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War, not oil prices, challenge the Gulf

Last Tuesday the Middle East Policy Council held their 85^th Capitol Hill Conference on “Economic Reform and Political Risk in the Gulf Cooperation Council (GCC).” Speakers were Aasim M. Husain, IMF deputy director of the Middle East and Central Asia; Ford M. Fraker, president of the Middle East Policy Center and former US ambassador to Saudi Arabia; Edward Burton, CEO and president of the US-Saudi Arabian Business Council; and Karen E. Young, senior resident scholar at the Arab Gulf States Institute. Richard Schmierer moderated.

Husain presented data on how different countries of the GCC are adapting to cheaper oil. Prior to the dramatic decline in oil prices in mid-2014, Gulf governments had been raising their spending by expanding energy subsidies, increasing government payrolls, and raising wages. Non-oil sectors were growing at an average of 7 percent throughout the GCC. When oil prices suddenly dropped from $110/barrel to $40/barrel in mid-2014, a GCC average 10% budgetary surplus turned into a 9% deficit overnight. Spending, which had been increasing by an average of 8-10% since 2011, is expected to contract by over 10% in coming years.

Most Gulf states are cutting back their capital spending by starting fewer new projects and slowing and canceling current ones. Many are raising subsidized energy prices—ending the longstanding policy in some countries of providing essentially free energy to their citizens. Some GCC members are also considering a value added tax. Even with these reforms, in the next five years we can continue to expect deficits of 7-10% of GDP. It’s a grim picture, even before you consider how cuts in spending will impact economic growth.

Over the next five years, 2 million youth will enter the workforce across the GCC. Husain predicts that 2/3 of those will find jobs. That optimistic figure relies on the necessity of non-oil sector growth in next five years generating more jobs than in the past.

Fraker emphasized just how dramatic recent changes in Saudi policy have been. He identified the main goals of Vision 2030—diversifying the Saudi economy and eliminating government inefficiency—and added that the biggest change brought about in the months since Salman bin Abdulaziz Al Saud’s assumption of the throne has not been any particular economic policy, but rather an “unprecedented” opening of Saudi government.

Decision-making had always happened behind closed doors without transparency or outside input. The rise to prominence of the Deputy Crown Prince Mohammad bin Salman changed that. He has opened government, for example by putting all government ministers on stage for unprecedented public questioning. Fraker wants the US to welcome these changes. Washington has a strategic interest in a stable Saudi Arabia and should therefore support its allies politically and economically.

Burton elaborated on business opportunities for American investors. Saudi Arabia is the third biggest spender on military equipment in the world.  Mohammed bin Salman’s goal to divert 50% of Saudi military spending to domestic contractors would create major opportunities for job-rich growth. Burton also foresees healthcare as a potential growth sector. Saudi Arabia suffers from high rates of obesity, diabetes, and other health challenges. The Kingdom is the Middle East’s largest information and communications technologies market,  particularly with its growing youth population.

Young analyzed GCC strategies and policies to make ends meet. Across the region, there has been a dramatic rise in bond issues. In the short term, there is no problem. Gulf countries are not heavily indebted and currently have access to the capital they need. Continued reliance on credit for the next five years could get dicey. This oil crisis is different from the 1970s crises. Over the course of the 2003-2014 oil boom, the Gulf invested in building lasting institutions, which enabled Kuwait and the UAE to adapt to the drop in oil price. The GCC is also much more integrated into the MENA region than it was previously. Egypt and Lebanon are dependent on Gulf foreign direct investment. Jordan and Morocco rely on foreign aid from the GCC to balance their budgets.

All the panelists managed to neglect the economic and political ramifications of GCC involvement in two regional conflicts. Husain talked about massive cuts in capital and social spending to ease the sting of deficits, but ignored the continued climb in Saudi defense spending since 2011, starting with Saudi involvement in funding and training opposition fighters in Syria.

Saudi Arabia will be running up against its biggest planned budget deficit in 2016, despite the slight uptick in oil prices and domestic fiscal reforms. GCC members are heavily involved in proxy wars in Syria and Yemen, so military spending is continuing to rise at an alarming rate. In 2016, Saudi Arabia surpassed Russia as the third biggest military spender, spending $87.2 billion. Qatar and the UAE have also increased their military spending while drastically cutting other spending.