The challenges facing GCC oil exporters in the face of persistently low oil prices are prominent and substantial, especially given the need to deliver on key economic diversification and social development targets. But government strategies have been the opposite to what is required.
The prolonged low oil prices follow years of high prices that saw budget spending levels reach record highs. This is causing governments to react by slowing down spending, which in turn reinforces the trend towards softer growth.
Fiscal policy in the region has historically been largely pro-cyclical, amplifying growth during high oil price years and detracting from it during weak oil price years, whereas the opposite is what is really required to promote sustainable growth.
Underpinning this cycle, especially during upturns, is a need to invest and change the structure of the region’s economies to be less dependent on oil.
Fiscal policy in the region is directly correlated to oil, and the sharp fall in oil prices over the past two years has led to sizable fiscal consolidation dampening non-oil growth. Fiscal consolidation was particularly sizable in Saudi Arabia where real gross domestic product (GDP) contracted from 3.6 percent in 2015 to 1.4 percent in 2016.
In the UAE, where the economy is more diversified, GDP growth was more resilient, falling from 3.8 percent in 2015 to 3.0 percent in 2016, according to Emirates NBD estimates. Overall GCC GDP is estimated to have declined from 3.5 percent in 2015 to 2.2 percent in 2016.
Such volatile growth rates, however, need to be placed in the context of achieving long run development goals. This means growth levels in the short term are likely to be volatile, as the good times allow for the easy financing to fast track those objectives.
Nevertheless, in the medium term, as the economies mature, promoting fiscal policies to stabilise economic cycles and smooth out growth levels over the years is becoming an important priority for GCC governments, especially in light of the limited role of monetary policy tools. These need to be applied with equal determination during both upturns and downturns, allowing economies to build buffers and keep public debt in check while reducing the risks of overheating.
A challenge the region faced during the oil boom years over the past decade was the efficient allocation of resources. Given the boom years translated into ever rising budgets for different ministries and government departments, spending decisions were sometimes hastily undertaken, resulting in overspending and a skewing of priorities.
Thus, as oil prices began contracting, funding for those projects was drawn down, resulting in unpaid bills for some contractors and stalled projects. This reinforced dampened sentiment during downturns, further detracting from growth dynamics that were already under pressure.
As a result, the large role of the government sector, and the associated role of government spending levels in the GCC, can lead to more volatile growth in the region, which in turn undermines the resilience of the overall economy.
To be well positioned to apply fiscal stabilising measures, economies first need to undertake long term adjustments. Diversifying sources of funding through expanding non-oil revenue streams is one key enabler. Oil revenues accounted for between 50-90 percent of total government revenues for the GCC, compared to an average of 24 percent for other similar oil exporters, according to IMF estimates for 2012-15.
Being able to run and fund deficits to allow budgets to expand during downturns is another. On both fronts, GCC states have begun to make progress. The introduction of a value-added tax (VAT) across the GCC next year signals new non-oil revenue raising measures are coming on stream, and sizable government bond issuances in 2016/2017 reflect a maturing of public debt infrastructure. Creating a framework for enabling effective fiscal policy will yield important benefits for long-term sustainable growth.
The scope of reforms, however, needs to extend further to ensure expenditures (especially current expenditures) remain at sustainable levels. To adopt the correct fiscal rules, they need to go beyond simply capping public debts, budget deficits and/or controlling expenditures. A fiscal framework anchors fiscal policy goals and helps an economy better achieve its medium and long-term objectives. It needs to be one that adapts to economic conditions preserving fiscal space to allow for the manoeuvring policy to respond to economic conditions. This allows fiscal policy to be more pro-active.
In the case of the oil exporting GCC, this means adopting a framework that can address volatility that is inherent in oil markets.
So far this transition is gradually taking place with infrastructure and economic diversification moving in lockstep with key reforms to fiscal policy on areas ranging from revenues to public debt management.
This is allowing for the required maturity needed for these economies to be able to apply fiscal stabilisation with a higher degree of effectiveness. That stabilisation will reduce uncertainty thus having positive long-term growth repercussions for the region.
Tim Fox, chief economist and Head of Research at Emirates NBD