Although Saudi Arabia is reducing state spending in response to the low oil price, a policy of ring-fencing strategic projects, "is likely to come at the cost of wide and unsustainable fiscal deficits", says a report by Bank of America Merrill Lynch.
Jean-Michel Saliba, MENA economist at the firm, says the decline in foreign exchange reserves means Saudi Arabia may soon resort to domestic borrowing. Even then, further cuts in state spending may be necessary.
"The absence of material adjustment is likely to imply a need for a sharper adjustment down the line if oil prices remain low for long," he says.
Despite these concerns, the research report recommends selective holdings of Saudi equities, notably in the consumer sector, where retailers Al Hokair and Al Othaim were tipped as offering potentially strong returns.
The report, entitled Frontier markets screening increasingly more attractive: Focus on quality, highlights the UAE as the most promising stock market in the Gulf region.
Saliba says refinancing may be necessary to help Dubai complete some of its planned projects, but says the emirate should be able to handle these challenges. The UAE as a whole is less vulnerable to low oil prices than other Gulf states, though there will be knock-on effects on liquidity, real estate and debt levels if the oil price stays low.
Hootan Yazhari, head of MENA and frontier markets equity research, says telecoms firm Etilsalat, real estate firm Emaar and bank ADCB are the most promising UAE-listed stocks.
"As our most preferred attractively valued GCC market, the UAE offers long term potential and healthy earnings momentum," says Yazhari.
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