Oil price fluctuations hampering GCC reforms

The seven countries which make up the Gulf Cooperation Council (GCC), namely Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, have some of the highest per capita incomes in the world. Yet despite its wealth, the region is classed as a frontier market. As is so often the case, oil has been both a blessing and a curse, bringing huge wealth to the region over the past 90 years or so, but in the process meaning these economies failed to develop into other sectors. Add in the fact that these countries are situated in the Middle East, a region synonymous with political instability, and it becomes apparently why investors have often steered clear.

Lower oil prices over the last few years, along with the US shale revolution and the push towards electric cars and cleaner energy, have made it clear that the GCC economies cannot rely on their oil wealth lasting forever. Yet while most of these countries will talk about the need to diversify their economies, how much progress has actually been made?

Not there yet

These economies are still oil dependent, says Christof Rühl, global head of research at the Abu Dhabi Investment Authority. While other oil producing nations have been hit hard by the fall in prices, and have seen their currencies devalued, the GCC countries are in a position to be able to weather the storm. “They have the reserves to be able to ride this out,” he says. “Yes, the share of non-oil GDP has been rising in the GCC over the last 15 years, but efforts at diversification have been less successful than is generally acknowledged.”

The oil price won’t rise and fall forever, he believes, rather consumption will peter out. “Long-term, we will have excess supply, not excess demand. The GCC countries might still be king, but it will be a much smaller kingdom.”

There has been a focus across the GCC to reform subsidies in particular, says Mazin Alnahedh, group chief executive officer at Kuwait Finance House, which were draining fiscal budgets. “There has also been a move to shift the focus from the public sector and into the private sector, and opening up these economies to foreign investors,” he says.

There has also been the development of capital markets, including improved transparency. Mr Alnahedh explains how Kuwait was recently added to the MSCI Emerging Markets Index, which has put pressure on publicly-listed companies to be more transparent.

Kuwait sees investments in healthcare and education as key pillars of growth, along with the expansion of service industries and a drive towards supporting small and medium sized enterprises. The country is also investing in becoming a petrochemical hub.

Yet the price of oil dictates what is implemented when.

“In Kuwait, when we saw the oil price drop below 40, there was pretty much panic and a push for reform,” he explains. “Parliament might not have been completely behind it, but they could certainly see the value in it. They could see budget deficits coming up and they had to take certain steps to deal with that.”

But once oil prices started going back up, these reforms get put into reverse. That should not be the case, says Mr Alnahedh, but it is the reality.

“Reforms need to be put in place now. Then if oil prices go up, so be it, great, but if they don’t then we have diversified. At least we will have other sources of revenue. But as it is, in my view the government and parliament tend to change their view as and when oil prices go up and down.”

Running low

It is no surprise that the most aggressive diversification has happened in Dubai and Bahrain, where oil is the least prevalent, says Hasnain Malik, global head of equity research at Exotix Capital. Abu Dhabi, Kuwait and Qatar have an enormous amount of latitude as to how they respond to oil price changes because of their tiny populations and the massive supply of oil resources or levels of sovereign wealth, he explains.

“The two interesting ones are Oman and Saudi Arabia. Oman doesn’t have those deep sovereign pockets, it has to diversify. Meanwhile, Saudi has a fiscal reduction going on, but also a political revolution. Austerity here is focused at the elite level of Saudi Arabia. The benefits for the mass population are continuing largely as before.”

Bahrain was the first in the GCC to drill for oil, and will arguably be the first to run out, explains Simon Galpin, managing director of the Bahrain Economic Development Board, it it began its diversification journey 15 to 20 years ago. “Now around 20 per cent of our GDP can be attributed to oil, 15 to financial services, 12 to manufacturing, so we are making quite good progress.”

There is no “Plan B” for Bahrain, he claims, irrespective of the oil price, and the country is looking for foreign investors to come in and help transform the country.

“Bahrain is a small economy and we have to try and make that an advantage. Perhaps by being a bit more nimble, by being very responsive. And for foreign investors, a small economy means they have greater access, to decision makers, to consumers, to investors and partners.”

The country has a very ambitious plan for physical infrastructure, reports Mr Galpin, including updating its oil refineries, expanding its aluminium smelter and expanding tourism, which are expected to cost more than $30bn.

In addition there are plans for the “soft infrastructure”, making sure the country remains business friendly, for example by updating bankruptcy laws to allow start-ups to fail and reinvent themselves, and allowing more sectors to have 100 per cent foreign ownership.

“We are also looking at things like fintech,” he says. “Our central bank has been very quick to move to allow fintech start-ups and scale-ups from around the world to come here and use our regulatory sandbox to develop fintech products, perhaps to make them sharia compliant, and opening them up to Islamic banks and a wider Islamic consumer base.”

There is a saying that data is the new oil, says Mr Galpin, and if that is the case then Bahrain was given a recent boost when Amazon web services choose to locate their new regional data centre in Bahrain.

Qatar quandary

The diplomatic crisis which began in June 2017, when several countries broke off diplomatic relations with Qatar and imposed trade bans, is yet another example of the political instability which has held this region back, believes Mr Malik at Exotix Capital.

Fragmentation is one of the shortcomings of the MENA region, he says. “It has a population to match the EU, enough sovereign capital to match China and some of the world’s cheapest supplies of petrochemicals and plastics, so the potential is massive. But it is a market with a lack of intra-regional trade. That has always hamstrung the region from reaching its full potential.”

There is no sign of the Qatar embargo ending anytime soon, he says but these are not new risks.

“These issues have characterised this region for some time and you could argue that equity markets have already priced them in, and that in some instances they have priced them in too much and there are now some interesting opportunities for value investors across parts of the GCC.”