Impact of Global Recession on Oman Economy by rpd19193

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									GCC Brief | 22 July 2009



        Downturn weakens outlook for GCC project
                   spending – part 2

       Governments have a stake in well over half of the $2.1 trillion of major projects currently
        taking place in the GCC. This could prove to be an asset in the downturn, shielding
        activity from rising risk aversion and credit constraints in the private sector.

       Nevertheless, the economic downturn is taking its toll. 19% of all projects have been put
        on hold or cancelled and this number could rise over time as investors readjust to more
        sober economic conditions.

       Although this will impose heavy short-term costs on the economy, by purging bad
        investments and lowering input costs, it may lead to more balanced and sustainable
        growth in the long-run.

In its latest GCC brief, NBK reports that the last GCC Brief (8th July), we looked at trends in
major industrial and infrastructure projects across the GCC, as captured in the database provided
by the Middle East Economic Digest (MEED). A total of $2.1 billion worth of projects were either
planned or underway at the end of 2Q 2009, most of which were in the construction sector and
weighted towards the UAE. This week, we look at who is undertaking these projects and how
they have been affected by deteriorating economic conditions in the region. In particular, we look
at the split in activity between the public and private sectors – an especially important issue in
today’s environment, where private sector firms have become more risk averse and access to
credit may be limited. Arguably therefore, the larger the role of the private sector, the greater the
danger of projects being postponed or cancelled.

Who’s in charge?
The MEED data does not officially distinguish between activity in the public and private sectors,
and separating the two is not always easy. In many Gulf countries, the line is blurred by implicit
government backing for some ‘private sector’ entities.

In what follows below, we have classified projects either as private sector, government, or joint
ventures (JVs), using our own judgment. The latter category, for example, includes not just
explicit JVs through schemes such as Public Private Partnerships (PPPs), but also stock
exchange-listed firms in which the government has maintained part ownership. Companies in this
category would include, for example, UAE property developer Emaar, which is 32% owned by the
Dubai government. On the other hand, Nakheel – the property developer whose parent company
Dubai World is majority-owned by UAE ruler Sheikh Mohammed bin Rashid Al Maktoum – would
be classified as a private company. We cannot claim that all of these judgments are 100%
accurate, but they should at least provide a reasonable guide. On balance, projects that are
labeled as JVs should probably be thought of as being more private sector-led, rather than state-
led.
Chart 1 shows that $833 billion (39%) of all active projects are being developed by the private
sector, while $822 billion (39%) are being sponsored by the public sector. (These figures exclude
projects that are ‘on hold’.) Even more striking, perhaps, is the large number of JVs being
undertaken, some $479 billion (22%). This means that the government has a direct stake in more
than 60% of all major projects taking place in the region. Clearly, its ability to do this has been
GCC Brief | 22 July 2009


supported by a surge in budget revenues over the past five years as oil prices have climbed.
Between 2004 and 2008, GCC governments generated combined estimated budget revenues of
US$1.7 trillion, well over double the preceding five years. Note, too, that the government’s share
of projects actually underway is slightly higher than that of the private sector, at 40%. In the past,
the opposite has been true, suggesting that public sector projects have proved more resilient in
the downturn.


                           Chart 1: Active projects by sponsor and status
                                                    ($ billion)


                   Government
                   (underw ay),
                       244                                                    Privat e sect or
                                                                              (planned), 594



            Government
           (planned), 578

                                                                               Privat e sect or
                                                                                (underw ay),
                                                                                     239
                       Gov/Priv JV
                       (underw ay),                                Gov/Priv JV
                           127                                    (planned), 352



Source: MEED projects database, as at end 2Q 2009
N.B. Excludes ‘on hold’ projects


It is also revealing to breakdown the government’s involvement according to each country. (See
chart 2.) At $486 billion, there are more private sector projects in the UAE than in all other GCC
countries combined. By contrast, the share of all UAE projects being undertaken by the
government sector is low, at 28%, compared to the GCC average of 39%. Notably, Oman also
has a low share of its $95 billion in projects being undertaken by the government (33%), thanks
partly to its promotion of private sector participation in the energy sector. In Bahrain, Kuwait and
Qatar, the government is responsible for the majority of projects.
GCC Brief | 22 July 2009


                          Chart 2: Active projects by country and sponsor
                                               $billions)

 1,000                                                                                       1,000
     900                                                                                     900
     800                       Government                                                    800
     700                       JV                                                            700
     600                       Private                                                       600
     500                                                                                     500
     400                                                                                     400
     300                                                                                     300
     200                                                                                     200
     100                                                                                     100
       0                                                                                     0
               Bahrain       Kuw ait        Oman      Qatar         KSA          UAE

Source: MEED projects database, as at end 2Q 2009
N.B. Excludes ‘on hold’ projects.


How do these figures translate to economic activity? Although it is not easy to measure the
impact of projects on GDP (for reasons we mentioned in part 1 of this note), we can make some
broad estimates. The total value of projects underway is $610 billion, equivalent to around 70% of
forecast GCC GDP in 2009. Since the (weighted) average lifetime of a project is 5-6 years, this
suggests that – on average - the projects could directly add some 10-15% to regional GDP
growth per year over their lifetime. The private sector is responsible for around 40% of this, with
the rest attributable to JVs and the government.

