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The Gulf Cooperation Council (GCC) logo is seen during a meeting in Manama, Bahrain April 7, 2016. To match GULF-HEZBOLLAH/LEBANON REUTERS/Jonathan Ernst -
Op-Ed

How GCC countries can address looming fiscal challenges

Editor's Note:

GCC countries must start by abandoning mega projects that are more likely to become resource-draining “white elephants” than drive real private sector growth and revenue generation, says Nader Kabbani. This article was originally published for the COVID Project by Georgetown University Qatar.

Gulf countries face a challenging fiscal environment

The six countries of the Gulf Cooperation Council (GCC) are facing economic challenges on two fronts. Like other countries, their top priority had been to manage the immediate public health and economic fallout of the global coronavirus pandemic. They have responded quite well; adopting strong testing, tracking, and quarantine procedures; closing non-essential businesses; restricting travel; and providing needed care to infected individuals. They have also announced economic stimulus packages totaling $97 billion. While there have been gaps in their support of migrant workers, overall, GCC countries have demonstrated a strong institutional capacity to deal with the short-term challenges of the pandemic.

GCC countries are now turning their attention to the second challenge; managing the long-term fiscal consequences of the fall in the prices of oil and natural gas. As a result of the pandemic-induced global slowdown in production and consumption, the average price of oil has fallen from $64 USD per barrel in 2019 to $40 USD in early June 2020. Oil prices are expected to remain below $60 USD per barrel through 2021. These prices are well below the fiscal breakeven prices of oil – the price at which governments are able to balance their budgets – for all Gulf countries except Qatar. This will greatly affect government revenues in the oil-dependent countries of the Gulf and test their ability to manage their finances.

Lower oil prices mean that, in addition to a projected economic contraction of 2.7 percent for 2020, Gulf Arab states face the prospect of large fiscal deficits in 2020. These deficits are expected to persist through 2021, even as economic conditions improve. The International Monetary Fund (IMF) is projecting the average fiscal deficit across all Gulf countries to be 12 percent in 2020. Bahrain and Oman are expected to have the largest deficits, reaching 20 percent and 17 percent respectively. This will place an enormous strain on their public finances. Kuwait, Saudi Arabia, and the UAE are also expected to have budget deficits exceeding 10 percent in 2020. Qatar is the only Gulf country that is projected to have a budget surplus in 2020, assuming that it is able to balance the economic costs of the pandemic with corresponding reductions in public outlays.

Gulf Arab countries have dealt with large falls in oil prices in the past. Earlier this decade, the average price of oil fell from $110 a barrel in 2013 to $44 in 2016. All Gulf countries, except Kuwait, ran deficits that reached as high as 22 percent in Oman, 17 percent in Saudi Arabia, and 14 percent in Bahrain. Gulf states responded by cutting financial outlays and diversifying their revenue bases. For example, in 2017, the six members of the Gulf Cooperation Council (GCC) agreed to institute a value-added tax (VAT) in their countries. Saudi Arabia and the UAE led the way, imposing a VAT of 5 percent in January 2018, followed by Bahrain a year later. Some countries expanded corporate taxes. By 2019, these policies, together with an increase in the price of oil to $64 per barrel, helped all Gulf countries sharply reduce these fiscal deficits.

It’s different this time around

Gulf states have responded to the fall in oil prices in 2020 largely by following the same playbook. They are cutting spending, primarily by reducing the number and compensation of expat workers in the public sector. They are trying to increase revenues by gaining or maintaining market share in the oil and gas sector. Some states have begun increasing taxes.  Saudi Arabia increased its value-added tax rate from 5 percent to 15 percent.  Kuwait and Oman are both planning to implement VAT in 2021.  However, there are a number of ways in which this time is different, requiring GCC states to consider a different set of policies.

First, the Gulf states’ fiscal space is not as flexible as it once was. Since 2015, they have been trimming their expat workforce. Nationals now comprise 85 to 90 percent of the public sector workforce in Bahrain, Oman, and Saudi Arabia and around 75 percent in Kuwait. There is little room to cut further. Qatar is the only country with the fiscal space to reduce public sector employment, with nationals comprising less than 50 percent of the public sector workforce. However, cutting too deep risks letting go of expertise that are needed. Some Gulf countries have begun to reduce the benefits of nationals, but they cannot cut too deep. In 2017, Saudi Arabia was forced to reverse a decision to reduce public sector benefits following a public outcry.

Second, over the past six years, Gulf countries have taken divergent paths to develop their private sectors. The World Bank’s Doing Business suggests that Bahrain, Kuwait, and the UAE all improved their business environments. Whereas, Qatar, Oman, and Saudi Arabia have not – although Qatar appears to have reversed course. In 2020, it was among the top 20 global business environment improvers. Instead, Gulf countries continue to rely on public sector enterprises and government-led mega projects as the main drivers of private sector development. This strategy has translated into low levels of foreign direct investment and non-oil exports, as well as unsustainable revenue streams. Private sector development, especially small and medium enterprises (SMEs), is key to broadening and diversifying the revenue base.

Third, as compared to 2015, countries of the GCC are more mired in and distracted by regional conflicts. In 2017, the UAE, Saudi Arabia, and Bahrain imposed an economic blockade on their neighbor Qatar in an effort to bring its foreign policy into alignment with theirs. Far from weakening Qatar, the blockade helped it become more economically resilient, inducing it to increase domestic production and diversify its supply chains. However, the blockade and other low-value geopolitical games being played out by Gulf states in the Gulf, the Horn of Africa, Libya, and elsewhere have distracted attention from economic reforms at home and pulled resources away from local development priorities. Addressing the current fiscal challenges requires resolving ongoing conflicts and increasing regional economic integration.

Finally, this time, GCC countries must strike a balance between their short-term efforts to stimulate their economies and long-term efforts at fiscal consolidation. Some have argued that the priority should be given to the former, with policy actions to balance their budgets coming later. However, this ignores the fact that a majority of the population in the GCC are expats and their long-term economic support is not a binding constraint. Thus, GCC governments must ensure that their stimulus packages go toward supporting enterprises and economic sectors that are most essential to their economic development and diversification plans. This requires introducing a new way of budgeting that economic management; one that is linked to clear development objectives and not simply a summation of ongoing activities.

The road ahead

Over the past five years, GCC countries have made substantial progress in adjusting their budgets to the realities of lower oil prices, mainly reducing public expenditures and diversifying their revenue streams. With oil prices falling further, GCC countries face even greater fiscal constraints. To meet this challenge, they must do things differently. GCC countries must start by abandoning mega projects that are more likely to become resource-draining “white elephants” than drive real private sector growth and revenue generation. Instead, they must allow SMEs to grow and become globally competitive. GCC countries must also abandon conflicts abroad that have diverted resources from priorities at home. Instead, they must increase collaboration and regional economic integration.  Finally, GCC countries must introduce new budgeting tools that allow them to target scarce resources and stimulus funding to those sectors that have the greatest potential to contribute to long-term economic development and diversification.

 

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