GCC states will find it hard to diversify away from hydrocarbons – S&P

The GCC countries including – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and Abu Dhabi – from the UAE – will find it “hard” to diversify their economies away from hydrocarbons, a new report by ratings agency S&P has found.

Currently, the Gulf states have close to 30 per cent of global oil reserves and 20 per cent of global gas reserves, with less than 1 per cent of the global population.

“This large hydrocarbon endowment and the high income it generates has resulted in past general government surpluses, low government financing needs, and net external asset positions for most GCC countries,” the report said.

But the region’s high concentration and dependence on the hydrocarbon sector, which averaged about 30 per cent of GDP and 60 per cent of total exports over 2015-2016 – despite low oil prices – could become a credit negative factor when not offset by substantial financial buffers, S&P stressed.

The sharp decline in oil prices – which reached lows of $29 at the beginning of 2016 from highs of $115 in mid-2014 – has resulted in a “significant economic slowdown and deterioration in fiscal and external balances” for net oil exporters in the Middle East.

Real GDP growth in the region fell to an average of 2.5 per cent for 2014-2016, half of its 2011-2013 rate. Some countries in the region have also posted current account and general government fiscal deficits during this period, compared to surpluses in the past.

Mainly due to the impact of sustained low oil prices on economic, fiscal, and external metrics, S&P has lowered its long-term foreign currency ratings on Oman (five notches), Bahrain (four notches), and Saudi Arabia (three notches) over the last three years.

It also recently lowered its long-term foreign currency rating on Qatar by one notch following the conflict in the GCC.

“These rating actions also reflected our view that GCC sovereigns have made only marginal progress in diversifying their economies away from hydrocarbons, given the still sizable contribution of the sector to their economies,” the report stated.

While non-oil real GDP has picked up in the region since 2000, the growth rate has gradually decelerated over the last three years in line with the decline in oil GDP.

This highlights that “diversification efforts are yet to pay off”, the report added.

All the GCC states have announced ambitious diversification plans, which have new impetus following the sharp and sustained decline in oil prices.

Most governments have presented National Development Plans (NDPs) or ‘Visions’ with 20- to 25-year time horizons, usually incorporating five-year intermediate strategies.

These strategies target the expansion of sectors such as tourism, business, and financial services along with logistics.

“In our view, it is likely to be a decade long or generational transition. We also believe that structural impediments will hamper the transition toward significantly more diversified economies,” the report opined.

The main challenges to diversification include:

Foreign exchange regime

The GCC countries’ US dollar exchange rate pegs hinder their ability to compete on price in non-oil export markets. As a result, the development of non-oil related activities is dampened, absent any offsetting of efficiency or technological capacity gains.

The IMF states that a fairly valued real effective exchange rate is essential to economic diversification, the report said.

Climate

While the hot climate in the region is supportive of tourism during most months of the year, the heat severely constrains the development of agriculture, with water and arable land scarce. GCC countries import almost all of their food and most other consumer and capital goods. However, development of agriculture, along with other primary sectors, is often the precursor of a shift to manufacturing (secondary sector) and services (tertiary sector), the report highlighted.

Education and skills

GCC governments are attempting to stimulate private sector-led economic diversification, which will require skills enhancement of the countries’ workforces.

The local workforce will likely require significant training and education to be eligible for high-paying private jobs, and investment in education will take time to bear fruit, said S&P.

Openness to doing business

Most GCC sovereigns have announced business-friendly reforms such as free trade zones, tax incentives, easing of tariff restrictions, and non-tariff barriers aimed at attracting foreign direct investment inflows and further boosting economic growth in non-resource based sectors.

However, the “stagnation in the implementation of business-friendly reforms witnessed outside of the UAE is likely to constrain foreign capital inflows, limiting the Gulf countries’ ability to spur private-sector driven economic growth,” the report pointed out.

Attractive public sector employment

Public sector workers currently benefit from substantial advantages compared to their private sector counterparts, with higher salaries and increased job security, contributing to limited labour market efficiency as public sector attractiveness reduces the incentives for GCC nationals to apply for jobs in the private sector.

“GCC governments have instigated policies introducing quotas, among other measures, to encourage the replacement of expatriate private sector workers with nationals. However, in our view, this does not address the issue of the skills mismatch between nationals and private sector jobs,” S&P said.

Similarities of the diversification plans

Dubai has managed to significantly develop non-oil based activities and has now become a financial and transport hub for the region via its airport, ports, and free zones, along with having one of the world’s biggest airlines by international passenger traffic (Emirates).

“With Dubai already leading the way, developing a competitive services sector economy may heighten the risk that GCC economies’ development occurs at the expense of each other. This is not to say there can’t be challengers, but many of the GCC sovereign’s development plans target the same areas such as tourism, financial services, and logistics,” S&P said.

This could create “significant overlaps” in the provision of these services, it added.

Overall, the challenges to GCC economic diversification remain “substantial”, the report said.

“Dubai has shown what can be done, but to some extent further developments in financial services, logistics, transport, and tourism could cannibalise the success of established players,” it added.