IBDE

By Abdullah Baabood, Director, Gulf Research Centre, University of Cambridge, IBDE Advisory Board Member

EXCHANGE: The Magazine for International Business and Diplomacy    No. 3 March 2011  

THE GULF CO-OPERATION COUNCIL (GCC) region, which comprises Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, has undergone rapid economic, demographic and social changes. According to the Economist Intelligence Unit (EIU) report, since 1998, the GCC’s real GDP has expanded by an annual average of 5.2% and by a cumulative total of 65%.

Although the global economy entered in 2011 a state of some uncertainty, the outlook for the GCC economies remains positive. Strong oil prices will sustain robust public spending and buoy confidence. The GCC’s share of the world economy is expected to grow steadily between now and 2020. The pace of growth will be slightly higher than aggregate global growth with an annual average of 4.5% in real terms, compared with 3.3% globally.

Indeed, higher crude prices and output will likely boost the combined nominal GDP of Gulf oil producers to a record high of more than $1.1 trillion in 2011 while their economies could fully recover within two years. Real GDP growth is projected to accelerate to 6 per cent in 2011 from an estimated 4.8 per cent in 2010 as sustained public infrastructure spending, supported by higher oil prices, helps spur faster non-oil growth. The GCC should also benefit from an easing of bank balance sheet strains, and another increase in hydrocarbons production, including oil. The GCC will, therefore, grow in importance as an economic and trading hub and by 2020; the GCC is expected to become a US$2trn economy, exporting nearly 25% of the world’s oil.

Oil and public spending underpins the GCC growth

This sustained growth was mainly driven by expansionary fiscal policies through public spending accompanied by a re-bound in the dominant hydrocarbons sectors following the decline in crude oil output in 2009 when OPEC quotas were slashed. Despite these quotas still being in place (but may change due to the recent events in North Africa and The Middle East), crude oil output in the GCC is estimated to have risen by 2.2 per cent in 2010, while NGL output has jumped by 14 per cent.

This combination of rising hydrocarbons output and stronger prices has led to a rebound in export earnings which have been reflected in higher current account and fiscal surpluses.

Although there are significant differences between the six members of the GCC, all have benefited from high energy prices and experienced a broad-based economic boom in recent years.

GCC oil export earnings rebounded strongly in 2010, driven by higher prices and an increase in production. While imports are also picking up as public sector investment programs are implemented, GCC external balances have improved and will continue to do so in 2011 as oil prices strengthen further. The current account surplus for the GCC as a whole is expected to rise to between $120-$140 billion (around 12 per cent of GDP) in 2010-11. Although still considerably lower than the $200 billion plus surpluses achieved in 2006-08, this will allow for a further build up in external assets boosting confidence and providing additional income revenues.

Record-high oil export receipts have been reflected in large government revenues, current account surpluses, accumulation of foreign assets and an investment boom. Although not on par, growth in the natural gas sector is also gradually picking up as a close second to the Oil sector in most GCC countries. Given its reserves (37% of the world's ‎proven reserves of oil and 23% of those of natural gas) the GCC is expected to be the incremental supplier of oil and gas for the entire world for decades to come.

Capital flows into the region should also remain healthy. Thus although oil output gains may be constrained by OPEC policies, this will be offset by stronger non-oil growth as a revival in private sector credit and investment activity combines with sustained public spending.

Public finances:

After years of strongly expansionary fiscal policies, aimed at mitigating the affects of the global crisis, the rate of increase of government spending is likely to increase even further following the recent dramatic events in the Middle East. Public spending will continue to be driven by long-term spending plans and will remain the key driver of growth in 2011 and beyond. These plans remain affordable in the context of the increased oil prices and large external savings, and GCC public finances will remain reassuringly strong.

The GCC consolidated fiscal balance is now estimated to have recorded a deficit of 3.2 per cent of GDP in 2009, principally reflecting revised data for the consolidated UAE fiscal accounts and the Saudi budget which show deficits of 12.2 and 6.1 per cent of GDP respectively. This reflected the large amount of public spending during the year to support banks and state owned enterprises as well as expansionary fiscal policies.

Overall the GCC fiscal balance is estimated to return to a surplus of 5.4 per cent of GDP in 2010. This is expected to rise further to nearly 7 per cent in 2011 as oil prices strengthen further. A stronger improvement will be precluded by the large multi-year infrastructure and development spending commitments by various GCC states, including Saudi Arabia's $400 billion five-year (2010-14) public investment program, Kuwait's $107 billion development plan, Oman's $78 billion development plan through 2015 and Qatar’s infrastructure developments associated with hosting the 2022 World Cup. This will lead to a further strong revival in nonoil growth.            

