Extra GCC spending pledges are set to reach $150billion, a 12.8% of GDP, while 2011 appropriations could reach 4.9% of GDP, supporting growth, according to Bank of America Merrill Lynch Global Research Report.
Highlighting the economic diversification efforts facilitated by the oil boom, the report suggested that it would continue, though overall regional growth will remain tied to oil price vagaries.
“At 4.2%, growth in the coming decade is set to remain broadly below pre-2008 levels due to a more streamlined investment pipeline, a recovering real estate sector and a likely less supportive global environment. The current pace of increase in discretionary spending in response to social tensions may have to be reined in to avoid turning it into a binding constraint on growth.”
“The initial response of GCC policymakers has been to sharply increase current spending to accommodate social pressures and to pledge intra-regional fiscal transfers to less endowed members,” the report said.
This, according to report, has averted potential disquiet over governance in most countries, though, over a longer-term horizon, economic reforms will be needed to buoy private sector growth and job creation.
The authors of the report expect the oil boom-led economic diversification program set up after the lost decade of the 1990s to continue over the next decade, unless oil settles in a marked or sustained manner below the regional breakeven price of $80 per barrel.
The Arab unrest will likely encourage GCC policymakers to deliver on their diversification plans though we are still wary of legacy projects and the potential for over capacity in specific sectors.
A more streamlined investment pipeline The investment bubble and euphoria of 2004-08, driven in part by abundant external financing, have deflated, though they also reflect the GCC’s limited, yet improving, absorption capacity in the light of geography.
On the demand side, it added, investment has mainly driven growth acceleration, though in Kuwait the former is lower than the EEMEA median due to political feuds. Consumption is most conspicuous in Saudi (50% of real GDP), while investment and government consumption generally account for 30% of GDP each in the region. A large, price-taking, pool of imported labor has meant very low non-oil productivity growth across the GCC.
The onset of regional socio-political tensions in part lays bare the failings of the labor market, according to report, particularly in Saudi Arabia given the confluence of a large youthful population and income disparities.
“Rapid labour force growths, structural rigidities, skill mismatches due to education sector weaknesses have led to large public sectors. In addition, high wage expectations for nationals and gender exclusion have led to low participation rates (45-65%). GCC job creation was strong during the oil boom, but benefited expatriates disproportionately. Diversification has been particularly successful in capital-intensive sectors enjoying a competitive advantage, low-cost feedstock.
“While the renewed Saudization drive seeks to alter labour market outcomes, this will likely impose costs on the private sector,” the report added.
“A longer-term strategy would involve pay, a social safety net, training and employment structural reforms to twist incentives.”
The recent GCC ramp-up in discretionary spending as a response to the Arab spring raises longer-term issues on the sustainability of the fiscal stance. This is not problematic in Kuwait, UAE or Qatar, especially as they have not experienced mass protests. Bahrain’s fiscal breakeven price is now above $110 per barrel while its hydrocarbon resources may be exhausted in the coming decade. Current spending trends will likely mean that, in the absence of fiscal reforms, the Saudi government starts running deficits from the next decade onwards and accumulates domestic debt (12% of GDP currently), increasing the oil breakeven fiscal price.
“Unless current spending is reined in, the introduction of structural reforms, lower subsidies, higher non-oil revenues, will need to be contemplated. Accumulated current account surpluses make the GCC a capital exporter, with a pool of savings to fund domestic investments. Most MENA countries run net external creditor positions vs BIS banks, with the exception of the UAE and Bahrain. Leverage at Abu Dhabi and Qatar has increased, but the asset-side remains solid. Dubai’s position but exposure to rollover risk with debt at 157% of GDP remains a medium-term concern.
“The oil boom has led to several notches of upgrade to sovereign ratings, but, for stronger GCC credits (UAE, Kuwait, Qatar); institutional settings are now a brake to ratings above Aa2/AA. Deterioration in Bahrain’s fiscal flexibility and politics are shorter-term constraints, while diversification, successful succession and a prudently expansionary fiscal stance will serve Oman and Saudi Arabia well,” it added.