Of course, these estimates are uncertain. They take no account, for example, of the goods and
services that are imported in order to supply and execute the projects, which would tend to
reduce their impact on GDP. This effect is likely to be large. But there are exclusions working the
other way, too, such as the effects on businesses and industries working downstream, which
would tend to magnify the overall impact of each project. And we have made no account for
projects that are not yet underway – at least some of which will surely come on stream and
provide a further boost to the economy. All in all, there is little doubt that the project sector is big
business for the Gulf economies and that both the public and private sectors are playing major
roles.

Impact of the global recession
But to what extent are these projects now under threat as the demand outlook weakens, credit
conditions tighten and the fizz disappears from the regional property market? Some projects have
already been cancelled outright, totaling $9 billion as of end 2Q 2009. This is a relatively small
number, but is almost certain to rise over time. Far more important is the number of projects that
have been placed ‘on hold’. These had reached a massive $506 billion by 2Q09, up from just $26
billion a year earlier. The two categories account for 19% of the region’s total project market.
GCC Brief | 22 July 2009



Chart 3 shows the cancelled and suspended projects together, broken down by sector. The
construction sector – which is mostly real estate but also some infrastructure such as ports,
bridges and railways - has taken the hardest hit. This sector accounts for 80% of the value of all
‘cancelled’/’on hold’ projects compared to 42% in June 2008. 261 construction projects are now
reported as either ‘cancelled’ or ‘on hold’, reflecting the contraction of the real estate sector and
the slump in property prices. These include Nakheel's $95 billion Harbour & Tower project, and
Saudi Arabia’s $15 billion Jeddah Mile High Tower.

                         Chart 3: Project cancellations and suspensions, %

                                             Pow er, 1.6    Wat er &
                     Pet rochems,                          Wast e, 0.2
                           7.6
               Oil & Gas,
                   9.3
               Indust ry,
                   1.6




                                                                   Const ruct io
                                                                     n, 79.7
Source: MEED projects database, as at end 2Q 2009.


On a smaller scale, the oil & gas and petrochemical sectors have witnessed a combined $87
billion worth of cancellations. As oil prices took a tumble in Q408, many petrochemicals projects
were deemed unfeasible and, therefore, suspended or cancelled. Such projects include Kuwait’s
$13 billion new refinery, Saudi's $6 billion Nama - Jubail Refining & Integrated Petrochemical
Complex and Oman’s $5 billion Daqum refinery, which were put on hold. The recent bounce in oil
prices, however, if sustained, could see renewed interest in some of these projects.

Unsurprisingly, more than two-thirds of all cancelled/on hold projects are from the private sector,
much higher than its share of all projects underway. By contrast, 29% of cancelled/on hold
projects are from the government sector and just 3% from JVs. This division may partly reflect the
obvious difficulties in obtaining funding for private sector projects as credit conditions have
tightened. But it may also reflect the fact that government-led projects may be less risky or
ambitious in nature, making them more robust in a downturn. If this is true, then the strong
government presence in the sector should be a considerable source of support for project activity
going forward. For the record, table 1 below shows some of GCC states’ largest recent project
cancellations and suspensions.
GCC Brief | 22 July 2009


                              Table 1: Major cancelled/on hold projects

 Project Name                        Country        Sector           Value ($ bn)       Start Date


 Jumeira Gardens                       UAE           Constr              95                2008
 Nakheel Harbour & Tower               UAE           Constr              95                2010
 Jeddah Mile High Tower                 KSA          Constr              15                2009
 New Oil Refinery Project             Kuwait        Oil & Gas            13                2008
 Nama Chemicals Complex                 KSA         Petrocm               6                 -
 Duqm Refinery                         Oman         Oil & Gas             5                2010
 QP/ExxonMobil Barzan Gas               Qatar       Oil & Gas             2                2010
 Dvpmt
 Dammam Oil Field                        KSA        Oil & Gas            1.2               2010
 Development
Source: MEED projects database, as at end 2Q 2009


What impact could the large number of cancellations and suspensions have on the economy?
Since the total value of these projects is currently $515 billion (similar to the ‘projects underway’
calculation above), their loss could theoretically knock some 10-15% per year off GDP growth.
The ultimate impact is likely to be much lower than this, however. A large slice of the value of
these projects would have been ‘lost’ to imports of labor, machinery and materials. If the projects
do not go ahead, these imports will not now take place. In addition, some projects may slowly
come back on stream as economic conditions improve, although this could be offset by further
cancellations.

More fundamentally, some of the abandoned projects – initiated in a period of excessive
exuberance - were likely to turn out to be bad investments, so should never have been initiated in
the first place. Their loss will end-up being a good thing for the economy. Moreover, the
cancellation of ‘uneconomic’ projects should lead to lower input costs, allowing more desirable
projects to be completed quicker, or at lower cost. This is likely to improve the allocation of
resources in Gulf economies over time.

Of course, it is not just through official cancellations and suspensions that the economic downturn
will affect the project scene. Many projects will be delayed or implemented at a more measured
pace than before. It is difficult to get a grasp on just how significant this effect might be, but it is
worth noting that just 25% of the projects slated to start in 1Q 2009 have yet to begin.

Overall then, the drop in project activity seems likely to provide a serious jolt to the GCC economy
in the short-run, largely through depressing aggregate demand. But this effect will fade: a
combination of government support for the financial system and expansionary fiscal and
monetary policies should prevent demand from falling too far - perhaps enough to see it stage a
modest recovery next year. And in the long-run there could be a silver lining to weaker project
activity. As expectations for returns and activity levels are revised down, firms and individuals are
likely to take a more careful view of what constitutes a good investment. This – in combination
with lower oil prices, slower credit growth and less rapid increases in population - could ultimately
produce a more balanced, sustainable growth rate for the region in future. □

								
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