The Gulf countries have a vital role to play in stimulating the next cycle of global economic growth, according the World Economic Forum (WEF). Indeed, the Gulf is emerging as a third destination vital for a transformational and sustainable recovery, after China and India.

The recent boom has focused world attention on the GCC economies—not only as exporters of oil and gas, but as investment destinations with major infrastructure projects, booming tourism and financial services sectors. As US economic growth has slowed, GCC investors have begun to diversify their assets more widely, making investments in Asia, Africa and within the Gulf region itself. Industrialising economies in Asia are intensifying their trade links with the Gulf and some of the world’s poorest countries have become increasingly dependent on remittances from the millions of foreign workers transforming the skylines of Gulf cities.

The seizure in global financial markets, the recent fall in the oil price and the economic slowdown in key trading partners are all beginning to have an effect on the GCC economies. Yet over the next decade or more, strong economic growth should be underpinned by the GCC’s integration, demographics and energy advantages and by a range of major investments that are already underway.

The GCC’s geographical location, and its cultivation of diplomatic and trade links with key Asian and African states, suggest that it is in a strong position to benefit from expected growth in the developing world. GCC states are already developing their trade and investment in these regions and seeking to build stronger links with key economies.

GCC Integration and changing patterns of regional links

Having achieved certain measures in economic integration like a customs union in (2003), a common market (2007), a regional central bank (2009) there is likely to be even closer economic and political integration between GCC countries. The GCC is likely to continue gradual efforts at economic integration, including a single currency, and greater harmonisation of legal and regulatory environments. Economic integration will depend on good political relations, but will take precedence over political integration. Development of a common foreign policy or a strengthening of shared security forces remains a longer-term project.

The GCC is a single market, which still enjoys enviable rates of growth and is approaching US$ 1 trillion in terms of GDP, the equivalent of India. The GCC will grow in importance as an economic and trading hub and by 2020, the region is expected to become a US$2trn economy, providing nearly one-quarter of the world’s oil supplies as well as increasing quantities of gas, petrochemicals, metals and plastics. As economic weight gradually shifts southwards and eastwards, emerging markets will become increasingly important trading partners and investment destinations.

Moreover, GCC sovereign wealth funds (SWFs) have built up sizable assets as a result of the recent oil boom reaching $1.6 trillion in 2007. Income from foreign investments and from services exports will therefore become increasingly important to keep the current account in surplus. GCC SWFs play several favourable roles in the region including creating economic stabilization, investing for the long term, and seeking high financial returns. But there are additional steps they can take to further enhance their roles. These include helping transfer knowledge through investments, boosting economic activities by managing government enterprise and supporting strategic projects, fostering regional and international co-operation, and instituting best practices reforms.

Destinations for overseas investment will combine the traditional and the new. Gulf private investors and sovereign wealth funds are likely to diversify their assets into Asia and Africa, and the region is likely to export more of its oil to industrialising countries. The region will continue to fund new investments, especially at this difficult time for the world economy. In due course there will be opportunities for privatization in the region and there is much to learn from the Gulf economies, which should be rightly recognized as a model for cross-border partnership. Over the next decade, the GCC will also develop further as a regional financial hub and a place for intraregional tourism.

Demographic growth

Meanwhile, the population has risen from just over 28m in 1998 to an estimated 39m in 2008.The GCC has one of the fastest-growing populations in the world. By 2020 this population is forecast to increase by one-third, to 53m people. The vast majority will be under 25 years of age. Over the next decade, as the GCC population soars by 30% to over 50m people. This rapid growth and the relative youth of the population present serious challenges as well as major opportunities. The GCC will remain an unusually young part of the world. This should help to make it an attractive investment destination and consumer market—although much will depend on the extent to which the young population can be harnessed as an effective labour force.

This robust population growth, together with the region’s affluence and its abundant natural resources, point to continued strong market demand, which in turn helps to make the GCC countries attractive prospects for foreign investors. At the same time, the region’s long-term economic growth will depend critically on the success of efforts to educate and employ the rapidly expanding young population.

Rapid population growth will remain concentrated in cities. This will put pressure on and create needs for public services, infrastructure and housing in urban centres needing more investments. It will also create a large pool of labour. Ongoing education reforms create further need for education and training co-operation to help solve the mismatches of existing skill sets of local labour.

Investment opportunities

GCC states are expected to continue to invest in essential areas such as healthcare, infrastructure, education and training, to build an attractive business environment for international companies seeking access the growing markets of the Gulf. Such states will act as a single market, where companies can operate easily across borders to access its US$ 1trillion potential. Furthermore, they will continue to diversify, which is essential if they are to enjoy the security and growth afforded by a balanced economy. Finally, while the GCC economies will increasingly reduce their dependence on oil, their strength at the heart of the world’s oil and gas riches should be treated as an opportunity to enable such growth and diversification.