GCC starts tightening its belt on glimmers of future austerity

In economics, markets are considered cyclical. Markets slump and after a period of contraction, rebound, more bullish than before. Gulf Cooperation Council (GCC) countries are banking on such a cycle to keep the status quo.

In the 1980s and 90s, oil prices were low and GCC states were running deficits. Once the oil price started moving upwards to the $100 a barrel territory, surpluses increased and the GCC had the liquidity to embark on vast spending programmes to open up and diversify their economies away from hydrocarbons. The 2000s were a boom period, epitomised in the glitz of Dubai, the skyline of Doha's West Bay, and the global spending spree of the Gulf Sovereign Wealth Funds (SWFs).

The 2008 financial crisis hobbled the boom times, but petrodollars kept these economies buoyant to ride out the crisis better than much of the world. The so-called Arab Spring from 2011 onwards presented a political challenge, but the cash was there.

The 45 percent drop in oil prices over the past twelve months has been a much bigger blow, although only the most optimistic opponent of the GCC order would consider it a nail in the coffin of the Gulf monarchies. The region simply has too much access to capital, and with small local populations – Saudi Arabia aside – able to fund its way out of this downturn in the near term.

Keeping the status quo, however, is proving costly. “It has become quite a bit more expensive to be a state in the region following the Arab uprisings, calculated in the vicinity of 10 to 15 percent more costly following large [government] handouts. It will be hard to roll that back, but eventually that's what will need to happen,” said Martin Hvidt, professor at Zayed University in Dubai.

Downward shift

The drop in oil prices is slated to reduce GCC energy export receipts from $743bn in 2012 to around $410bn in 2015, according to the Institute of International Finance (IIF), a 45 percent slide. This is projected to lead to the consolidated fiscal balance of the GCC to go from a surplus of 4.8 percent of GDP in 2014, to a deficit of 7.5 percent of GDP this year.

“For larger GCC economies this is not an issue in the short term, there is confidence, but it does affect fiscal strategies. Except for Qatar, all economies are slowing down and this will affect the private sector,” said Steffen Hertog, associate professor in Comparative Politics at the London School of Economics.

All the GCC states' budgetary break- even oil price is above the current barrel price of around $56. Qatar has the lowest at $65.3 per barrel, followed by Kuwait at $68.2, and the UAE at $78.2, but for Saudi Arabia it is $104.6, Oman $113.2, and $130.2 for Bahrain, according to April figures from the IIF. “Bahrain has pretty much no liquid solvent savings. Oman has a fair amount but it will burn through reserves quickly if it doesn't cut spending, which looks unlikely,” added Hertog.

Bahrain, the GCC's problem child since the 2011 uprising, will need to be financially propped up, with $10bn pledged by the GCC Fund. “Bahrain will be bailed out by the UAE and Saudi Arabia. I don't think it will be a generous bail-out, so will perhaps be the first one to do substantial reforms,” said Hertog.

While Qatar is expected to be the least affected, the fiscal break-even oil price is expected to increase 14.2 percent this year, according to the IIF, but with the bulk of government revenues coming from liquefied natural gas (LNG), this poses a further challenge, as gas prices are not expected to rise in the short to medium term. Indeed, with Australia and the US ramping up LNG output, Qatar has been knocked out of pole position as the world's largest LNG exporter.

Somewhat opportunely for Doha, having had its wings clipped by Riyadh and the UAE after a decade as an expansive regional foreign policy actor, culminating in the “loss” of Egypt when the Muslim Brotherhood was overthrown in 2013, there are fewer external funding constraints.

“If Qatar was continuing its expansionary approach at full pace, perhaps we'd look closer at the consequences,” said Richard Mallinson, geopolitical analyst at London-based Energy Aspects.

For the GCC's big economic and political players, Saudi Arabia and the UAE, constrained times are ahead. Saudi Arabia's budget expenditure grew by 12 percent a year from 2009 to 2014, almost doubling from $126.7bn to $228bn, and overspent last year by $38.6bn. But Riyadh has the cash and the economic clout to weather a deficit for the immediate term.

“Saudi Arabia has substantial reserves, some $100bn in overseas bank deposits and can withdraw them any time, so it doesn't need to liquidate investments and has significant deposits in local banks,” said Hertog.

