Make hay while the sun shines
So it is with economic reform in GCC states: Better do it now while we have options, before it becomes necessary, painful and costly in the future.
Pessimism dominated the latest International Monetary Fund’s reports on the region, mainly because of sharp oil price drop. Pessimism and modern economics have been nearly inseparable since the “dismal science” was founded nearly three centuries ago. But panic is antithetical to wise economic decision-making, because panic could lead to hasty and unwise actions.
To consider matters wisely, let us start with the good news: GCC economies are in no danger of collapsing. Many countries would happily trade their economic woes with ours. Take Saudi Arabia, for example, which sits atop one quarter of the world’s proven oil reserves, as well as considerable reserves of gas and minerals.
Financially, Saudi Arabia owns some $700 billion in foreign reserves. Internally, the government owns over one half of the shares of companies listed in the Saudi stock market. It also owns large unlisted companies, such as Aramco, valued at over $5 trillion, probably the most valuable company in the world.
Saudi government debt, at less than 2 percent of GDP, is extremely low, as 60 percent of GDP is considered safe in normal times. During recent difficult times, we have seen debt exceeding 100 percent of GDP in many countries. Among industrialized economies, according to the Organization of Economic Cooperation and Development (OECD), debt to GDP ratios have exceeded 100 percent in the US, Belgium, Canada, France, Britain, not to mention Iceland, Ireland, Italy, Portugal and Greece (167 percent). In Japan, it exceeded 200 percent of GDP.
In sum, Saudi Arabia sits comfortably on a large cushion of financial, investment and natural resources. There is no risk in the near future that its ability to finance development programs would change, even if it has to borrow or issue bonds.
The bad news is the oil price collapse is pushing the annual budgets of GCC states into big deficits, estimated to reach or exceed 13 percent of GDP by the end of 2015. Balance of payments, which was in surplus to the tune of 15 percent of GDP in 2014, will turn into slight deficit in 2015.
In addition to the oil price drop, regional military conflicts also sap economic health. The IMF expects the nonoil sector growth to dip to four percent in 2015 and 2016 in the region, compared to six percent in 2014.
For these reasons, the IMF suggests reducing government employment levels, raising taxes and bringing energy prices locally in line with international levels.
It also suggests greater reliance on private sector growth, with support for businesses, increased incentives for nationals to work there, as well education and training reforms.
These are the usual prescriptions IMF dispenses in normal circumstances, and usually they can be dismissed easily as one-size-fit-all generic advice.
Everyone agrees that government spending, for one, should be designed with an eye for fiscal sustainability in the near term and intergenerational fairness in the long term.
Since oil prices are expected to stay low in the near future, spending priorities will have to be revisited. Some reforms may have negative impact on the average citizen’s welfare, but they do not have to be.
Spending priorities have to be revisited, but it would be difficult to reduce spending on defense while the country is at war, or on people’s basic needs such as health, security, education and job training. But levels of growth of government employment should be put under control, especially in government departments where the need is less urgent.
Private sector support should be increased, instead of reduced, as well as incentives for nationals to join the private sector.
As for fuel prices, they can be managed without affecting the people with limited means. By combining fuel price rises with increases in welfare payments and salaries for low-level employees, in the public and private sectors, the government would be able to cut waste, improve its finances, increase fuel efficiency and improve air quality, without affecting the income of average wage-earners.
Tax reform is long overdue, as IMF advises. However, to maintain equity, a value-added tax (VAT) regime could be introduced in a package that includes excises on luxury and harmful goods, while doing away with a lot of regressive nuisance taxes and levies that overburden poor families.
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