A World Bank Group Publication for the Gulf Cooperation Council Economies Gulf Economic Monitor Deepening Reforms In Focus: Pension systems in the Gulf Gulf Economic Monitor Deepening Reforms In Focus: Pension systems in the Gulf Executive Summary The global economy and global trade continued to expand in to tightened fiscal policy and a cooling of the regional property 2017, led by strengthening demand across advanced and devel- boom. Government deposits at banks grew, including in Qatar oping economies. Global trade grew at an over -four percent to compensate for the withdrawals by foreign depositors fol- pace in the year. Oil markets have tightened as energy demand lowing the diplomatic rift with Saudi Arabia, the UAE and has strengthened in line with the global recovery, and as crude other Arab countries. Central banks raised interest rates to oil supply has been curtailed by OPEC and Russia (the OPEC+ maintain their currency pegs, but policy remains accommoda- agreement). This has boosted the average crude oil price to tive with low real rates. around US$53 a barrel in 2017, up 24 percent from 2016, and to around US$64 currently. Global financing conditions have The outlook for the global economy remains positive. Global remained favorable despite a 100 basis-point policy rate hike growth is expected to strengthen to an average 3.0 percent an- by the U.S. Federal Reserve since November 2016. nually in 2017-19. Crude oil prices are expected to average US$58 a barrel in 2018 and edge up to US$59 a barrel in 2019, Economic activity was weaker than expected across the GCC kept in check by rising US oil production and as growth in during 2017, dragged down by lower crude oil production and global energy demand moderates. Global financing conditions the negative short-term effects of fiscal adjustment. Growth for should gradually tighten, but are generally expected to remain the region is estimated at just 0.5 percent, the weakest in sever- accommodative. Risks to the baseline global outlook are al years and down from 2.5 percent the previous year. The skewed to the downside and include bouts of global financial GCC reduced oil output beginning in January 2017 and the volatility, weaker than expected energy prices, geopolitical OPEC and Russia agreed twice to extend the 1.8 million barrel tensions and rising trade protectionism. a day output cutback through December 2018. The GCC gov- ernments continued with fiscal adjustment measures with Sau- Growth in the GCC is expected to resume in 2018 -19 support- di Arabia and the UAE introducing excise taxes on tobacco ed by a moderate recovery in oil prices, as the OPEC+ produc- and carbonated drinks. External debt issuance continued to tion restraint helps oil prices and supports a slower pace of increase to help fund deficits. fiscal consolidation and an upgrade in investor sentiment. The expiry of the agreement after 2018 should provide support to Trade balances have begun to improve aided by rising export headline growth as oil production rises. The recovery will be receipts due to higher oil prices, while fiscal austerity has kept led by fixed investment and there will be less of a drag on imports depressed. This is helping ease pressure on currencies growth from a poor performance in public consumption and and reserves. Inflation has moderated with the weaker activity. net exports. Despite this improvement, aggregate growth for Credit growth has also slowed, reflecting weaker demand due the region will remain soft at just 2.1 and 2.7 percent in 2018 and 2019 respectively, a significant deceleration compared to Saudi Arabia’s which aims to lift the private sector share of years prior to the fall in oil prices in 2014. Inflation will pick the economy from 40 to 65 percent and the small and medium up in 2018 as the value -added tax (VAT) is introduced across enterprise contribution from 20 to 35 percent. Implementing the region, but will moderate in 2019. The recovery in oil these structural transformation programs requires continuing prices will help reverse, or narrow, current account deficits, political commitment from the GCC governments. albeit at different paces based on services and income ac- count results. Further fiscal consolidation remains a necessity in parallel with these transformation programs. Energy prices subsidies de- Fiscal balances are set to steadily improve across the GCC clined by 1.5-5.0 percentage points of GDP from 2013 to 2016, with the expected gains underpinned by ongoing fiscal reform but the gains in petroleum subsidy reform were due more to the and new adjustment measures to be implemented in 2018-19, decline in benchmark international prices than to domestic including the introduction of consumption taxes. The gains will price increases. The introduction of the VAT should help the help moderate the recent rise in government debt. The GCC GCC raise non-hydrocarbon revenues by an estimated at 1.2- countries are expected to maintain their currency pegs to the 2.1 percent of GDP. Other measures are equally vital: second U.S. dollar and central banks will likely follow U.S. rate hikes. round adjustments to energy and other subsidized prices while The positive medium-term outlook requires strong banks, and protecting the most vulnerable households, control of the wage the GCC banks are generally well capitalized to take advantage bill, and strengthening of the quality of public investment. Ad- of the expected recovery in growth. dressing sustainability, equity and welfare challenges confront- ing pension and social benefit systems will be critical if these Risks to the regional outlook are on the downside in the medi- are not to be a drag on economic growth, fiscal sustainability um term. Lower than expected oil prices could exert pressure and labor market stability. on the OPEC producers to extend or deepen their production reduction agreement and dampen medium-term growth in the Promoting private sector activity will enable economic diversi- GCC countries. Any further escalation of the diplomatic dis- fication. Playing oversized roles in their economies, including pute should be avoided as it could have negative repercussions through state-owned enterprises, the GCC governments have on the region as a whole. Slippage in the implementation of begun to consider the privatization of state assets. They are country reform plans arising from weak institutional capacity also increasingly turning to public and private partnerships to will rob the GCC of the benefits of fiscal adjustment and of engage private capital in infrastructure. While privatization and deeper structural reforms that aim to diversify their economies. PPPs will be vital elements of private sector development, the overriding strategy for the GCC governments will be to estab- Over the longer term, the enduring dominance of oil and gas lish the enabling business environment by creating the legal production, exports, and revenues in the GCC countries argues framework for private activity, reforming regulation, and pro- for the vigorous implementation of structural reforms. The terms moting competition. of trade shocks in 2008-09 and in 2014-16 barely dented the dominance of the hydrocarbon sector in the GCC, with the The GCC countries must reform their labor markets to support bulk of the adjustment so far driven by spending cuts rather private activity. Distortionary policies have created labor mar- than the emergence of other traded sectors. ket segmentation: the public sector attracts nationals through high wages, while the private sector employs mainly low- Structural reforms should focus on: economic diversification, skilled foreigners. Reducing the incentives favoring public private sector development, and labor market and fiscal re- over private sector employment will encourage nationals to forms including pensions, which are discussed in the In Focus seek private sector jobs. Attracting and retaining highly skilled chapter of this report. The GCC’s economic diversification foreign workers is necessary if the GCC are to become ambitions (away from hydrocarbons) are articulated in various knowledge driven economies. Increasing the labor force partic- country Vision statements and investment plans, bannered by ipation of women will invigorate the labor markets. The Pulse of the Region The global backdrop second half of 2017, reaching over US$60 a barrel cur- rently, thanks to the maintenance of a deal struck at the end of 2016 between OPEC and Russia (the OPEC+ The global economy and trade continue to expand, agreement) to jointly curb production (Figure 4). This led by strengthening demand across advanced deal, which was set to expire in March 2018, has been and developing economies extended through December 2018. Global energy demand has also lifted over this period, helping to support the re- The cyclical recovery in global growth, underway since mid - covery in prices. Production rose in November to 97.8 2016, strengthened further during 2017. Global growth aver- mbd, with the OPEC output lower for the fourth consecu- aged 3.4 percent quarter-on-quarter at a seasonally-adjusted tive month at 32.4 mbd but with non - OPEC output edging annualized rate (qoq saar) in the first three quarters of 2017, up higher. The OPEC producers raised their compliance rate from an average 2.5 percent in the first three quarters of 2016 with the supply reduction pact to 91 percent through No- (Figure 1). The upswing reflects: stronger domestic demand, in vember 2017. Inventories continued to fall from their pre- the advanced economies, principally in the United States, the vious record levels, signaling an ongoing market re- Euro Area and Japan; resilient growth in developing econo- balancing. Nevertheless, expectations are that price up- mies led by China; and, renewed activity among the major side potential will remain limited by rising shale produc- commodity exporters including Brazil and Russia. The global tion in North America. manufacturing Purchasing Managers’ Index (PMI) indicates that the strong momentum continued into the final quarter of Global financing conditions have remained 2017 (Figure 2). favorable Strengthening demand has spilled over into trade, which ex- Long-term bond yields in the United States remained steady in panded briskly during 2017, following two years of pro- 2017, despite the cumulative 100 basis-point increase in the nounced weakness (Figure 3), and indications are that momen- Federal Reserve policy rate from November 2016 to December tum was maintained in the final quarter (Figure 2). 2017 (Figure 5). The low yields reflect the expectations of a more gradual phase of monetary policy normalization by the Oil markets have tightened as energy supply has Federal Reserve. The U.S. dollar has also depreciated by 6.3 been curtailed percent in real effective terms from January to December 2017. In emerging markets, portfolio flows remained stable, and as- The price of benchmark Brent crude rose steadily in the set prices, buoyant. Global GDP growth Purchasing Managers’ Index (PMI) Quarter-on-quarter seasonally-adjusted annualized rate 50+ = expansion 4.0 58 3.5 56 3.0 54 2.5 52 2.0 50 1.5 48 1.0 46 0.5 May-2013 May-2014 May-2015 May-2016 May-2017 Jan-2013 Jan-2014 Jan-2015 Jan-2016 Jan-2017 Sep-2013 Sep-2014 Sep-2015 Sep-2016 Sep-2017 0.0 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Manufacturing output New export orders Global trade growth Energy prices Percent year-on-year US$ 15 120 18 16 10 100 14 5 80 12 0 60 10 8 -5 40 6 -10 20 4 May-2013 May-2014 May-2015 May-2016 May-2017 Jan-2013 Jan-2014 Jan-2015 Jan-2017 Jan-2016 Sep-2013 Sep-2014 Sep-2015 Sep-2016 Sep-2017 -15 Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 Crude oil, avg. of Brent, Dubai, West Texas Intermediate, US$/bbl (lhs) Value Volume Natural gas, Japan (LNG), US$/mmbtu (rhs) Long-term US interest rates Global outlook and risks Percent The outlook for the global economy remains positive 3.5 3.0 Global growth is expected to strengthen to around 3.0 percent 2.5 annually in 2017-19, from a post-crisis low of 2.4 percent in 2.0 2016 (World Bank, 2018a). In the advanced economies, 1.5 growth will reach 2.2 percent in 2018 following a broad - 1.0 based domestic demand -led recovery, before moderating to 0.5 1.9 percent in 2019 as negative output gaps shrink and more 0.0 modest productivity gains weigh on potential growth. In the Jan-2013 Jan-2014 Jan-2015 Jan-2016 Jan-2017 Oct-2013 Oct-2014 Oct-2015 Oct-2016 Oct-2017 Jul-2013 Jul-2014 Jul-2015 Jul-2016 Jul-2017 Apr-2013 Apr-2014 Apr-2015 Apr-2016 Apr-2017 emerging market and developing economies (EMDEs), growth is anticipated to reach an average of 4.6 percent in 2018-19 (Figure 6), with activity in the commodity importers U.S. 10-Year Treasury Bond Yield strengthening while obstacles to growth in the commodity U.S. Federal Funds rate (effective) exporters gradually diminish. Growth in the EMDEs will be GDP growth supported by improved external factors, including a favorable global financial environment. Percent year-on-year Global trade is also expected to remain strong at around 4.0 percent in 2018-19. The forecast represents a significant up- 5.0 grade from previous projections and reflects a recovery in 4.5 4.0 global demand especially capital spending by the advanced 3.5 economies, a rebound by China from its protracted trade slow- 3.0 down, and renewed imports by commodity importer EMDEs 2.5 (Figure 7). 2.0 1.5 1.0 Oil prices are still expected to recover at a moderate pace. 0.5 Crude oil prices, which averaged US$53 per barrel in 2017, are 0.0 expected to average US$58 per barrel in 2018 as the market 2015 2016 2017e 2018f 2019f continues to rebalance (Figure 8). The increase reflects strong World oil demand, falling stocks, and production restraint among the Advanced economies Emerging market and developing economies OPEC and non-OPEC producers. Projected increases in U.S. shale production make it unlikely that the global market will tighten significantly in 2018. Natural gas prices are projected to rise 3 percent in 2018. Markets are seen remaining well sup- Trade volume growth plied over the next several years due to a surge in LNG capaci- Percent year-on-year ty, mainly from Australia and the United States, and the likely reemergence of Egypt as a gas exporter with the scale -up of production from the Zohr field. 