The fall in oil prices is hitting the GCC hard, and the six countries have swung from a combined surplus of 10.6 per cent of GDP in 2013 to a deficit of 13.2 per cent of GDP in 2015, according to the Washington-based IMF’s latest Regional Economic Outlook for the Middle East.

Next year the combined deficit is forecast to continue, with the IMF anticipating it will be 12.6 per cent of GDP.

The IMF’s predictions are based on countries making some budget cuts, but the institution warns that what has already been announced and undertaken is not deep-reaching enough to address the size of the deficits in the medium term.

Middle East and Central Asia oil production and exports

Middle East and Central Asia oil production and exports

Depleting reserves

If these budget cuts are not undertaken and no additional debt is issued, Saudi Arabia, Oman and Bahrain will run through foreign assets and reserves in five years or less. The UAE, Kuwait and Qatar are much less vulnerable due to their higher hydrocarbons revenue per capita and could rely on buffers for more than 20 years under the same conditions.

In any case, the IMF recommends the GCC states use the fiscal buffers they have built up in the form of reserves and sovereign wealth to cushion the impact of lower oil prices.

“All these countries have strong starting positions,” said Masood Ahmed, director of the Middle East and Central Asia department at the IMF, speaking at the launch of the report. “They built up financial resources, which they can use to offset the pace of the adjustment… and take a phased gradual approach. But this is not avoiding the need to adjust, as these buffers will get exhausted.”

Building up debt is also risky. It took Saudi Arabia and the UAE a generation to pay off debt issued when oil prices were low in the 1980s and 1990s.

GCC economic indicators
  2008-12* 2013 2014 2015f 2016f
Real GDP growth (%) 5.5 3.2 3.4 3.3 2.8
Oil GDP growth (%) 3.4 0.1 1.3 2.9 1.4
Non-oil GDP growth (%) 6.3 6.2 5.5 3.8 3.8
*=average; f=forecast. Source: IMF

Despite intensive investments in diversifying their economies, non-oil GDP growth in GCC countries is expected to slow as government spending falls, from 5.5 per cent in 2014 to 3.8 in 2015 and 2016.

“It’s very important now that each country has plans to address its deficit so there is clarity and certainty for the private sector,” said Ahmed “Uncertainty makes the private sector more hesitant to invest and hire.”

Only Kuwait will buck the trend as the failure to spend as budgeted in the past five years means infrastructure investment cannot be delayed in the country. The necessary public spending will mean non-oil GDP growth will fall only 0.5 percentage points to 3 per cent in 2015 and 2016.

The next few years will show to what extent public spending drives the private sector, and how successful the GCC’s diversification efforts have been.

Mena oil exporters fiscal buffers and oil breakeven price projections
Country Fiscal breakeven oil prices 2015 ($) Fiscal breakeven oil prices 2016f ($) Fiscal buffers (years)
Qatar 55.5 57.8 25
Kuwait 49.1 51.8 24
UAE 72.6 67.5 29
Iraq 81 75.9 0
Iran 87.2 70.4 7
Oman 94.7 97.5 4
Algeria 96.1 93 5
Saudi Arabia 105.6 95.8 5
Bahrain 107 105 2
Libya 269 207.6 2
Yemen 314 304 1
Mena=Middle East and North Africa; f=forecast. Source: IMF

Spending efficiently

This highlights the issue of efficiency in public spending and investment. The IMF estimates that Middle East and North Africa infrastructure projects could reach the same results with 20 per cent less spending if they were more efficient, saving 2 per cent of GDP.

GCC countries are likely to target capital spending due to the political sensitivity of cutting public sector wage bills and subsidies. The IMF, as usual, recommends reducing subsidies and introducing some form of taxation, although it does not factor this into its calculations. The fund estimates that energy subsidies cost the GCC $70bn a year, or 5 per cent of its GDP.

“A VAT [value-added tax] instrument lends itself to early implementation,” said Ahmed. “It has been studied for severalyears, the technical work is advanced, and it is one of the better tax options. It is time to move from study to implementation, but this is best done as a GCC-coordinated effort.”

Unemployment concerns

The projected economic slowdown has worrying implications for job creation in the region.

