By Dhuha Fadhel
Brand view: For years the GCC successfully turned their oil and gas endowment into material economic dividends, but how sustainable is this in the face of lower-for-longer oil prices?
The latest episode of falling oil prices that started in mid-2014 saw average growth rates plummet throughout 2015-16, reaching only 0.3 percent in 2017, based on our estimates.
The lower-for-longer oil prices ($67 by the end of 2017 compared with an average of $100 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 the economic performance of these countries. In particular, 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, 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 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 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, policymakers 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 and better job security 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.
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 percent at the turn of the year. Other GCC countries appear to be lagging in this area.
We believe that the potential revenue from 5 percent VAT would be below the level needed to close the large fiscal deficits in many cases.
Also, GCC countries will need to implement measures to address deeper structural issues. Such reforms should aim to: improve the conduct of fiscal policy; improve the business environment; 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, most notably through developing their local debt market.
Dhuha Fadhel is Director, Senior Economist at Standard Chartered Bank
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