5.0 Global financing conditions are assumed to remain accommo- 4.5 dative. The normalization of monetary policy in the United States matters for the GCC countries, whose currencies are 4.0 pegged to the U.S. dollar, and for whom policy will tighten in 3.5 tandem.1 Nevertheless, the increase in U.S. policy rates is ex- pected to proceed gradually and without triggering large in- 3.0 creases in market volatility. An easing of lending conditions in 2.5 the major economies is expected to offset the anticipated grad- ual rise in long-term interest rates. Most emerging markets are 2.0 expected to face generally accommodative financial condi- 1.5 tions, with higher policy rates partially offset by a recovery in 2015 2016 2017e 2018f 2019f risk appetite. Risks to the baseline global outlook are skewed to the down- side in the medium term (World Bank, 2018a). Faster than Energy prices expected policy rate or balance sheet normalization by the U.S. US$ and the major central banks could raise borrowing costs and trigger an abrupt tightening of financing conditions to the detri- ment of EMDEs. Other major risks include those emanating 60 10.5 from unilateral trade restrictions and retaliatory responses that 58 10.0 slow global trade and raise the cost of tradable goods for con- 56 9.5 sumers, and rising geopolitical tensions that affect economic 54 9.0 activity or hurt investor confidence. 52 8.5 50 8.0 In energy markets, there are substantial risks to the forecast. 48 Supply to the global market from politically-stressed oil pro- 46 7.5 7.0 ducers, including Iraq, Libya, Nigeria, and Venezuela could be 44 6.5 volatile. Conversely, while an agreement to extend oil cuts 42 40 6.0 2015 2016 2017 2018f 2019f Crude oil, avg. of Brent, Dubai, West Texas Intermediate, US$/bbl (lhs) 1/ Kuwait’s currency is anchored to a basket of currencies in which the U.S. Natural gas, Japan (LNG), US$/mmbtu (rhs) dollar has a relatively heavy weighting. GDP growth GDP growth Percent year-on-year Quarter-on-quarter 7 3.0 6 2.5 2.0 5 1.5 4 1.0 3 0.5 2 0.0 1 -0.5 -1.0 0 -1.5 -1 -2.0 -2 -2.5 Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q1-2016 Q2-2016 Q3-2016 Q4-2016 Q1-2017 Q2-2017 Q3-2017 Q4-2017 Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q1-2016 Q2-2016 Q3-2016 Q4-2016 Q1-2017 Q2-2017 Q4-2017 Q3-2017 Bahrain Qatar Saudi Arabia UAE - Abu Dhabi Qatar Saudi Arabia through 2018 has been finalized, it is unclear how long OPEC three quarter outturns, growth for the GCC is expected to be and Russia can keep prices high without bringing too much lower in 2017 than previously forecast (Gulf Economic Moni- U.S. shale oil supply back online. Over the medium to long tor, June 2017). term, however, global energy markets are anticipated to un- dergo a significant shift away from coal and oil towards lower Saudi Arabia, the GCC’s largest economy, posted its weakest -carbon fuels, with the shift mainly driven by countries ’ com- economic performance since 2009, with the economy contract- mitments under the Paris agreement to lower global carbon ing by 0.7 percent in 2017. The weakness reflected the impact emissions.2 While the pace of the transition is uncertain, it of oil production cuts undertaken as part of the OPEC+ agree- will be affected by both technological innovation which low- ment, and soft non-oil sector growth due to ongoing fiscal ad- ers the cost of producing cleaner energy (e.g. through renewa- justment. As a result the economy slipped into a recession dur- ble energy) and shifts in policy by major energy consumers ing 2017, shrinking by 2 percent quarter -on-quarter seasonally such as India and China. 3 This suggests continued urgency for adjusted rates (qoq, sa) in Q1 and by 1.3 percent in the second energy producers like the GCC to undertake structural reforms quarter (Figure 9 and Figure 10). The second half of the year that reduce their dependence on commodities and diversify fared better, but quarterly growth softened in the fourth quarter their economies. to 0.5 percent (qoq sa). In the UAE, the economy in Abu Dhabi contracted by 0.9 per- Regional developments cent yoy in the second quarter of 2017. Growth in the federal capital and the largest of seven emirates had been 2.8 percent yoy in the second quarter of 2016. In Dubai, the second largest emirate, the growth rate was 3.2 percent in the first quarter of Economic activity was weaker than expected 2017, compared to 2.4 percent in the first quarter of 2016 and across the GCC ... 3.9 percent in the fourth quarter of 2016. As with Saudi Ara- bia, the slowdown in the UAE, the GCC’s second largest econ- Growth in the Gulf Cooperation Council (GCC) economies omy, was largely due to weakness in the hydrocarbon sector. was weaker than expected in the first three quarters of 2017. Property markets have also softened, particularly in Dubai as The results contrast with those reported for the global econo- reflected in a slowing land and building sales transactions over my and reflect lower crude oil production by the OPEC coun- the course of 2017. tries and softer domestic activity overall. With the subdued Economic activity was likely sluggish in the UAE in the sec- ond half of the year. Non-hydrocarbon GDP had only given 2/ Natural gas is likely to be less affected than coal and oil because it is rela- growth a weak lift in the first and second quarters of the year. tively cleaner in combustion, and is likely to be a bridge fuel in the transition to a low-carbon global economy. With PMI data, which cover the non-hydrocarbon sector, indi- 3/ For example, India has announced that it will allow the sale of only electric cating that output and new orders were in expansion territory cars by 2030 while China plans to end the sale of fossil -fuel-burning vehicles, through 2017, an uptick in the total economy index (the head- though it’s not yet clear when the ban will kick in. The United Kingdom and France have both recently decided to outlaw the sale of new internal- line index) in December 2017 (Figure 11) indicates that a re- combustion cars by 2040. covery is, however, likely in the offing in 2018. relatively buoyant. Consumer spending picked up during the Purchasing Managers’ Indexes (PMI) course of 2017, also reflected in strengthening import demand for consumer goods. On a further positive note, residential Deviations from Index Value of 50 (Expansion) property sales rose 20 percent yoy in the third quarter, follow- ing healthy gains in the second quarter, signaling that the cor- rection of the past two years has run its course. A strong pipe- 12 line of, and the speedier award of contracts for, infrastructure 10 projects under the 2015-19 Development Plan have supported 8 6 activity in the non-oil sector, particularly in construction and 4 transpor. Still, overall growth has slowed down in the country, 2 which remains among the most dependent among the GCC 0 economies on the hydrocarbon sector (55 percent of real GDP in 2016), as crude oil production declined 5.1 percent yoy in May-2015 May-2016 May-2017 Jan-2015 Jan-2016 Jan-2017 Nov-2015 Nov-2016 Nov-2017 Jul-2015 Jul-2016 Jul-2017 Mar-2015 Mar-2016 Mar-2017 Sep-2015 Sep-2016 Sep-2017 the first three quarters of 2017 from a year earlier. Saudi Arabia Oil production also dropped by 3.0 percent yoy in the first United Arab Emirates three quarters of 2017 in Oman, still largely dependent on the Saudi Arabia: Long-run average (Aug 2009 - Dec 2014) United Arab Emirates: Long-run average (Aug 2009 - Dec 2014) hydrocarbon sector (40 percent of GDP in 2015). Imports (a proxy for consumer spending in Oman) were flat in the first quarter of 2017, although they gained in the second quarter. Weaker public spending in the period had knockdown effects Qatar has been affected by, but is successfully adjusting to, on private consumption. the diplomatic rift with Saudi Arabia, the UAE and other Arab countries. Growth was anemic in the first half of the year, be- Bahrain was the sole exception, with growth picking up in the fore the diplomatic rift, with the economy contracting 0.2 per- first three quarters of 2017. The economy grew by an average cent qoq sa in the first quarter of 2017 and 0.9 percent in the 3.6 percent yoy in the period from 1.5 percent yoy in the fourth second quarter (Figure 10), mainly reflecting the effects of quarter of 2016 (Figure 1). Bahrain is least dependent among fiscal consolidation over the past year, in particular, with the the GCC countries on hydrocarbons (20 percent of GDP in efforts to rationalize public capital expenditures. Saudi Arabia, 2015), and growth in the first three quarters was driven by non - the UAE, Bahrain, and Egypt severed diplomatic relations and oil activity, anchored on the private sector. Growth in the year froze trade flows with Qatar in June 2017. These measures led likely exceeded that forecast at midyear, the exception among to an initial sharp drop in imports of 40 and 35 percent yoy in the GCC economies. June and July respectively and contributed to an increase in food inflation to 5.1 percent yoy in July. They also dented … dragged down by lower crude oil production… investor sentiment, as reflected in a drop in equity prices, and squeezed commercial bank access to foreign funds, re- The GCC reduced oil output beginning in January 2017. OPEC flected in the decline in non -resident deposits at Qatari banks had originally agreed the previous November to cut oil produc- (from US$51 billion, or 24 percent of total bank deposits, in tion by 1.2 million barrels per day (mbd) for a half -year begin- May 2017 to US$39 billion, or 19 percent of total bank de- ning in January 2017. The deal aimed to end the three -year posits, in September. The funding squeeze raised interbank supply glut in the global oil market and support international rates and forced commercial banks to borrow more from the oil prices which had fallen by more than a third from US$111 Qatar Central Bank. per barrel (Brent crude) in June 2014 to US$31 per barrel in January 2016. The agreement was broadened in December However, the impact has been short-lived. Qatar has responded 2016, with non-OPEC suppliers, led by Russia, pledging 0.6 to the trade restrictions by re-routing trade (using Iranian air- mbd of additional output cuts. This agreement has been subse- space and Omani ports and opening the new $7.4 billion quently extended to continue through 2018. Hamad Port), diversifying sources of imports (purchasing food from or through Iran, Oman, Turkey and China) and enhancing As OPEC’s biggest producer, Saudi Arabia has shouldered the domestic food processing. As a result, food inflation has decel- largest cutbacks. Crude oil production by Saudi Arabia fell 4.2 erated, while goods imports are back to pre-dispute levels. Qa- percent from 10.4 mbd in the first three quarters of 2016 to 9.9 tar has also explored other sources of bank finance; the govern- mbd in the first three quarters of 2017 (Figure 12). Production ment increased public sector deposits by US$28 billion from by the other GCC producers, including by Oman, a non-OPEC May to September; and, the central bank injected liquidity into member together with Bahrain, dropped 3.4 percent from a the financial system. Growth has subsequently recovered to 3.0 combined 7.5 mbd to a combined 7.2 mbd over the same two percent qoq sa in the third quarter of 2017. periods. Overall, compliance by the OPEC members to the production agreement was 115 percent in November 2017 and Oil production cuts also weighed down on growth in Kuwait in averaged 91 percent in January to November 2017, according the first half of the year. However, non-oil activity has remained to the International Energy Agency. Meanwhile, Brent prices climbed steadily over the past six months reaching US$67 per barrel, up more than 40 percent from US$46.4 in November Crude oil production 2016, when the agreement was first struck. Million barrels per day 10.8 7.8 … and the negative short-term effects of fiscal adjustment 10.6 7.6 10.4 The GCC countries continued with fiscal adjustment plans, 10.2 7.4 albeit at different paces in 2017. Many of the fiscal consolida- 10.0 7.2 tion plans were set soon after oil prices collapsed from mid - 9.8 2014 and caused huge fiscal deficits through 2016. In many 9.6 7.0 cases, the adjustment measures were front -loaded in 2015-16. 9.4 Most governments continued with second phase efforts in 9.2 6.8 2017, although some have proceeded more cautiously and Q1 Q2 3Q 4Q Q1 Q2 Q3 Q4 Q1 Q2 Q3 2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 gradually than originally planned. Altogether, the reforms, so far focused on energy price and subsidy adjustments and gov- Saudi Arabia United Arab Emirates + Kuwait + Qatar + Oman (rhs) ernment expenditure reductions, have dampened domestic de- mand in the GCC countries. However, policy makers have also begun to turn attention towards measures to potentially soften the impact of the subsidy and tax reforms on consumers. rates are 100 percent on tobacco products and energy drinks and 50 percent on carbonated drinks. In general, the UAE has Saudi Arabia introduced a 100 percent excise tax on tobacco emphasized revenue measures this year; previously, the gov- and sugary drinks and a 50 percent excise tax on soft drinks in ernment increased electricity and water tariffs, removed fuel June 2017. Spending on subsidies was 65 percent lower in the subsidies, and reduced capital transfers to Government Relat- first half of 2017 from a year earlier, and grants 24 percent ed Entities (GREs). More recently, the government has fo- smaller. Overall, Saudi Arabia’s fiscal deficit has fallen from cused on fees: a 4 percent municipality fee on hotel bills and a 16.9 percent of GDP in 2016 to an estimated 9.0 percent in 3 percent municipality fee on the annual value of expatriates ’ 2017. Improving fiscal outturns gave the government an occa- rental contracts in Abu Dhabi, and parking fees and fees for sion to pause with compensation reform -- the government hotels and airport passengers in Dubai. Altogether, the previ- reversed in April 2017 some of the cuts in civil service allow- ous and current measures helped the government close the ances enacted in September 2016. Nevertheless, it has proceed- fiscal deficit in 2017. ed with key policy measures aimed at generating fiscal savings and enhancing revenues, including the introduction of a VAT Fiscal consolidation in Qatar has helped to narrow the fiscal in January, a hike in gasoline prices (by 83-127 percent, de- deficit. In response to the fall in international oil and gas pric- pending on the type), and higher electricity tariffs. es, the government had cut back current spending and em- barked on energy subsidy reform. Notably it had also pared In an effort to ease the direct and indirect impact of the fiscal back a substantial