For many years those of us who study the countries that form the Gulf Cooperation Council – Saudi Arabia, the UAE, Qatar, Kuwait, Oman and Bahrain – have grown accustomed to using and hearing one term more than any other: diversification. But what has also been just as common has been the frustration at the pace of the process.
The simple fact is that due their bountiful natural resources the GCC countries have many of the symptoms of what is known as Dutch Disease, the theory that economies which have a dominant export experience significant development in that area, but underdevelopment in others.
The IMF, World Bank and OBG have long been advocates of economic reform that will enable an environment where other economic sectors can grow and contribute to state revenues. This is, of course, easier said than done. Every state in the region has a diversification strategy, and they have been implemented with varying degrees of success. All of these require the private sector to play a greater role, too.
However, when hydrocarbons prices were high enough for budgets to show surpluses, it was difficult to generate much urgency to drive through the sometimes painful reforms necessary. Furthermore, the social contract that exists between state and citizen in the Gulf makes change even harder. In many cases the states’ largesse in every sense has meant that the private sector remains relatively underdeveloped.
But now that oil prices have entered what some have referred to as the “new normal”, i.e. a much lower band, diversification and economic reform have taken on a whole new urgency.
How is this change manifesting itself?
1 – Subsidy Reductions
Generous government subsidies have long been hallmarks of the Gulf. However, they have never been sustainable in the long term. They also have the capacity to create dependency, too, which is always a concern. Over the past 18 months each and every state has set about reducing the scale of subsidies, both to households in the form of utilities and food, and also those to industry.
This has inevitably had an impact on households and industry alike, squeezing expendable income and margins in equal measure. However, at the time changes were made, for example in the UAE with fuel prices, which are now set monthly, many of the fears expressed, for example, that it would lead to significant inflationary pressure, have not materialized.
2 – VAT
The decision to implement a value-added tax was taken at the regional level by the GCC. It will see the imposition of a 5% levy on most goods, consumables and services. It is the first time such as tax has been introduced in the GCC and is a significant development.
Certain items will likely be exempt from the tax – basic food and health supplies, for example. Businesses that sell VAT-liable products or services add on the percentage and then, as a VAT-registered businesses, file a VAT return to the relevant authority.
But what does this mean in practice? Well, as well as being a boon for the financial services and IT systems companies who will be well placed to advise on the implementation of VAT systems and reporting structures, the real beneficiary in the long term will be the governments’ coffers. Raising revenue via VAT is in many senses is a reflection of a maturing economy. It can be varied as a fiscal tool, too, so that in good times it can be raised and in periods of financial stress, lowered as a stimulus.
A more subtle benefit that VAT brings, though, is another layer of transparency, as VAT registration and filing will enable greater scrutiny and analysis of how the markets work. In a region that has seen major steps forward in this regard, this is another welcome development.
3 – Public vs Private
One of the most frustrated elements of the GCC’s economic reform strategies has been the development of autonomous private sector growth. Now, as the governments of the region look to accelerate reform, the private sector is being looked to with renewed enthusiasm. The trouble is that in some places they have felt the squeeze to such a degree from austerity measures and the dramatic reduction in government spending, that sentiment is at low ebb and they are struggling to find growth opportunities.
This is, of course, perhaps an inevitable side effect of the necessary changes being made – the subsidy reductions, for example. Either way it looks as though it will be some time before the impact has worked itself through. A businessman I spoke with in Saudi Arabia recently spoke plainly that if the government cuts too hard as the dominant engine of growth, the private sector, in many senses a fledgling in comparison, could find itself without the momentum to succeed.
On the other hand, another businessman said that while current conditions were definitely difficult, they also form an environment where entrepreneurship will flare sooner or later, quite simply out of necessity. There’s no doubt truth in both.
There is really no easy, straightforward path to the economic reforms the GCC countries require. However, the signs are positive in that these changes, which have been talked about for years, are finally happening. To be sure, they’re not comfortable, but we must take notice that the governments over the past 18 months have taken measures that even in the preceding year were unthinkable.
Change is always difficult but economic reform taking place in the Gulf shows it is more likely to happen when necessary than suggested.