Wednesday,18 October, 2017
Current issue | Issue 1271, (19-25 November 2015)
Wednesday,18 October, 2017
Issue 1271, (19-25 November 2015)

Ahram Weekly

GCC: Reform needed

With world oil prices at record lows, fiscal and monetary reform in the oil-rich Gulf economies is now more urgent than ever, writes Niveen Wahish

Oil-rich Gulf economies
Oil-rich Gulf economies
Al-Ahram Weekly

Citizens of the oil-rich Gulf countries hardly pay any taxes, receive subsidised fuel, free basic services and are guaranteed a job in the public sector. But economists believe these policies are now unsustainable, especially with world oil prices hitting record lows.

“Sticky” is how Adeel Malik, an economist at Oxford University in the UK, described these commitments, made by governments during better times, before fiscal deficits became common.

“They are now drawing on their reserves to cover the deficits,” Malik said. Oil is trading near a six-year low, with crude oil for December delivery falling to $40.74 a barrel on the New York Mercantile Exchange on Friday, according to Reuters.

Malik was addressing a conference held in Kuwait, titled “Monetary and Fiscal Institutions in Resource-Rich Arab Economies.” The conference was organised by the Economic Research Forum (ERF), a regional research network, in cooperation with the Arab Fund for Economic and Social Development.

According to the ERF, the oil-rich Arab countries account for close to half of global oil reserves and a quarter of natural gas reserves, yet they have neither achieved economic prosperity nor approached the ranks of the developed nations.

Malik sees the low oil prices as an opportunity to change that. Just like individuals who are able to reform in bad times, when oil prices are low, countries can start considering urgent institutional reforms.

“All across the Gulf Cooperation Council (GCC), there is talk about reforming subsidies on items such as food and fuel. These discussions are not common in periods of high oil prices,” he told Al-Ahram Weekly.

There could be an opportunity for political reform as well. Transitions from military rule and one-party states can be traced to when oil prices have fallen in countries such as Mexico and Indonesia, according to Michael Ross, a professor of political science at the University of California.

However, Ross said there is no precedent for oil exporters who have reserves above a certain level. Oil tends to reduce a state’s accountability to its citizens because the state does not collect taxes and thus is not answerable to citizens, Ross said.

Accountability is an area that also needs reform, Shantayanan Devarajan, chief economist of the World Bank’s Middle East and North Africa Region department, told the conference. He explained that with oil revenues going straight from the oil-producing companies to the governments concerned, this has resulted in the people not knowing the exact size of such revenues.

This could lead citizens to believe that the government is making more than it is disclosing, he added. “Building credibility on the revenue side may make fiscal reform easier,” he said. The lack of accountability may also result in people feeling that this money is not theirs, which may keep them from scrutinising the government.

It is natural that people do not like subsidies to be taken from them, according to Malik, but governments do not have any alternative but to begin such a discussion. He said that some regimes will go for easy options, like drawing on reserves, or they will issue debt. “This is a politically cheap instrument to get some liquidity into the system,” he said.

But institutional reform will not happen overnight. It is a painful process, explained Malik, adding that it requires a two-way dialogue between citizens and the state. In the Arab world there is no culture of bargaining between different actors of society, he said. “Yet these are important ways for societies to adjust, by bargaining and sorting out their differences.”

Different speakers spoke about the mismanagement of oil revenues by resource-rich Arab economies. Jeffrey Nugent, an economist with the University of Southern California, said that these countries have achieved little progress in raising non-oil revenues and have failed to convert oil resources into physical and human capital.

“Even investment expenditure is inefficiently allocated to white elephants,” he said.

The World Bank’s Devarajan said he wants this to change in preparation for the post-oil era, even though that could be many years away. He spoke of a different type of diversification in the GCC countries.

“Think not in terms of industries but people. Invest in human capital so that in 20 years they know which industries to operate,” he said.

Kamiar Mohaddes, a senior lecturer at the University of Cambridge in the UK, told the conference that oil abundance is not bad in itself, but high oil-price volatility is a bad thing. What is important is to insulate the economy from these resources, he said.

The undesirable consequences of oil-revenue volatility could be avoided if resource-rich countries were able to improve the management of volatility in resource income by setting up forward-looking institutions with the aim of saving when commodity prices are high and spending accumulated revenues when prices are low, he said.

He and many other speakers drew attention to Norway’s experience as a successful manager of oil resources. “It might be possible within a democratic system with good institutions and an accountable government to avoid some of the undesirable consequences of oil-revenue volatility,” he said.

The Norwegian government pension fund, which aims to manage petroleum revenues in the long term, is an example of how a stabilisation and sovereign wealth fund could help offset not only the volatility of oil revenues, but also help smooth out government expenditures, he said.

But Norway discovered its oil resources when it had good institutions, pointed out Mahmoud Al-Iriani, an economic advisor to the Dubai Economic Council. “If you have good institutions to start with you will manage resources very well, but it if it is the other way around, there is no way out because interests have already been built,” he said.

Building good institutions is important to avoid the fate of Venezuela where, despite years of high oil revenues, economic performance has been disastrous, Francisco Monaldi, a fellow in Latin American energy policy at Rice University in the US, said.

The country has a budget deficit of about 30 per cent of GDP, a situation that had started even before the recent decline in oil prices, he added.

Monetary institutions should also be an important part of reform. According to Hoda Selim, an economist with the ERF, central banks in the Gulf economies suffer institutional weaknesses related to political autonomy and accountability. Nonetheless, the GCC had had better outcomes because of other factors such as their dollar exchange rate peg, which imported credibility from the US and benefits from a stable US economy, she said.

Another factor had been “the sheer amount of GCC wealth, which translates into massive amounts of reserves accumulation and sustains the peg. Fiscal surpluses do not put pressure on monetary policy and generally insulate from the effects of shocks,” she said.

Selim said that central bank independence will matter when the peg to the dollar is abandoned. Economists believe that it is high time that the GCC economies do this, or peg their currencies to a basket of currencies, to avoid having to follow US monetary policy, which may not suit the growth of their economies.

Whatever the GCC countries decide to do, Davarajan believes that they need to start carrying out reforms to better realise their potential, especially given their advantage of not being in the midst of a financial crisis.

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