Gulf Steam: economies in the region gather pace

The shift away from oil

While the oil price boom is driving optimism on this year’s prospects, the region’s medium-term outlook hinges on a shift away from the black stuff. Here, progress is patchy. Kuwait remains the most dependent on oil of the GCC countries, with oil and gas making up around 40% of GDP and over 90% of export revenues. With fewer oil reserves, the UAE was forced to diversify its economy earlier, and now relies on property and construction, tourism, financial services, logistics and trade – including in gold – to supplement hydrocarbon revenues. A gold price of around USD 1,900 - USD 2,000/oz, which we see continuing in coming months, should prove a tailwind here. Even so, oil accounted for around 29% of UAE GDP in 2020, according to federal estimates. In 2016, when Saudi Arabia’s Crown Prince Mohammed bin Salman unveiled his Vision 2030, he foresaw non-oil revenues rising almost fourfold by 2020. Today, however, oil remains the lion’s share of the Kingdom’s GDP, and has actually risen in recent years.

The big question now is whether the current oil price bonanza will fuel transition projects, or remove some of the urgency to diversify. We note that Russia has historically channelled oil revenues above USD 42/barrel into its sovereign wealth fund, and the region’s members would also benefit from formal mechanisms to sequester oil wealth. Yet we see reason for optimism that the windfall will not be squandered. GCC countries have demonstrated fiscal discipline in recent years. They have set out clear and quantifiable diversification targets in regional policy ‘visions’ (including Saudi Arabia’s Vision 2030, Qatar’s National Vision 2030 and Kuwait’s Vision 2035). Their countries’ leaders recognise that diversification is an economic imperative. Global oil demand will have to start falling rapidly to meet net zero 2050 targets. In Bahrain, oil reserves are expected to run out within the next decade. To add to the urgency, the Middle East is badly affected by climate change: by some estimates, the region is warming at twice the global average, making some areas potentially uninhabitable this century.

Vast sovereign wealth reserves also give the GCC members an unprecedented tool to advance the diversification agenda. Saudi Arabia is using its fund to back electric vehicle manufacturer Lucid Group, with plans to buy between 50,000-100,000 vehicles over the next decade, and to create jobs in sustainable technologies and advanced manufacturing. With less than 2% of the land arable-farmed across much of the region, GCC countries are investing in vertical farms. Rapid urbanisation is fuelling investments in smart cities. Encouragingly, there are also signs that public and investor opinion is behind the sustainability transition: a recent Lombard Odier survey of wealthy Gulf individuals found that 85% are seeking to increase their exposure to sustainable investments.

Tax revenues rising, amid further business reforms

The region is also actively seeking sources of financing outside the oil sector. Tax revenues are rising. Last year, Oman became the fourth GCC member to impose value-added tax (VAT), while also raising electricity and water tariffs. Meanwhile, a raft of more business–friendly reforms, including new bankruptcy laws and greater permitted foreign ownership of businesses, has been implemented, with Saudi Arabia, Bahrain and Kuwait among the top ten improvers in the World Bank’s 2020 ‘Ease of Doing Business’ report. In the UAE, some 2021 reforms were designed to bring the economy more in line with Western norms, including shifting the working week from Sunday-Thursday to Monday-Friday.

These reforms – combined with an easing of drinking laws and the UAE allowing unmarried couples to cohabit – go down well with foreign workers, who make up around half of the GCC’s population. But in other areas, the business environment looks less attractive. In Saudi Arabia, multinationals including Uber have been hit by retroactive taxes worth millions of dollars. Unpredictable policy changes remain an issue. In 2021, Riyadh surprised the corporate world by declaring that after 2023 it would no longer sign contracts with foreign companies that did not have a regional headquarters there. Foreign investment in Saudi Arabia has correspondingly plummeted in recent years, and despite a recent uptick, remains well below levels seen a decade ago.

The ‘resource curse’ lingers over labour markets

Meanwhile, oil riches have long resulted in generous subsidies and benefits for nationals that can deter work. In the UAE, fewer than half of Emiratis participate in the labour market. GCC nationals who do work overwhelmingly take up jobs in the public sector, which tend to pay better, have longer holidays and shorter working hours. This stifles the private sector’s development, an issue that Gulf states have spent decades trying to address. To date, these actions – principally via private sector wage subsidies – have seen little success. In Kuwait, which introduced them in 2001, the private sector still only employs around 8% of the total national workforce, and the economy has added far more public than private sector jobs in recent years. Recent advances in labour market reform, including laws that prevent gender discrimination at work in Bahrain, Saudi Arabia and the UAE, and the introduction of a minimum wage in Qatar, are a step in the right direction, notes the IMF. Still, the GCC’s youthful population underscores the need for structural changes, as more hit working age in coming years.

Healthy competition

One further reason for optimism is a trend that many see as a risk factor: growing competition between the region’s largest economies, Saudi Arabia and the UAE. In July 2021, disagreement unexpectedly arose at an Organization of the Petroleum Exporting Countries (OPEC) meeting, reflecting different views on the speed of the energy transition: the UAE wanted to boost supply and monetise reserves earlier, while Saudi Arabia favoured restricting production. The desire to boost non-oil industries is resulting in greater rivalry in everything from foreign investment to golf courses. Yet we do not see this as a zero sum game. Mega projects like Saudi Arabia’s new sustainable city NEOM could drive up foreign investment and tourism across the region. Concurrently, Abu Dhabi and Dubai are working more closely together, with discussions over consolidation in the banking sector, stock exchanges and airlines, as well as more regulatory and legal harmonisation that could all favour growth.

Indeed, as GCC countries move along the same path of relinquishing oil dependence, they will continue to share many of the same challenges and strengths. Now that previous issues with Qatar have been resolved, at 41 years old, the GCC has proved an enduring economic and political union. Its members share strong strategic and geopolitical interests that in our view should drive well-managed competition – and largely positive reform dynamics – in the years ahead.

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