No austerity, but no handouts either

Riyadh's budget this year is $230bn, up on 2014, and will strive to not go over budget again. As for all GCC states, the government is looking into areas to cut funding. Military spending could be one area, budgeted at $80bn in 2014, according to Citi figures, but with the war in Yemen any cuts there are unlikely.

The kingdom will be hoping that instability doesn't spread from its southern neighbour, particularly to its restive eastern provinces, lacking the largesse to fork out “loyalty handouts” to citizens, as happened in 2011 when Riyadh shelled out $100bn. In February, following the accession of King Salman, two months additional salary was given to state employees, costing some $32bn, according to Citi figures.

“Current spending is more politically sensitive. They would be wary of another handout if there is a political crisis to keep citizens happy. Something really bad would need to happen” for that to occur, said Hertog.

The fiscal squeeze is going to have significant knock-on effects, especially as the GCC states have not diversified away enough from hydrocarbon revenues. Indeed, the GCC is in a Catch-22 situation, needing petrodollars to bankroll diversification efforts, but, with less revenues, not able to do so at the rates needed. Furthermore, much of the diversification is on the back of the hydrocarbon sector, such as downstream petrochemicals.

“The atmosphere in the UAE is a wider economic slowdown. Low oil prices isn't just about government spending, the whole economy is linked to it,” said Mallinson.

The GCC's diversification attempts, particularly getting citizens into the private sector through nationalisation programmes – Saudisation, Qatarisation etc. - have broadly failed due to high public sector salaries. If low oil prices continue, and budgets are increasingly squeezed, GCC governments will have to carry out reforms, be it introducing value added tax, slashing energy subsidies, and/or reducing benefits.

“It will very much be up to the ruling families to persuade nationals of the need to reduce benefits, to make everyone see they are all in the same boat, that there is a crisis, to maybe survive without any political problems,” said Hvidt. “If low prices keep up for another year, there is no doubt in my mind they'll have to readjust their budgets.”

Impact on rest of MENA

The economic slowdown in the GCC due to the low oil price is going to have a wider ripple effect, lowering consumer spending, impacting financial services, and halting the infrastructure and related projects that provides much needed regional employment.

To what degree financial assistance and FDI from the Gulf to the rest of the region will be impacted is hard to gauge. The lower oil prices are clearly having an impact at the MENA level though, with current account balances projected to slide from 7 percent in 2014, to negative 2 percent in 2015.

“Largesse may become a bit more limited but I don't think the taps will be turned off entirely. You can see from the crisis in Yemen a lot of premium is paid to regional alliances, and the GCC realises the expectations of less wealthy states for inward investment, as seen with the relationship with the [Abdul Fattah al-]Sisi government,” said Mallinson. Indeed, the UAE, Kuwait and Saudi Arabia have provided Egypt with over $12bn in aid, central bank deposits and for petroleum products, while cumulative Saudi investments in Egypt are estimated at nearly $32bn.

As GCC states eat through their reserves, such funding could become more constrained, especially given global economic volatility and the turbulence in the MENA. Egypt will continue to need major funding - it is not as easily propped up as Jordan - and Yemen will need significant funds for Riyadh to capitalise on its military adventurism to shore up future political support. As such, the GCC, Riyadh in particular, could face tough choices as to whether to direct financial support externally or internally.

“Egypt is considered a priority, but between domestic needs and funds to Egypt, the domestic needs will be grandfathered,” said Hertog.

Ultimately, the GCC faces tough choices to rein in budgetary spending unless oil prices rebound. “In the short to mid run they're fine, if low prices continue it could be a really severe crisis, although reforms could postpone the reckoning. Now it’s like the mid-1980s, maybe soon back to like the 1990s,” added Hertog.

A full cyclical return to the boom times of the 2000s however, seems unlikely, and in the midst of geopolitical turbulence, major challenges lie ahead.

- Paul Cochrane is an independent journalist based in Beirut, where he has lived since 2002. He covers the Middle East and Central Asia for specialized publications, business magazines and newspapers. His work has been featured in over 70 publications, including Reuters, Money Laundering Bulletin, Accountancy Futures, Commercial Crime International, Petroleum Review and Jane's. Educated in Britain and the US, he earned a Master’s degree in Middle Eastern Studies at the American University of Beirut.