public investment program for 2014-2024 to balance measures on vulnerable segments of the population, $130 billion from $180 billion, prioritizing projects related to Saudi Arabia unveiled a new national cash transfer scheme, the FIFA 2022 World Cup. As a result, the fiscal deficit is esti- “Citizens’ Account”, in December 2016. The program reim- mated to have declined to 4.9 percent in 2017 from 9 percent in burses low- and middle-income households for the welfare 2016. Qatar is expected to slow consolidation measures to con- losses they incur during the fiscal reform process. The govern- tain the costs of the diplomatic rift with Saudi Arabia, the UAE ment earmarked Saudi Riyal 30.0 billion (US$8.0 billion) an- and other Arab countries. Government efforts to ease the costs nually for the program and confirmed the first set of disburse- of the measures imposed on the economy and to lighten the ments in December 2017, which varied by the income of the effects of the measures on the population will likely limit the beneficiary household and their number of dependents. The scope for cutting spending sharply. The fiscal costs of dealing support scheme aims to assist vulnerable households cope with with the imposed measures, including the costs to the govern- the economic costs of the fuel price increases, the VAT on ment of rearranging supply chains in the economy, will not food and beverage items, and changes in wages and public pose a substantial risk to fiscal stability, however, given the sector allowances. As such, it remains vital that the program be country’s huge financial buffers. well-targeted to ensure that the transfer payments reach the intended beneficiaries. Fiscal reforms are progressing more slowly in Kuwait, reflect- ing divergent views between the government and the country’s The UAE announced excise taxes on tobacco beginning in parliament regarding spending priorities. With low oil prices October 2017, and in tandem with Saudi Arabia, also imple- persisting, the government had posted consecutive double -digit mented the VAT in January 2018. As with Saudi Arabia, the deficits of about 17 percent of GDP (excluding investment Bahrain has introduced some fiscal adjustment measures. The General government international debt securities revenue enhancing initiatives include higher tobacco and alco- hol taxes and higher government service fees. However, the outstanding, US$ billion, end-of-period government may need a more sizable and front -loaded fiscal consolidation program, considering that Bahrain is the most indebted among the GCC countries (82 percent of GDP in 45 2016). The government may well consider other non -oil reve- 40 nue measures, further cuts to energy subsidies, and steps to 35 contain the wage bill. 30 25 International debt issuance continues to increase 20 15 To fund fiscal deficits, Saudi Arabia and the UAE followed up 10 with more international sovereign debt issues in 2017. Saudi 5 Arabia turned to the international debt market for the third 0 time in less than a year with the largest emerging market debt Bahrain Kuwait Oman Qatar Saudi UAE sale in the year, a US$12.5 billion issue (a US$3.0 billion five Arabia -year tranche, US$5.0 billion 10-year tranche, and US$4.5 Q4-2015 Q3-2017 billion 30-year tranche) in September 2017. The global bond followed a US$9.0 billion Sukuk (Islamic bond) in April 2017 and a US$17.5 billion conventional bond in October 2016, income from the sovereign wealth fund (SWF), the Kuwait Saudi Arabia’s first international sale ever for which demand Investment Authority (KIA) and transfers to the inter - was four times the debt sale. Abu Dhabi, the largest of the generational saving fund, the Future Generations Fund) in UAE’s seven emirates, joined Saudi Arabia in tapping strong FY2015-16, a far cry from double-digit surpluses prior to investor demand for emerging market debt with a US$10.0 2014. However, on a general government basis (including in- billion issue (a US$3.0 billion five -year tranche, US$4.0 bil- vestment income and transfers to the SWF), public sector fi- lion 10-year tranche, and US$3.0 billion 30 -year tranche) in nances are in modest surplus. The government has also had October 2017. some success in undertaking partial energy subsidy reforms, raising electricity utility prices in September 2016. However, Kuwait debuted in the international sovereign bond market in the second round of electricity and water tariff adjustments on March 2017. A US$3.5 billion five -year bond and a US$4.5 apartments, implemented in August 2017, were less than ini- billion ten-year issue attracted more than US$20.0 billion in tially proposed. Plans to introduce a 10 percent corporate tax bids and sold at yields of around 2.8 percent and 3.6 percent have also been shelved, and Kuwait is lagging both Saudi Ara- respectively. Oman completed 90 percent of its foreign bor- bia and the UAE in the implementation of indirect taxes, par- rowing plan for 2017 with a US$5.0 billion issue (a US$1.0 ticularly excises. The government, instead, has started to focus billion five-year tranche, US$2.0 billion 10-year tranche and on potential cost-savings from other sources, including through US$2.0 billion 30-year tranche) in March 2017 and a US$2.0 the use of public private partnerships (PPPs) to finance infra- billion Sukuk sale in May 2017. Earlier, Oman returned to the structure projects and through the privatization of state assets. international bond market after an absence of 20 years with a The Kuwaiti public sector is among the largest in the world US$1.0 billion five-year issue and a US$1.5 10-year issue in and also relative to its GCC peers, with spending amounting to June 2016. Qatar also returned to the market with its first sale 51 percent of GDP in 2016. But it is also among the most de- after four years with a US$9.0 billion bond issue in May 2016, pendent on oil receipts, which contributed 89 percent of total and indications are that the government is considering another revenues, highlighting the need for the authorities to more ag- bond issuance in the coming months. In August, Fitch became gressively develop non-oil sources of public revenues. the third major credit rating agency to downgrade Qatar ’s long- term debt rating one notch to AA- (on par with Belgium and Fiscal outturns in the first half of the year indicate that Oman is South Korea). Downgraded to four levels below investment - on course to narrow its fiscal deficit in 2017. Total revenues grade at B-1 by Moody’s in July 2017, Bahrain raised US$3.0 were 28 percent higher in the first half of 2017 than in the billion in three tranches in September 2017, including a same period in 2016, mainly due to stronger oil revenue than in US$1.2 billion Sukuk, after receiving bids worth US$15.0 bil- 2016. Total expenditures were about 3 percent lower year -on- lion. This followed a US$600 million conventional issue in year. The savings came from higher utility tariffs on large cus- February 2017 and a US$1.0 billion conventional bond and tomers. Overall, the government, which has had the biggest US$1.0 billion Sukuk in October 2016. fiscal deficit in the GCC in the past two years (17.5 percent of GDP in 2015 and 20.6 percent of GDP in 2016), managed to In addition to international debt issues, Saudi Arabia raised cut the budget deficit 31 percent from Omani Rials 3.7 billion debt financing from local investors. Three monthly domestic (US$9.7 billion) in the first half of 2016 to Omani Rials 2.4 Sukuk sales, starting in July 2017, raised Saudi Riyals 37.0 billion (US$6.3 billion) in the first half of 2017. billion (US$9.9 billion). Crude oil exports Export receipts have begun to rise with the up- Million barrels per day tick in oil prices, while fiscal austerity has kept imports depressed… 8.4 7 Production quotas initially kept crude export volumes low and receipts subdued, notwithstanding higher oil prices. Crude oil 6 8.0 export shipments by the GCC countries fell in line with their 5 production cuts following the OPEC+ agreement (Figure 14). 7.6 4 Crude oil export receipts have subsequently picked up moder- 7.2 3 ately (Figure 15). The rise in oil prices to over $60 in the fourth 2 quarter of 2017 will lead to further improvement in receipts. 6.8 1 6.4 0 Qatar’s gas exports have continued despite the diplomatic rift Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q1-2016 Q2-2016 Q3-2016 Q4-2016 Q1-2017 Q2-2017 Q3-2017 with Saudi Arabia, the UAE and the other Arab countries. Qa- tar is the world’s largest producer and supplier of liquefied natural gas (LNG), exporting 7.6 million tons in 2016, approxi- Saudi Arabia (lhs) UAE + Kuwait + Qatar + Oman + Bahrain (rhs) mately 30 percent of global supply, mainly to Japan and other customers in Asia. Natural gas comprises a larger portion of Qatar’s goods exports (48 percent of total merchandise exports in 2016) than does crude oil (36 percent). While Qatar has kept Oil exports, nominal value growth rate global natural gas exports flowing during the standoff, includ- Percent year-on-year ing to the UAE and Egypt, rising global energy supplies are keeping natural gas prices subdued and this should continue to weigh on overall hydrocarbon receipts. 80 60 Bahrain and the UAE benefitted from the global trade recov- ery. Bahrain and the UAE are least dependent among the GCC 40 countries on hydrocarbon exports, and would have benefitted 20 most from the upswing in global trade beginning in mid -2016 0 (Figure 16). Still, non-hydrocarbon exports remain small, rela- -20 tive to hydrocarbon exports, among the GCC to make a signifi- -40 cant impact on the group’s headline trade numbers. Oman has meanwhile benefited from a re-routing of trade by Qatar away -60 Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q1-2016 Q2-2016 Q3-2016 Q4-2016 Q1-2017 Q2-2017 Q3-2017 from Saudi Arabia and the UAE. Import growth may have bottomed out from mid - to late-last Kuwait Oman Qatar Saudi Arabia year, but the improvement appeared weak in the first half of 2017. For the five GCC countries for which 2017 import data are available, imports were still weak for Saudi Arabia and Qatar in the third quarter of 2017 (Figure 17). The economy Non-oil exports, nominal value growth rate fell into a recession in the second quarter of 2017 in Saudi Ara- Percent year-on-year bia, and budgetary expenditures declined two percent yoy in the first half of 2017, affecting imports. Imports dropped more than 35 percent yoy in June and July in Qatar after the diplo- 60 matic conflict erupted in early June and closed off trade routes 40 to the country. Imports continued to decline in November, but at a slower rate of 2 percent yoy. On a positive note, import 20 growth may have begun to stabilize in Bahrain and Kuwait. 0 Bahrain posted a 18.3 percent yoy growth in the third quarter -20 of 2017, after an average 7.9 percent yoy uptick in the first and -40 second quarters. And, Kuwait reported a 13 percent yoy in- -60 crease in the third quarter of 2017 following an 11.2 percent Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q1-2016 Q2-2016 Q3-2016 Q4-2016 Q1-2017 Q2-2017 Q3-2017 yoy gain in the first quarter. Subdued imports amid a modest recovery in exports result- Bahrain Kuwait Oman ed in Kuwait, Oman, Qatar and Saudi Arabia posting trade Qatar Saudi Arabia UAE Imports, nominal value growth rate Nominal effective exchange rates Percent year-on-year Change, + = appreciation 20 United States 10 0 UAE -10 Saudi Arabia -20 Qatar -30 Oman Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q1-2016 Q2-2016 Q3-2016 Q4-2016 Q1-2017 Q2-2017 Q3-2017 Bahrain -10 -5 0 5 10 15 Bahrain Kuwait Oman Qatar Saudi Arabia UAE Jan-2015 - Dec 2016 Dec 2016-Nov 2017 surpluses in the first to third quarters of 2017. Additionally, other Saudi sovereign wealth fund Public Investment Fund Qatar and Saudi Arabia reported current account surpluses (PIF), and the deposit by the PIF of funds with banks abroad. through the third quarter of 2017, reversing the deficits in Reserves have since slightly improved to US$493 billion at 2016 and 2017. the end of 2017. … easing pressure on currencies and reserves By at least one metric, months of imports of goods, the GCC foreign reserve positions are generally adequate, except in The early trade surpluses have eased pressure on the GCC cur- Bahrain. Notwithstanding the drawdowns, Saudi Arabia ’s re- rencies, just as the U.S. dollar has weakened. Previously, a serves stood at close to 50 months of imports of goods in the strengthening U.S. dollar (the U.S. dollar index gained 13.3 third quarter of 2017, compared to 56 months in end -2016. By percent in broad nominal terms and 12.4 percent in broad price mid-year, Kuwait had 13 months and Qatar 11 months, and at -adjusted terms from January 2015 to its 14-year high in De- the end of the first quarter, Oman had 7.5 months. The UAE cember 2016), collapsing oil prices beginning in mid -2014, had foreign reserves worth five months of imports in end -2016 and sharp current account deficits in 2015-16 exerted pressure and Bahrain four months, although the latter had dropped to on the GCC currencies’ peg to the U.S. dollar. The GCC coun- two months in end-June 2017. tries drew down 22 percent of reserves from a combined $908 billion in end-2014 to US$705 billion in end-2016. Other than the foreign reserves held by their central banks, the GCC countries also have recourse to the assets of their sover- Maintaining their dollar pegs, the GCC currencies have depre- eign wealth funds. GCC sovereign wealth funds are among the ciated against trading partner currencies in tandem with the largest in the world, including in Qatar, Kuwait and the UAE, U.S. dollar. The U.S. dollar lost 5.7 percent in broad nominal which have served as anchors for investor confidence in their terms from January to November 2017, and the GCC curren- economies and have earned generally high investment grade cies adjusted in the same direction (Figure 18). ratings in international markets. Qatar and Saudi Arabia continued to draw down on reserves In addition, Bahrain has had support from a regional resource, in the first half of 2017, although for altogether different the GCC Development Fund. Bahrain has the smallest central purposes. Qatar used US$9.5 billion of reserves in the sec- bank foreign reserves and the smallest sovereign wealth fund ond quarter of 2017 as it battled the measures imposed on it. (Mumtalakat Holding Company) with assets estimated at The decline has been stemmed in recent months, and re- around US$10.6 billion, one third of 2016 GDP. But Bahrain serves have