February, 8, 2008
Almost every day we read headlines about the Gulf Cooperation Council (GCC) countries, their massive capital injections and investments and the transformation of oil wealth into a new kind of soft power. Although there are significant differences between the six members of the GCC (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and United Arab Emirates), all have benefited from high energy prices and experienced a broad-based economic boom in recent years. Record-high oil export receipts have been reflected in sound government revenues, current account surpluses, large accumulation of foreign assets and an investment boom. The near-term economic outlook is quite favourable. High growth in the region is set to continue over the next few years, driven by high energy prices and growth in non-hydrocarbon sectors. The GCC will also capitalise on increased trade flows between the Gulf, the broader Middle East / North Africa region and Asia. According to a recent McKinsey Global Institute (MGI) study, even with an oil price of USD 50 per barrel the GCC would earn USD 4.7 trillion in oil export revenues up until 2020, equivalent to 2.5 times the earnings over the past 14 years. In addition, the MGI expects the total net foreign assets of the GCC to exceed USD 2 trillion dollars in 2008. With these figures in mind, it is not surprising that investors, regulators and policy makers are taking an ever greater interest in the region.
Changing trends in the region
In the last few years there has been a dramatic change throughout the GCC with respect to development plans, investment strategies and attitudes towards foreign investors. GCC countries are slowly opening up to foreign investors in domestic equity markets and in other selected sectors, as well as easing rules and streamlining procedures for non-GCC firms and launching several new free trade zones. While petrodollars remain the principal source of wealth in the region, investments in infrastructure, industry, real estate and tourism are growing. In the U.A.E., Dubai has become the hot spot for financial services and tourism and Abu Dhabi is on track to become a cultural tourism destination. Both Saudi Arabia and Qatar are leading advances in manufacturing, especially in petrochemicals and metals.
This oil boom looks more structural. Since the beginning of this decade, the GCC countries have adopted investment and development plans different from those seen during the previous oil booms of the 1970s and 1980s. Wary of boom-bust cycles, the GCC countries have built up reserves, paid down their public debt and accumulated surpluses that have been transferred to oil stabilisation funds, sovereign wealth funds (SWF) and other state-controlled investment institutions. Economic management has improved dramatically and asset deployment has become more sophisticated in the region.
Diversification is on the rise. Throughout the GCC there is a shift from the public to the private sector as the main engine of growth. Both the public and the private sector have sought to reduce dependence on hydrocarbons by increasing domestic investments and diversification. Opportunities for investors can now be found in the financial sector, construction, real estate and tourism.. Diversification is intended to create high value-added jobs in a wider array of activities. For this purpose, GCC governments are stepping up investments in social infrastructure - health care, education, training and innovation.
New global players emerging in the region. The largest sovereign and other investment funds in the GCC have now become powerful players in the global financial system. While there are growing concerns in the developed world about the potential influence of sovereign wealth funds, the diversification strategies and investments of the GCC’s SWFs will provide enormous opportunities for future generations in the region. As SWFs invest increasingly in the Middle East region, they can help deepen financial markets, foster ongoing diversification and generate much-needed jobs for GCC nationals.
Regional trade is expected to expand with the recently launched Common Market (CM). The six members of the GCC launched a Common Market in January 2008 (many of the operational details are yet to be finalised). The CM will open wider avenues for inter-GCC trade and investment activities. The agreement covers economic and investment services, dealings in the stock market and the establishment of public and private companies. The CM allows for the free flow of capital and gives GCC nationals freedom of movement, residency and employment — in both the private and public sectors — in all six countries. Regardless of whether the CM is followed by the planned monetary union and single currency in 2010, the ongoing process will bode well for increased intra-regional trade flows and will draw more foreign investment to the region.
Risks and vulnerabilities
Regardless of the robust outlook for the near term, the GCC countries have their share of economic challenges and risks. Despite increased diversification efforts, the region still relies predominantly on hydrocarbon industries. Even though real non-hydrocarbon growth is continuing to outpace hydrocarbon growth (in all GCC countries except Qatar), hydrocarbon revenues still represent around 84% of total government revenues. This makes the region vulnerable to energy price fluctuations and geopolitical risks. In a downside scenario, if a recession in the US led to a sharp decline in oil prices, this would have a significant impact on the GCC economies, although the downturn would be mitigated by major infrastructure projects already underway or proposed.
Rising inflation, low real interest rates and currency appreciation pressures are important macro challenges. The region is faced with an ever growing inflation problem (close to double digits in the UAE and Qatar). To a large extent, this problem is generated by a weak US dollar, to which most GCC currencies are pegged. Further USD weakening will call into question the sustainability of current exchange-rate pegs and force GCC governments to revalue sooner rather than later.
High unemployment among GCC nationals is another pressing issue. The GCC countries are still highly dependent on a large expatriate labour force and hindered by the limited domestic supply of adequate skills. The majority of jobs in the private sector are taken by expatriates and most of the national labour force is employed in the government sector. Increasing unemployment rates among nationals and high population growth have prompted the imposition of barriers for foreign workers in the GCC. Investment in human capital and institutional reforms to integrate the labour market are critical. Raising the education level of GCC nationals will allow them to meet the demands and take advantage of the GCC’s changing economic structure.
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