## _100512 - 17.      Monetary conditions have remained highly accommodative, helping to offset

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### Monetary conditions and credit
- Policy rates have stayed exceptionally low, in line with those applying to the anchor currencies for the region’s exchange rate pegs.
- Monetary stance has provided important support to the ongoing recovery.
- All GCC countries have seen growth in local bank credit to the private sector increase over the past year, although the pace remains anemic in Kuwait and UAE where non-oil growth is also still relatively low.
- Conditions for external funding have tightened with ongoing deleveraging by European banks and a general reduction in capital flows to emerging markets.

### Inflation and price pressures
- Despite buoyant activity and expansionary policies, price pressures are well contained.
- CPI inflation has mostly moderated over the past year and has in all cases been below 5 percent in the latest data.
- Food and rental prices have generally been subdued, with food prices in many cases held down by subsidies and the real estate market in some countries still facing a supply overhang from the pre-2009 boom.

### Fiscal and external balances; breakeven oil prices
- GCC fiscal surplus estimated to have reached about 13 percent of GDP in 2011; external current account about 24 percent of GDP in 2011.
- Both balances projected to remain broadly stable in 2012 as oil prices have leveled off.
- Rising government spending has continued to increase underlying breakeven oil prices to a historical high, implying heightened vulnerabilities.
- Figure note: Average oil price in 2012: $106.

### Growth projections
- Real non-oil GDP growth projections:
  - 2011: 7 percent
  - 2012: just under 6 percent
  - 2013: 5½ percent
- Slowdown reflects lower growth in government spending and weaker external conditions, partially offset by accommodative monetary conditions and positive private sector momentum.

### Oil income outlook and uncertainties
- Oil production is expected to fall slightly in the year ahead.
- Based on futures prices, the World Economic Outlook projection has crude prices declining gradually over the medium term, falling below $100 per barrel in 2015.
- With continued increases in government spending, fiscal and external surpluses are, with unchanged policies, projected to decline in 2013 and beyond, with the combined fiscal surplus turning to deficit around 2017.
- Distribution of options prices for oil have widened and are now skewed upwards, suggesting markets assign greater weight to geopolitical risks and supply disruptions than to further slowdown in global oil demand.
- Downside risks include potential disruptions to shipping if conflict escalates; longer-term risks include advances in energy production from shale and other unconventional sources that could depress hydrocarbon prices.

### Spillover risks from Europe and a global slowdown
- Two main transmission channels:
  - (i) real sector effects from lower global growth and energy demand; and
  - (ii) financial links to global and European banks.
- A global growth slowdown could sharply reduce oil export revenues, weakening external and fiscal balances and potentially affecting financial and economic conditions.
- Large public external asset buffers and low government debt levels should help mitigate the impact on non-oil activity in most GCC countries.
- Reduced access to foreign funding if European banks retrench could cause temporary liquidity shortages; large domestic liquidity buffers and ample foreign reserves should help bridge such squeezes, but long-lasting retrenchment would require alternative funding sources.

### Downside oil price scenario and simulation results
- Downside scenario specification:
  - Assumes a $30 drop in oil prices that starts in 2013 and lasts through the medium term (similar to the two-year post-2008 drop but without recovery).
- Public external assets and debt:
  - Total public external assets in the GCC estimated at about $1.6 trillion or over 110 percent of GDP in 2011.
  - Under the baseline scenario, GCC total public external assets projected to reach over $3 trillion by 2017.
  - In the downside scenario they reach $2.2 trillion (up from a projected 1.9 trillion at end-2012).
- Current account impacts (downside scenario by 2017):
  - Four countries projected to experience current account deficits by 2017: Bahrain, Oman, Qatar, and Saudi Arabia.
  - Oman projected to record the largest projected deficit at over 17 percent of GDP.
  - Comparing baseline projection for 2017 with downside for the same year, the UAE and Bahrain are the least affected, with declines of 8 and 7 percent of GDP, respectively.
- Fiscal impacts:
  - GCC in aggregate would under the downside scenario go into deficit by 2014, and all GCC economies would run fiscal deficits by 2017.
  - Bahrain and Oman stand out with deficits of 16 percent of GDP each; Saudi Arabia projected to reach a double digit deficit.
- Public external assets dynamics:
  - Majority of GCC countries either remain in surplus or record deficits beyond 2015 (Oman being the exception), so GCC total public external assets increase even in the downside scenario though accumulation slows and falls in some countries.
- Economic activity caveats:
  - Simulations assume oil production remains unaffected; a real fall in global energy demand is likely to reduce hydrocarbon exports and negatively affect overall GDP growth.
  - Simulations assume government spending remains unaffected, which for countries where public external assets decline could test fiscal space.
  - Sharp oil price drops could indirectly hit non-oil activity via reduced consumer and business confidence and declining asset prices.

