BY KAREN E. YOUNG
In ‘Twin Crises Deepen Gulf States’ Policy Competition and Independence’, I argue that, for the Gulf Arab states, the twin crises of the Covid-19 pandemic and the collapse of oil prices in 2020 have accelerated trends already in motion. For finance ministers, it must feel like bailing out a sinking boat with a tin cup.
There will be no simple policy solution to the structural pressures for fiscal reform. The oil exporters of the Gulf Cooperation Council (GCC), even the wealthier ones like the United Arab Emirates, simply have higher spending patterns than their current revenues support. But the Covid-19 pandemic has called upon states to intervene and support domestic economies, making the competing priorities of shrinking public sector payrolls and stimulating domestic demand all the more difficult. What emerges are trade-offs that reveal leadership priorities, and important distinctions within the ever-weakening body of the GCC on a range of policies from immigration, labor markets, tax and sovereign debt.
The context of the current economic reality of Gulf Arab oil exporting states begins in late 2014. Global oil markets are still contending with a fundamental recalibration of supply, which US shale continues to upend. The Organization of the Petroleum Exporting Countries (OPEC) response to the advent of shale production began with a partnership with non-OPEC members Russia and Mexico in December 2016. That partnership is still in place, though it faced some volatile renegotiations in March and April of 2020.
Unfortunately, the global structural pressures of plentiful oil supply (much of it due to technology advances and efficiencies of US shale production), an expected plateau of oil demand from 2035 onwards, and the necessity of government stimulus to shield economic decline from the Covid-19 pandemic all make the economic diversification agenda more precarious. The recent reliance on foreign reserves and savings built up when oil prices were high in the “magic decade” between 2003 and 2014 is unlikely to be replaced in the near term, exposing governments to future fiscal vulnerability and possible currency devaluation.
While access to international debt capital markets has been good for all of the GCC states, including those with weaker credit ratings like Bahrain and Oman, governments are entering an addictive cycle, relying on debt to meet an annual funding gap. The coming debt service burden will substantially restrict fiscal policy into the future. The generous age of Gulf social services and benefits will come to an end.
The policy response to the twin crises is geared to meet two challenges, one short-term and one longer-term. First is the short-term challenge of domestic economic recovery and boosting domestic demand. Second is the longer-term fiscal challenge and the decisions necessary to reduce government expenditure. Fiscal belt-tightening is bound to focus on domestic expenditure in social services and public sector wages, but it will also need to come to grips with the foreign economic policy limitations of Gulf States’ regional financial intervention, as a source of aid and investment across the Middle East, Pakistan and the Horn of Africa..
Most importantly, the twin crises of Covid-19 and low oil prices have been devastating to local demand in the GCC economies. For those economies that have smaller citizen populations as a proportion of total population, the threat of expatriate job losses, less disposable income and discretionary spending and then repatriation or exit, all make the expected recovery more difficult. In those states with advances in the diversification agenda, the current global economic climate is not hospitable. What we have seen in non-oil growth is largely in sectors very sensitive to the Covid-19 pandemic: hospitality, tourism, travel (airlines), real estate and logistics. None of these sectors are doing well. And with government spending in contracting declining, the obvious outcome has been job losses, but not just in construction and low wage employment, but more across sectors and income levels—expatriate exodus, which further dampens domestic.
The scope of stimulus so far across the GCC has focused on some suspension of fees, electricity fees in industrial zones, some discount lending to local banks, some deposits to local banks, a few small and medium-sized enterprise (SME) support funds and direct support to citizen workers in the private sector (notably in Bahrain, Kuwait, Qatar and Saudi Arabia), but all are limited in terms of three to six months in 2020. At the same time, there is some movement towards austerity, including diminishing the number of citizens receiving cash stipends for lower income families in Saudi Arabia, raising the VAT to 15% in Saudi Arabia. And in Oman, mandates of retirement for older citizens working in the public sector. Across the board, budget cuts to ministries in Oman and Saudi Arabia have been attempts to get fiscal expenditure down.
Oil has been a great source of capital; it’s not clear that a new growth strategy can equal that. Capital invested abroad via sovereign wealth funds would need to grow at a rate capable of replacing lost oil revenue; capital invested at home will be limited without a more open regulatory playing field and amplified by foreign direct investment (FDI). The simple math is that government spending needs to be reined in.
The short-term will likely be a shuffling through fueled by debt issuance, new taxes and fees, and a reliance on local bank sectors. Labor markets are certain to contract, but it is not yet clear that job creation for nationals will be an automatic benefit. For those states with smaller citizen populations relative to total population, the priority to stimulate domestic demand will translate to more open immigration policy, but with clear targets to higher-income consumers and potential investors. For other states, the fiscal deficits will require immediate budget constraints, increased tax and revenue schemes, and perhaps wider privatization efforts to attract foreign investment. The future can only be a more competitive political landscape, as more people compete for fewer state resources. And that may be just the crisis the region needs to begin to think about a post-oil future.
Karen E. Young is a resident scholar at the American Enterprise Institute.