begun to increase, nonetheless at US$37 billion has had the strong support of the GCC, especially Saudi Ara- in end-November 2017, these are still down 8 percent rela- bia, through the GCC Development Fund, which supports the tive to end -June 2017. The reduction in reserves (excluding Vision 2030 development goals. Bahrain had been allocated gold) in Saudi Arabia – from US$535 billion at the end of US$6.7 billion for projects as of end -June 2017. The explicit 2016 to US$484 billion at the end of September 2017 – is support from the GCC and the implicit backing of Saudi reportedly associated with the transfer of assets from the Arabia likely played some part in supporting investor confi- Saudi Arabia Monetary Authority (SAMA), which controls dence in Bahrain ’s US$3.0 billion international debt sale in the sovereign wealth fund SAMA Foreign Holdings, to the September 2017. CPI inflation Inflation has moderated Percent year-on-year Consumer prices remain subdued in the GCC so far in the year, compared to 2016. Prices in Saudi Arabia have been 5 falling since the beginning of 2017, reflecting sluggish do- mestic demand (Figure 19). Deflation pressures eased 4 somewhat in June after the government introduced excise 3 taxes on tobacco, sugary drinks and soft drinks (food and 2 beverages account for 20 percent of the consumer price 1 index (CPI) basket). Inflation has decelerated in the UAE; 0 in Kuwait, due to weak food prices and declining housing costs; and, in Qatar, despite the disruption in food imports -1 Jan-2017 Oct-2017 May-2017 Nov-2017 Dec-2017 Jul-2017 Apr-2017 Jun-2017 Feb-2017 Aug-2017 Sep-2017 2015 2016 Mar-2017 beginning in June 2017. The economic measures imposed on Qatar had a mixed impact on the country ’s inflation, pushing up food prices on one hand but depressing housing prices on the other. Bahrain Kuwait Oman Qatar Saudi Arabia UAE After rising to a four -year high of 2.8 percent in March 2017, inflation in Oman moderated to 1.7 percent yoy in November. With subsidy reform ongoing (domestic fuel Bank claims on the private sector, growth prices were linked to movements in international oil prices Percent year-on-year beginning in early 2016), inflation is likely to edge up again in the coming months. Inflation has slowly risen in 2017 in Bahrain, from 0.8 percent yoy in January to 2.9 percent yoy 30 in November. Still, the annual rate in 2017 will remain low- 25 er than the 3.0 percent in 2016. Higher utility tariffs will 20 lead to a further pickup of inflation in Bahrain, although not 15 as much as in 2016 when cuts to subsidies exerted upward 10 pressure on prices. 5 Credit growth has slowed 0 -5 Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q1-2016 Q2-2016 Q3-2016 Q4-2016 Q1-2017 Q2-2017 Q3-2017 Bank credit to the private sector has trended downward across the region. In part, this reflects both weaker demand due to a slowing of the infrastructure boom across the GCC region as Bahrain Kuwait Oman governments have tightened fiscal policy and a cooling of re- Qatar Saudi Arabia UAE gional property booms. Credit growth in the first to third quar- ters of 2017 was lower than in the first to third quarters of 2016 in all of the GCC countries (Figure 20). In Qatar, private sector credit growth has stabilized at around 7 percent yoy in recent Government deposits at banks, growth months, despite the diplomatic rift, likely due to continued Percent year-on-year demand related to FIFA projects. Deposits at banks, including government deposits, grew in 30 80 the period. Total deposits at banks grew faster in the first to 20 60 third quarters of 2017 than they did a year ago, except in Kuwait where the growth rate has trended downward. Gov- 10 40 ernment deposits also grew more robustly in countries 0 20 where they comprise an important source of bank funding. -10 0 In Oman, where they comprise 20 percent of bank liabili- -20 -20 ties, government deposits expanded an average 14 percent -30 -40 yoy in the first to third quarters of 2017. In Qatar, the in- Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q2-2016 Q3-2016 Q4-2016 Q1-2017 Q2-2017 Q3-2017 Q1-2016 crease in government deposits has more than compensated for withdrawals by foreign depositors, so that public sector deposits now account for more than a third of banking sec- Bahrain Kuwait Oman tor deposits. Saudi Arabia UAE Qatar (rhs) Central bank policy rates Lending rate, adjusted for CPI inflation rate Percent Percent 5 6 4 5 3 4 2 3 1 0 2 May-2015 May-2016 May-2017 Jan-2015 Jan-2016 Jan-2017 Nov-2015 Nov-2016 Nov-2017 Jul-2015 Jul-2016 Jul-2017 Sep-2015 Sep-2016 Sep-2017 Mar-2015 Mar-2016 Mar-2017 1 0 Q1-2015 Q2-2015 Q3-2015 Q4-2015 Q1-2016 Q2-2016 Q3-2016 Q4-2016 Q1-2017 Q2-2017 Q3-2017 Bahrain Kuwait Oman Qatar Saudi Arabia UAE U.S. - Federal Funds target Bahrain Kuwait Oman Qatar GDP growth GDP growth, percent year-on-year, and contribution Percent year-on-year to growth, percentage points 6 4 5 2 4 3 0 2 -2 1 -4 0 2017e 2017e 2017e 2017e 2017e 2017e 2018f 2019f 2018f 2019f 2018f 2019f 2018f 2019f 2018f 2019f 2018f 2019f -1 2017e 2017e 2017e 2017e 2017e 2017e 2019f 2019f 2019f 2019f 2019f 2019f 2015 2015 2015 2015 2015 2015 Bahrain Kuwait Oman Qatar Saudi Arabia UAE Bahrain Kuwait Oman Qatar Saudi Arabia UAE Private consumption Government consumption Fixed investment Net exports Jun 2017 forecast Jan 2018 forecast GDP growth policy remains accommodative. Real lending rates stand mostly under 5 percent (Figure 23). Central banks raised rates, but policy remains accommodative Near term prospects and key risks Most GCC central banks raised policy rates in tandem with the U.S. Federal Reserve. With their currencies pegged to the U.S. dollar (or to a basket of currencies with a heavy The economic outlook for the GCC countries remains positive weighting on the U.S. dollar, in the case of Kuwait), the GCC (Table 1), supported by a gradual and moderate recovery in oil central banks largely matched the U.S. rate hikes of Decem- prices and the expiry of the OPEC+ production agreement after ber 2016 and of March, June, and December 2017. Saudi 2018, sustained construction activity, and a slower pace of fis- Arabia, the UAE, and Bahrain raised policy rates four times cal austerity (Figure24). Aggregate regional growth is projected over the same period; Kuwait, twice (in December 2016 and to increase from a very weak 0.5 percent in 2017 to 2.1 percent March 2017); and Qatar, once (in December 2017). Oman in 2018 and 2.7 percent in 2019, mainly led by a resumption in raised rates gradually each month, taking the average repo growth in Saudi Arabia and Kuwait. Stronger global growth and rate from 1.19 percent in December 2016 to 1.74 percent in robust international trade and favorable financing conditions October 2017. Notwithstanding the rate increases, monetary will support the upturn in the GCC economies. Growth in 2018 will be led by fixed investment to boost fixed investment growth. The 2018 budget for Dubai envisages a 20 percent increase in spending over 2017 budget Fixed investment will lift growth in most GCC countries. Mas- plans and a 46.5 percent increase in infrastructure investment. sive construction and public investment programs are under- Growth in the UAE will also be supported by an easing in the way in the UAE, Qatar, and Kuwait (Figure 25). There will be pace of fiscal consolidation, underway since 2015, and a recov- scope for contributions to growth from private consumption, as ery in trade and tourism. The UAE will continue to benefit well, in Saudi Arabia, Oman and Bahrain. Overall, there will from its safe haven status in the region and its role as a com- be less of a drag to growth from a poor performance in public mercial hub in trade with Iran. The implementation of the val- consumption and net exports in 2018-19 than in 2015-17. ue-added tax (VAT) and excise taxes in 2018 is not expected to have a significant adverse impact on economic growth. Growth will recover moderately in Saudi Arabia to 1.8 percent in 2018, as the economy adjusts to the effects of the fiscal con- Fixed investment is also expected to drive growth in Qatar solidation begun in 2015. Growth will then strengthen in the through 2019, barring an escalation of the country’s rift with its medium term, beginning at 2.1 percent yoy in 2019, as the GCC partners or any worsening of the economic fallout from the structural reform measures advanced under Vision 2030 and measures imposed on the country. The multi-year US$130 bil- the National Transformation Program are implemented. The lion infrastructure program (98 percent of 2016 GDP) for the reforms aim to reduce the country’s dependence on oil and 2020 FIFA World Cup will help offset the effects of the expedite the development of the private sector. The economy measures imposed by Saudi Arabia, the UAE, and other Arab contracted in Saudi Arabia in 2017, at an estimated 0.6 percent. countries. The future launch of the US$10 billion Barzan Gas Oil GDP will decline in line with Saudi Arabia’s commitments Project, slated to add 2 billion cubic feet per day to the produc- under the OPEC+ agreement under which the world ’s second tion capacity of the world’s largest LNG gas exporter, will also biggest oil producer in 2016 shoulders the largest of the OPEC support medium-term growth, which is expected to pick up to production cutbacks through end 2018. 2.8 percent in 2018 and 3.3 percent in 2019. Major labor reforms announced in the summer for expatriate workers --- a first In the UAE, fixed investment will spur growth back to over among GCC countries --- will improve conditions for expatriates, 3.0 percent by 2019. The implementation of mega projects and also help attract and retain highly skilled expatriates who are associated with Dubai’s hosting of the universal exposition necessary to meet long term diversification objectives. Growth Expo 2020 (the first to be held in the MENA region) is expected in 2017 was likely a percentage point lower than previously been sustained. External funding for major infrastructure pro- CPI inflation jects will likely be cut by a fourth following the diplomatic rift with Qatar (the GCC Development Fund had previously com- Percent mitted US$10.0 billion for projects through 2021, US$2.5 bil- lion of which had been pledged by Qatar). Exports from indus- trial projects slated for completion in 2019 -21 will partially 5 offset the lower levels of fixed investment in the future: alumi- 4 num exports from the new potline at Aluminium Bahrain, set to become operational in 2019, and petroleum products from 3 the expansion of the Sitra oil refinery, in 2020 -21. Growth is 2 forecast at 1.7 percent in 2018 and 2.1 percent in 2019. 1 Inflation will pick up in 2018, but moderate in 0 2019 -1 Inflation is expected to generally pick up in the GCC in 2018, 2015 2016 2017e 2018f 2019f as the VAT is introduced across the region. In Saudi Arabia Bahrain Kuwait Oman and the UAE, where the authorities have implemented the Qatar Saudi Arabia UAE VAT and excise taxes starting in January 2018, CPI inflation is anticipated to rise to 4.9 percent and 2.9 percent respectively (Figure 26). These and the other forecasts of rising inflation in forecast, at 2.2 percent, embedding the effects of the ongoing 2018 assume that the inflationary impact of the VAT will be fiscal consolidation as well as of trade diversion resulting from one-off, and will not lead workers to demand higher wages or the measures imposed on Qatar by its larger GCC partners. sellers to raise prices more generally. The forecasts also as- sume that the VAT will not have cascading effects --- the max- Growth in Kuwait is expected to rebound to 3.5 percent in imum direct effect on the price level will not exceed the tax 2019. Early improvements in project implementation and gains rate (5 percent). These appear to be reasonable assumptions, in fixed investment were unlikely to have offset the decline in reinforced by the expectation that the zero -rating (i.e., the ex- oil GDP in 2017 for the GCC’s economy that is second most emption) of certain classes of goods and services will reduce dependent on the hydrocarbon sector. However, plans to invest the inflationary impact of the tax. US$115 billion (over 107 percent of 2016 GDP) in the oil sec- tor over the next five years should boost oil GDP in line with Thereafter, inflation will moderate in 2019. The inflationary the gradual recovery in oil prices in 2018 -19. The growth fore- impact of the VAT will dissipate after 2018-19. Moreover, the cast for 2019 assumes continued improvements in project im- GCC governments would have implemented the bulk of energy plementation under the Five-Year Development Plan for price subsidy reforms by the end of the forecast period, damp- 2015/16 to 2019/20, including progress with long -stalled stra- ening their short-term price-boosting effects. Inflation is ex- tegic large-scale infrastructure and construction projects, and pected to hover under 2 percent in Oman and Saudi Arabia in with public-private partnerships (PPPs). 2019, under 2.5 percent in Bahrain and the UAE, and under 3.5 percent in Kuwait. In Oman, growth is expected to recover to 2.3 percent in 2018, after a moderate growth rate of less than 1 percent in 2017. The The recovery in oil prices will help reverse, or expected growth recovery will be mainly driven by a boost in narrow, current account deficits the hydrocarbon sector accompanied by pro -business reforms. The state-owned Oman Oil Company and British Petroleum The GCC countries, except Oman and Bahrain, are expected to started production in September 2017 from the massive post current account surpluses, at the latest by 2019. Exports US$16.0 billion Khazzan Gas Project. Deploying the largest will benefit from the conclusion of the OPEC+ supply reduc- application so far in the Middle East of U.S. -style fracking tion agreement – expected after 2018 – and the gradual and technology, the two phases of the project will deliver an esti- moderate recovery in oil prices through 2018-19 as oversupply mated 10.5 trillion cubic feet of recoverable gas resources by in oil markets diminishes. The pace at which current account 2020. In general, recent efforts by the authorities to advance balances will improve will vary among the GCC countries the goals of the 9th Five-Year Development Plan of 2016-20 (Figure 27), determined as well by the performance of their through a set of concrete actions under the National Program services, primary income, and secondary income accounts. for Enhancing Economic Diversification (Tandfeedh), includ- ing projects in manufacturing, logistics and tourism, are ex- The surplus in the UAE will be more modest than in the past, pected to boost growth prospects in the medium -term. averaging 2.8 percent of GDP in 2017-19, compared to 13.9 percent of GDP in 2010-13 before oil prices halved from mid- Bahrain may not replicate last year’s growth uptick in 2017-19. 