### Financial links with global and European banks
- Total foreign bank claims on the GCC amounted to $328 billion in the first quarter of 2012; funds provided to global banks by the GCC amounted to $462 billion.
- Country patterns:
  - UAE is the main destination for foreign bank lending (40 percent of total foreign bank claims).
  - Saudi Arabia is the largest creditor to global banks (47 percent of total foreign bank liabilities).
  - Bahrain has claims and liabilities exceeding well over 100 percent of GDP (off-shore banking dominant).
  - Foreign bank lending to Qatar and the UAE amounts to about 40 and 30 percent of GDP, respectively, with over half of inflows going to the non-bank sector in each country.
- Commercial banks' foreign liabilities as share of total liabilities (2012):
  - Bahrain: over 40 percent.
  - Qatar: 29 percent.
  - UAE: 17 percent.
  - Oman, Kuwait, Saudi Arabia: below 10 percent.
- European bank exposure:
  - European bank claims on GCC economies amounted to $220 billion in the first quarter of 2012 (65 percent of total claims).
  - Financing from euro area banks is relatively small across the GCC—at less than 10 percent of GDP—except for Bahrain.
  - Exposure to GIIPS banks is less than 2 percent of GDP in all GCC countries.
- Trends since the global financial crisis:
  - Foreign bank lending to the GCC has on aggregate declined by 5 percent since September 2008 (Qatar being the exception).
  - Foreign claims on Kuwait and Bahrain have fallen by over 55 and 25 percent, respectively.
  - Foreign bank liabilities to the GCC have recently regained momentum (except Bahrain); Qatar tripled claims on foreign banks since September 2008.
- Retrenchment between 2011:Q1 and 2012:Q1:
  - European bank claims on the GCC fell by about 2 percent.
  - The UAE and Qatar saw a 23 and 19 percent drop, respectively, in lending from euro area banks.
- A sharper scaling back of European banks could affect long maturity syndicated loans and project financing, creating funding pressure amid increased infrastructure spending.

### Policy responses and financing options
- Short-term: governments could help bridge temporary funding gaps.
- If retrenchment is long lasting: alternative external or domestic sources may have to fill the gap.
- Recent notable increase in issuance of domestic sukuks in the GCC in 2012 is encouraging and has been partially attributed to the pull-back in European bank lending.
- Further development of regional debt markets could help channel large pools of domestic liquidity to finance large-scale infrastructure projects.

### Banking system soundness
- Capital adequacy ratios have increased for most countries in the GCC since 2009 and are currently above recommended minimum international standards.
- Non-performing loan ratios have fallen or remained stable in all GCC countries since 2009 with the exception of the UAE where the banking system’s loan concentration to the troubled real estate sector remains high.
- Provisioning rates are relatively high in most systems, with Saudi Arabia and Oman provisioning in excess of their current non-performing loans.
- Notable exceptions: the UAE and Kuwait where provisioning rates have declined, reflecting rising non-performing loans in the UAE and lower specific provisioning due to write-off of bad loans in Kuwait.
- Provisioning coverage note: Provisioning coverage in Saudi Arabia, Oman and Qatar includes general as well as specific provisioning.
- Kuwait-specific note: Since the onset of the global crisis Kuwait has required banks to set aside additional “precautionary” provisions, which are not reported in the table.

- Exact financial soundness indicators (Table 1):
  - Capital Adequacy Ratio (2009 / 2011)
    - Saudi Arabia: 16.5 / 17.3
    - UAE: 19.9 / 21.2
    - Qatar: 16.1 / 20.6
    - Kuwait: 16.7 / 18.5
    - Oman: 15.5 / 15.9
    - Bahrain: 19.6 / 20.3
  - Non-performing Loans (share of gross loans) (2009 / 2011)
    - Saudi Arabia: 3.3 / 3.2
    - UAE: 4.3 / 4.2
    - Qatar: 1.7 / 1.7
    - Kuwait: 11.5 / 7.3
    - Oman: 2.7 / 2.4
    - Bahrain: 4.3 / 4.5
  - Provisioning Rate (percent of non-performing loans) (2009 / 2011)
    - Saudi Arabia: 89.8 / 132.8
    - UAE: 94.4 / 67.8
    - Qatar: 84.5 / 86.3
    - Kuwait: 38.3 / 33.9
    - Oman: 104.0 / 120.6
    - Bahrain: 63.9 / 65.9

### Other potential spillover channels
- External credit risk:
  - A large share of the region’s oil revenue is saved abroad by sovereign entities, private corporations, and individuals.
  - Limited availability of information on the geographical composition and risk profile of public external asset portfolios restricts assessment of exposure to European assets.
  - Under the assumption that a significant share of investment is in sovereign debt securities, some exposure to European sovereigns is likely.
- Private portfolio investment geography:
  - Information available for Kuwait and Bahrain shows most portfolio investments are within the GCC and only limited exposure to Europe and GIIPS.
- Foreign direct investment (FDI) as a spillover channel:
  - FDI inflows to the GCC averaged 6 percent of GDP per annum between 2005 and 2011.
  - Stock of inward FDI (2011) — Percent of GDP:
    - Bahrain: almost 62 percent
    - Saudi Arabia: 31 percent
    - UAE: 25 percent
  - Average inflows of FDI (2005–11) — Percent of GDP:
    - Bahrain, Qatar and Saudi Arabia averaged between 7–10 percent of GDP per year.
  - Geographic origin of FDI:
    - Available data for Kuwait and Saudi Arabia suggest a large share of FDI has originated from within the GCC.
    - A significant share of FDI in Saudi Arabia has come from Europe (over 23 percent of the total stock in 2010), with France as the largest European investor (9 percent).

