Regional Analysis 2020 Middle East

Middle East Market Review 2020

As a market that is already susceptible to volatility as a result of fluctuating oil prices, the Middle East has been dealt a double blow by the impact of COVID itself, coupled with the impact that COVID is having on the oil market.

-7.3%
Economic growth 2020
US$1.45tn
Projects planned across the GCC states in 2020

Middle East market summary 2020

Middle East market summary 2020

Middle East Market Review

With the impact of COVID and the realisation of its impacts beginning to be felt around the world, Kevin Gardiner, Associate Director at Linesight, discusses the economic and construction industry performance for the Middle East.

Economic overview

Despite the diversity in the Middle East construction industry making it difficult to draw broad conclusions and forecasts, there are a number of common factors influencing all economies in the region to various extents, including the COVID-19 pandemic. Once again, oil prices are also having a significant impact on growth, along with geopolitical tensions, global trade wars and macroeconomic performance as a whole. These factors coalesce in the region to make the GCC less predictable than most major global markets.

In spite of lacklustre growth in the region over the past few years, economic expansion within the GCC states was expected to reach a modest 2.5% in 2020, according to initial forecasts by the IMF. Not surprisingly, this has been revised downwards to a projected contraction of 7.3% in Middle East oil-exporting countries as of July 2020, due in part to the impact of the global pandemic. Pre-COVID, upside growth prospects were primarily driven by significant investment in infrastructure and major capital projects across key sectors such as hospitality, entertainment, education and healthcare. GCC economies have been dealt a ‘double blow’, as turmoil in the oil markets has been compounded by the economic impact of pandemic-linked lockdowns, particularly in the tourism and trade sectors. Austerity measures in the form of steep government spending cuts have been implemented across the GCC and will have an adverse impact on growth in the short to medium term across the region.

Despite significant regional government efforts to diversify economies in recent years, the GCC’s dependence on oil plays a major role in economic activity and will have a significant impact on the pace of recovery post-pandemic. Since hitting a ten-year low in January 2016, oil prices improved considerably, rising from below US$30 per barrel to US$64 per barrel on average in 2019. 2020 has been another difficult year, as hopes for a more buoyant oil market have been eroded by downward pressure on oil prices, resulting in an estimated loss of US$270 billion in GCC government revenues according to the IMF. This loss of revenue will hinder the ability of oil-exporting governments to stimulate economic growth through expansionary budgets.

Low oil prices have resulted in subdued economic performance in the region in previous years and incentivized governments to pursue ambitious fiscal consolidation measures, including cutbacks on capital expenditure and benefits to public-sector employees, reform of energy and water subsidies, the introduction of land taxes and the introduction of 5% VAT. The pace of consolidation softened in 2019, as most governments approved expansionary budgets with particular focus on developing the non-oil economy and public infrastructure along with pursuing various National Development Plans such as ‘Saudi Vison 2030’ and ‘Qatar National Vison 2030’. The initial outlook for 2020 showed signs of positivity and saw the UAE approve the largest budget since the establishment of the country, whilst Saudi Arabia intended to reinvest the part-sale of state-owned assets such as Saudi Aramco to offset a marginal decline in Government expenditure. The unforeseen economic impacts of COVID-19 have forced governments to curtail some non-essential spending and focus on preservation rather than growth. In addition, some austerity measures have been reinstated, including the implementation of a 15% VAT rate in KSA that came into effect on 1st July 2020, a trend which is likely to continue as governments seek to protect finances.

Construction

Construction activity plays a significant role in regional economic development in the region. In 2018, US$101.8 billion worth of projects were awarded across the GCC region compared to US$102.3 billion in 2019, and this muted growth is reflective of the challenging environment mentioned above. At the outset of 2020, with macroeconomic headwinds showing no sign of abating in the short term, a large-scale region-wide pickup in project awards in 2020 was unlikely. Despite this, there was an estimated US$1.45 trillion projects planned across the GCC states, many of which were supported by solid fundamentals, including increased population growth, young demographics and a growing requirement for infrastructure across multiple sectors. Whilst the monetary impact of COVID-19 on estimated project awards is yet to be established, pandemic-related lockdowns are having a significant impact on the construction sector and will impact underlying fundamentals.