2014. In addition to a better crude oil export performance, pro- Elevated levels of oil production in early 2016 have not since gress with transportation infrastructure projects will augment Current account balance General government balance Percent of GDP Percent of GDP 10 0 5 -5 0 -10 -5 -15 -10 -15 -20 -20 -25 Bahrain Kuwait Oman Qatar Saudi UAE Bahrain Kuwait Oman Qatar Saudi UAE Arabia Arabia 2015 2016 2017e 2018f 2019f 2015 2016 2017e 2018f 2019f non-oil export earnings. In Saudi Arabia, the recovery in oil Fiscal adjustment will continue, with favorable prices will boost oil export receipts. Merchandise trade will results… also be spurred by rising export volumes of aluminum, phos- phates and petrochemicals. The authorities have also an- Fiscal balances are set to steadily improve across the GCC nounced plans to curb current transfers (remittances). Qatar countries. The expected gains are underpinned by fiscal re- will benefit from the recovery in oil and gas prices. Its surplus forms, many of which are underway and others of which are to will decline, however, as capital goods imports for its infra- be introduced in 2018 and 2019 (Figure 28). All six GCC structure projects expand and as the import costs associated countries had previously agreed to implement a region -wide with the diversion of trade to alternative partners (that has been harmonized value added tax (VAT) system starting in 2018. necessitated by the rift with its neighbors) increase. The coun- The Unified VAT Agreement allows a basic tax rate of 5 per- try’s continued reliance on international oil firms and foreign cent, albeit with certain classes of goods and services exempt workers will keep its primary and secondary income accounts from coverage, and sets the framework under which each in deficit. Qatar is most reliant among the GCC countries on member state will issue its own local law to implement the tax. expatriate labor, with some 2.2 million expatriate workers in The degree of preparedness for the VAT varies, with the UAE the country relative to a native population of about 300,000. the most advanced in terms of administrative and business ca- pacity and systems. Saudi Arabia and the UAE are implement- Kuwait is expected to post a current account surplus in 2017 - ing the tax in January 2018, with the other GCC countries ex- 19. The trade performance in Kuwait will be driven by oil ex- pected to follow suit by 2019. ports, which have comprised over 90 percent of total merchan- dise exports over the past two decades. The improvement in oil In Saudi Arabia, the fiscal deficit is expected to narrow sub- prices, relative to previous years, will lead to a modest narrow- stantially from 16.9 percent of GDP in 2016 to 4.9 percent of ing of the current account deficit in Bahrain in 2017 -19. An GDP in 2019. The government previously committed that the increase in exports from major industrial projects, aluminum next phases of the revenue and expenditure reform programs from Aluminum Bahrain and refined petroleum products from outlined in the Fiscal Balance Program will be introduced as the Sitra oil refinery, will will also help narrow the deficit. scheduled, including: the continued reform of the household allowance program from 2017 onward; the implementation of The current account deficit in Oman will likely persist, but the VAT in 2018; the introduction of luxury tariffs in 2018; the should narrow steadily over 2017-19. Oman will maintain a adjustment of non-household electricity prices and household merchandise goods trade surplus as oil prices recover and as water prices to their reference prices by 2018 and 2019 respec- natural gas exports increase following the start of production tively; and, the linkage of all unpegged energy product prices from the Khazzan Gas Project. The services account, histori- to reference prices by 2019. The government also committed cally in deficit, will benefit from rising tourism receipts. As in that expenditure savings identified by the Bureau of Spending Qatar, the primary income account in Oman will remain in Rationalizations will be realized. deficit from continuing profit repatriation by foreign compa- nies, and the secondary income account, from high levels of The 2018 Saudi budget, however, indicates that the authorities outward remittances in the GCC economy that is second most are now taking a more gradual approach to fiscal adjustment, dependent on expatriate labor. prioritizing growth over fiscal consolidation and pushing out plans to balance the budget to 2023 (from 2020 previously) in gradually, while increasing public investment to support order to soften the impact of the adjustment on households and growth. Nevertheless, fiscal reforms are necessary. The public firms. Spending is expected to rise by 5.6 percent in 2018 over sector is one of the largest in the world, with a spending to 2017 budgeted levels, the highest on record for the country. GDP ratio of just over 50 percent. Oil rents are distributed This reflects a more gradual approach to cutting subsidies: the through subsidies, transfers and public employment, with 80 target of reaching parity with international oil prices has been percent of employed Kuwaiti nationals working in the public postponed from 2020 to 2025. The higher spending also re- sector. Reducing the heavy footprint of the state on the econo- flects earmarks for the “Citizens’ Account” cash transfer pro- my, and shifting its role from “rowing to steering” the econo- gram. The deficit is projected to decline to 7.6 percent of GDP my is critical if private sector activity is to flourish. The gov- in 2018, supported by rising oil revenues and receipts from the ernment is expected to gradually remove fuel and electricity newly introduced VAT. The deficit could however prove larger subsidies, reprice government services and implement the given the cost of new support measures announced in January VAT to channel spending towards more productive uses, and 2018: additional monthly allowances for state employees, pen- to help diversify revenue away from oil. A medium -term fis- sioners and social security recipients; extra stipends for stu- cal framework will help guide implementation of the fiscal dents; one-off bonuses for soldiers on the Yemen front; and, consolidation plan. state coverage of VAT costs for health and education services as well as for first-time home purchases. Besides the issuance Oman should come close to cutting its large fiscal deficit by of debt, the 2018 fiscal deficit is expected to be partly financed half by 2019. Fiscal outturns in the first half of 2017 indicate by drawdowns of Saudi Riyal from the stock of government that the deficit is expected to narrow to 13 percent in the year deposits and international reserves. from 20.8 percent in 2016. A forecast fiscal deficit of 10.1 percent of GDP by 2019 assumes the timely and steadfast The fiscal position will remain sustainable in the UAE in the implementation of fiscal adjustment: the introduction of the forecast period. Ample fiscal space will allow the UAE to VAT and the imposition of excise duties. The government more gradually execute its fiscal adjustment program, which has also agreed to raise the basic corporate income tax rate to had been front-loaded in 2015-16 following the collapse of oil 15 percent from 12 percent, to impose a 3 percent rate on prices from mid-2014. The introduction of the VAT in 2018 very small companies that had been previously exempt, and will complement recent energy subsidy reforms and help diver- remove other exemptions. sify revenues away from oil. Moreover, continued efforts to contain the growth of public spending will generate fiscal sav- Bahrain will see a modest improvement in its fiscal position ings to help support public investment. The deficit is expected through 2019. The fiscal deficit is forecast to narrow slightly to improve steadily from 3.2 percent of GDP in 2017 to 1.0 from an estimated 13.2 percent of GDP in 2017 to 10.2 percent percent of GDP in 2019. of GDP in 2019. Some of the increase in revenues from the planned implementation of the VAT in 2018-19 will be offset Notwithstanding the diplomatic rift, Qatar is expected to contin- by rising interest payments on government debt. Bahrain has ue with its fiscal consolidation plan in the medium-term. The the largest gross government debt among the GCC countries. government is expected to persevere with fiscal adjustment, fo- cusing on tax policy, including the VAT and indirect taxes and …and help moderate the recent rise in gross gov- levies, as well as tax administration measures. The government ernment debt is also expected to continue to reduce subsidies and to rational- ize recurrent expenditures, albeit at a more measured pace as Narrowing fiscal deficits imply that the increase in government Qatar endeavors to protect its population from the economic and debt over the forecast period will be relatively more moderate social costs of the trade restrictions. The introduction of the than recently experienced. General government gross debt is VAT and excise taxes in 2018-19 will help Qatar contain the forecast to stay flat at around 21 percent of GDP in the UAE in deficit at under 4.0 percent of GDP in 2018-19. 2017-19, and at 54 percent of GDP in Qatar. Gross debt will still rise, but stay under 55 percent of GDP in Oman, under Kuwait will likely post fiscal deficits in the near term, but low- 40 percent of GDP in Kuwait and under 25 percent of GDP in er than in 2015 and 2016, when investment income from and Saudi Arabia. In Bahrain, where the fiscal deficit will decline transfers to the sovereign wealth fund are excluded from the only modestly, gross debt will expand from 91 per cent of calculations. For many years, the government has anchored GDP in 2017 to 107 percent of GDP in 2019. fiscal policy on obligatory annual transfers of resources (a min- imum 10 percent of all state revenues and 10 percent of the net International debt securities issuance will remain important for income of the General Reserve Fund) to the Future Genera- deficit financing in the medium-term. On the assumption that tions Fund (the inter-generational saving fund), which has global financing conditions will remain benign in the forecast helped provide the government substantial stock of asset buff- period, the GCC governments will likely return to the interna- ers of over US$500 billion. The sovereign wealth fund, the tional debt market for additional sovereign issues in 2018-19. inter-generational saving fund and the low gross government Debt sale terms had been favorable in 2017. Saudi Arabia ’s debt in end-2017, estimated around 27 percent of GDP, pro- US$9.0 billion issue was 3.6 times over -subscribed; Kuwait’s vide Kuwait the policy space to implement fiscal consolidation US$8.0 billion, 3.6 times; Oman’s US$7.0 billion, four times; General government gross debt U.S. Federal Reserve FOMC participants’ assessments of Percent of GDP appropriate monetary policy, mid-point of target range or target level for the Federal Funds rate, December 2017 120 100 5.0 4.5 80 4.0 60 3.5 3.0 40 2.5 20 2.0 1.5 0 1.0 Bahrain Kuwait Oman Qatar Saudi UAE 0.5 Arabia 0.0 2015 2016 2017e 2018f 2019f 2017 2018 2019 2020 Longer run Capital adequacy ratios, and Liquidity ratios, Profitability, Asset quality, Foreign exchange risk, end-2016 end-2016 22 Capital adequacy Liquidity 22 Profitability Asset quality Foreign exchange risk 21 Capital Adequacy 60 2.5 10Capital Adequacy 10 20 20 50 2.0 8 8 19 18 18 40 6 6 16 17 1.5 16 30 4 4 14 14 1.0 15 2 2 20 12 12 0.5 0 0 13 Regulatory tier-1 capital 10 to risk-weighted assets Regulatory Return on asset s tier-1 capital to loans Non-perfoming risk-weightedNet assets open position in Regulatory ti er-1 capi tal t o risk- Liquid asset s to short-term liabi lities to total gross loans foreign exchange to weighted assets capit al 75th percentile Median 25th percentile Bahrain 75th percentile Median 25th percentile Bahrain Kuwait Qatar 75th percentile Saudi Arabia UAE 75th Percentile Kuwait Qatar 75th Percentile Saudi Arabia 75th Percentile UAE 75th percentile Median and, Bahrain’s US$3.0 billion, five times. Thanks to the pro- Banks remain well-capitalized spect of a low interest rate environment, GCC issuances will likely attract investors anew, given their better yield and supe- The positive medium term outlook requires strong GCC banks. rior credit quality. According to the 20172 IMF Financial System Stability As- sessment on Saudi Arabia, the banking system had started to Maintaining their currency pegs, central banks normalize by end-2016 after sharply higher government do- will likely follow U.S. rate hikes mestic borrowing tightened banking liquidity in 2015-16. Stress tests show that most banks, including all systematically The GCC countries are likely to maintain their currency pegs. important banks, would be able to continue meeting regulatory The exchange rate anchor implies that the GCC central banks capital requirements in the event of additional severe economic will likely raise rates in tandem with the U.S. Federal Reserve. shocks. Moreover, all banks would be able to cope with addi- The U.S. central bank, which raised rates anew in December tional adverse liquidity shocks. 