### Policy challenges and recommendations
- Macroeconomic stance:
  - The strong growth outlook implies diminishing need for near-term policy stimulus.
  - Given risks to the outlook, continued emphasis on reducing vulnerabilities and strengthening foundations for economic diversification and longer-term growth is important.
- Fiscal policy:
  - Pace of government spending growth can be scaled down from recent highs.
  - Most GCC countries should plan to reduce the growth rate in government expenditure to gradually lower the ratio of their non-oil deficits to non-oil GDP.
  - Use of fiscal surpluses and past savings to smooth spending in a global downside scenario.
- Monetary and financial stability:
  - The accommodative monetary stance is appropriate, but vigilance for buildup of financial sector risk and price pressures is necessary.
  - U.S. interest rates—imported via pegged exchange rate regimes—are likely to stay low through at least 2015.
  - If credit expansion leads to domestic price pressures or indicators signal overheating, fiscal policy tightening would be the first line of defense given exchange rate pegs.
  - Macroeconomic and financial stability tools recommended:
    - Ceilings on loan-to-deposit and debt service-to-income ratios
    - Loan provisioning and capital requirements
    - Minimum liquidity ratios
    - Active use of macroprudential tools
- Preparedness for global downside scenario:
  - Insulate economies by proactively using buffers from large fiscal surpluses and past savings to maintain government spending and provide liquidity to the financial sector.
  - Recognize that a sustained decrease in oil prices would be difficult to manage, underscoring risks from hydrocarbon dependence.
- Addressing underlying vulnerabilities and long-term challenges — specific steps:
  - Reducing fiscal risks and strengthening the fiscal outlook:
    - Contain increases in entitlements that are hard to reverse.
    - Prioritize growth-enhancing investments in infrastructure.
    - Reform costly energy subsidies by bringing domestic fuel prices closer in line with international markets.
  - Strengthening fiscal frameworks and institutions:
    - Introduce multi-year budgeting supported by macro-fiscal units and possibly a formal fiscal rule.
  - Bolstering the financial sector:
    - Intensive surveillance of systemic and weak banks.
    - Early intervention in weak banks.
    - Establish early warning systems.
    - Strengthen bank resolution frameworks.
    - Use of macroprudential tools to manage buildup of risks.
    - Test monetary instruments and emergency liquidity arrangements; consider crisis simulation exercises.
    - Upgrade regulatory and supervisory frameworks for banks in line with global initiatives and strengthen disclosure requirements.
  - Deepening domestic debt markets:
    - Put in place legal and financial infrastructure and regular placement of government debt across maturities to establish a yield curve.
    - Develop corporate debt market to enhance domestic financing options and reduce reliance on foreign funding.
- Labor market and social policy:
  - Ensuring sufficient job creation for nationals is crucial given rapid increases in the working age population and private sectors that rely mainly on foreign labor.
  - Policy options to boost job creation:
    - Enhance education and training systems.
    - Improve job placement services.
    - Potentially provide targeted subsidies for hiring new labor market entrants.
  - Address differences in wages and benefits that lead nationals to prefer public over private sector employment.
- Statistics and data:
  - Enhancing statistical systems should remain a high priority to improve timeliness, quality, and periodicity of macroeconomic statistics.
  - Regional initiatives (Gulfstat and Arabstat) would help harmonize statistical measures and anchor improvement plans.

### Selected economic indicators and key statistics (2007–13, various aggregates)
- Real GDP (Percent change) selected values:
  - Bahrain: 2007 8.4; 2008 6.3; 2009 3.2; 2010 4.7; 2011 2.1; 2012 2.0; 2013 2.8
  - Kuwait: 2007 6.5; 2008 4.2; 2009 -7.8; 2010 2.5; 2011 8.2; 2012 6.3; 2013 1.9
  - Oman: 2007 6.7; 2008 13.1; 2009 3.1; 2010 3.9; 2011 5.0; 2012 5.4; 2013 3.9
  - Qatar: 2007 18.0; 2008 17.7; 2009 12.0; 2010 16.7; 2011 14.1; 2012 6.3; 2013 4.9
  - Saudi Arabia: 2007 2.0; 2008 4.2; 2009 0.1; 2010 5.1; 2011 7.1; 2012 6.0; 2013 4.2
  - United Arab Emirates: 2007 6.5; 2008 5.3; 2009 -4.8; 2010 1.3; 2011 5.2; 2012 4.0; 2013 2.6
  - GCC countries: 2007 5.3; 2008 6.3; 2009 -0.2; 2010 5.5; 2011 7.5; 2012 5.6; 2013 3.7
- Real Oil GDP (Percent change) selected values:
  - GCC countries: 2007 -2.0; 2008 4.8; 2009 -6.0; 2010 5.2; 2011 7.9; 2012 4.8; 2013 0.0
- Real Nonoil GDP (Percent change) selected values:
  - GCC countries: 2007 8.9; 2008 7.0; 2009 2.7; 2010 5.2; 2011 7.0; 2012 5.9; 2013 5.5
- CPI inflation (average) (Percent) selected values:
  - GCC countries: 2007 6.6; 2008 11.0; 2009 3.0; 2010 3.2; 2011 3.6; 2012 3.5; 2013 3.6
- Government sector — Fiscal balance (Percent of GDP) selected values:
  - GCC countries: 2007 17.9; 2008 24.8; 2009 -0.7; 2010 4.5; 2011 12.7; 2012 14.6; 2013 11.2
- External sector — Current account balance (Percent of GDP) selected values:
  - GCC countries: 2007 19.9; 2008 22.7; 2009 7.5; 2010 14.4; 2011 24.1; 2012 23.6; 2013 21.1
- Memorandum items (US$ billions, unless otherwise indicated):
  - Nominal GDP, GCC countries: 2007 897.5; 2008 1,136.0; 2009 907.5; 2010 1,067.8; 2011 1,372.1; 2012 1,484.6; 2013 1,534.3
  - Current account balance, GCC countries: 2007 197.9; 2008 294.3; 2009 109.0; 2010 178.5; 2011 362.6; 2012 382.9; 2013 342.3
  - Oil price (US$ per barrel, simple average of three spot prices Dated Brent, West Texas Intermediate, and the Dubai Fateh):
    - 2007 71.1; 2008 97.0; 2009 61.8; 2010 79.0; 2011 104.0; 2012 106.2; 2013 105.1
  - Oil production (million of barrels per day): 2007 15.7; 2008 16.2; 2009 14.8; 2010 14.9; 2011 16.6; 2012 17.5; 2013 17.4

