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Sat 27 Aug 2016 12:22 AM

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Private sector development to play key role in transformation of GCC economies

Falling oil prices have significantly placed oil-producing countries in a position to adopt structural and policy improvements.

Private sector development to play key role in transformation of GCC economies
Shady Shaher Elborno, Head of Macro Strategy at Emirates NBD

2016 is looking to be a watershed year in the region as policymakers launch and adopt significant policy initiatives to reduce dependence on oil.

From diversifying sources of funding through exploring taxation, to reducing expenditures by trimming energy subsidies, and tapping bond markets to fund deficits. Yet as these measures address the fiscal side of the economy, policymakers are now looking at the underlying fundamental challenge to the structure of regional economies. That of a gradual divergence from public sector-led economies to private sector-led economies. Development of the region’s private sector will play an important role in the transformation of economies in the wider MENA and the GCC.

Transitioning from economies that are powered by the hydrocarbon sector, and driven by large public sectors to ones that are private sector-led is a shared goal for policymakers in the region. Saudi Arabia’s Vision 2030 announced earlier this year crystalises the renewed drive of a region that is mindful of the need of making that transition work, as it has placed the private sector and fostering Small Medium Enterprises (SME) development as central to its economic transformation. The IMF in July highlighted the importance of boosting the role of the private sector and easing restrictions for foreign direct investment (FDI) for the UAE economy. This came around the same week the UAE government loosened rules requiring bank guarantees for SMEs to help spur growth of that sector.

Three key challenges constrain the potential for private sector and SME development in the GCC. First is access to finance. World Bank (WB) figures indicate that less than only 8 percent of lending goes to SMEs in MENA, and even less in the GCC at only 2 percent. This is below the global average of 18 percent and 22 percent for middle income and high income countries respectively. The second key challenge is the business eco-environment, covering issues ranging from licensing to the provision of support services.

Region’s biggest: The World Bank said Saudi Arabia’s current account balance is set to improve but remain in deficit at 2.8 percent of GDP in 2016.

Finally, a challenge and omnipresent opportunity for the private sector is employment. The public sector accounts for more than 90 percent of GCC citizen’s employment, and the public sector wage bill as a percentage of GDP has been rising. A combination of dependencies on low skilled labour for the private sector combined with a significant incentive gap between private and public sector accentuates challenges.

In all developed and developing economies, access to finance plays a crucial role in private sector development. Given the scale of projects that have been undertaken by governments in the region, banks have played a large role in state connected lending. While this has played a crucial role in supporting the region’s social and economic development, it has created distortions in allocation of credit, by crowding out the private sector. Furthermore, broadening the scope of bank lending to the private sector will be enhanced by the development of mature credit market infrastructure.

Given the lower oil price in 2016 we have seen most governments across the region step forward and tap capital markets globally, which will help develop regional capital markets and build a domestic yield curve.

A regulatory and legal framework that avoids being overly restrictive, and creates an environment that is conducive to the growth of private sector firms.

The reform process in this area should be one that reduces administrative complexities, ensures regulations are clear and transparent, and introduces efficient mechanisms for administering them, such as e-channels. One example is Dubai’s “Smart Dubai” strategy plans to align the monetary and operational efforts of 26 government departments.

Finance: Banks play a key role in state connected lending.

This greater integration of government departments highlights how e-government channels can offer businesses a one-stop shop to set up businesses with minimal administrative wrangles. Equally important is measuring and assessing public institutions against their progress on these reforms. It is important to note the role of expectations from stakeholders in measuring governments against the pace of reforms being promised. Failing to meet up to expectations reduces confidence, weakens credibility, eventually raising barriers and costs for business access.   

Addressing the human resource element is both a challenge and a goal in itself. As underlying much of the region’s initiatives to create more private sector and SME driven growth is the related opportunities it presents for employment.

A key challenge has been the incentive gap between the private and public sector. This needs to be addressed, explicitly this means that the private sector needs to identify how to better attract nationals from an attractive public sector. Also, nationalisation programmes and quotas need to adopt more pro-active strategies that identifies sectoral needs and sets smart targets in line with them.

Given the significant reforms initiatives we have seen from the region over the last year, we remain optimistic that more is to come. Policymakers are gradually moving from addressing larger policy challenges that relate to their immediate budgetary needs to more granular ones like access to finance, the business environment and human resource challenges that affect private sector development. While the drop in oil price over the better part of the past two years has posed challenges to budgets, it has been a boon to structural and policy improvements in the region. Ultimately this will gradually shift the region to a new paradigm of private sector led growth.

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