Sharp fluctuations in the oil price emphasise the significance of structural reform and economic diversification in the Middle East.
Since mid-2014, Brent crude prices have more than halved to around $50 per barrel. Prices have remained volatile while the market rebalances and as concerns about oversupply alternate with reports of production cuts. For oil exporters, the procyclicality of oil rents and current account balances as a share of GDP exacerbates risks of macroeconomic instability.
In 2013 oil export revenues exceeded $1.2tn for Gulf Co-operation Council economies (Saudi Arabia, Bahrain, Kuwait, the United Arab Emirates, Oman and Qatar). The International Monetary Fund projects that revenues will fall to $720bn by the end of 2017. As oil revenues account for, on average, more than 45% of tax revenues, the resulting budget deficits of over 9% in GCC countries are unlikely to recover in the near term.
In response, GCC members have drawn down their fiscal buffers, including international reserves and sovereign fund savings. This has enabled fiscal authorities to withstand fluctuations in the oil price without sacrificing their exchange rate pegs.
Access to international capital markets has allowed GCC economies to raise $66bn in bond issuances in the last year, ensuring they can meet short-term debt obligations. By the end of 2016 total dollar debt in the GCC had reached a record $244bn – new highs are likely as budget deficits persist through to 2021.
High levels of government spending have been key for regional economic development and are the chief mechanism for transferring the benefits of oil wealth to the population. Years of social spending have increased public employment and wages, as most of the population continues to be employed by the public sector.
Traditionally, GCC countries have relied heavily on energy subsidies to maintain social stability. According to IMF estimates, GCC economies spent $175bn on post-tax subsidies in 2016, accounting for 10% of the region’s overall GDP. Given the GCC’s high government spending multiplier and reliance on oil wealth transfers, weaker spending and the planned introductions of VAT and excise duties in many member economies will inevitably weaken short-term growth prospects.
Arab oil exporters often respond to economic downturns by increasing current spending (wages and subsidies) and reducing investment spending. This means that while the population’s welfare is maintained in the short term, investment contributions within GDP may suffer.
Between 2010-13, Bahrain increased spending on wages and social benefits to 24.6% of non-oil GDP, from 20.4%, whereas spending on investment fell to 5.1% of non-oil GDP, from 10.1%. Cuts to spending are likely to impede growth of the non-oil sector, damping diversification efforts.
Economic diversification is the best way for the GCC to contend with protracted periods of low oil prices. Member states have long-term development plans, including the ‘Saudi Vision 2030’ and ‘New Kuwait 2035’ initiative, aimed at decreasing dependence on oil wealth.
These strategies involve placing greater emphasis on private sector job creation, reforming bureaucratic processes, developing the small and medium-sized enterprise sector, and fostering private sector investment. The privatisation of state-owned enterprises or parts of these businesses, as in the case of oil giant Saudi Aramco, is intended to alleviate worsening deficits and reduce inefficiency.
However, these programmes face high political hurdles. Kuwait and Oman have found it difficult to pass government reforms, new labour laws and legislation in the light of opposition from those who benefit from maintaining the status quo.
The most vocal political leader in the region so far is Mohammad bin Salman Al Saud, the deputy crown prince of Saudi Arabia. Aside from encouraging transparency in ministries and overseeing the Saudi Aramco initial public offering, the prince wants to increase female labour force participation in the historically conservative country to 30% from 22%.
Limited fiscal and monetary room for manoeuvre have tested GCC countries’ ability to stabilise their economies. Plans for further fiscal consolidation are likely to contribute to weaker growth, and debt accumulation has so far been treated as the solution for maintaining welfare and subsidy programmes. Short-term access to capital has allowed the GCC to meet its spending needs, but failure to diversify the economy and the tax base threatens member states with unsustainable debt.
Bhavin Patel is an Economist at OMFIF.