Where growth was previously forecast, it was generally supported by government commitments to increase spending in sectors such as infrastructure, healthcare and education. In recent years, GCC governments have also been making remarkable investments in the tourism and hospitality sectors, as well as leisure attractions. Saudi Arabia, in particular, which has been active in pursuing both social and economic reform, has launched a variety of megaprojects, including the Red Sea Project, Qiddiya Entertainment City, Project Neom and Diriyah Gate, which have a combined value of US$532 billion. Considering the current pandemic, workload expectations over the next twelve months generally depend on an allocation of government funds to stimulate economic recovery and curtail the economic impact of COVID. Given the turmoil in the oil markets and lack of activity in various market segments, the feasibility of many projects, including government-led infrastructure works, will be closely scrutinized. Some economic development programmes have already felt the impact of funding reallocation, such as Ghadan 21 - a US$13 billion development programme in Abu Dhabi, which has seen some projects being suspended and project teams demobilised. Workloads are also reported to have fallen across both public and private sectors in most Middle East counties.

Value of GCC contract awards by country, 2016 - 2019 ($m)

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Where growth is forecast, this is generally supported by government commitments to increase spending in sectors such as infrastructure, healthcare and education. GCC governments are also making remarkable investments in the tourism and hospitality sectors, as well as leisure attractions. Saudi Arabia in particular, which has been active in pursuing both social and economic reform, has launched a variety of megaprojects, including the Red Sea Project, Quiddiya Entertainment City, Project NEOM and Diriyah Gate, which have a combined value of US$532B. Much of the funding for these projects was to be supported by the part sale of Saudi Aramco, which was initially estimated to raise US$500bn. However, recent reports suggest that only US$25bn was raised, casting doubt over the viability of some of these schemes.

Whilst the UAE has historically been the market leader in the GCC construction market, Saudi Arabia has closed the gap, with the value of unplanned projects, estimated to be US$1.2t, compared to US$780bn in the UAE. It is worth noting that if the Saudi forecast is adjusted for Project NEOM, estimated to cost US$500bn alone, the pipeline in both countries is relatively similar in value terms. Meanwhile, Kuwait, Qatar, and Oman, whilst being the next largest markets in terms of pipeline value, are significantly smaller than both Saudi Arabia and the UAE.

Value of planned and unawarded GCC projects ($m)

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The impact of COVID-19 on construction industry output is yet to be fully determined, and is dependent on how quickly restrictions ease and economic activity resumes. Notwithstanding this, further jobs losses are expected across the GCC, with financial constraints and insufficient demand being cited as two driving factors. Hospitality and retail segments are set to be impacted heaviest in the short-term on the back of air travel restrictions and decreased footfall, whilst the impact of working from home may be a catalyst for longer-term trends, such as consolidation or downsizing of office space, impacting the commercial sector. New ways of doing business, including virtual meetings in lieu of business travel may have longer term impacts on specific project viability in associated market segments. 

 

On a positive note, pandemic-related restrictions have served as a catalyst for further advancement in the technology sector. The data centre market in the GCC, in particular, has remained relatively resilient as the shift towards virtual working platforms and online shopping is compounded by longer-term trends, such as investment in 5G technology, thus creating demand in the technology market segment. 

Despite some disparity across the GCC countries, tender prices have experienced a downward trend, which is expected to continue. A recent survey forecasted a 4% decline in tender prices in the UAE, despite rising material costs, which will put pressure on contractor margins. Whilst labour costs are expected to decrease as contractors move to lower direct costs, this may be offset to a certain extent by a decline in productivity on-site, which is estimated to vary between 10% to 30%. 

The downward pressure on contractor margins and tender prices is evident in an emerging trend of ‘below-cost bidding’, with 50% of respondents in a recent survey by the RICS reporting that they were receiving bids below cost. Should this trend continue, it poses a risk to the long-term financial stability of contractors engaged in the practice and their ability to successfully deliver projects which have been awarded. 

RICS Consensus 12-month expectations

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Emerging trend of 'below-cost bidding'

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Summary:

As a market that is already susceptible to volatility as a result of fluctuating oil prices, the Middle East has been dealt a double blow by the impact of COVID itself, coupled with the impact that COVID is having on the oil market. The pre-COVID growth forecasts were driven primarily by planned expenditure on large infrastructure and capital projects, so the austerity measures being employed will undoubtedly have an adverse impact on growth in the short to medium term across the region. 

As an industry that plays a significant role in the economic development of the region, the full impact of the pandemic for construction remains to be realized, but already, it is evident that the effects of the lockdowns are being felt and will impact underlying fundamentals. While many sectors will be profoundly affected, such as retail and hospitality, others will see a shift in the new norm, such as the rethinking of commercial spaces to facilitate the new distancing measures and other regulations, and some, such as data centres will see an upturn due to increased demand for web services and virtual platforms. All in all, similar to most other regions, the long-term impacts remain to be seen.

Contributors: Ciaran McCormack, John Chavez, Kevin Gardiner

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