File picture: An oil facility in Saudi Arabia. The GCC countries have recognized the need to reduce their reliance on oil and are all implementing reforms to diversify their economies as well as fiscal and external revenues. Image Credit: AP

Dubai: The GCC countries that account for a fifth of the world’s oil production need to urgently adapt their fiscal policies to the reality of lower oil prices in the longer term, the International Monetary Fund (IMF) said in a Staff Report on Thursday.

The report, ‘The Future of Oil and Fiscal Sustainability in the GCC Region’ noted that oil market is undergoing a fundamental change. New technologies are increasing the supply of oil from old and new sources, while rising concerns over the environment are seeing the world gradually moving away from oil. This spells a significant challenge for oil-exporting countries of GCC who account for a fifth of the world’s oil production.

The GCC countries have recognized the need to reduce their reliance on oil and are all implementing reforms to diversify their economies as well as fiscal and external revenues. Nevertheless, as global oil demand is expected to peak in the next two decades, the associated fiscal imperative could be both larger and more urgent than implied by the GCC countries’ existing plans.

According to the IMF staff study, at the current fiscal stance, the region’s financial wealth could be depleted by 2034. Fiscal sustainability will require significant consolidation in the coming years.

Continued growth of demand for natural gas will benefit some of the GCC countries with sizable gas reserves. In the IMF’s benchmark projection, the Gas reserves including the recent discoveries will delay the peak in hydrocarbon GDP by about a decade.

In the IMF’s projection, hydrocarbon revenue will peak by about 2048. Assuming continued annual non-oil real GDP growth rate of three percent, this implies a path of a persistent decline in hydrocarbon fiscal revenue in percent of GDP. In the benchmark projection, this ratio would halve by 2050 from the present level of 23 per cent. The decline would be steeper should the alternative scenarios of faster improvements in energy efficiency and stricter environmental protection policies materialize.

GCC needs to prepare

The IMF report has observed that anticipating and preparing for what comes next will be critical for GCC. The GCC region is home to the largest concentration of oil exporters and oil remains critical to both external and fiscal revenues and overall GDP.

Although the importance of non-oil sectors has increased in recent decades, many of them rely on oil-based demand either in the form of public spending of oil revenue or private expenditure of oil-derived wealth. The 2014–15 oil price shock, which notably slowed non-oil growth in most of the region, was a stark reminder of this dependence.

“Recognizing this challenge, the GCC countries are all implementing programs to diversify their economies as well as fiscal and external revenues away from oil. The success of these programs will be central to achieving strong and sustainable growth in the years to come,” the IMF study said.

What can be done?
Ongoing reform efforts in the region will provide momentum over the next five years, but they need to be accelerated to challenges posed by oil market dynamics according to the IMF. Current IMF staff projections envisage continued fiscal consolidation in all GCC countries. These projected fiscal paths appear to be more consistent with fiscal gradualism.

Accelerating and sustaining adjustment in the long term will require broadening the scope of fiscal reforms. The measures to deliver the required fiscal consolidation and how to split them between revenue and expenditure require a tailored country-specific approach.

The IMF study has observed that faster economic diversification will not resolve the fiscal challenge on its own and countries will also need to increase their non-oil fiscal revenue. While the recent introduction of VAT and excises in some countries have opened up the potential for to build on this, the IMF study said the region needs to move from wide-ranging fees toward fewer broad-based taxes to diversify government revenues.

As part of longer term fiscal planning the IMF said governments will likely need to downsize. “Wider reforms, spending restraint and optimization toward areas with highest economic impact will be critical. Progress has already been achieved in some areas, such as reduction of energy and water subsidies in several countries. But there remains significant scope for rationalizing other categories of spending, including reforming the region’s large civil service and reducing public wage bills,” the report said.