*Prepared by May Khamis, Tobias Rasmussen, and Niklas Westelius.*

### Executive Summary ......................................................................................................

### Executive Summary

### I. International Context
- The global recovery is described as "already sluggish" and has "suffered new setbacks"; the euro area crisis intensified in the first half of 2012 and growth has slowed across the globe.
- Key risks noted:
  - "A further escalation of the euro-area crisis or a failure to avoid the 'fiscal cliff' in the United States" entail significant downside risk.
- Recent economic developments and indicators:
  - Global manufacturing and trade weakening; demand for durables flagged.
  - Euro-area periphery experienced the most pronounced downturn; periphery bond yields rose and stocks fell.
  - Since late July, a new bond-buying program by the European Central Bank and further monetary easing by the U.S. Federal Reserve have "led to a marked improvement in market sentiment."
- Advanced economies:
  - Growth slowed noticeably; real GDP contracted in the United Kingdom.
  - U.S.: employment and output growth lower than expected; housing market showing tentative signs of improvement.
  - Japan: growth fell sharply as reconstruction-related boost waned.
- Emerging markets:
  - Still outperform advanced economies but momentum has faded.
  - China: annual real GDP growth near "almost 8 percent in the second quarter" but continuing to decline; earlier policy tightening and weak external demand cited.
  - India: pace of expansion moderated significantly.
  - Many emerging markets faced equity price declines, capital outflows, and currency depreciation due to investor risk aversion.
- Inflation and commodities:
  - Headline inflation slipped from "4½ percent" in the last quarter of 2011 to "around 3½ percent."
  - Commodity price movements varied; oil prices rose by "over 20 percent since early June" due to geopolitical risks and production outages; food prices increased by a similar amount.
  - Futures markets indicate oil and food prices "will fall back somewhat over the next year."
- Policy outlook:
  - Fiscal tightening eased and monetary policy easing expected to support activity.
  - In advanced economies, cyclically adjusted fiscal balances improved by "about ¾ percent of GDP" in 2011 and similar adjustment expected for 2012 and 2013.
  - Emerging and developing economies adjusted by "1¼ percent of GDP" in 2011 with no significant tightening expected.
  - Monetary policy easing likely to continue though constrained where rates are close to zero.
- Baseline forecast caveats:
  - The projected gradual pickup in output depends on: (i) European policymakers stabilizing and reducing sovereign spreads; and (ii) U.S. policymakers avoiding the "fiscal cliff."

### II. Developments in the Middle East and North Africa (MENA) Region
- Regional growth and composition:
  - MENA real economic growth fell from "5 percent in 2010 to 3.3 percent in 2011" and is projected to pick up to "5.3 percent in 2012."
  - Much of the region-wide movement driven by Libya’s 2011 collapse and 2012 rebound in oil production.
- Political transitions and disruptions:
  - Changes of government in Egypt, Libya, Tunisia, and Yemen accompanied by social unrest and disruptions to economic activity; conflict in Syria intensified and affected neighbors.
  - Interruptions reduced tourism and foreign direct investment; rebound limited by weak conditions in Europe and elsewhere.
  - "Management of popular expectations will remain a challenge."
- Outlook for oil importers:
  - Near-term growth subdued; growth for oil importers (excl. Syria) projected at "1.4 percent" in 2012.
  - Buffers largely run out; fiscal and current account balances deteriorating; borrowing costs rising; deficits harder to finance without external assistance.
- Official financing to transition countries:
  - Of "$17.5 billion in official financing disbursed since the start of 2011," GCC countries provided "$7.1 billion."
  - The set of transition countries included: Egypt, Jordan, Libya, Morocco, Tunisia, and Yemen (figure note).
- Outlook for oil exporters:
  - Buoyed by accommodative fiscal and monetary policy; real GDP growth for oil exporters projected at "6.6 percent in 2012," up from "3.9 percent in 2011."
  - Non-oil GDP growth expected at "4.8 percent in 2012."
  - Significant cross-country differences: Yemen and Iran facing negative growth in 2012 (Iran reflecting lower export revenue from tightened U.S. sanctions and the EU oil embargo).
  - Many countries expected to see relatively fast growth in construction, infrastructure, and non-tradable consumer sectors.
- Key regional risks:
  - Commodity prices and global growth: weaker global demand could lead to a prolonged large drop in oil prices, worsening fiscal and external balances for exporters.
  - Geopolitical tensions could cause sharp oil price increases; net effect on revenue depends on export volumes and supply disruptions.
  - Oil importers would be negatively affected by higher oil prices and further rises in international food prices.
  - Maghreb countries are particularly vulnerable to a further downturn in Europe due to trade ties.

