Low oil prices prompt talk of reform

The fall in crude prices could lead to a rethink about government spending priorities in the Gulf. Published in MEED, 24 December 2014

he fall in oil prices in the second half of 2014 has tested the assumptions of many Middle East governments. In early December, the price of a barrel of Brent crude dropped below $70 for the first time since May 2010. Oil prices have been well above $100 a barrel for most of the past four years and the rapid fall marks a potentially very significant moment for the region’s economies.

Many observers now expect prices to stay at these lower levels. Saudi bank Jadwa Investment says prices are likely to be about $85 a barrel in 2015 and $83 a barrel in 2016. Another Saudi bank, Samba, is predicting that prices will hold in a range of $70-$90 a barrel for the next three to five years. Should these predictions play out, it means the region’s big oil exporters will have to face up to a substantial drop in revenues.

Government budgets have become bloated by rises in public sector salaries and inflated levels of spending on welfare, subsidies and infrastructure investment in recent years. Turning that around may prove painful.

As it stands at the moment, countries in the Gulf and in parts of North Africa such as Algeria have seen a steady rise in their breakeven oil prices – the level at which government spending and revenues are balanced. According to the Washington-based Institute of International Finance, the breakeven price will be above $100 a barrel for seven of the region’s big oil exporters in the coming year. The only countries that will be able to report a budget surplus when prices are as low as $70 a barrel are Kuwait and Qatar.

There is no need for concern among policymakers just yet, as there are substantial pots of money in sovereign wealth funds and the authorities can, of course, take other action such as selling bonds to cover any shortfall. Even so, it looks like many governments will have to review their spending and perhaps even look for cutbacks. Given the dominant role of the state in these economies, this could in time lead to a slowdown in some countries such as Saudi Arabia, according to London-based research group Capital Economics.

Washington’s IMF has been urging the region’s oil exporters to adopt a more sustainable fiscal strategy. In a speech in Kuwait on 25 October, Christine Lagarde, the IMF’s managing director, pointed out some of the reforms that were needed among Gulf governments. “Oil prices have fallen by about 25 per cent since the summer, and this will affect fiscal and external balances in the region,” she said. “While the substantial fiscal buffers that have been built up in most countries over the past decade will allow governments to maintain spending plans in the near-term, in almost all GCC countries it increases the urgency for fiscal consolidation in the medium term.”

Economic incentives

Lagarde outlined changes that Gulf countries could pursue, including getting more locals into private sector jobs and increasing economic diversification. “Many policies are being implemented to achieve these objectives, and important progress is being made,” she said. “Nevertheless, getting the economic incentives right so as to encourage workers to seek employment in the private sector and firms to produce in export-oriented sectors is a key missing element of policies to date.”

The problem these governments face is that, for all the investments made during the recent oil boom, the structures of their economies have not really changed. They may be able to boast world-class airports and ports, growing stock markets and cities full of impressive skyscrapers, but their dependency on oil and gas revenues remains extremely high.

“While we see progress in economic diversification in some countries, perhaps most notably in Saudi Arabia, overall the successes are not sufficient to outweigh the structural challenges that need to be tackled,” said Moritz Kraemer, sovereign credit analyst at US ratings agency Standard & Poor’s, in a report on the GCC economies published on 10 November.

In other parts of the region, the fall in the price of oil is more welcome. Energy importers such as Jordan have found the recent high oil price environment tough to cope with and the stress on public finances in these countries should be eased over the coming year. The lower oil prices are also coming at a time when political stability appears to be returning to some of these countries, including Egypt and Tunisia, which should also help their economic fortunes.

However, there is also a need for reforms in these countries to improve their long-term health. As the Arab uprisings highlighted, the opportunities for the millions of young Arabs streaming out of schools and universities and into the jobs market every year are often underwhelming, and governments need to do more to address this issue.

