ABU DHABI – Supported by strong oil revenues and spurred by unrest in neighboring countries, the Gulf oil exporters – especially Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, Oman, and Bahrain, which form the Gulf Cooperation Council (GCC) – have lately ramped up public social and investment spending. The business-intelligence publication MEED estimates that the value of projects that are planned or underway is nearing $2.46 trillion – more than 150% of these countries’ combined GDP (up from 128% a year ago).
Given this, it is not surprising that the International Monetary Fund sounded cautious in its latest economic outlook for the Middle East, urging the governments of the oil-exporting countries to rein in hard-to-reverse expenditures and pursue high-quality capital investments and social programs. After all, fiscal management is a particularly delicate problem in resource-rich countries, with a few key considerations determining success.
First, policymakers must aim for “intergenerational equity.” They cannot simply do what is best for their country today; they must also consider the implications of their choices – how much oil wealth they consume, how much to invest in human and physical capital, and how much to save – for future generations.
It is of course tricky to establish the level of government spending that is consistent with intergenerational equity, owing to uncertainty about oil reserves, future oil prices, and investment returns. But the IMF has attempted to do so – and reckons that spending in most GCC countries is too high.
Second, both government spending and growth in non-oil sectors are influenced by fluctuations in oil revenues. This can compromise short-term economic stability and potentially lead to boom-bust cycles.
As it stands, the GCC’s aggregate fiscal break-even oil price (at which oil revenues are sufficient to cover government spending), currently around $75 per barrel, is below this year’s average Brent crude oil price of $108 per barrel. But the fiscal break-even oil price for most GCC countries – in particular, Oman, Kuwait, and Saudi Arabia – has risen in the last two years.
The third consideration for managing public finances in oil-rich countries is that traditional fiscal indicators, which measure overall government revenues and expenditures, do not lend themselves to comprehensive assessment, and can mask underlying structural weaknesses. A more useful approach would separate the oil variable from revenues, spending, and economic activity.
On that basis, GCC governments’ revenue shortfalls relative to their spending – the so-called “non-oil fiscal balance” – amounts to almost 50% of their non-oil GDP. Although this reflects a decline from the 2011 peak of 57%, the long-term trend is upward: the average shortfall was 41% in 2005-2010, compared to 37% in 2000-2005.
In the GCC, these challenges are being compounded by the rise of shale oil and gas, mainly in the United States. The International Energy Agency’s forecast that the US will overtake Saudi Arabia as the world’s top oil producer in 2015 has led major GCC oil producers – notably the Saudis, the United Arab Emirates, and Kuwait – to postpone investment in expanding their output.
Given this highly uncertain environment, what can GCC policymakers do to address their fiscal-policy challenges?
First and foremost, spending decisions should be decoupled from oil prices. Instead of following a pro-cyclical fiscal policy (spending more when oil prices are high, and vice versa), policymakers should evaluate the non-oil economy on a stand-alone basis, and make fiscal-policy decisions based on metrics like a target for the non-oil fiscal balance.
Moreover, policymakers should work to build a diverse, resilient, and self-sustaining private sector, which can cushion the economy from oil-revenue volatility. So far, government-led capital spending in order to develop competitive private sectors has had mixed results. In 2000-2012, non-oil productivity declined in all GCC countries except Saudi Arabia, which experienced only a marginal increase.
The good news is that much can be done to reverse this trend. Easing access to finance for the private sector, strengthening legal frameworks, making the private sector more attractive to nationals (more than two-thirds of whom are currently public employees), and coordinating investment in areas like logistics would go a long way toward improving private-sector competitiveness in the GCC.
Investment governance frameworks also need to be strengthened, in order to ensure that projects are objectively appraised, selected, and prioritized on the basis of their financial and human-capital returns. Although the GCC countries have built world-class infrastructure over the last four decades, they remains prone to malinvestment, especially during periods of sustained high oil prices. Establishing institutional mechanisms to address this bias and enhance fiscal discipline would help to break this inclination.
Finally, moving beyond one-year budgets to a multi-year fiscal framework would enhance the stability and efficiency of public spending. Countries like Kuwait and Qatar have already established macro-fiscal units, which they are working to strengthen. Others GCC government should follow suit.
Fortunately for the GCC, it has a long oil-production horizon, and most members have built significant fiscal buffers. But, over time, failure to address relevant fiscal challenges could outweigh these advantages. To avoid such an outcome, GCC leaders must act now.
The views expressed are those of the author and not of the National Bank of Abu Dhabi.