Are Oil Economies Heading for a Debt Crisis?

Are Oil Economies Heading for a Debt Crisis?

Published: September 26th, 2020

Gulf states have found an appetite for debt amide the collapse in global oil prices. Saudi Arabia, Abu Dhabi, Bahrain and Dubai have all issued government bonds this year – the first time in more than a decade that Gulf states have stepped-up their debt issuance en masse.

The moves aren’t unusual for the region’s petro-focused economies. When money is flowing in, and the going is good, governments feel free to spend. When oil prices tank, they issue debt to hold them over until prices rise again.

The trouble is, no one knows this time if prices will ever bounce back.

Back in August the Abu Dhabi emirate announced it would issue what analysts called the longest bond ever offered by a Gulf state. The Emirate took on 50-year debt adding up to USD 5 billion, with issuance finished in the first week of September. The level of over-subscription for the bond stood as a testament to investor confidence in what is still one of wealthiest Emirate’s in the region.

At the same time, sister emirate Dubai also announced that it was setting in motion plans for a bond issue, it's first since 2014. Dubai has since raised USD 2 billion on global bond markets. As in the case of Abu Dhabi, Dubai’s bond was oversubscribed.

The UAE is relatively diversified vis a vis to other Gulf oil states, but its economy has taken a beating from the coronavirus-induced crude price crash. The petro-statelet had an urgent need to replenish its cash reserves.

An old strategy for new times

Strong demand for government issue debt is a good sign. It suggests investors believe that the debt issuer is reliable. But in unprecedented times, can Gulf economies afford to follow their old playbook and hope for the best? With recovery in oil prices forecast to happen at a snail’s pace, if at all, could this crisis be the straw on the camels back that pushes the region’s governments to reform?

Analysts will tell you that any economy dependent on a single export for the majority of its budget revenues can’t rely on borrowing for long-term survival. With growth prospects dimming across the Gulf region, local economies are already in the midst of contraction.

So Gulf governments are going back to a familiar toolbox: borrow cash and slash public spending. This time, though, they may be overtaken by events. The COVID-19 effect on energy consumption shows no sign of abating. With no reference point for scenario planning, the region’s governments could find themselves in a tight spot, caught in a pincer movement between oil market moves and global finance.

One structural weakness is the central role public spending plays as the main growth driver in Gulf countries. A recent statement by the chief economist of Abu Dhabi Commercial Bank said that If public spending drops, consumption will too. That will have a knock-on effect on growth. The indications are that this is already happening across countries and across industries.

PMI figures released by IHS Markit in August showed that non-oil private sector indicators had fallen below 50 in the UAE and Saudi Arabia, the statistical dividing line between growth and contraction. It came as a surprise to analysts following improvements seen in the previous month, which had been against expectations thanks to low oil prices.

The IMF says that, with the exception of Qatar, every Gulf economy is expected to slide into deficit this year. As the region’s biggest economy, Saudi Arabia is expected to fare best with a deficit of around 11 per cent of GDP. Oman will be hit hardest with a deficit of nearly 17 per cent.

There is nothing extraordinary about states going into deficit, but in this case, the lack of financial wiggle room will make Gulf region finance ministries extremely uncomfortable.

Investor interest in bond issues may have been upbeat, but will it stay that way for future debt if prices continue in the $40 a barrel doldrums? That’s well below established Gulf breakeven levels for production. The IMF says Saudi Arabia needs to hit $76 per barrel or more to break even in 2020. That could drop to an easier to achieve $67 in 2021, but with Brent crude set to hit $65 next year, it’s too close for comfort

The unprecedented situation is interfering with the Gulf government objectives to diversify their economies and reduce their oil dependence. This is particularly acute in Saudi Arabia. With its ambitious goal to transform from a petro state to a fully diversified economy by 2030, the squeeze on finances fees like cruel timing. The policy objective would have been financed by revenues drawn from oil sales, which cratered this year once the pandemic began its global spread.

As the Middle East’s largest producer of oil, Saudi Arabia is also coping with the drop in oil revenues by tripling its VAT, slashing public spending, and getting rid of state subsidies for its large workforce of civil servants.

Other Gulf oil states are scaling back public spending as it’s the only the item on their balance sheets they can cut. The alternative is even higher taxes or reduced grants and subsidies for citizens, which would be politically unpopular.

A blend of added debt and reduced spending seems to be the name of the game. The risk, of course, is that the strategy is predicated on an eventual return to higher crude oil prices. If they’re going to avoid falling into a spiral of debt aggravated by further reduced revenue, such bets will need to pay off. Otherwise, it could destabilise the region.

Show Results