GCC GOES FROM STRENGTH TO STRENGTH

The Palm Jumeirah in Dubai
The Palm Jumeirah in Dubai

The Gulf Cooperation Council’s status as a safe-haven amid socio-political frictions in the wider Arab world and Syria’s devastating civil war has risen in the past three years, as non-oil private economic activity and infrastructure development programmes continue to flourish helped by high budget spending and favourable business conditions in the six-member bloc, comprising Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE.

The energy-rich region of over 50m people had a combined gross domestic product (GDP) of $1.65 trillion in 2013, according to the Institute of International Finance (IIF), a Washington based association of private banks, making it the world’s 12th biggest economy, slightly below that of Canada ($1.78 trillion), but surpassing both Australia ($1.44 trillion) and Spain ($1.31 trillion). While real GDP (inflationary adjusted) grew at an annual average rate of 5.6% between 2010-13, above the 3.9% mean for Middle East and North Africa (MENA) region, based on the International Monetary Fund (IMF) figures.

Growth is becoming more ‘inclusive’ thanks to fairer distribution of national wealth and good governance. Thus all segments of the population, not only a privileged few, have prospered and enjoy free access to public services, which remain the envy of most southern European nations. In fact, the Gulf’s basic infrastructures and social indicators, such as life expectancy, literacy rates and healthcare, are comparable with those of the ‘First World’. The past decade has seen huge gains in living standards, which explains for sustained political stability.

Average per capita income in the GCC has risen nearly three-fold from $12,000 in 2002 to $32,768 by 2013. By country this ranges from $24,524 in Saudi Arabia, the Gulf’s most populous nation, to $104,756 in Qatar (the world’s richest state). Kuwait and the UAE are also ranked among high-income OECD economies, with a per capita GDP of $48,761 and $43,774, respectively. On current expansion, the GCC’s aggregate GDP could reach $2 trillion over the medium-term driven by infrastructure investments and strong private sector credit as well as steady hydrocarbons production. Endowed with some 30% and 23%, respectively, of the world’s proved oil and natural gas reserves, core Gulf- exporters, led by Saudi Arabia play a critical role in global energy market.

Standard & Poor’s – the international credit ratings agency – classifies Kuwait (AA), Qatar (AA), the UAE (AA) and Saudi Arabia (AA-) in same group as ‘high grade’ OECD sovereigns, reflecting strong economic fundamentals, and massive liquidity – the GCC states are net creditors to global capital markets – along with formidable energy resources and sophisticated banking systems, which comply fully with international codes/standards of the Basle Committee. The Gulf economies are rapidly diversifying and attracting more foreign direct investment (FDI) in non-oil sectors – a marked contrast with previous decades – dominated by investments exclusively in the hydrocarbons industry.

Broad-based economy

The GCC non-oil economy (a more representative measure of economic activity) is behind recent brisk expansion, with several infrastructures, tourism, shopping malls and real estate projects either completed or under-construction.

A surge in public and private investments has had positive ‘multiplier-effect’ on the financial, telecoms and transport sectors. Manufacturing is supporting regional growth, as energy-intensive processing industries such as petrochemicals and metals have received sizeable investments in recent years.

The UAE, which had embarked on large-scale diversification before the oil boom, remains a regional leader, followed rapidly by Qatar.

Private sector growth is expected at 6.2% this year, up from 5.9% in 2013, supported by robust domestic demand, and both private consumption and capital expenditures – reflecting sustained low interest rates. Regional banks have recovered from the stresses caused by global financial crisis and credit growth remains buoyant. By contrast, government sector growth is forecast to slow to 3.5% from 5% in 2013 as national authorities start tightening macro-prudential policies, which have been lax (i.e. expansionary) for a decade.

The scale of investment in the Gulf requires finance from multiple sources, including regional and international banks, Sovereign Wealth Funds (SWFs), securities exchanges and private equity funds. The cost of planned projects in Saudi Arabia is being put at colossal $1.1 trillion – much of which will be embarked upon for the 2015-19 Development Plan. The Kingdom’s capital, Riyadh, is in the midst of a construction boom, including a new financial Centre, a metro network, an additional airport terminal and a number of mass housing schemes. The Saudi authorities plan to develop new sectors such as automotives, which, in turn, will encourage ancillary activity across related sectors.

Qatar’s mega investment programme to advance economic diversification and preparation for the 2022 soccer World Cup is fast gathering momentum. Capital expenditures between 2014-2018 (excluding hydrocarbons) are estimated at $182bn. Projects include roads, ports, rail, metro, real estate developments, a new central business district in Lusail, as well as building eight giant football stadiums. Infrastructure remains a key feature of Kuwait’s new five-year Development Plan, which will include expansion in air/seaport capacity, rail, power stations and hospitals. The $125bn plan envisages public private partnerships (PPPs) in infrastructure services to finance a large portion of projects, structured on build operate transfer (BOT) model.

The ‘twin’ surpluses are considerable, albeit on a declining trend. The IIF estimates that GCC’s consolidated fiscal surplus should average 8.3% of GDP in 2014 – down from 14.7% in 2012, reflecting slightly lower oil receipts and higher public spending. Whilst the region’s current account surplus is expected to moderate to 17% of GDP, compared with highs of 24% of GDP in 2012. Nonetheless, core Gulf-exporters continue to amass vast stock of foreign assets – the net value of which is forecast to reach $2.35 trillion (equivalent to 138% of GCC’s GDP in 2014). SWF assets of the UAE, Kuwait, and Qatar are projected at $1.58 trillion in 2014 from $1.44 trillion in 2013, according to the IIF.

