The reality of reduced oil prices is imposing fiscal discipline on the region’s governments and companies. On the plus side if the changes are sustained GCC economies will be stronger in the long run.
Year in review: Why economic reform was the Middle East’s business story of the year
GCC economies are at crossroads. The slump in oil prices since 2014 has affected the GCC countries in many ways. Unlike previous episodes of price collapse, the latest one is marred with ambiguity about its recovery and the demand dynamics going forward.
A new normal in oil prices is being formulated as we speak.
Countries have been compelled to accelerate structural reforms to diversify their economies away from hydrocarbons, boost the role of the private sector, and create jobs for their rapidly growing labour forces.
This is a historic shift that ranks as the most significant economic story of 2016 for GCC countries.
It is a new reality that is imposing fiscal discipline on the region’s governments and consequently companies. If these changes are sustained, they will make regional economies stronger and more viable in the long run.
But if implementation is poor, they will increase the chance of economic diminishment.
All countries in the region have embarked on significant deficit-reduction efforts – which begun in 2015 – and are bound to continue.
Despite recent consolidation measures, including reforms to domestic energy prices, deficits are projected to remain large – all countries are anticipated to record fiscal deficits in 2017, as they have over the last two years.
Going forward, only Kuwait, and the UAE are set to post surpluses by 2021. Substantial budgetary cuts will have to be made in order to maintain balanced budgets for all countries upwards of 30 per cent.
For example, Brent crude will average for 2016 just north of US$40 per barrel while Saudi Arabia’s 2016 expenditures would have required an oil price upward of $75 per barrel.
Brent was trading at $56.21 a barrel yesterday.
Some countries have also started – or are planning – to take measures to rein in the public sector wage bill, including through hiring freezes (Oman) and streamlining benefits (Oman and Saudi Arabia).
Saudi citizens have started coming to terms with how the Saudi Vision 2030 plan will affect their lives.
It’s expected that value added taxes will be introduced in 2018 throughout the GCC. More specifically, in October, Saudi Arabia suspended bonuses and trimmed allowances for its employees, including a 20 per cent cut to minister’s salaries and a 15 per cent cut in Shura Council salaries.
Oil prices will help determine if Saudi Arabia will be able to sustain a balanced budget by 2020.
Further fiscal adjustment is needed, which will require difficult policy choices and the adoption of well-devised measures to protect the vulnerable. To address large budget deficits, GCC economies have adopted a mix of spending cuts and revenue-raising measures.
In particular, they have demonstrated determination in addressing the politically difficult issue of low domestic fuel prices – all GCC countries, for example, have hiked energy prices over the past couple of years.
Authorities in Saudi Arabia started raising the price of fuel at the end of last year, including an increase in the price of gasoline by a minimum of 50 per cent.
The 2016 January-July average prices for diesel in the UAE and Oman, and for natural gas in Bahrain and Oman, are very close to or above US price levels. The social contract is gradually being reformed, in parts of the GCC, and nationals have demonstrated resolve and understanding that times are changing. Higher energy prices will help slow the region’s rapid growth in energy consumption and will support fiscal adjustment. Energy consumption per capita in the GCC is not only high, but is also rising rapidly (in Qatar, Saudi Arabia, and the UAE, in particular).
According to the International Monetary Fund (IMF), the average estimated implicit cost of low energy prices for the six GCC countries based on 2016 prices ranges from 0.8 per cent of GDP for the UAE to over 7 per cent of GDP for Kuwait.
The explicit cost of energy subsidies in the budget for the GCC varies considerably across countries, but averages about 1 per cent of the region’s GDP. Government financial assets over the past two years have been drawn down as part of the deficit financing programme. After a significant withdrawal of financial assets in 2015, a larger portion of the 2016 fiscal deficits (which amount to about $193 billion) was covered by issuing debt.
Bahrain, Oman, Qatar, Saudi Arabia, and Abu Dhabi have issued bonds and obtained syndicated loans in international markets this year. GCC sovereigns will continue to the international market in 2017.
Such diversification is necessary as it will help divert pressure from domestic banks to finance deficits and will help increase liquidity and bring down borrowing costs.
As is increasing the role of the private sector, including through public private partnerships (PPPs) in Kuwait and Oman; other countries such as Saudi Arabia are expected to follow.
Several countries are planning privatisation programmes (Kuwait, Oman, and Saudi Arabia).
Saudi Arabia has announced its intention to sell a minority stake in Aramco, the world’s most valuable oil and gas company, while accelerating capital market reforms to ease access for foreign investors.
Oman has drafted a foreign investment law that should help entice foreign investors.
The envisaged economic transformation, as reflected in country diversification plans, will take time. Careful and steady implementation and prioritisation will be key to success.
Going forward the GCC will be impacted by the ability of the domestic economies to reform successfully but also by the direction of the global economy.
There are plenty of risks facing the global economy in 2017, including: the rebalancing in China, the price in commodity prices, slow productivity growth, unfavourable demographic trends, the direction of global trade and conflicts.
There are four things that regional authorities need to keep in mind while trying to reform their economies going forward.
First, non-oil revenue programmes have to be measured so they don’t impinge on private sector growth and investments. The same can be said about cutting down on government expenditure which should be undertaken but minimising adverse effects on consumption. Introducing for example a value added tax carry less adverse effect than slashing salaries and pensions.
Second, sharp cuts over the short term have to be avoided as consumption and private investment react negatively and reduces output and confidence.
Third, privatisation is an important hallmark of structural reforms and need to be taken seriously. The process can be long but transparency and governance are important as well as regulatory oversight.
Fourth, a clear road map that prioritises policies is essential. All can’t be done at once and reform is a long process of trial and error.
John Sfakianakis is the director of economic research at the Gulf Research Centre in Riyadh
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