Francisco Quintana In the current context of global economic deceleration and high instability, how will the countries of the Gulf Cooperation Council (GCC) fare in the coming months? The European Union is years away from a recovery. The United States faces a political dead end that might spark a massive reduction in spending, further hampering its low growth. The reconstruction process that led Japan's growth in 2012 is coming to an end. Emerging Asia kept the global economy and oil prices at sustained levels during the crisis, but is now showing signs of slacking growth. In the first half of 2012 China's growth eased from 9.2 to 7.6 percent, its lowest growth rate in three years. The rest of Asia is following a similar trend. Is it possible for GCC countries to thrive in this context? The short answer is: yes. At least for the next six months. Long-term growth in the GCC is far from granted, but, in the coming months only two factors can seriously prevent the GCC countries from doing well and both of them are improbable. The first would be a major collapse in oil revenues (that could happen with high oil prices: a closure of the Strait of Hormuz by Iran would make prices soar but GCC countries, unable to get their oil out of the region, would not benefit from it) and, second, a surge in the level of social unrest inside the region. While both events could take place independently, they are in fact strongly linked. Why will oil revenues remain high? Oil is a commodity particularly sensitive to changes in the political and economic landscape. Economic fundamentals suggest that prices should come down. Global supply is expanding, pushing prices down. Libya is almost back to its pre-war level of production of 1.8 million barrels. Iraq is rapidly expanding production; it is estimated to have overtaken Kuwait's 2.8 million and Iran's 3 million barrels per day this summer. More importantly, economic deceleration will eventually reduce demand for oil, bringing its price down. But these price pressures will probably be more than offset by opposite forces. In terms of supply, Iraqi exports are subject to volatility due to sabotages in their pipelines in Turkey, poor infrastructure and internal disputes among its authorities. In addition, the embargo on Iran is reducing its exports rapidly, decreasing from 2.7 million of barrels a day one year ago to 1 million now. In terms of demand, during the last three months of the year policy actions in Europe, the US and China will inject additional liquidity that will provide a floor to, or even increase, the price of oil. However, if prices still decrease below the regional breakeven price, OPEC can cut production to boost prices back near the $100 level. Only a conflict between Israel and Iran could put the flow of oil revenues for the Gulf countries in danger. Such a conflict, although possible, is not the base case scenario. In summary: expect high prices. The steady inflow of oil revenues, will allow GCC countries to extend the ongoing policy of buying social peace via rapid increases in current expenditure. Kuwait saw a 25 percent across-the-board salary increase in 2012 in the public sector, which employs 90 percent of the Kuwaiti workforce. Fuel subsidies alone account for 7 percent of the gross domestic product (GDP). Saudi increased total spending by 25 percent in 2011 and all other countries in the GCC did similarly. This trend is boosting consumption, a key driver of GDP, while the rest of the world suffers sluggish credit and retail sales growth. The bad news for the region is that a) this trend can't be sustained in the long term. Kuwait is expected to start running a deficit by 2017 according to the IMF. A sizeable reduction in oil revenues could still be handled by using their reserves of foreign currency, but it would bring orward the fiscal deficit problem by a few years, b) in the event of fiscal constraints, it is far more difficult to eliminate salary entitlements and subsidies than any other type of expenditure, and c) the rapid increase in current expenditure (wages and subsidies) is not compatible with a much needed large level of investment in infrastructures, which would increase the long-term competitiveness of the region. The problems that are being solved now will eventually reappear, and probably on a larger scale. In this sense, policy in the region is not that different from the “kick the can down the road” approach that has characterized Europe for the last few years. – The author is an economist at KuwaitChina Investment Company
