KUWAIT CITY, Feb 9: Kuwait Financial Centre “Markaz” has recently held a presentation on “Top GCC Risks for 2016 & Beyond” for its clients and market experts at Chairman’s Club. The presentation was delivered by M.R. Raghu, Head of Research at Markaz and Managing director of Marmore MENA Intelligence, a research subsidiary of Markaz providing services of financial research and analysis of Mena economies, markets, and companies in the MENA region.
The general takeaway from the presentation is that in order to deal with times of economic change, a growing urban class seeking better jobs and increasing stresses on the general infrastructure, meaningful and systematic reforms are a clear necessity; not a luxury.
Raghu made a comparison of risks that were anticipated to occur in 2015, and those that had actually come to pass. The former enumerated risks such as Russian sovereign defaults, Grexit, Bleak EU and China growth outlook, ISIS, Risk of social unrest in the EU etc., some of which materialized, while others did not. The fall of the oil price to sub-$40 per barrel due to OPEC members change of strategy to defend market share than market price, the successful conclusion of the Iran nuclear deal and the drastic fall of the Brazilian Real were surprising to most tracking world markets.
Raghu then outlined the risks that could be most plausibly expected in 2016. With the oil price declining to sub-$40 per barrel questions are being raised as to how much longer OPEC can continue with its current policy of pumping as much oil as it can in a quest to win more market share and drive out high cost producers. Some of the big producers, such as Venezuela, Nigeria and Algeria that rely on oil exports for their revenue, do not have the luxury of oil surpluses, and are facing widening fiscal and current account deficits. Even for GCC exporters, assuming low oil prices persist, public foreign assets could decline substantially over the next 5 years, while gross public debt could rise to 59% of GDP. In the current scenario, GCC (read OPEC) is being severely tested in terms of their strategy to preserve and enhance market share at the cost of price.
US interest rates were finally hiked by 25bps on 16 Dec 2015, with the Fed raising the range of its benchmark interest rate by a quarter of a percentage point to between 0.25% and 0.50%, and further rate hikes expected in 2016, with the median projected target at 1.375%. With US bonds and interest rates serving as global benchmarks, these expected hikes will increase the cost of money in the US, and change the value of everything around the world. Stock markets will be affected due to lesser availability of cheap capital and private sector borrowing would also be impacted.
China’s borrowing binge post the 2008 global financial crisis has led to burgeoning rise in credit, which stands at 240% of GDP at the end of Q3 2015. Rising credit growth in a period of slow economic growth is magnifying the indebtedness. China’s bond market is now the third largest in the world, after USA and Japan, at about $5.6tn, with bond issuance having grown by 56% in 2015, prompting warnings of a bubble like situation in the market. Fears of falling industrial production and economic slowdown in China have affected the global markets, with prices of major commodities taking a hammering.
After a decade of negative equity/bond correlations, rate shocks in 2016 could result in a less stable relationship, coupled with rising inflation and uncertain global monetary policy. In such a scenario, bonds will no longer be good hedges for under performing equities.
The total stock of global debt is close to $60tn, with the increase attributed to non-financial corporate debt, especially in emerging market economies. The challenges faced by debt-laden emerging markets has been referred to as the “third wave” of the financial crisis, due to rock bottom commodities prices, stalling growth in China and low global inflation.
Capital flows to emerging markets have weakened sharply since 2014, with a marked decline seen in 2015. With foreign inflows seemingly likely to fall below 2008 levels and rising domestic outflows, it is expected that net capital flows to EMs in 2015 will be negative for the first time since 1988. This pullback from EMs has been driven primarily by internal factors: a sustained slowdown in EM growth, amplified by rising uncertainty about China’s economy policies, and a hike in the US interest rates.
In August 2015, there was a wave of currency devaluations, led by China’s depreciation of Yuan by nearly 2%, with several major emerging markets, such as Vietnam, Russia, Brazil etc. following suit. China’s decision to allow slow but steady depreciation to encourage exports has added to concerns that its economy may be more fragile than expected.
Studying the above risks leads us to believe that the least riskiest economy for 2016 is the US economy, opined Raghu. Developed economies of Europe falls next in line with Middle East economies (especially GCC) following it. The riskiest economies in 2016 would be the emerging markets for the reasons articulated above.
Looking at the GCC in particular, growing deficits, instability of Chinese economy and markets, and enduring geopolitical issues are the high risks for this region. With the oil exporters facing deficit situations, many countries have already begun tapping into their reserves and borrowing from the markets to bridge the widening fiscal balance. GCC countries have also started rationalizing subsidies in a bid to curb expenditure.
In some cases, tax reforms are also debated to augment non-oil revenues. The slow growth in China, the largest importer of commodities, including crude, affects the GCC economies, which rely on Chinese exports for their revenues. And finally, regional conflicts continue to destabilize the region, and discourage investments. The biggest challenge to GCC in this low oil price environment is to infuse investor confidence through counter-cyclical investments by the government which can spur growth.
While faced with risks and challenges, governments will have to use the momentum that targeted reforms generate to achieve sustainable long-term goals. The public and the private sector will have to undertake strategic alliances together, which means that reforms have to underpin the platform of stable trust.