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Saudi Arabia’s efforts toward diversification cushion oil price drop

Saudi Arabia's government spending has intensified the need for longer term fiscal, environmental and resource sustainability in the Kingdom

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Although Saudi Arabia has substantial financial reserves to withstand low oil prices over the next few years, recent government spending has intensified the need for longer term fiscal, environmental and resource sustainability in the Kingdom, according to a new report commissioned by ICAEW titled “Economic Insight: Middle East Q2 2015” produced by Cebr, ICAEW’s partner and economic forecaster.

Lower oil prices will have a greater impact on Saudi Arabia’s economic growth over the medium rather than the short term.

As a result of the government’s decision to allocate additional funding to social activities like education, the breakeven crude oil price has surged from just under $75 in 2009 to $90 in 2015.

While the Finance Ministry plans to address this by curbing public sector salaries and allowances, which comprise roughly half of the budget, a longer- term strategy for generating growth among non-oil sectors is now crucial for the Kingdom.

Fortunately, Saudi Arabia has been investing significantly for many years in education, agriculture, and banking and finance to limit its oil dependence.

Recently, the Kingdom announced that from mid-June 2015 foreigners will have direct access to its stock market.

The opening of the $570 billion-plus bourse is a substantial leap forward for regional equity markets and is likely to draw a number of investors that see potential in the Kingdom’s proliferation of longstanding companies and the growing, increasingly affluent, population.

GCC economies could take advantage of lower oil prices to justify fuel subsidy reductions since diminishing government revenue will create a more pressing need to limit spending.

Also, if fuel subsidies are removed during a period of subdued oil prices, the inflationary impact will be felt less sharply by the population.

Scott Corfe, ICAEW Economic Adviser and Associate Director at Cebr, said: “There is no doubt Saudi Arabia is on the right path for diversifying its economy, but with lower oil prices here to stay, more action needs to be taken to safeguard the Kingdom’s financial reserves over the medium term.”

It is not just fiscal sustainability that will be a priority for Saudi Arabia over the coming years; environmental sustainability is also crucial.

GCC countries currently have some of the highest rates of carbon dioxide emissions in the world. While government-backed initiatives to promote environmentally-friendly business practices are being implemented, these alone will not sufficiently lower per capita CO2 emissions.

The report outlined the need for the business community to self-regulate – and for action to be taken at industry level to help curb the GCC’s carbon footprint.

It also highlighted the role of the accountancy profession in helping modify business’ behavior by setting benchmarks.

It noted that governments or environmental ministries in the region can then use this approach to rank companies within a particular industry in terms of their carbon footprint, which in turn could encourage underperformers to re-evaluate their operations without actually imposing regulations.

Resource sustainability is another important consideration for the sustainability of economic activity in the region.

With population growth in the GCC region expected to expand at a rate above the world average, coupled by rapid urbanization, many countries will struggle to meet water demands.

Since the GCC countries place substantial pressure upon their internal water resources for domestic and industrial use, in the interests of long-term, sustainability, there is an urgent need for a region-wide water management strategy.

Michael Armstrong, FCA and ICAEW Regional Director for the Middle East, Africa and South Asia (MEASA), said: "The great fall in the global oil price need not reduce the impetus to use energy efficiently.

Many of the GCC countries are now recognizing the urgency of the situation to secure their future development.

This includes Saudi Arabia which is aiming to save a fifth of its energy use by 2030 through an efficiency drive designed to prevent domestic consumption from eating up oil for export.”

The report also showed that UAE’s GDP growth in 2015 should reach 3.9% thanks in part to its diversifying strategy.

In the last couple of years, the country has also invested greatly in setting up satellite campuses of world-renowned educational institutions such as New York University (NYU).

This will not only draw international, tuition fee-paying students to the country but it should also boost the local labor force by giving Emirati populations access to world-class education.

Besides, the report said despite a slight boost after hosting the Formula One Grand Prix in April, Bahrain’s economic growth in 2015 as a whole is expected to slow to 2.7%, down from 4.0% last year.

Given that 90% of government revenues come from oil and gas, the country will be severely impacted by the drop in oil prices.

However, infrastructure spending should prove to be a source of growth in the short term. Furthermore, Qatar’s GDP is expected to grow 7.1% over 2015 as the country is less dependent on its hydrocarbons resources than many of its fellow GCC members.

The continued investment in ambitious projects such as Education City as well as less stringent restrictions on foreign firm ownership will support growth also.

For Kuwait, the report said despite the countyr’s comparatively low fiscal break-even oil price, the country’s economy grew by just 1.4% in 2014.

In 2015, the country’s GDP is expected to grow to 1.8%, fuelled by a sustained level of spending on job creation and youth development.

In addition to this, the Capital Markets Authority’s plans to further align the regulations of the Kuwaiti stock exchange with international norms are expected to improve the country’s investment environment.

Oman’s economy, on the contrary, is expected to expand by 3.5% in 2015. Helping economic growth will be infrastructure investment into ports, roads, and railways.

Assuming a deal with Iran is reached this year, the country also stands to gain from welcoming an international expansion of Iranian businesses.