In a global market where the price of oil per barrel has fallen more than 70 per cent since June 2014, the sharp and prolonged drop in price has wiped $360bn off Gulf Cooperation Council members’ revenue in 2015 alone. Subsequently, the bleak trading climate has forced states across the GCC to reassess public spending strategies as they attempt to plug the revenue gaps in their far-reaching, nation-building programmes.
With oil prices so low, Gulf states have been forced to re-think how they fund their development and infrastructure spending. To boost income, GCC countries have announced plans to introduce a value added tax (VAT) in 2018 – a first of its kind – on regional citizens and residents.
In Saudi Arabia, the Deputy Crown Prince indicated that the kingdom will seek to bolster revenue, stating in no uncertain terms that ‘nothing is off the table’.
The current climate is completely at odds with the market landscape of only half a decade ago when – confronted with the Arab Spring protests of 2011 – GCC states revised their annual budgets and increased public spending by up to 25 per cent. The extra spend was pledged into key areas of social-economic improvements for citizens as governments committed to spending freely on infrastructure, defence, education, public sector wages and subsidies.
In Saudi Arabia, the late King Abdullah commissioned the building of a desert megacity at a cost of $100bn. The project included the $1.2bn Kingdom Tower, slated to become the world’s tallest building.
Due to increasing regional geopolitical security concerns, the GCC combined spent $113bn on military hardware in 2014; with Saudi Arabia alone spending approximately $81bn.
Generally speaking, GCC countries enjoy some of the world’s lowest debt-to-GDP ratios and will be able to borrow comfortably from international money markets, if necessary.
Despite this good credit perk, GCC governments will inevitably run budget deficits – because of which they are collectively exploring economic diversification options.
Saudi, the largest country in the GCC, continues to pursue diversification policies but, overall, its economy remains very dependent on hydrocarbons. The United Arab Emirates’ success is that it has been more open to tourism than Saudi Arabia, and has positioned Dubai as a transit hub (with around 70 million passengers per year passing through Dubai alone).
Where is oil headed?
The low oil price environment also played an essential role in Iran joining Saudi Arabia as the region’s top producers of oil. This is especially the case for Iran after the removal of the international sanctions. There is also an impact from ISIL controlling major oil fields within Libya and Iraq, coupled with the continuing conflict in Syria between the Bashar Al Assad regime and the international committee commanded by the United States.
GCC countries currently hold 30 per cent of the world’s proven oil reserves, with Saudi Arabia in the lead (15.7 per cent), followed by Kuwait (6 per cent) and the UAE (5.8 per cent).
Together, the GCC countries produced 28.6 million barrels per day in 2014, equivalent to 32.3 per cent of total global production.
While lower oil prices affect all GCC countries, they are not affected in the same way. The decline in oil prices affects Oman and Bahrain most, whereas the Saudi Arabia, UAE, Kuwait and Qatar are less affected. Despite similarities in economic structures, the countries differ in terms of economic size, population, levels of diversification and fiscal break-even prices.
The UAE’s economy is one of the most diversified among the GCC countries, making it resilient to falling oil prices. Hydrocarbon revenues account for 25 per cent of GDP and 20 per cent of total export revenues. The non-oil private sector shows strong growth fuelled by domestic demand and tourism, especially in Dubai.
Domestic demand is powered by strong retail sales and rising confidence. Dubai’s retail sales, which rose by 7 per cent in 2014, is estimated to rise further, due to further increases in tourism. Dubai’s real estate market is burgeoning through foreign investment, as well as wealth from the neighbouring Abu Dhabi.
Saudi Arabia: speeding up the diversification process
Saudi Arabia’s new Vision 2030, launched by Mohammed bin Salman, the king’s son and defense minister, is the newest and most ambitious of all the diversification policies that all the Gulf countries have been developing for years now. The elements that really stand out include the privatisation through a local IPO of a small (up to 5 per cent) stake in Saudi Aramco, the state oil company. The remaining shares in Aramco would be transferred to the country’s public investment fund, creating a substantial Saudi sovereign wealth fund for the first time.
While 80 per cent of its export revenues and around 85 per cent of its budget revenues come from the oil sector, the kingdom is speeding up its diversification process.
The main drivers of economic growth are strong government spending to fuel private consumption and the construction sector.
In early 2015, the Saudi Arabian General Investment Authority announced the kingdom’s Unified Investment Plan, which consists of four sector specific approaches in order to boost investment. These include the integration of the energy sector, raising productivity in the construction, tourism, real estate and retail sectors, boosting mining and transport development and further investment in education to improve the kingdom’s competitiveness.
There are 40 promising investment opportunities in the healthcare sector worth $71bn including the manufacturing of medical hardware and equipment, medicines, vaccines as well as the establishment and management of hospitals. There are also 36 attractive transportation investment projects in the pipeline which include the manufacturing of buses, train carriages and spare parts, as well as providing technical and technological support services for the creation and development of infrastructure.
The government also seeks to support consumer spending by providing two months’ bonus salary to state employees and subsidies worth $5.3bn for electricity, water and housing. This investment stimulates consumption, especially retail sales, and partly compensates for the negative impact of lower oil prices on incomes.
Mohammed bin Salman appears to bring fresh confidence to these efforts because he has the backing of his father and the low oil price makes the case for reform clearer (and is forcing all the other Gulf countries to cut subsidies and spending).
Also, perhaps, the turmoil in the Arab region is discouraging opposition movements in the countries that remain peaceful, strengthening the appeal of the political status quo compared to uncertain alternatives.
But the changes in the economic relations between the citizens and the state will inevitably alter the political relations too, especially with an increasingly well-educated and globally connected youth population with economic expectations that typically exceed their job prospects.
As oil continues to be a major contributor to economic performance in the GCC, economic diversification is vital for the Gulf countries to ensure continued healthy growth. This has been showcased in Saudi Arabia and the UAE, which are driving sustained GDP growth through significant government investment in non-oil sectors.
Elias Aaraj is an analyst at Saxo Bank Trading Desk