In Tunisia, the situation is at a potential turning point. The country is the last remaining hope that the Arab uprisings might lead to the creation of a healthy, mature democracy, but much hinges on the policies that the next government will follow. Elections in late September saw the secular Nidaa Tounes party gain the largest share of seats in parliament, although not enough for an absolute majority. There is cautious optimism that it will be able to make some of the difficult decisions that will be needed in the coming years.

“The victory for Nidaa Tounes in Tunisia’s parliamentary election is likely to raise hopes that economic reforms are in the pipeline,” said Jason Tuvey, Middle East economist at Capital Economics, in a research note published on 27 October. “Perhaps more importantly, the fact that the election passed smoothly and that there is a growing consensus among politicians in all of the major parties to push through difficult policies to reduce the economy’s vulnerabilities and raise investment means that the country’s longer-term growth prospects are brightening.”

Morocco reforms

Further west, in Morocco, the government has already cut subsidies quite substantially and the economy has proved relatively resilient in the face of weak conditions in its key export markets of the EU. In a bid to diversify its range of partners, the government has been trying to expand economic ties to countries in sub-Saharan Africa. It has also been bringing in reforms to its stock market and the rest of the finance sector in an effort to attract more interest from investors. Capital Economics predicts that strong growth in the country’s manufacturing sector should make it the best-performing economy in North Africa in the coming years.

The countries of the Levant face more difficult conditions given the war in Syria and the impact it is having on neighbouring Lebanon and Jordan, not least in terms of the millions of refugees that now have to be accommodated in those states.

“We have effectively 1.5 million refugees for a population of 4 million in Lebanon,” Alain Bifani, director-general of Lebanon’s Ministry of Finance, told a press briefing at the IMF World Bank annual meetings in Washington on 9 October.

Syria’s war has also spilled over into Iraq, as the country continues to struggle with its own domestic problems. The economy is estimated to have contracted by 2.7 per cent in 2014. According to the IMF’s forecasts, it will grow by 1.5 per cent in the coming year, but further political problems could easily throw that prediction off course.

Until recently, it looked like there had been the potential for a positive development in one corner of the region. However, the long-running talks between Iran and the group of six international powers led by the US over Tehran’s nuclear programme once again failed to provide a breakthrough by the deadline of 24 November.

All sides have agreed to keep talking and have set a new deadline of 30 June 2015. If a deal can be struck, it will open the way for the layers of sanctions that have been imposed on Tehran to be lifted and for the Iranian economy to rejoin the global market. That would not only be transformative for Iran, but it could also bring a welcome boost for some of Tehran’s key regional trading partners, notably the UAE. In the meantime, the lower oil prices will hurt the Iranians as much as anyone.

Regional outlook

For all the bad news in the region, the overall picture for the economy of the Middle East and North Africa (Mena) region is relatively promising compared with many other parts of the world. The most recent forecasts from the IMF suggest that the GDP of the Mena region will grow by 3.8 per cent in 2015. That is appreciably faster than the 2.3 per cent seen in 2013 or the 2.6 per cent in 2014, and in line with global growth rates next year. It is also well ahead of other parts of the world, including the advanced economies of North America, Europe and the Pacific Rim, as well as Latin America and the Caribbean.

Other areas of the world are growing much faster, such as the emerging economies of Asia, but there are some potential benefits for the Middle East if it can tap into demand in those markets. “Rapid growth in the Asia-Pacific [region] will support the Middle East’s expanding role as the world’s most competitive petrochemicals hub, underpinning long-term growth in Middle East chemicals exports to emerging Asian markets,” says Rajiv Biswas, Asia-Pacific chief economist at US-based research group IHS Economics.

On a country-by-country basis, GDP growth is expected to improve in 14 out of 18 countries in the region, with Mauritania and Oman staying the same and only Bahrain and Saudi Arabia seeing the figure slip back. Even so, the individual growth rates will not be enough to make a significant dent in long-term problems such as high levels of youth unemployment. For that to happen, more reforms and far greater economic diversification are needed.