I am writing from Washington, where the International Monetary Fund has recently released a report on future fiscal risks facing GCC countries. Although the report (Economic Prospects and Policy Challenges for the GCC countries) is highly speculative, it has garnered a lot of media attention nevertheless. Doomsday scenarios are always popular, especially when they are about countries that are perceived as smug and self-satisfied about their past economic performances and future prospects.
Despite its obvious shortcomings, the IMF report warrants a careful look. Its conclusions, in particular, are worth contemplating, not solely because the report was issued under the imprimatur of IMF, and as such carries with it the faith and authority of that institution. We should carefully reflect on IMF warnings, even when they are based on worst-case scenarios.
The IMF report concedes that the GCC economies have been enjoying high growth, fueled by “high oil prices, expanded oil production, expansionary fiscal policies, and low interest rates.” It also points out that “fiscal and external surpluses are large, inflation is moderate, and prospects for growth remain positive.”
These “symptoms” have made them the envy of the world. What is the problem then? According to the IMF, GCC “economies remain dependent on hydrocarbon extraction and rising government spending has raised breakeven oil prices, implying heightened vulnerabilities.”
The IMF believes that abundant oil income has encouraged increased government spending, based on unrealistic assumptions about future oil prices. This optimism has also made GCC economies more dependent on oil than they should be given the uncertainties in oil prices.
Although risks to the GCC stemming from exposure to anemic European economies are limited, the IMF sees possible substantial effects of the global slowdown, which would reduce oil demand and consequently lower prices. As such, it concludes that “rapid deterioration in the global economy could bring about developments similar to what the region experienced in 2009, including a sharp fall in oil prices and disruptions to capital flows.”
The IMF is not oblivious to the fact the GCC countries were able to recover from the 2009 crisis and that its fiscal and external surpluses have remained large. It notes that GCC’s fiscal surpluses have reached about 13 percent of GDP in 2011 and external current account about 24 percent of GDP! It also concedes that both balances are expected to remain stable in 2012.
But the IMF dismisses the fact that most GCC countries have sufficient savings to cushion even a sizeable shock due to a fall in oil prices.
Why the pessimism, you may ask?
There are two main reasons for this pessimistic assessment. First, the IMF is alarmed that a 20 percent increase in GCC public spending during 2011, especially in Saudi Arabia. The spending jump in 2011 was due to larger wage bills, new benefits for jobseekers, and new capital expenditure. It is concerned that such jumps in spending may continue, based on optimistic oil price forecasts.
Second, the IMF expects oil revenues to decline due to lower prices and lower demand for oil. It expects oil production to fall slightly in 2013. Moreover, based on futures prices and its latest projection in the World Economic Outlook, it expects crude prices to decline gradually over the medium term, falling below $ 100 per barrel in 2015. Accordingly, if government spending keeps going up, it projects fiscal and external surpluses to decline in 2013 and beyond, with the combined GCC fiscal surplus turning to deficit around 2017.
This last bit of speculation is what got the media buzzing over the past week.
The IMF advice is to reduce spending, to improve long-term fiscal positions. Its recipe to do that is five-fold:
• Contain (i.e., stop) increases in spending on entitlements that are hard to reverse.
• Prioritize (i.e., reduce) investments in infrastructure.
• Strengthen fiscal frameworks and institutions.
• Bolster the financial sector, e.g., through enhancing supervision and deepening domestic debt markets.
•Increase private sector job creation for nationals.
There is no doubt that some of these suggestions are worthwhile. We may disagree with the first suggestion, because increased spending is necessary to reform education and improve skills of GCC nationals. Most would also disagree with IMF suggestion that investment in infrastructure should be reduced, because improved infrastructure (roads, trains, airports … etc) is necessary for investment and improving standards of living at the same time.
It is surprising that the IMF has overlooked two areas where a lot of work could be done to achieve the same results without limiting growth. One is domestic fuel prices. If they were appropriately raised, fiscal balances would improve beyond any of IMF suggestions, even if oil prices were to fall drastically worldwide.
The second is workers’ remittances, which act as an ever-increasing strain on external balances. Finding appropriate investment vehicles for those remittances within the GCC would benefit foreign workers, provide additional capital for investment, and improve balance of payments all at the same time.
In sum, while the IMF reflects genuine concern for GCC future fiscal and external balances, it appears based on farfetched assumptions about future oil prices. More seriously, its prescriptions are at odds with the actual needs of GCC economies, and the real concerns of its citizens.
(This article appeared on the Saudi-based Arab News on Nov. 4, 2012.)