Staying in the black

Gulf governments are becoming increasingly dependent on high oil prices to balance their budgets. Is this sustainable? Published in The Gulf, July 2011

Setting government budgets has proved to be an inexact science in the Gulf. The difference between what governments expect to earn and spend is often at odds with what actually happens.

Over the last decade Saudi Arabia has, on average, spent 21 per cent more each year than it budgeted for, according to Saudi investment bank Jadwa. At the same time, the oil price has been 60 per cent higher than the budget estimate. Other governments have been in a similar position and the trend is likely to accelerate this year as they try to placate restive populations by spending freely at a time of high oil prices.

With the exception of Qatar, all the governments that have released details of their budgets are predicting a deficit this year, albeit on the basis of typically conservative oil price estimates. The question is whether oil prices will remain high enough throughout the year to cover their spending and, if not, what they can do to address the shortfall?

For now, it looks as if most governments will be able to keep any budget deficits in check. Oil has been trading at more than $90 a barrel for most of the year and analysts expect prices to remain high. National Bank of Kuwait, for example, is projecting an average price of $110 this year and the latest oil demand estimates from the International Energy Agency, covering the period to 2016, assume an average oil price of $103 a barrel.

For some finance ministries, however, even those prices will offer only a little room for manoeuvre. Bahrain is expected to need an average oil price of around $100 a barrel this year to break even, according to economists, while its neighbour and protector Saudi Arabia requires $90 a barrel. Others are in more comfortable positions, with Kuwait needing a price of $79 a barrel and both the United Arab Emirates and Oman requiring more than $60. Qatar would break even at just $41 a barrel.

"Oil prices could fall a long way before the Kuwaiti budget falls back into balance or even deficit," says Daniel Kaye, senior economist at the National Bank of Kuwait. "If you look at oil prices of $110-120 per barrel on average this year, you’re looking at another very healthy budget surplus, in the region of KD10 billion ($36.4 billion). By comparison to some of the GCC countries, Kuwait’s fiscal position is strong. The fiscal position of Bahrain and Oman, where the natural resources aren’t as abundant, look the weakest."

The breakeven oil prices are high due to the massive spending commitments that governments have made this year. Most countries are likely to spend more on law enforcement, but they will also be dolling out more food and fuel subsidies, paying public sector employees more and investing in housing and infrastructure – all in an effort to keep their populations placid and their economies moving.

The countries which have done most to boost spending are Saudi Arabia, Kuwait and Bahrain, although it remains unclear whether all the spending plans that have been announced will actually go ahead this year.

Saudi Arabia’s King Abdullah unveiled a SR135 billion ($36 billion) package of measures in February, including higher allowances for public sector staff and increases in student grants. A month later a further package worth SR350 billion was announced, raising the minimum wage for government employees, providing more benefits to the armed services and increasing the amount available in home loans from the Real Estate Development Fund, among other things.

Kuwait announced a $4 billion handout to its citizens in late January, equivalent to about $4,000 per person. As its budget has yet to be approved by parliament, further spending commitments may still be made.

Bahrain, meanwhile, offered BD1,000 ($2,650) to each household in mid February and also increased food subsidies and social welfare allowances. In early June, Manama then stepped up its efforts, revising its budget and pushing up spending for the year from the BD2.57 billion ($6.8 billion) previously envisaged to BD3.12 billion.

Not all have been so spendthrift, however, and some states have even been trying to rein in spending. According to a bond prospectus issued by the Dubai government on 10 June 2011, for example, spending this year will be down 6.4 per cent compared to the 2010 budget.

"There is a kind of dichotomy that has emerged among the GCC countries," says Jarmo Kotilaine, chief economist of Saudi Arabia’s National Commercial Bank. "If you look at the three constituent budgets in the UAE – Abu Dhabi, Dubai and federal – they are cutting back on spending and trying to be more sensible about the way money is spent. You have a similarly restrictive stance in Oman."

Whether they have been free-spending or parsimonious, the high oil price means most governments will be confident that they can balance their books this year. But if oil prices do fall, or spending levels increase, some countries may yet end up with a deficit. For those that do, the easiest options are to either dip into their savings or issue bonds.

"Any deficits that these GCC countries are likely to see can be quite easily financed, either out of reserves that have accumulated over the last decade or through borrowing," says Kaye. "Borrowing conditions for governments in general have improved over the last couple of years. If any GCC government did want to borrow I wouldn’t think conditions would be that onerous."

Some governments, such as Abu Dhabi, might even welcome the opportunity to borrow as it will help to foster the local bond market which they are keen to develop.

Another alternative, for Bahrain and Oman at least, may be to seek further assistance from their GCC neighbours. Already the GCC has pledged $10 billion in aid to each country over the next ten years, although it remains unclear when the money will be given, on what terms, or what it will be spent on.

But even if the deficits can be easily managed this year, there are some longer-term risks. In particular, the current spending sprees make the economies ever more dependent on the public purse rather than the private sector. At a time of planned diversification, that is a problem which all governments, including even Saudi Arabia, will need to address with renewed vigour before long.

"Saudi Arabia is now beginning to face fiscal sustainability considerations," says Kotilaine. "They have a significant cushion in the various government reserve funds and the fact that government debt is now just over 10 per cent of GDP [gross domestic product], so they could take quite a major fiscal hit and they wouldn’t have to worry too much. But there is concern about the government trying to play too great a role in the economy over all these commitments they’ve made.

"What if they don’t turn out to be short-term commitments and they end up creating structure entitlements that become extremely burdensome? Will they be able to pay the bills? Yes. Will they be able to manage the expectations that this is generating? That is trickier."

Bahrain faces an additional difficulty in terms of the damage that this year’s violence has done to its reputation as a politically stable, business hub for the region. It is impossible to know what the long-term effect will be, but there has been some immediate impact, not least in the downgrades by credit ratings agencies.

"These [political] events are likely to have damaged economic growth significantly, especially in services sectors such as tourism, trade and financial services," said Tristan Cooper, head analyst for Middle East sovereigns at Moody’s at the time of its downgrade in May. "The timing and pace of any economic recovery will very much depend on political developments. In any case, the negative effect on consumer and investor confidence will likely linger."

Ultimately, the challenge all GCC governments face as they try to manage their budgets is a familiar one. They need to create sustainable economic growth and diversify their economies while boosting employment levels. The difference this year is that new political and social elements have been added to the financial challenges.

"The enduring legacy of the Arab Spring in the Gulf is that there is a greater expectation of a more inclusive growth paradigm that will pay greater heed to social needs and expectations," says Kotilaine. "The problem is in the past they [governments] have made various handouts pretty indiscriminately. If they want to address the social concerns in a fiscally sustainable fashion they are going to have to learn to become more selective and I don’t think they are too far down that road yet."

For as long as oil prices remain high most governments will probably find it easier to ignore this issue and to continue spending freely. However, if those prices slip then the fiscal and political pressures they face are likely to rise quickly.