2017, signaled that it saw the Federal Funds rate at 2.125 per- cent in 2018 (median value) and at 2.8675 percent by the end Financial soundness indicators also show that other GCC bank- of 2019 (Figure 30). The GCC central banks will likely keep ing sectors are well capitalized. While the other GCC financial pace with the U.S. rate increases. Declining international re- systems have not been recently subject to comprehensive and serves in Oman and Bahrain are of concern however. in-depth assessments, as done in Saudi Arabia, basic financial strength and vulnerability indicators show that banks in the GCC countries score well on capital adequacy and liquidity relative to the global median or to Saudi Arabia, as a benchmark (Figure 31). Nonetheless, profitability, asset quality, and foreign exchange risk Hydrocarbon GDP, exports ratios need careful monitoring in some cases (Figure 32). and revenues in the GCC Risks and long-term challenges Risks to the regional outlook are on the down- side in the medium-term In the near- to medium-term, the risks to the positive outlook arise from uncertainty in the oil price forecast, any escalation in the ongoing diplomatic rift between Qatar and Saudi Arabia and its partners, and weak institutional capacity which may derail progress with the difficult structural reform measures. There are significant upside and downside risks to the oil price forecast. On the upside, stronger demand, world output disrup- tions arising from geopolitical disputes, or production short- falls in U.S. shale could tighten markets and raise prices above the forecast. On the downside, slower demand growth, faster than expected growth in U.S. shale oil production, rising out- put from Libya and Nigeria (which are exempt from the pro- duction cuts), or weaker compliance with the OPEC+ agree- ment could derail the rebalancing and lower prices below the forecast. Lower than expected oil prices will dampen medium - term growth in the GCC economies, given their heavy reliance on oil and gas production, exports and revenues, and will exert pressure on the OPEC producers and their non -OPEC allies to extend or deepen the production agreement. Any escalation of the diplomatic dispute in the GCC could hurt economic prospects in the region as a whole. The harm will arise not from any further disruption to trade, given the small amount of intra-regional goods exchange in the GCC, but from damage to investor sentiment, which will derail investment activity, or to market sentiment, which will disrupt financial flows. The multi-sectoral reform agendas of the GCC countries are necessarily complex, requiring strong political resolve as well as strategic coordination and strong institutional capabilities if they are to be implemented well. Slippage on any of these fronts will rob the GCC of the benefits of fiscal adjustment and of economic reorganization. Complacency may set in as oil prices rise and fiscal and external account deficits narrow. Po- litical resistance could grow as economic reforms dislodge vested business interests and expenditure and subsidy reforms harm middle and lower income households. And administrative capacity could decline as structural reform measures advance in scope and scale. The lack of institutional experience with the complexities of adjustment and reform programs could also be a complicating factor. The enduring dominance of oil and gas production, exports and revenues in the GCC economies (Box 1) argues for the vigorous Qatar, the world’s largest LNG producer, has the Hydrocarbon GDP contributed little to economic largest hydrocarbon sector, percentage of GDP growth in 2015-16, in percentage points 70 10 60 50 5 40 0 30 20 -5 10 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 2012 2013 2014 2015 2016 0 Qatar Kuwait Saudi Oman United Arab Bahrain Bahrain Kuwait Oman Qatar Saudi UAE Arabia Emirates Arabia Rising oil prices (2000-07, 2010-13) Falling oil prices (2008-09, 2014-16) 2000-16 Hydrocarbon GDP Nearly all of Kuwait’s exports are hydrocarbon ex- The terms of trade deteriorated most sharply for ports, percent of total merchandise exports Kuwait, Saudi Arabia, Qatar and Oman, 2010 = 100 100 140 80 120 60 100 40 80 20 60 0 Kuwait Qatar Saudi Oman Bahrain UAE 40 Arabia 2010 2011 2012 2013 2014 2015 2016 Rising oil prices (2000-07, 2010-13) Falling oil prices (2008-09, 2014-16) Bahrain Kuwait Oman 2000-16 Qatar Saudi Arabia UAE Hydrocarbon receipts are 85 percent of government The GCC made large-scale spending cuts as hydrocar- revenues in Saudi Arabia, the world’s second largest bon revenues dried up. General government spending, oil producer, percent of general government revenue cumulative decrease in 2015-16, in percent from 2014 100 0 80 -5 60 -10 40 -15 20 -20 0 -25 Kuwait Qatar Saudi Oman Bahrain UAE Arabia -30 Rising oil prices (2000-07, 2010-13) Falling oil prices (2008-09, 2014-16) Bahrain Kuwait Oman Qatar Saudi UAE 2000-16 Arabia implementation of structural reforms to accelerate economic the parliament. Accordingly, although the government has not diversification. Following the collapse of oil prices beginning backtracked, reforms have been watered down4 or postponed. in mid-2014, the GCC countries designed ambitious plans to transform their economies, starting with fiscal consolidation in Fiscal reform and further consolidation remain the aftermath of the oil price decline and progressing toward a necessity private sector development, public sector reform, and social development in the medium to long term period. The downside Further fiscal consolidation is needed in the GCC countries. The risks to the forecasts for an economic upturn in 2018 -19 high- sharp reversal of fiscal surpluses into fiscal deficits beginning in light the need for the GCC countries to strengthen their com- 2014 compelled the front-loading of the fiscal adjustment in mitment to these reform plans. 2015-16. The early steps, focused on a first-phase increase in energy prices and utility tariffs, were a good start. Energy price The GCC structural reform plans need clarity, subsidies declined by 1.5-5.0 percentage points of GDP from prioritization, sequencing… and political com- 2013 to 2016 (Figure 33). But the gains from the petroleum price mitment subsidy reform in 2013-16 were due more to the decline in benchmark international prices than to domestic prices increases, The redrafting of the National Transformation Program (NTP) which underlies the theme that, despite recent efforts, energy --- into NTP2.0 --- affords Saudi Arabia the opportunity to give price rationalization remains an unfinished agenda (Figure 34). its reform plans greater clarity and focus. Originally designed to overhaul the Saudi bureaucracy with program targets for But, energy price reform alone is insufficient to put public fi- each government ministry through 2020, the NTP is now one nances on a sustainable footing and to ensure that oil wealth is of 12 “vision realization plans” associated with Vision 2030. shared equitably with future generations. Fiscal consolidation Detailing the program elements of the NTP, which had since requires both revenue and expenditure measures, and they are been expanded to lift the private sector share of the economy likely to be sizable considering the GCC countries ’ heavy reli- from 40 to 65 percent and the small and medium enterprise ance on volatile hydrocarbon revenues, their unsustainable (SME) contribution from 20 to 35 percent among other targets, levels of spending on subsidies and transfers and the use of should help with the effective implementation of Vision 2030, public sector employment as a key safety net. Saudi Arabia’s ambitious and wide-ranging effort to signifi- cantly transform its economy over the next 15 years. The introduction of the value-added tax (VAT) and the excise taxes on tobacco products and carbonated drinks should help As with Saudi Arabia’s Vision 2030, the other GCC countries’ the GCC raise revenues from other than hydrocarbon sources. own Vision documents aspire to construct competitive econo- So far, Saudi Arabia and the UAE have passed the legislation mies that are diversified away from hydrocarbons. Bahrain’s and set the administrative arrangements to implement the VAT Economic Vision 2030, Kuwait’s Vision 2035, Oman’s Vision in January 2018. The remaining GCC countries are expected to 2020, Qatar’s National Vision 2030, and the UAE’s Vision 2021 introduce the VAT sometime in 2018 and potentially as late as also aim to develop productive industries and enhance human 2019. The revenue from a VAT is likely to be significant for capital in the GCC countries. The Vision statements are uniform- most GCC countries (Figure 35). ly supported by development plans that seek to operationalize the overarching goals with specific public policies and concrete Measures on the expenditure side may be more contentious, but are government programs, including by Qatar’s National Develop- equally vital to the adjustment effort. The reforms include: second- ment Strategy (2017-22), Bahrain’s National Development Strat- round adjustments to energy and other subsidized prices while pro- egy (2015-18), Kuwait’s Development Plan (2015-20), and tecting the most vulnerable households, control of the government Oman’s Ninth Development Plan (2016-20) and National Pro- wage bill by limiting both wage increases and employment, and gram for Enhancing Economic Diversification (Tanfeedh). measures to strengthen public investment management to improve implementation capacity and investment efficiency. It is important, The political commitment to reform remains vital. The GCC however, that the GCC governments schedule and calibrate the authorities would benefit from continuing efforts to refine their fiscal proposals carefully, as any excessive tightening might exact long-term development objectives and prioritize and sequence unreasonable social costs and unduly damage growth prospects. their reform plans as evolving conditions warrant. However, recrafting the strategy documents should not detract from the Promoting private sector activity will enable obviously more important task of executing the reform plans. diversification and spur productivity Implementing the structural transformation programs across multiple sectors requires continuing political commitment from Promoting private sector activity will enable economic diversi- the GCC governments, which on occasion may have wavered fication. Playing oversized roles in their economies, including with recent decisions to reverse previous reform measures or to postpone the initiatives to the outer years of the Vision periods. In Kuwait, for instance, while the government has announced 4/ This is particularly true of electricity price reforms. Prices were originally intended to quadruple. However, by the time reforms were implemented, the major reforms, embedded in the Economic Reform Agenda, cumulative average increase amounted to only 180 percent. In addition, plans it has faced difficulty in building consensus, particularly from for a business profits tax have been delayed. Energy price subsidies Change in petroleum price subsidies, in percent of Percent of GDP GDP, and contributions to change in petroleum price subsidies, in percentage points 10 4 8 2 6 0 -2 4 -4 2 -6 Bahrain Kuwait Oman Qatar Saudi UAE 0 Arabia Bahrain Kuwait Oman Qatar Saudi UAE International oil price change Price adjustment Arabia Consumption Residual 2013 2016 Change in petroleum subsidy Potential revenue from a 5 percent VAT Value of government shares in listed state-owned Percent of GDP enterprises, and total stock market capitalization Percent of GDP, end-2015 100 2.5 80 2.0 60 1.5 40 1.0 20 0.5 0 0.0 Bahrain Kuwait Oman Qatar Saudi UAE Bahrain Kuwait Oman Qatar Saudi UAE Arabia Arabia Average C-efficiency ratio = 0.58 Value of government (excluding pension funds) shares in listed SOEs Base = 90 percent of private consumption Stock market capitalization through state-owned enterprises, the GCC governments have of the government’s privatization resolve comes with the begun to consider the privatization of state assets. Data on gov- planned sale in 2018 of a five percent stake in the Saudi Ara- ernment shares in listed companies show that the market value bian Oil Company (Aramco), the world ’s largest oil and gas of these assets are significant (Figure 36), and therefore the company by revenue, in an initial public offering (IPO) that scope for private engagement is substantial. could possibly raise US$100 billion (15 percent of 2016 GDP), reportedly to help develop other industries in the coun- Saudi Arabia’s privatization programs should enhance private try. The government converted Aramco to a joint stock com- sector development in the medium to long term. The govern- pany in January 2018, a key step to the IPO. ment has announced a series of initiatives, employing differ- ent modalities of private management and investment, in a In addition the GCC countries are increasingly turning to wide range of sectors, including airports, waste water treat- public -private partnerships (PPPs) to engage private enter- ment facilities, and hospitals. In airports, the proposals include prise and capital in infrastructure. Most countries have de- the management of the King Abdulaziz International Airport, veloped or are developing the legal frameworks to tender the sale of a stake in the King Khalid International Airport to and manage PPPs. Kuwait revised its original 2008 PPP law private investors, and, the transfer of ownership of the King in 2014 and organized a new body in 2015, the Kuwait Au- Fahd International Airport to the Public Investment Fund thority for Partnership Projects (KAPP), to encourage for- (PIF), one of two Saudi sovereign wealth funds. A major test eign private investment. KAPP is also currently preparing Harnessing the energies of private activity and fostering pri- Doing Business global ranking vate entrepreneurship is a complex undertaking. Raising the private sector’s share in the economy also involves, among 1 = best others, business environment reform, business development services, local economic development initiatives, and women’s entrepreneurship development. The GCC authorities need to 1 view these activities as long-term efforts, for which sustained 22 13 engagement will be necessary. 43 20 2621 39 33 64 85 63 66 61 6568 Overall, the GCC countries need to focus on improving their 71 106 96 8383 92 business environment. Among GCC countries, the latest Doing 94 127 102 Business global rankings show the UAE as having the most 148 business friendly environment; moreover, the country has 169 maintained its relatively high rankings over the past decade. 