GCC employment forecasts

GCC employment forecasts

Already 1 million Saudi, Qatari, Kuwaiti, Bahraini and Omani nationals are out of work, and an extra 2 million are expected to enter the job market by 2020. If the public sector reduces its hiring and the private sector is hit by reduced government spending, 28.5 per cent of the new entrants will remain unemployed.

This would push the GCC’s unemployment rate from about 12.8 per cent to 16 per cent over the next five years.

Saudi Arabia could exhaust reserves in five years

Saudi Arabia
  2008-12 2013 2014 2015f 2016f
Real GDP growth 6.1 2.7 3.5 3.4 2.2
Real non-oil GDP growth 7.5 6.4 5 2.9 3
Fiscal balance (% of GDP) 10.2 5.8 -3.4 -21.6 -19.4
Sama gross foreign assets (equivalent months of imports) 30.3 33.8 36.8 32.4 27
Gross government debt (% of GDP) 8.7 2.2 1.6 6.7 17.3
f=forecast. Source: IMF

Saudi Arabia’s fiscal position is the most cause for concern. Based on the budget measures already announced, the IMF expects the kingdom to run substantial deficits for the next five years.

The fund projects the fiscal deficit to reach 21.6 per cent of GDP in 2015 and 19.4 per cent in 2016.

Saudi economic indicators

Saudi economic indicators

To finance this deficit, Riyadh will have to continue issuing debt and drawing down on foreign reserves. The IMF predicts that the kingdom’s gross government debt will shoot up from a low of 1.6 per cent of GDP in 2014 to 17.3 per cent in 2016.

Leaving the planned debt issuance of $5bn a month aside, at the slightly reduced spending levels projected by the IMF, Saudi Arabia would run through its reserve of $660bn in foreign assets in just five years.

Clearly, substantial savings will have to be made, but cutting military spending in Yemen, energy subsidies and transfers to the population is politically hard to carry out. There is a risk that capital spending will suffer.

“The government is looking at spending items and is in the process of forming plans to address the deficit,” says Masood Ahmed, director of the Middle East and Central Asia department at the IMF. “Once these plans become clearer, we will see where the figures go.”

Saudi Arabia has already put a freeze on contract awards and public sector hiring for the rest of 2015, to keep the deficit within manageable levels. But in the medium term, it will have to choose a consolidation strategy, and maintain investment in vital infrastructure and social projects.

UAE best prepared for slowdown

UAE
  2008-12* 2013 2014 2015f 2016f
Real GDP growth (%) 2.3 4.3 4.6 3 3.1
Real non-oil GDP growth (%) 2.9 5 4.8 3.4 3.6
Fiscal balance (as % of GDP) 7 10.4 5 -5.5 -4
Gross government debt (as % of GDP) 18.7 15.9 15.7 18.9 18.3
Source: IMF; *=average; f=forecast

Thanks to recent diversification successes and energy price reforms, the UAE is the best-prepared GCC country to face falling oil revenues. But it will not escape the effects.

“The UAE is already quite diversified compared with the rest of the GCC; about a third of its economy is non-oil,” says Masood Ahmed, director of the Middle East and Central Asia department at the IMF.

“It is already addressing how to close the deficit, by looking at expenditure plans. It is taking profitability into account on assessing whether oil projects will go ahead, and prioritising its capital spending.”

UAE economic indicators

UAE economic indicators

Expenditure is expected to rise from 32.8 per cent of GDP in 2014 to 36.8 per cent in 2015, before falling to 33.9 per cent in 2016.

Non-oil GDP growth, which was at 4.8 per cent in 2014, will slow to 3.4 per cent and 3.6 per cent in 2015 and 2016 respectively.

“This is the result of consolidation in government spending plans, and the anticipation of this by the private sector,” says Ahmed. “The deficit this year will be about 5.5 per cent, but it should be smaller over the next two years, and then become balanced.”

However, the UAE starts from a worse position than other GCC countries in terms of debt, as legacy government debt was at 15.7 per cent of GDP in 2014. This slightly constrains the government’s ability to balance use of fiscal buffers with new debt issuance, but the IMF expects public debt to rise to more than 18 per cent of GDP.