### III. Developments in GCC Countries
- Overall assessment:
  - GCC economies benefited from historically high oil prices and expanded production; expansionary fiscal policies and low interest rates provided additional stimulus.
  - Fiscal and external surpluses are generally large; consumer price inflation is moderate; outlook for growth remains positive.
  - Economies remain dependent on hydrocarbon extraction; rising government spending has raised breakeven oil prices and heightened vulnerabilities.
  - Risks from direct exposure to Europe are limited; indirect effects via oil demand and prices could be substantial.
- Growth and production:
  - "Overall real GDP growth for the GCC reached 7.5 percent" in 2011—the highest since 2003.
  - Oil production rose by "over 10 percent" in 2011.
  - Non-hydrocarbon growth increased in all countries except Bahrain.
- Fiscal stimulus and spending:
  - In 2011 overall spending grew by "some 20 percent in U.S. dollar terms," about double the pace of the previous two years.
  - Much higher spending was in current expenditure, including larger wage bills (all countries) and new benefits for job-seekers (Oman and Saudi Arabia).
  - Capital expenditure also increased sharply in Saudi Arabia.
- Policy stance and implications:
  - The strong baseline outlook reduces the need for near-term policy stimulus.
  - Most GCC countries can plan to "reduce the growth rate in government spending in the period ahead" to prevent overheating and improve long-term fiscal positions.
  - With low inflation, the accommodative monetary stance implied by the region’s currency pegs "remains appropriate."
- Vulnerabilities and buffers:
  - Although most GCC countries have sufficient savings to cushion a sizeable shock, a prolonged drop in oil prices could test available buffers.
  - A rapid deterioration in the global economy could produce outcomes similar to 2009—sharp fall in oil prices and disruptions to capital flows.

### IV. Spillover Risks from Europe and a Global Slowdown
- Overall characterization:
  - Risks to the GCC from exposure to Europe are limited, but indirect channels—particularly via oil demand and prices—could have substantial impacts.
  - A rapid global deterioration could cause a sharp fall in oil prices and capital flow disruptions; many GCC countries have savings to cushion shocks, but prolonged low oil prices would test buffers.
- (Sections in the source break down spillovers into: A. Trade linkages and exposure to Europe; B. Financial links and exposure to global and European banks; C. Other potential spillover channels. Detailed numeric tables and figures supporting these points are provided in the full chapter.)

### V. Policy Challenges and Recommendations
- Main policy priorities highlighted:
  - Reduce fiscal risks and improve the fiscal outlook by:
    - Containing increases in spending on entitlements that are hard to reverse.
    - Prioritizing growth-enhancing investments in infrastructure.
  - Strengthen fiscal frameworks and institutions.
  - Bolster the financial sector by:
    - Continuing to enhance supervision.
    - Strengthening macroprudential policy frameworks.
    - Deepening domestic debt markets.
  - Advance private sector job creation for nationals.
- Policy stance recommendation:
  - Given the strong baseline outlook, "diminishing need for near-term policy stimulus" and scope to reduce the growth rate of government spending.
  - Maintain accommodative monetary stance consistent with currency pegs while focusing on reducing vulnerabilities and strengthening foundations for diversification and longer-term growth.

*Prepared by May Khamis, Tobias Rasmussen, and Niklas Westelius.*

### 17.      Monetary conditions have remained highly accommodative, helping to offset

### _100512 - 17.      Monetary conditions have remained highly accommodative, helping to offset

### Monetary conditions and credit
- Policy rates have stayed exceptionally low, in line with those applying to the anchor currencies for the region’s exchange rate pegs.
- Monetary stance has provided important support to the ongoing recovery.
- All GCC countries have seen growth in local bank credit to the private sector increase over the past year, although the pace remains anemic in Kuwait and UAE where non-oil growth is also still relatively low.
- Conditions for external funding have tightened with ongoing deleveraging by European banks and a general reduction in capital flows to emerging markets.

### Inflation and price pressures
- Despite buoyant activity and expansionary policies, price pressures are well contained.
- CPI inflation has mostly moderated over the past year and has in all cases been below 5 percent in the latest data.
- Food and rental prices have generally been subdued, with food prices in many cases held down by subsidies and the real estate market in some countries still facing a supply overhang from the pre-2009 boom.

### Fiscal and external balances; breakeven oil prices
- Driven by the surge in oil revenue, the GCC’s fiscal surplus is estimated to have reached about 13 percent of GDP in 2011 and the external current account about 24 percent of GDP.
- Both these balances are projected to remain broadly stable in 2012 as oil prices have leveled off.
- Along with rising government spending, underlying breakeven oil prices have continued to increase and are at a historical high, implying heightened vulnerabilities.
- Figure note: Average oil price in 2012: $106.