190 Other GCC countries (save Oman) however have seen rank- Bahrain Kuwait Oman Qatar Saudi UAE ings deteriorate since 2010 (Figure 37). Arabia 2010 (out of 183 countries) 2017 (out of 190 countries) Nevertheless, regulatory reforms have begun to stem the 2018 (out of 190 countries) deterioration, and in the case of Kuwait and Saudi Arabia have actually begun to improve since 2016. Regulations on which the Doing Business rankings are measured, includ- a PPP Investor Guidebook aimed at informing and guiding ing those pertaining to property rights, investor protections, public entities and private investors on best practices for dispute resolution, and contract enforcement, are central to structuring and implementing PPP projects. After Dubai whether economies perform well and whether the perfor- passed a PPP law in 2015 that does not require private inves- mance is sustainable. These business rules and regulations tors to make an initial public offering of shares in the project are also well within the control of governments to enact company, the UAE is considering a PPP law based on the and enforce. For the GCC countries, the quality of the busi- Dubai model. Saudi Arabia is also considering new legisla- ness environment is crucial to any effort to raise the partic- tion to facilitate the tendering of PPP projects. And, Qatar ipation of the private sector in, and the contribution of do- and Oman have drafted PPP laws that were planned to be mestic small and medium enterprises to, the economy. Sau- enacted in late 2017 or early 2018. di Arabia carried out a record number of reforms during the past year to improve the business climate for small and Several PPP projects have been tendered and awarded since. medium enterprises that included measures to ease the pro- Oman’s Sultan Qaboos Medical City was structured as a PPP cess of starting a business, registering property and strong- in 2016. Dubai awarded a large car park PPP in 2016 and has er protections for minority investors. Paying taxes was sim- opened tender for the metro transport hub Union Oasis Station. plified by improving the online platform for filing and pay- Saudi Arabia awarded four airport PPPs in 2017, in Taik, ing taxes, which reduced the number of hours needed to Yanbu, Hail and Al-Qassim. Kuwait has opened tenders for pay taxes from 67 to 47. To facilitate trade across borders, railways, hospitals and schools. Qatar is expected to tender a the time for documentary compliance for exports and im- World Cup football stadium and hospitals. ports was shortened by reducing the number of documents required for customs clearance, which decreased the time The competitive and regulatory environments will determine for documentary compliance by nine days for both exports whether the PPPs succeed. The expectation with infrastruc- and imports. ture PPPs in the GCC, as elsewhere, is that privately imple- mented projects will result in greater efficiencies in the de- Economic diversification and private sector de- velopment of infrastructure, the management of assets, and velopment require labor market reforms the provision of services. Whether the GCC projects will achieve these efficiencies will depend on how the govern- To advance their economic transformation objectives, the GCC ments design the economic incentives and structure the busi- countries will need to reexamine their labor market policies. ness environments under which the PPP projects will operate. Distortionary policies and practices have created segmentation A lack of competition, for example, will provide the PPP in the GCC labor markets, where the public sector attracts na- projects little incentive to upgrade quality or to reduce costs. tionals through high wages and the private sector employs In addition, poor contract regulation – an inability to enforce mainly low-skilled foreigners. On average, foreign labor ac- the verifiable terms of contracts, to police the contracting counts for about 80 percent of private sector jobs. The segmen- process to deter fraud, and to create modes of resolution in- tation is particularly acute in Qatar, which has seen huge de- cluding through the bankruptcy code – will hobble PPP oper- mographic imbalances emerge because of the import of low - ations. Poorly structured PPPs could also contribute to con- skilled male foreign workers to work on public investment and tingent fiscal liabilities construction projects. Reducing the incentives favoring public over private sector employment will encourage nationals to seeks private sector Employment-to-population ratio (aged 15+ years) jobs. The GCC governments are generally employers of first Percent resort for nationals, and offer more generous compensation and better working conditions than the private sector. Redirecting nationals toward private sector employment, including by de- 100 creasing the public-private sector wage gap, investing in edu- cation that supports the skills needs of private industry, and 80 providing for unemployment insurance, will serve the objec- tives of economic diversification and private sector develop- 60 ment. Moreover, reducing the ready availability of government jobs, trimming the size of the public workforce, and moderat- 40 ing the growth of public wages will help the GCC governments cut the wage bill, advance fiscal adjustment, and boost public 20 sector reform. 0 Attracting and retaining highly skilled foreign workers is also Bahrain Kuwait Oman Qatar Saudi UAE Arabia necessary if the GCC countries are to become knowledge - Male Female Total driven economies. There are often stringent restrictions in place on the mobility of foreign workers (who tend to be tied to one employer under sponsorship systems), most of whom are low-skilled and, thus, have low productivity.5 The GCC GCC policy makers also need to address signifi- countries have begun liberalizing the movement of workers cant challenges in domestic pension systems (the sponsorship system for instance has been fully liberalized in Oman and Bahrain). Qatar has passed a law allowing perma- As in other Arab countries, GCC countries also face sustaina- nent residency for some expatriates (those providing bility, equity and welfare challenges with their pension sys- “outstanding services”) – a first among GCC countries. Hold- tems. These issues need to be addressed urgently if they are not ers of the new permanent residency will be able to shift jobs to be a drag on economic growth, fiscal sustainability, and la- freely and can, for the first time, access free state education bor market stability. In particular, pension systems in the GCC and healthcare, and have the right to own property and run are fragmented and characterized by limited coverage (mainly some businesses without needing a Qatari partner. Such re- by excluding expatriates). Despite the low coverage, pension forms can help improve labor market outcomes by encouraging spending is high and benefit rates are misaligned, with contri- competition and efficiency in labor markets, support invest- bution rates raising concerns about fiscal sustainability. The ments in on-the-job training, and enable countries to attract and pension reform agenda is accordingly important for policy retain the highly skilled workers needed to help achieve their makers in the GCC countries given their aspirations to broaden long-term diversification objectives. their economic base, spur private sector development in the non-oil economy, and develop their labor markets. The In Fo- Increasing the labor force participation rate of women will cus section of this report sets out potential solutions and pro- invigorate the labor market. Women ’s labor force participa- posals that could help improve pension outcomes. tion and employment are low in the GCC countries (Figure 38). According to one study, the income loss from gender gaps in women ’s labor force participation, workers ’ pay, and entrepreneurship are highest in the Middle East and North Africa (MENA) region, where the estimated total loss amounts to 27 percent of income per capita. In this connec- tion, Saudi Arabia ’s recent decision to lift the ban that pro- hibits women from driving is a positive step that could have a significant economic impact by raising the labor force participation rate of women in the country --- it would make commute to work less difficult, would entice more women to seek work, and would make employing women more ap- pealing to firms. 5/ According to IMF estimates, only 15 percent of workers in Saudi Arabia, Oman, Bahrain, Qatar and Kuwait possess some form of tertiary education. The UAE is an exception, where a third of expatriates that can be characterized as highly skilled. IMF. 2013. “Labor Market Reforms to Boost Employment and Productivity in the GCC”. I think it is important to note that although GCC countries are high income countries, they have much room for improvement. This is evident in overall functioning of the economies, the effectiveness of their public sectors and delivery of public ser- The collapse in 2014 oil prices – from over US$110 in June vices, health and educational learning outcomes, employability 2014 to just US$30 in January 2016 undoubtedly shook the of their citizens in an increasingly connected global environ- GCC economies. The shock has exposed fundamental structur- ment, the lack of dynamism of their private sectors and the al weaknesses in these economies, and the conventional way inability of firms (outside the oil sector) to export internation- these countries operated became unsustainable. ally and so on. So far, GCC countries appear to have managed to find a for- If you just look at the public sector, you will see that it has an mula that works in adapting to new global oil price dynamics. outsized economic footprint across the region. Private sector Initially, the uncertainty about the oil price floor and the dura- firms are almost wholly dependent on government spending. tion of low oil prices led to some delays in introducing effec- Similarly, citizens count on lifetime employment in the public tive measures. Their adjustments, thus, have been a mixture of sector where there is weak monitoring of performance, and some spending restraint, particularly cutting investment spend- they depend on transfers to finance housing, education, health ing, some borrowing on international capital markets, and also and subsidies for energy and water consumption. This “social some use of the big financial assets that they had built up dur- contract” has undoubtedly meant that citizens enjoy a very ing the boom years. Once oil prices stabilized around $40 a high standard of living – they also pay no taxes. Yet, this sys- barrel, the protracted nature of the oil price collapse has be- tem has also contributed to very serious distortions in the econ- come clear. Going into 2018, I believe the region ’s economies omy, affected incentives of citizens to invest in themselves (in have a little more confidence in oil price dynamics. They have terms of the right kind of human capital and technical skills) realized that the initial strategies have bought them breathing and also stifled innovation and creativity, which are at the heart space for two-three years. But these transitory solutions will of the dynamism of other advanced economies. The govern- not be sufficient in addressing the medium and long -term chal- ment meanwhile channels revenues from hydrocarbon resources lenges faced by the GCC economies. – which is an exhaustible resource, and the outlook for which has deteriorated given that the world is in the early stages of I would also like to emphasize that the GCC citizens should be transitioning towards cleaner energy sources – into unproduc- protected during these reform processes. Authorities should tive uses: large and bloated public sectors, high levels of subsi- ensure a basic minimum safety net, while encouraging citizens dies, poorly planned (and at times, poorly implemented) public to work. In this edition of the Gulf Economic Monitor, we talk investment projects that are not aligned with the long -term about how pension and social protection systems also face con- needs and aspirations of these countries. siderable challenges. Pensions and social insurance schemes are fragmented (e.g. Oman has ten institutions and ten schemes), The upshot is that the GCC countries have realized that the and need to be integrated (Bahrain has started administrative status quo cannot continue. The days of depending on volatile integration). By and large, pensions systems have low coverage oil revenues to fund unproductive and increasingly unafforda- - e.g. number of contributors plus beneficiaries as percent of the ble expenditures are gone. Diversifying the economy and fully total population are 10 percent for Saudi Arabia and Oman, and utilizing the talents of people has become an imperative. GCC 3 percent for UAE and Qatar - and need to be expanded. countries have thus been transforming their economies via ma- jor reform programs and the UAE really stands out as being an GCC economies are already very open in many ways and many early leader – for instance it has been the first to dismantle have good infrastructure. But they need to make sure that the energy subsidies. The Kingdom of Saudi Arabia, although it infrastructure supports private sector activity, for instance by has started late, has also begun to vigorously rethink its eco- increasing the connectivity of firms to export markets. They also nomic model and its economic policies in the form of Vision need to strengthen domestic business environments. Aside from 2030. Progress has been slower in Kuwait, but the government the UAE which is ranked 21 (out of a 190 countries), World is keenly aware of the challenges. Bank Doing Business Indicators, which span areas such as the ease of starting a business, getting permits, paying taxes etc. But, overall, despite much progress, there is much left to do show that the other GCC countries score very poorly. Qatar, the as well. Transforming from an oil -dependent economy to a Kingdom of Saudi Arabia and the Kuwait are ranked 83, 92 and self-propelled, human capital oriented one requires some fun- 96 respectively which is about par with Botswana, Zambia, Guate- damental changes in the mindset; some also call this a new mala and Tonga. Firm-level surveys in Kuwait for example, show, social contract. that small and medium sized enterprises (SMEs) are most con- cerned by excessive business regulations, regulatory uncertainty, inadequate skills of the workforce and corruption. All these factors combine to hinder not just domestic investment but also FDI. First, keep in mind that GCC countries do not need to discard Where the quality of their workforce is concerned, it is not just their existing social contracts but rather to upgrade them to a matter of spending more, but rather spending well to get bet- reflect new realities of low-for-long oil prices, increasing glob- ter outcomes. This includes, for example, investing in early al competition and the long-term threats from climate change. childhood education, investing in teacher training and certifica- tion, educational standards and testing. Public spending must shift away from its current role of trans- ferring oil rents to citizens in the form of public employment, subsidies and transfers. It should be aligned with the long - terms goals of policy makers and citizens, in terms of investing I do not think it