Revenue diversification key to fiscal management in GCC

Over the past decade, the GCC underwent major economic transformations, with an aim to diversify their economies away from the hydrocarbon sector. While some countries concentrated on establishing a strong industrial base, others emphasised on services. Saudi Arabia and the UAE developed energy-intensive industries such as petrochemicals, cement and metals (mostly through free zones or specialised industrial zones) to benefit from comparative advantage, while Bahrain and Dubai focused on infrastructure development so as to become a major service/financial hub, or trade and transit centre, or a tourist destination.

An analysis of changes in non-hydrocarbon gross domestic product (GDP) as a share of total GDP indicates that diversification is generally on the rise across GCC countries. Unsurprisingly, Bahrain’s GDP is the least hydrocarbon-dependent due to its low level of hydrocarbon resources. The UAE, Qatar and Oman reported the strongest diversification drive, with their share of non-hydrocarbon GDP in total GDP increasing by more than 1500 bps during 2000-11. In contrast, Qatar has the least diversified economy while Saudi Arabia’s non-hydrocarbon GDP share in total GDP increased from 68 per cent in 2000 to almost 80 per cent in 2011. From a growth perspective, the non-hydrocarbon GDP delivered unprecedented growth for all GCC countries and has surpassed GDP growth in the hydrocarbon sector by leaps and bounds. The strongest increase in average annual real GDP growth was witnessed in Qatar, due to a boom in the natural gas sector, while Saudi Arabia reported weaker growth during 2000-15.

While the GCC economies are clearly moving towards diversification, the structure of government budgets and export revenues registered nominal changes over the past decade. For most GCC states, hydrocarbon revenues accounted for over 80 per cent of total government revenues in 2013, while this figure was close to 70 per cent for more the diversified economies of Qatar and the UAE. While the economic diversification efforts have propelled the share of non-hydrocarbon GDP, its contribution to government revenues remains small primarily due to policy decision of maintaining a low- or zero-tax environment to assist private sector activity.

Moreover, the main source of non-hydrocarbon government revenues — which include trade taxes (custom duties), payroll and employment taxes along with a large number of license fees and charges — has been constantly eroding due to the Free Trade Agreements and World Trade Organisation commitments whereas license fees are increasingly viewed as growth impendent for private sector as they directly increase the cost of doing business.

Creation of sovereign wealth funds (SWFs) and subsequent investment in diversified assets have generated additional revenues (which can surpass 10 per cent of total budget in countries like Qatar, Kuwait and UAE) for GCC governments and have partly offset the negative effects of oil-income dependency of public revenues in the past decade. Moreover, the large international reserves amounting to $906 billion (Dh3.3 trillion) in 2014, about 55 per cent of the region’s GDP, that have accumulated over time from hydrocarbon income should provide adequate cushioning against international shocks in the near term. However, the need for fiscal consolidation is imperative especially considering the stagnating oil prices (hovering at about $105 a barrel since 2011) and probable decline over a medium term, as speculated by various market analysts.

The GCC can take valuable lessons and best practices from other oil-surplus countries such as Norway, which has a well-established oil wealth management model and oil income account for just about 30 per cent of government revenues. While most of the GCC SWFs invest both inside and outside the country, Norway SWF only seeks investments outside the country to ensure risk diversification and to shield the non-hydrocarbon economy from transitory and volatile revenues stemming from the petroleum sector. Moreover, each year, money is withdrawn from the Norway SWF only to cover any non-oil budget deficit, whereas the GCC countries rely more heavily on hydrocarbon revenues to finance current spending. Further, unlike GCC, the ownership and management of Norway’s SWF are handled by two separate agencies so as to ensure transparency in asset allocation and investments. In addition to effective management of SWFs, the GCC should also build on tax reforms and spending-related structural changes. Introduction of region-wide value-added tax, a proposal which has been discussed and delayed for over a decade now, and cuts in oil subsidies are two prominent aspects that require immediate resolution.

In conclusion, notable progress has been made towards economic diversification since 2000; however, the non-hydrocarbon sectors still have only a limited gearing effect on the rest of the economy and government revenues continue to be largely driven by hydrocarbon income across the GCC. With eroding international reserves and persistent stagnation/decline in oil prices, the GCC will need to reassess the structure of state budget, which may warrant tax and spending-related reforms. Further, the GCC should also instigate oil-wealth management best practices from other oil-surplus countries so as to avoid foreseeable pitfalls.

On the positive side, the GCC has large international reserves, which give it the time and resources to test various approaches and methods to efficiently manage oil wealth. Moreover, all GCC countries are already working towards long-range economic and social development plans (for example, Saudi Arabia’s long-term strategy 2025, Vision 2020 in Oman, Vision 2021 in the UAE, Vision 2030 in Bahrain, and Qatar National Vision 2030) that should facilitate sustainable development and reduce hydrocarbon revenue dependence in the mid-long term.

Shailesh Dash, Founder and CEO, Al Masah Capital Management Limited