Risk factors

Resumption of faster growth in advanced OECD economies (led by the US) would prompt central banks to end a policy of quantitative easing. That, in turn, could lead to a rise in risk premiums (i.e. higher borrowing costs) for developing countries and lower FDI inflows. The overall effect on global demand, hence, on oil prices is uncertain. The ‘de facto’ peg of GCC currencies (except the Kuwaiti Dinar) to the greenback will translate increases in US interest rates into higher Gulf interest rates, which would slow investment and growth in non-oil sectors. The US Federal Reserve (central bank) is expected to start raising its policy rate during 2015 – a move that will tighten monetary policy in other jurisdictions.

A moderate rise in external funding costs should not harm major Gulf exporters because of their limited exposure to global debt markets, highly liquid/strongly capitalised banking sectors and large SWFs. But Bahrain is vulnerable to higher global interest rates and some of Dubai’s government-related entities could face difficulties rolling over their corporate debts. However, Dubai’s recent agreement to refinance $20bn of bonds and commercial loans maturing this year has cleared uncertainties about its near-term debt obligations. In Bahrain, fiscal vulnerabilities led to a credit downgrade to (BBB) and subsequently sovereign borrowing costs have increased in recent months.

The 2013 ‘fiscal breakeven’ Brent price was estimated at $75 per barrel. Bahrain and Oman need oil prices above $100/barrel to balance their budgets and the figure for Saudi Arabia is estimated at $85/barrel. Futures markets suggest crude prices may decline by about $6 during 2014-15. A recovery in Iraq, Iran and Libyan production, coupled with rising supply from unconventional sources (shale gas) in North America may weigh on GCC oil exports and crude prices. Though fiscal positions of Bahrain and Oman remain weak, but core Gulf- producers can absorb short-lived low fuel prices thanks to large financial buffers and modest public debt – hence making them less vulnerable to external shocks.

The rise in asset prices (notably in housing and equities) and concurrently positive wealth effects could increase ‘demand pull’ price pressures. While recent changes in labour market policies and the consequent wage increases, notably in Saudi Arabia, could also underpin ‘cost push’ pressures. Inflation, however, should remain subdued in the near-term, reflecting both the absence of global inflationary pressures and the openness of GCC economies.

Policy challenges

Creating productive jobs for swelling populations is a key priority. The Gulf’s labour markets are heavily segmented; nationals dominate public employment, while expatriates hold most private sector jobs. Hiring of expatriates has outpaced that of nationals, largely due to skills mismatches and unrealistic expectations of high wages and job security by GCC nationals. With an increasingly ‘over-burden’ bureaucracy, the government cannot continue providing new jobs. On current trends, however, private sector jobs may only absorb one-third of nationals entering the labour market every year.

Private sector jobs could be more attractive through regulations and measures to increase nationals’ take-home pay. The IMF advises that carefully designed ‘wage subsidies’ can induce private firms to employ more indigenous. To be cost-effective, wage subsidies should be aimed at groups with chronic unemployment and high labour demand elasticities. More and better-quality vocational and on-the-job training (relevant to specific needs of private employers) would boost productivity of nationals and enlarge the production sophistication and capacity of GCC firms to compete in global markets for high value chain businesses.

Reducing reliance on oil would increase productivity growth, strengthen economic potential and combat volatility of output. The region has made progress in diversification; the share of GCC hydrocarbon sector to real GDP has declined in the past decade, from 41% in 2000 to 33% now, the IIF estimated. But hydrocarbons contribution to total budget receipts remained high at 84% on average in the past three years, though down from 97% in 1984. The national authorities have yet to diversify their domestic revenue base.

The Gulf countries can invest more in high-quality projects to underpin diversification drive. In view of their strategic location between Europe and East Asia, large-scale investments in logistics and tourism infrastructure should be coordinated across member-countries to avoid duplication and inefficiencies. Diversification can be enhanced by shifting attention from the quantity to the quality of capital spending, increasing access to finance for small and medium-sized enterprises (SMEs), developing local debt markets, and increasing female labor force participation – which remains low compared to other regions.

Making business start-ups easier and facilitating competition help foster entrepreneurship and innovation. Moreover, easing restrictions on inward FDI would encourage foreign firms with business expertise to provide goods, services,

knowledge transfers, and new jobs. The World Bank ranked only the UAE and Saudi Arabia among top 30 countries (out of 189) on the ease of doing business in 2013. Bahrain, Oman and Qatar occupied 46th, 47th and 48th position, respectively, with Kuwait plunging to 104th spot in the table.

Over the medium-term, robust output growth depends on building diversified capacities with reduced dependence on hydrocarbons through sustained structural reforms and improved industrial competitiveness.

In essence, the GCC’s durable prosperity is vital for MENA region in terms of continuous financial support, job creation, remittances and a source of badly needed FDI in non-oil Arab countries stretching from Morocco to Jordan.

Moin Siddiqi

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