Why subsidies should be in the spotlight in 2015

Gulf countries have pledged to keep spending this year, but they also need to prepare for an era of cheaper oil, says Ed Attwood
Why subsidies should be in the spotlight in 2015
By Ed Attwood
Fri 02 Jan 2015 02:35 AM

Since the slump in the oil price during the latter part of last year, the headlines have been unrelenting. “Age of Plenty Seen Over for Gulf Arabs as Oil Tumbles” ran one. “Falling Oil Price Dims Arabian Nights” ran another. The inference is simple: a lower oil price means less revenues for government coffers, leading to lower spending and a slowdown in economic growth as a result. However, judging by the recent budget announcements by some Gulf states, 2015 looks very much like business as usual.

The UAE’s federal budget for this year, which is still to be rubber stamped by the Supreme Council, looks set to rise by just over 6 percent. The Saudi budget, released on 25 December, also revealed a marginal increase in lending, although it also showed a rare deficit, and projected an even bigger one for this year. Having said that, Saudi Arabia can easily plug that gap using either its foreign exchange reserves or – more likely – by borrowing. Not only would the banks fall over themselves to offer the kingdom cheap rates, but it would also give the country an opportunity to develop its local debt markets. Elsewhere in the Gulf, the story is not quite so smooth, with both Bahrain and Oman most at risk of running sizeable deficits in the near future due to the higher oil price required to balance their budgets.

While the near term looks settled, the Gulf nations do need to prepare for a scenario in which $60 oil, or sub-$60 oil, becomes the norm, rather than a one-off. To do that, policymakers will first need to look towards the lowest hanging fruit, which in most cases is the GCC’s huge expenditure on subsidies. Kuwait is a case in point. In this week’s issue of Arabian Business, in which we asked some of the region’s top executives for their thoughts on the year ahead, Kuwait Banking Association secretary general Hamad Al Hasawi succinctly points out the kind of problems the country is facing.

Al Hasawi points out that a whopping 70 percent of state spending is directed towards wages and subsidies, and that despite warnings from the IMF that a deficit is inevitable by 2018, the government’s budgets just keep growing. Making matters worse is that subsidies are even handed over to those who don’t need them.

“It is clear that the current mechanism of subsidisation in Kuwait suffers from several flaws,” Al Hasawi says. “Subsidies are provided to all consumers, irrespective of their income, without a limit, to the extent that high-income groups actually benefit more from subsidies than low-income ones. This makes the whole system unfair.”

Kuwait’s problems stem from the fact that it has effectively guaranteed each of its citizens a job in the public sector, which explains why around 93 percent of the national workforce work for the government, or government-linked institutions. In a further cost to the state, the government also encourages nationals to work in the private sector by paying them a monthly incentive in addition to their normal salary. It’s clearly not a situation that can, or should, last forever.

Cracking down on subsidies will not be popular, but is necessary for the greater good of a country’s economy. In the UAE, measures are already being put in place. In November, Abu Dhabi announced that it would charge its citizens for their water supply, a service that had previously been provided for free. This measure will not necessarily add a huge amount to state coffers, but it will promote water conservation and hopefully ensure that less seawater is desalinated – an expensive electricity-intensive process that uses up precious natural resources that could otherwise be exported. More measures like those introduced by Abu Dhabi would be welcome in the year to come.

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