### Growth projections
- Real non-oil GDP growth is projected to slow from 7 percent in 2011 to just under 6 percent in 2012 and then to 5½ percent in 2013.
- Slowdown reflects lower growth in government spending and weaker external conditions, partially offset by accommodative monetary conditions and positive private sector momentum.

### Oil income outlook and uncertainties
- Oil production is expected to fall slightly in the year ahead.
- Based on futures prices, the World Economic Outlook projection has crude prices declining gradually over the medium term, falling below $100 per barrel in 2015.
- With continued increases in government spending, fiscal and external surpluses are, with unchanged policies, projected to decline in 2013 and beyond, with the combined fiscal surplus turning to deficit around 2017.
- Distribution of options prices for oil have widened and are now skewed upwards, suggesting markets assign greater weight to geopolitical risks and supply disruptions than to further slowdown in global oil demand.
- Downside risks include potential disruptions to shipping if conflict escalates; longer-term risks include advances in energy production from shale and other unconventional sources that could depress hydrocarbon prices.

### Spillover risks from Europe and a global slowdown
- Two main transmission channels: (i) real sector effects from lower global growth and energy demand; and (ii) financial links to global and European banks.
- A global growth slowdown could sharply reduce oil export revenues, weakening external and fiscal balances and potentially affecting financial and economic conditions; large public external asset buffers and low government debt levels should help mitigate the impact on non-oil activity in most GCC countries.
- Reduced access to foreign funding if European banks retrench could cause temporary liquidity shortages; large domestic liquidity buffers and ample foreign reserves should help bridge such squeezes, but long-lasting retrenchment would require alternative funding sources.

### Downside oil price scenario and simulation results
- Downside scenario: assumes a $30 drop in oil prices that starts in 2013 and lasts through the medium term (similar to the two-year post-2008 drop but without recovery).
- Public external assets and debt:
  - Total public external assets in the GCC are estimated at about $1.6 trillion or over 110 percent of GDP in 2011.
  - Under the baseline scenario, the GCC’s total public external assets are projected to reach over $3 trillion by 2017.
  - In the downside scenario they reach $2.2 trillion (up from a projected 1.9 trillion at end-2012).
- Current account impacts:
  - In the downside scenario, four countries are projected to experience current account deficits by 2017: Bahrain, Oman, Qatar, and Saudi Arabia.
  - Oman is projected to record the largest projected deficit at over 17 percent of GDP.
  - Comparing baseline projection for 2017 with downside for the same year, the UAE and Bahrain are the least affected, with declines of 8 and 7 percent of GDP, respectively.
- Fiscal impacts:
  - The GCC in aggregate would under the downside scenario go into deficit by 2014, and all GCC economies would run fiscal deficits by 2017.
  - Bahrain and Oman stand out with deficits of 16 percent of GDP each; Saudi Arabia is projected to reach a double digit deficit.
- Public external assets dynamics:
  - Majority of GCC countries either remain in surplus or record deficits beyond 2015 (Oman being the exception), so GCC total public external assets increase even in the downside scenario though accumulation slows and falls in some countries.
- Economic activity:
  - Simulations assume oil production remains unaffected; a real fall in global energy demand is likely to reduce hydrocarbon exports and negatively affect overall GDP growth.
  - Simulations assume government spending remains unaffected, which for countries where public external assets decline could test fiscal space.
  - Sharp oil price drops could indirectly hit non-oil activity via reduced consumer and business confidence and declining asset prices.

### Financial links with global and European banks
- Total foreign bank claims on the GCC amounted to $328 billion in the first quarter of 2012; funds provided to global banks by the GCC amounted to $462 billion.
- Country patterns:
  - UAE is the main destination for foreign bank lending (40 percent of total foreign bank claims).
  - Saudi Arabia is the largest creditor to global banks (47 percent of total foreign bank liabilities).
  - Bahrain has claims and liabilities exceeding well over 100 percent of GDP (off-shore banking dominant).
  - Foreign bank lending to Qatar and the UAE amounts to about 40 and 30 percent of GDP, respectively, with over half of inflows going to the non-bank sector in each country.
- Commercial banks' foreign liabilities as share of total liabilities (2012):
  - Bahrain: over 40 percent.
  - Qatar: 29 percent.
  - UAE: 17 percent.
  - Oman, Kuwait, Saudi Arabia: below 10 percent.
- European banks account for the majority of outstanding claims on the GCC:
  - European bank claims on GCC economies amounted to $220 billion in the first quarter of 2012 (65 percent of total claims).
  - Financing from euro area banks is relatively small across the GCC—at less than 10 percent of GDP—except for Bahrain.
  - Exposure to GIIPS banks is less than 2 percent of GDP in all GCC countries.
- Trends since the global financial crisis:
  - Foreign bank lending to the GCC has on aggregate declined by 5 percent since September 2008 (Qatar being the exception).
  - Foreign claims on Kuwait and Bahrain have fallen by over 55 and 25 percent, respectively.
  - Foreign bank liabilities to the GCC have recently regained momentum (except Bahrain); Qatar tripled claims on foreign banks since September 2008.
- Retrenchment of European banks:
  - Between 2011:Q1 and 2012:Q1, European bank claims on the GCC fell by about 2 percent.
  - The UAE and Qatar saw a 23 and 19 percent drop, respectively, in lending from euro area banks.
  - A sharper scaling back of European banks could affect long maturity syndicated loans and project financing, creating funding pressure amid increased infrastructure spending.

