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Thu 1 Feb 2007 05:33 PM

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Reforms may tackle gap between states

Experts think the new oil boom may be preventing some countries from reforming and this is leading to a widening gulf between those who export oil and those who don’t

According to panellists speaking at the Arab Strategy Forum in Dubai, the countries of the Middle East are diverging. The divergence, they said, is between the Gulf States, the other oil-producing countries of the region, such as Iran, Algeria and Syria, and between the non-oil producing countries, including Egypt, Jordan and Lebanon. These three groups of countries can be classified according to the approach they take to reform.

In a recent report entitled
MENA Economic Developments and Prospects 2006: Financial Markets in a New Age of Oil

, research showed the resource-poor economies are not enjoying as many spill over effects from the high price of oil, compared with other oil booms from recent history. In fact, the report finds the relationship between economic growth of these countries and the price of oil has weakened substantially.

The reasons include less aid from oil-rich countries, fewer job opportunities for Arab labourers in the Gulf, and less money flowing from oil rich countries to resource-poor countries.

Major oil exporters are now under huge pressure to reform. Prior to 2003, Iran started to reform, but the new oil revenue has caused this to slow, said Mustapha K. Nabli, chief economist and director, Social and Economic Development Group, Middle East and North Africa region.

The outlook is better, said Nabli, for GCC countries where much of the oil wealth is accommodated by the private sector. There is more dynamism in the Gulf in terms of more productive schemes and diversification because the private sector insists on reforms. Here, increased oil revenues have been used to pay down debt and have flowed to the banking sector rather than to government coffers.

Moderating the discussion, Tarik Yousef observed that less than three years ago forecasters were predicting oil prices would remain at around US $25-30 per barrel for the next decade. In response, the Arab world had no choice but to reform. Three years on, oil prices are averaging US $50 per barrel and the region is enjoying a period of euphoria and prosperity that few expected.

The consensus for reforming the oil industry today remains unaltered from three years ago: more market-based diversification for the oil producing countries and integration into the global economy.

The problem today lies with whether the new oil boom, and the wealth it has brought, will prevent these reforms from being implemented and dissuade countries from meeting the current challenges of a growing industry.

"It has allowed [major oil exporters] to relax and not reform the financial sector and energy subsidy regime," Nabli said. "The oil revenue has increased public spending and created temporary jobs. In Algeria, also, the employment rate has been growing for a number of years, but this is not sustainable. Now Iran's growth, which was 7% a few years ago, is now between 3-4%, and the need for reform is ever-present."

Some of the Middle East's major oil exporters have been badly hit by the oil boom largely because of static business and pricing reforms. Nabli has identified the correlation between oil wealth and reforms, noting that the more oil resources a government has, the less reforms they implement.

The oil boom of the 1970s was not effective in bringing about economic development, and the economies of this region have remained weak, government run and less efficient as a result, said Nabli. The problem with this, according to Lisa Anderson, dean of the School of International and Public Affairs (SIPA), was that the oil wealth didn't translate into economic development and into the creation of a sustainable economic engine for taxes.

Conversely, the new oil boom has had little bearing on the region's minor oil exporters' dynamics for reform, said Nabli.

"Oil importers such as Jordan and Morocco have undergone major reforms, notably in the financial markets, business environment and public administration. But at the same time, civil reform has often been neglected," he said. "Domestic price subsidies have been less apparent, as have subsidies for workers, goods and services, meaning the customer has paid the price for the recent oil boom."

Clearly, the non-exporters do not have the resources to recycle. The bulk of the oil revenue is being recycled through the governments of the major oil exporters because most of these are socialist states and remain essentially publicly dominated. Iran, Algeria and Syria all fall into this category. Here the state maintains the economy, including the oil wealth, with resources being allocated by the public sector.

Speaking optimistically about the future of the Gulf Cooperation Council states however, Vahan Zanoyan, president and CEO of Petroleum Finance Company (PFC), argues that the oil-driven GCC economic boom would not be derailed even if petroleum prices fell significantly. The main reason, he added, was that member states had gone beyond mere monetisation of oil reserves to using energy revenue to develop downstream private investment by bringing in foreign technology and know-how and developing industrial and technological clusters in such fields as petrochemicals.

This, he says, has gone hand in hand with regulatory reform and a general willingness to meet global benchmarks.

Zanoyan added that the oil boom has created competition within the GCC, making it more difficult to enact reforms.

"There is huge competition to attract foreign investment, coupled with a desire to become the centre of something, which can only be achieved with a certain level of transparency," he said. "These reforms are real and are directed at very specific issues of competitive advantage. Some of the instability in the Middle East has reinforced the reforms."

Panellists were divided over the benefits of oil revenues. Nabli noted that historically, Middle East oil proceeds had been used to develop human capital through education, improved public health and by reducing poverty to the lowest levels in the developing world. However, Lisa Anderson, dean of the School of International and Public Affairs (SIPA), described higher oil prices as a "curse in disguise" as they tended to sideline the private sector and encourage reckless spending.

"Of the many pernicious lessons learned from the oil boom of the seventies, the most stark was the realisation that vast oil reserves buy political stability," said Anderson. "The temptation to use these reserves to prop up regimes is bold and understandable, but this does not make it right. There is still that dynamic in the Gulf region. Wasting money on military resources or using it to serve political stability is not the same as using oil revenue for political and economic development."

She added how the relationship between citizens and government has become distorted by the availability of oil revenues: the more revenues, the more this line blurs. One would hope to see a relationship of mutual obligation between citizens and government, but by and large, these relationships are ruptured in oil producing countries, and there is a continuing alienation and mutual hostility in the large oil producing countries. This is something that availability of oil revenues, despite sustaining political stability, is unlikely to address.

However, the panellists agreed that despite the increased revenue, reforms are essential given the region's population growth and increasingly large numbers of new entrants to the labour force.

The World Bank, however, is convinced the region has learned from the mistakes of the past: "During the current boom, only some 25% of the additional revenue has been spent, compared to 60% during the 1974 boom. Oil producers in the region have exercised more prudence with windfall revenue management than during prior booms. Increasing integration with the rest of the world and within the region, as well as greater diversification into non-energy economic activities, is being pursued to varying degrees."

The true test, said Zanoyan, is whether the big stakeholders and ruling families are willing to hand over control of the industry to the technocrats who run the ministries and large public enterprises.

"It is the ultimate test of transition when even the ruling families become part of the system managed by professionals. This is already happening in Saudi Arabia and certainly gives cause for optimism should the trend continue," he said.

What do you do with oil revenue?

“The Arab world holds more than 50% of the world’s oil and gas reserves. At the same time only six Arab states are members of OPEC. Current oil revenues and international investment have the potential to have a major impact on the development of the region and the world. Thus, wise deployment of the oil boom windfalls towards structural reforms is crucial, not only to the region’s economic development, but also to the health of the global economy.”

The Moutamarat Arab World CEO Guide.

"There is more dynamism in the Gulf in terms of more productive schemes and diversification because the private sector insists on reforms."

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