to restrain imported inflation.

With hydrocarbon revenues impacted by the collapse in oil and gas prices and elevated capital expenditures, Qatar is likely to record its first fiscal deficit since 1999 this year, equivalent to -2.3 percent of GDP. Similarly, the current account surplus is forecast to narrow to a 16-year low of 3.2 percent of GDP in 2016 before rising next year in line with a further recovery in oil prices.

The fiscal deficit expected this year comes despite a concerted effort by the authorities to rationalize expenditures by restraining current spending and scaling back non-essential capital spending. Recent data from MEED projects suggests that this is indeed happening, with the value of contracts awarded so far in 2016, at just $2.1 billion, down a staggering 90 percent from the $20.1 billion worth of contracts signed during the first half of last year.

Moreover, the government has proceeded to reform the state’s finances, introducing a QAR 600 billion ($165 billion) spending cap on new investment projects for 10 years, creating a macro-fiscal unit and public investment management department (PIM), overhauling the country’s sovereign wealth fund, the Qatar Investment Authority (QIA), and privatizing semi-government institutions. The authorities have begun withdrawing subsidies to certain state institutions in tandem with the broader, nationwide removal of fuel and utility subsidies. The cost of fuel subsidies in Qatar is, however, low by GCC standards, accounting for less than 1 percent of non-hydrocarbon GDP.

With $36 billion in international reserves and an estimated $256 billion under management by the QIA, Qatar’s fiscal buffers are sufficient for the time being to finance the deficit. Having said that, the authorities have already indicated that any deficits would be financed exclusively through borrowing rather than reserve drawdowns. In addition to at least $7.5 billion in domestic bonds and sukuk issued since September 2015 and a syndicated loan of $5 billion secured earlier in the year, a triple-tranche US dollar-denominated bond sale of around $9 billion is expected shortly. This is expected to raise public debt from a low of 30 percent of GDP in 2014 to potentially over 50 percent of GDP by year’s end.

Bank credit growth, a key driver of non-oil activity, has rebounded from the single digit lows of early 2015 to come in at a robust 14.8 percent y/y in March, according to central bank figures. Spearheading the revival has been the public sector, which has begun increasing its demand for credit after a 10-month debt-repayment period in 2014-15 as it pushes ahead with the government’s infrastructure development plan. In contrast, private sector credit growth has been in double digits since 2011, although the pace of growth has slowed in recent months to a 19-month low of 15.7 percent y/y in March. Demand from the construction, real estate, services and consumption sectors account for much of the increase of the last two years. Lending to the real estate sector in particular has accelerated rapidly over the last year, rising by 34.8 percent y/y in March, to the extent that ratings agencies are once again citing concentration risk; banks’ exposure to the real estate sector reached 30 percent in March.

The flow of deposits, especially public sector deposits, into the banking system has slowed significantly since oil prices began falling in mid-2014 As of March, total bank deposit growth had moderated to 4.0 percent y/y, which is the slowest rate of growth since the financial crisis. Public sector deposits have been contracting for the best part of a year and a half, and were down -8.5 percent y/y in March.

Foreign currency deposits have borne the brunt of the fall, pushing broad money supply growth (M2) into negative territory in both February and March (-0.4 percent y/y in March) for the first time since the financial crisis.

With deposit growth trailing credit growth, concerns over tightening liquidity have resurfaced: the banking sector’s loan-to-deposit-ratio was 119 percent in March, which is not far off April 2012’s post-financial crisis-high of 121 percent. 3-month interbank rates have consequently spiked, hitting a peak of 1.7 percent in May.

The prospect of liquidity draining from the system and higher cost of funds prompted the authorities to suspend the central bank’s monthly auction of T-bills and sukuk early in 2016. The contribution of interbank funds to banks’ total funds was back up to 24.6 percent in March. Banks’ reliance on foreign funds has also increased, with the share of non-resident deposits to total funds up from 4 percent to 11 percent in 2 years. Indeed, the net foreign liability position of banks climbed to a high of $33.4 billion in February, or 154.6 percent of foreign assets. This represents almost 11 percent of the system’s total asset base, up from 0.3 percent in November 2014.

Given the demands of a fixed exchange rate regime, Qatari domestic interest rates tend to be closely aligned with US interest rates. However, the Qatar Central Bank (QCB), with one eye on keeping borrowing costs down, has yet to follow the US Fed’s 25 bps rate rise last December and increase its own benchmark lending and deposit rates. These are currently at 4.5 percent and 0.75 percent, respectively.

Despite an improvement in sentiment related to the recent rally in oil prices, the benchmark Qatar Exchange Index (QE) remains down by -6.8 percent year-to-date at 9,716. Thinner volumes amid a series of disappointing corporate earnings announcements have not helped. The market is hoping that the introduction of margin trading and securities lending for institutional investors and the inclusion of the Qatari bourse in the FTSE’s emerging markets index will boost liquidity.

For the time being, with its sizeable fiscal buffers and AA credit rating, Qatar remains well positioned to negotiate the current period of low oil prices. However, public debt and borrowing costs are rising and likely to increase further in 2016 with the expectation of another round or two of US rate rises. Moreover, there are reports that capacity constraints are once more affecting the roll out of projects. Qatar has already been placed on negative watch by Moody’s. Risks to Qatar (and GCC countries more broadly) are reflected in elevated sovereign CDS spreads. The arrival of Australia and the US as major LNG exporters will undoubtedly put gas prices under further pressure.

 

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