### Policy responses and financing options
- Short-term: governments could help bridge temporary funding gaps.
- If retrenchment is long lasting: alternative external or domestic sources may have to fill the gap.
- Recent notable increase in issuance of domestic sukuks in the GCC in 2012 is encouraging and has been partially attributed to the pull-back in European bank lending.
- Further development of regional debt markets could help channel large pools of domestic liquidity to finance large-scale infrastructure projects.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2012/_100512.pdf*

### 34.      The soundness of GCC banking systems has strengthened over the past couple of

### 34.      The soundness of GCC banking systems has strengthened over the past couple of

### Banking system soundness
- Capital adequacy ratios have increased for most countries in the GCC since 2009 and are currently above recommended minimum international standards.
- Non-performing loan ratios have fallen or remained stable in all GCC countries since 2009 with the exception of the UAE where the banking system’s loan concentration to the troubled real estate sector remains high.
- Provisioning rates are relatively high in most systems, with Saudi Arabia and Oman provisioning in excess of their current non-performing loans.
- Notable exceptions: the UAE and Kuwait where provisioning rates have declined, reflecting rising non-performing loans in the UAE and lower specific provisioning due to write-off of bad loans in Kuwait.
- Provisioning coverage note: Provisioning coverage in Saudi Arabia, Oman and Qatar includes general as well as specific provisioning.
- Kuwait-specific note: Since the onset of the global crisis Kuwait has required banks to set aside additional “precautionary” provisions, which are not reported in the table.

- Exact financial soundness indicators (Table 1):
  - Capital Adequacy Ratio (2009 / 2011)
    - Saudi Arabia: 16.5 / 17.3
    - UAE: 19.9 / 21.2
    - Qatar: 16.1 / 20.6
    - Kuwait: 16.7 / 18.5
    - Oman: 15.5 / 15.9
    - Bahrain: 19.6 / 20.3
  - Non-performing Loans (share of gross loans) (2009 / 2011)
    - Saudi Arabia: 3.3 / 3.2
    - UAE: 4.3 / 4.2
    - Qatar: 1.7 / 1.7
    - Kuwait: 11.5 / 7.3
    - Oman: 2.7 / 2.4
    - Bahrain: 4.3 / 4.5
  - Provisioning Rate (percent of non-performing loans) (2009 / 2011)
    - Saudi Arabia: 89.8 / 132.8
    - UAE: 94.4 / 67.8
    - Qatar: 84.5 / 86.3
    - Kuwait: 38.3 / 33.9
    - Oman: 104.0 / 120.6
    - Bahrain: 63.9 / 65.9

_Source: Country authorities._

### Other potential spillover channels
- External credit risk:
  - A large share of the region’s oil revenue is saved abroad by sovereign entities, private corporations, and individuals.
  - Limited availability of information on the geographical composition and risk profile of public external asset portfolios restricts assessment of exposure to European assets.
  - Under the assumption that a significant share of investment is in sovereign debt securities, some exposure to European sovereigns is likely.
- Private portfolio investment geography:
  - Information available for Kuwait and Bahrain shows most portfolio investments are within the GCC and only limited exposure to Europe and GIIPS.
- Foreign direct investment (FDI) as a spillover channel:
  - FDI inflows to the GCC averaged 6 percent of GDP per annum between 2005 and 2011.
  - Stock of inward FDI (2011) — Percent of GDP:
    - Bahrain: almost 62 percent
    - Saudi Arabia: 31 percent
    - UAE: 25 percent
  - Average inflows of FDI (2005–11) — Percent of GDP:
    - Bahrain, Qatar and Saudi Arabia averaged between 7–10 percent of GDP per year.
  - Geographic origin of FDI:
    - Available data for Kuwait and Saudi Arabia suggest a large share of FDI has originated from within the GCC.
    - A significant share of FDI in Saudi Arabia has come from Europe (over 23 percent of the total stock in 2010), with France as the largest European investor (9 percent).

