By Dhuha Fadhel, Senior Economist, Thematic Research, Regional Research- Standard Chartered UAE
For years the Gulf Cooperation Council (GCC) successfully turned their natural resources – oil and gas – into material economic dividends, but how sustainable is this in the face of lower-for-longer oil prices?
GCC countries are now among the world’s 30 richest countries in terms of GDP per capita and fared well compared with emerging markets, developed markets and the world economy throughout 2008-14.
However, the latest episode of falling oil prices that started in mid-2014 saw average growth rates plummet throughout 2015-16, reaching only 0.3 per cent in 2017, based on our estimates.
The lower-for-longer oil prices [USD67 by the end of 2017 compared with an average of USD100 during 2008-14] and subsequent lower growth are creating three big challenges for the GCC.
First, global oil prices have always played a major role in determining growth rates, and consequently income levels, of these economies. For instance, lower oil prices turned current account surpluses into significant deficits in most cases, putting pressure on foreign exchange reserves. Furthermore, fiscal balances turned into deficits, prompting GCC countries to tap international capital markets, leading to increases in government debt.
Second, the dominance of oil and gas has resulted in a phenomenon familiar to commodity-exporting countries. Non-tradable sectors, such as property, tend to flourish (these attract a large share of oil and gas revenue), while tradable sectors, especially manufactured exports, do less well.
There are two key issues with this. First, higher oil prices can fuel asset price bubbles that could pose risk to the overall macroeconomic stability of GCC economies. For example, the high oil prices that prevailed before mid-2014 led to rapidly rising house prices in Abu Dhabi and Dubai, followed by a significant correction as oil prices started to fall from the second half of 2014.
Second, GCC economies are often characterised by stubbornly low productivity, with labour-intensive sectors such as construction and light manufacturing (less dependent on technology and high-skilled labour) taking the lead over more high-value-added sectors, such as finance and high-tech manufacturing. Given the importance of productivity for long-term growth, the GCC’s current low productivity levels may translate into lower growth rates in the medium to longer term.
Outside the distortions caused by overreliance on oil and gas, policy makers face a third pressing issue in the near future: demographics. An increasing number of young people will enter the labour market in the coming years. Traditionally, GCC nationals seeking employment have favoured the public sector, given it offers higher wages, better job security, shorter working hours and longer holidays than the private sector. However, the public sector has reached saturation point, which means the GCC must find new ways to attract people to other sectors, or develop new sectors to absorb excess labour.
How can GCC countries tackle these challenges? In short, via reform. The question is, what type of reform?
To address their short-term imbalances, the GCC will need to continue with fiscal consolidation while structural reforms are needed to address longer-term issues.
The UAE and Saudi Arabia have led regional fiscal consolidation efforts to increase government revenue with the introduction of consumption taxes (value added tax – VAT) at 5 per cent at the turn of the year.
Other GCC countries appear to be lagging in this area. We believe that the potential revenue from 5 per cent VAT in GCC countries would be below the level needed to close the large fiscal deficits in many cases. Hence, introducing VAT will need to be accompanied by drastic cuts in current expenditure (especially subsidies and social benefits). Energy subsidy reforms introduced in 2015-16 were viewed as a positive step in this direction. However, further reform is likely in the future given that subsidies and social benefits are estimated to be equivalent to 8 per cent of total GCC GDP.
Also, GCC countries will need to implement measures to address deeper structural issues currently preventing them from reaching their long-term growth potential. Such reforms should aim to: improve the efficiency and conduct of fiscal policy; improve the business environment and reduce red tape; upgrade the regulatory system; address labour-market issues; introduce more ambitious industrial policies that aim to integrate GCC economies into the global supply chain; and continue to deepen the financial sector.
On the latter, a key development is the local debt market. This would provide these economies with new sources of financing, reduce pressure on local banks and the need to borrow from abroad at the same time as providing monetary authorities with effective tools to manage liquidity while preserving their currency pegs.
GCC countries, to some extent, provide a good example of how successful a country endowed with natural resources can be. However, the continued reliance on oil and gas both on the fiscal and external fronts has exposed these countries to macroeconomic instability related to the fluctuations in oil markets and, going forward, will continue to bring challenges especially in a lower-for-longer oil price environment.
GCC countries should prioritise reforms to help bring their fiscal and external balances back to more sustainable levels. Efforts targeting fiscal consolidation in the short term should continue alongside long-term structural reforms, to help sustain high growth in the future.