### Policy challenges and recommendations
- Macroeconomic stance:
  - The strong growth outlook implies diminishing need for near-term policy stimulus.
  - Given risks to the outlook, continued emphasis on reducing vulnerabilities and strengthening foundations for economic diversification and longer-term growth is important.
- Fiscal policy:
  - Pace of government spending growth can be scaled down from recent highs.
  - Most GCC countries should plan to reduce the growth rate in government expenditure to gradually lower the ratio of their non-oil deficits to non-oil GDP.
  - Use of fiscal surpluses and past savings to smooth spending in a global downside scenario.
- Monetary and financial stability:
  - The accommodative monetary stance is appropriate, but vigilance for buildup of financial sector risk and price pressures is necessary.
  - U.S. interest rates—imported via pegged exchange rate regimes—are likely to stay low through at least 2015.
  - If credit expansion leads to domestic price pressures or indicators signal overheating, fiscal policy tightening would be the first line of defense given exchange rate pegs.
  - Macroeconomic and financial stability tools recommended:
    - Ceilings on loan-to-deposit and debt service-to-income ratios
    - Loan provisioning and capital requirements
    - Minimum liquidity ratios
    - Active use of macroprudential tools
- Preparedness for global downside scenario:
  - Insulate economies by proactively using buffers from large fiscal surpluses and past savings to maintain government spending and provide liquidity to the financial sector.
  - Recognize that a sustained decrease in oil prices would be difficult to manage, underscoring risks from hydrocarbon dependence.
- Addressing underlying vulnerabilities and long-term challenges — specific steps:
  - Reducing fiscal risks and strengthening the fiscal outlook:
    - Contain increases in entitlements that are hard to reverse.
    - Prioritize growth-enhancing investments in infrastructure.
    - Reform costly energy subsidies by bringing domestic fuel prices closer in line with international markets.
  - Strengthening fiscal frameworks and institutions:
    - Introduce multi-year budgeting supported by macro-fiscal units and possibly a formal fiscal rule.
  - Bolstering the financial sector:
    - Intensive surveillance of systemic and weak banks.
    - Early intervention in weak banks.
    - Establish early warning systems.
    - Strengthen bank resolution frameworks.
    - Use of macroprudential tools to manage buildup of risks.
    - Test monetary instruments and emergency liquidity arrangements; consider crisis simulation exercises.
    - Upgrade regulatory and supervisory frameworks for banks in line with global initiatives and strengthen disclosure requirements.
  - Deepening domestic debt markets:
    - Put in place legal and financial infrastructure and regular placement of government debt across maturities to establish a yield curve.
    - Develop corporate debt market to enhance domestic financing options and reduce reliance on foreign funding.
- Labor market and social policy:
  - Ensuring sufficient job creation for nationals is crucial given rapid increases in the working age population and private sectors that rely mainly on foreign labor.
  - Policy options to boost job creation:
    - Enhance education and training systems.
    - Improve job placement services.
    - Potentially provide targeted subsidies for hiring new labor market entrants.
  - Address differences in wages and benefits that lead nationals to prefer public over private sector employment.
- Statistics and data:
  - Enhancing statistical systems should remain a high priority to improve timeliness, quality, and periodicity of macroeconomic statistics.
  - Regional initiatives (Gulfstat and Arabstat) would help harmonize statistical measures and anchor improvement plans.

### Selected economic indicators and key statistics (2007–13, various aggregates)
- Real GDP (Percent change) selected values:
  - Bahrain: 2007 8.4; 2008 6.3; 2009 3.2; 2010 4.7; 2011 2.1; 2012 2.0; 2013 2.8
  - Kuwait: 2007 6.5; 2008 4.2; 2009 -7.8; 2010 2.5; 2011 8.2; 2012 6.3; 2013 1.9
  - Oman: 2007 6.7; 2008 13.1; 2009 3.1; 2010 3.9; 2011 5.0; 2012 5.4; 2013 3.9
  - Qatar: 2007 18.0; 2008 17.7; 2009 12.0; 2010 16.7; 2011 14.1; 2012 6.3; 2013 4.9
  - Saudi Arabia: 2007 2.0; 2008 4.2; 2009 0.1; 2010 5.1; 2011 7.1; 2012 6.0; 2013 4.2
  - United Arab Emirates: 2007 6.5; 2008 5.3; 2009 -4.8; 2010 1.3; 2011 5.2; 2012 4.0; 2013 2.6
  - GCC countries: 2007 5.3; 2008 6.3; 2009 -0.2; 2010 5.5; 2011 7.5; 2012 5.6; 2013 3.7
- Real Oil GDP (Percent change) selected values:
  - GCC countries: 2007 -2.0; 2008 4.8; 2009 -6.0; 2010 5.2; 2011 7.9; 2012 4.8; 2013 0.0
- Real Nonoil GDP (Percent change) selected values:
  - GCC countries: 2007 8.9; 2008 7.0; 2009 2.7; 2010 5.2; 2011 7.0; 2012 5.9; 2013 5.5
- CPI inflation (average) (Percent) selected values:
  - GCC countries: 2007 6.6; 2008 11.0; 2009 3.0; 2010 3.2; 2011 3.6; 2012 3.5; 2013 3.6
- Government sector — Fiscal balance (Percent of GDP) selected values:
  - GCC countries: 2007 17.9; 2008 24.8; 2009 -0.7; 2010 4.5; 2011 12.7; 2012 14.6; 2013 11.2
- External sector — Current account balance (Percent of GDP) selected values:
  - GCC countries: 2007 19.9; 2008 22.7; 2009 7.5; 2010 14.4; 2011 24.1; 2012 23.6; 2013 21.1
- Memorandum items (US$ billions, unless otherwise indicated):
  - Nominal GDP, GCC countries: 2007 897.5; 2008 1,136.0; 2009 907.5; 2010 1,067.8; 2011 1,372.1; 2012 1,484.6; 2013 1,534.3
  - Current account balance, GCC countries: 2007 197.9; 2008 294.3; 2009 109.0; 2010 178.5; 2011 362.6; 2012 382.9; 2013 342.3
  - Oil price (US$ per barrel, simple average of three spot prices Dated Brent, West Texas Intermediate, and the Dubai Fateh):
    - 2007 71.1; 2008 97.0; 2009 61.8; 2010 79.0; 2011 104.0; 2012 106.2; 2013 105.1
  - Oil production (million of barrels per day): 2007 15.7; 2008 16.2; 2009 14.8; 2010 14.9; 2011 16.6; 2012 17.5; 2013 17.4

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2012/_100512.pdf_