will, and there are several reasons for that. First, in human and physical capital and capabilities of these coun- the countries themselves realize that even if oil prices have recov- tries, and ensuing a level playing field for all participants in the ered somewhat, they are far lower than they were prior to 2014, private sector. so they cannot do business as usual as was the case when oil pric- es were over $100 a barrel. So, they must adjust their policies to The other important area of reform is public employment. The live with low-for-long oil prices. Second, I think these countries bloated public sectors have created segmented labor markets -- have put a lot of effort into preparing strategies to structurally - the public sector attracts nationals through high wages, the adjust their economies, and they are just beginning to implement private sector employs mainly low-skilled foreigners - in Qa- those strategies. I think they’re starting to see some gains in terms tar, the excessive import of low-skilled foreign laborers to of broadening their tax base, getting the private sector a little work on public investment and construction projects has creat- more involved in the economy than before, getting non-oil ex- ed a huge demographic imbalances and put pressure on gov- ports growing more than before, and I think people in these coun- ernment infrastructure and public services. To develop the pri- tries are excited to see a more vibrant jobs market than they had vate sector and encourage nationals to seek private sector em- previously, a jobs market not so reliant on public sector job crea- ployment, governments need to reduce the incentives favoring tion. So, I think the combination of realizing that it still a very public over private sector employment, including by: decreas- different environment for oil prices, but a lot of work has been ing the public-private sector wage gap; investing in education put into strategies to reform the economies, and the people are that supports the skills needed by private industry; reducing the hungry for kind of job creation that would come with these strate- ready availability of government jobs; and moderating the gies. These give them sufficient incentives to continue with the growth of public wages. reforms despite the partial recovery in oil prices. In focus Reforming Pension Systems The pension and social insurance systems of the GCC coun- expatriates that address their long -term financial security tries, as those of many other Arab nations, face sustainabil- needs. This will, in turn, help GCC countries attract and re- ity, equity, and welfare challenges. By and large, GCC pen- tain highly skilled global talent that is needed to help build sion systems are among the most generous in the world, but knowledge-driven economies. are insufficiently funded so that they have increasingly re- lied on general budget funding rather than on contributions or on returns on assets. Allowances for early retirement in The pension industry landscape some countries, meanwhile, has further undermined finan- cial sustainability of pension schemes and also served as a disincentive to work effort (including for women). In addi- The GCC countries, have variants of mandatory contributo- tion, none of the GCC countries provide pensions for expat- ry earnings -related social insurance system for citizens. riate workers, while some nationals working in the private Coverage of workers in the private sector activities sector (notably the self -employed) are covered on a volun- (notably self -employed) tends to be low, mainly reflecting tary basis. the fact that these are expatriate workers that are not in- cluded in national pension systems. The insurance systems All these issues need to be addressed urgently if they are not are mostly financed on a pay -as-you -go basis, with pen- to be a drag on economic growth, fiscal sustainability, and sions calculated using a formula (defined benefit). The labor market stability. The pension reform agenda is particu- most common programs provide old age, disability, and larly important for the GCC countries in view of efforts to survivors' pensions (Figure 39). Some countries provide diversify their economies, raise private sector activity, and benefits for work injuries, and occupational diseases, and develop their labor markets. This Special Focus broadly de- unemployment, if not for sickness and maternity, and fami- scribes the pension landscape in GCC countries, and sets out ly allowances. System design varies widely across the potential solutions and proposals that policy makers could GCC, in law and in practice. adopt to improve their pension outcomes. International best practice suggests that policy makers focus on key principles Generally, pension spending is high since benefits are when considering the design of their pension systems, includ- among the highest in the world. The contributory systems ing financial sustainability, affordability, equity, predictabil- were designed to be financed through contributions of em- ity, robustness, and economic and administrative efficiency. ployers and employees, but they have largely and increas- While it may not be possible to extend pension coverage to ingly relied on general budget funding rather than on con- expatriates, it will also be important to provide solutions for tributions or on returns on assets. The additional use of The GCC pension systems commonly cover for old age, disability and survivors’ pensions (social insurance programs in the GCC countries) government budget funds, in this context, represents a large trying to integrate) their different schemes gradually into a implicit subsidy (that comes at the cost of other priority unified national scheme, with the objective of having the spending), one that is becoming increasingly unaffordable same social insurance system cover all employees in the given the fall in oil prices in recent years and prospects that country. Bahrain, for example, has integrated administrative- they will likely remain low over the medium to long -term. ly, but civil servants and private sector employees are still In addition, there is much room for improvement in the subject to different rules. governance of social security institutions and pension de- partments. The sustainability issues confronting the Arab The fragmentation of pension systems in the region produces pension systems are similar to those confronting other considerable economic and operational inefficiencies. Trans- countries globally. parent and efficient rules to transfer rights across schemes are rarely in place, so the mobility of the labor force is re- Sustainability issues facing the pension system are height- stricted, preventing the efficient allocation of resources in ened by demographic and labor market dynamics. The GCC the economy. Fragmentation is also viewed as a source of countries have relatively young populations, but old -age labor market and social inequity, with some segments of the dependency ratios are projected to rise rapidly over the next labor force receiving preferential treatment from the public 30 years from under five percent in 2015 to over 20 percent pension system. Moreover, fragmentation increases adminis- by 2050. Fertility rates are expected to continue to decline trative costs. while survival rates are projected to improve further. An expected increase in female participation rates will also have While social insurance and pension coverage rates in the Arab dramatic effects on the size of the labor force going forward. region are relatively modest, on average approximately 35 per- It is not certain, however, given the current construct of pen- cent of the labor force, the coverage in the GCC countries is sion systems, that the expansion of the labor force and of even lower. The number of contributors and beneficiaries of employment in the formal sector will be matched by an in- social insurance programs do not exceed 10 percent of the pop- crease in the size of the population covered by social insur- ulation in Saudi Arabia and Oman and three percent in the ance and pensions. UAE and Qatar (Figure 40). Coverage is usually limited to national workers in the public sector and part of the private sector. While high rates of informality explain the low cover- Challenges for the pension schemes age rates in most Arab countries, the explanatory factor is en- tirely different in the GCC countries – their large numbers of expatriate workers. Most countries in the GCC, as in the Arab region, have frag- mented pension systems, with more than one scheme cover- Very generous survivorship, disability and early retirement ing different groups of workers. The pension systems mostly pension provisions add to the high costs of the pension pro- cover civil servants and formal private sector workers (Table grams discussed in previous section. The programs were in- 2). The different schemes have different qualifying condi- tended to be pay-as-you-go schemes, in which current contrib- tions, different benefit formulas, and other different charac- utors pay for current beneficiaries, and the pension is calculat- teristics. Some countries have been integrating (or have been ed following a formula that relates retirement income benefits Pension schemes in the GCC are generally fragmented (pension and social insurance schemes in the GCC countries) • • • • • • • • • • • • to individual earnings. In practice, however, benefit promises at various retirement ages have generally been misaligned with The GCC pension systems have low coverage rates contribution rates. In addition, in some countries such as Qatar, (number of contributors plus beneficiaries of social not only are normal retirement rules very generous, but early insurance programs, in percent of the total population) retirement rate is allowed with low penalties. This can serve as a disincentive to work (specially for women), including to seek other jobs, hampers labor market mobility and also results in 12 the loss of workers that have accumulated valuable on -the-job skills and experience during their time in the labor market. 10 The high spending rates raise questions of affordability and sustainability. Affordability pertains to the costs of the pen- 8 sion benefits. And, sustainability is a function of retirement benefits and the contributions made to earn pension rights. 6 With most schemes covering civil servants running deficits, resources to fund the pension systems are often drawn from the general budget. But the use of public resources to subsi- 4 dize the pensions of formal sector workers, civil servants, and the military is inequitable and highly questionable, even in 2 resource abundant countries, where other public spending also compete for (high yet) limited resources for optimal alloca- 0 tion. The international best practice is to use general revenues Oman Saudi Bahrain Kuwait Qatar UAE to provide targeted benefits to the poor or to those with little Arabia or no capacity to save. A distinctive feature of labor markets in the GCC countries is which will be legally required to monitor at least the private their large number of expatriate workers --- up to 90 percent of pension system and ideally social security institutions as well the labor market in some. These workers will predominantly when they are investing assets. These supervisors should be retire in their home countries rather than in the host countries independent and have clear goals and the powers and resources where they are employed. Contributions during the entire ac- to safeguard pension promises that are made each day but may tive life, however, are essential in any pension scheme to pro- not be paid out for many decades. duce adequate pensions upon retirement. Special arrangements in pension systems in the home countries could allow these Multi-pillar schemes are sometimes adopted to reach adequate workers to contribute directly to their home country pension combination of conflicting objectives. The GCC countries have systems. These workers could send remittances to their home at least a mandatory, earnings-based, publicly-managed country pension accounts so that the windfall from temporarily scheme for some workers (Pillar 1). They may consider devel- higher wages would help secure their old-age income security oping other pillars, however (Figure 41). Mandatory and vol- and that of their families. However, while this possibility exists untary private pensions, for instance, have a strong role to play in some countries, it is neither generalized nor exempt from in diversifying a pension system. They can also help improve implementation difficulties. Nevertheless, addressing the pen- labor market efficiency, particularly if pensions are portable sion needs of these expatriates remains important, particularly between the public and private sectors. if GCC countries, which aim to become knowledge -driven economies in the long-term, wish to attract and retain the best Moreover, GCC policymakers should be mindful that pension of global talent. systems development and reform is linked with labor market reforms and capital market development. Delivering income in old age is not just a pension issue, but a retirement income Options for reform issue. Workers can and should find multiple ways to earn in- come in old age – not only through public and private pen- sions, but also through continued work (if needed), through Reforms should be driven by a clear objective for the pension insurance products, and through the benefits of home owner- system in the coming decades. This should focus on ensuring ship. Therefore, labor market reforms and capital market de- sustainable, adequate and equitable pensions, with broad cov- velopment are integral to the provision of income in old age. erage that are delivered in an efficient and secure way. Pension systems can and should redistribute income but it is important Six actions are recommended to advance the that the mechanisms be transparent. A pension system is af- GCC pension systems toward a sustainable, eq- fordable only if it can be financed without heavily compromis- uitable and welfare-enhancing path: ing other social or economic objectives, and sustainable only when it has the capacity to pay current and future benefits over • Develop adequate data to understand the pension system. a long horizon under reasonable assumptions without shifting Absent quality data, it is not possible to conduct income substantial burdens to future generations. Benefits are adequate distribution analysis and pension entitlements microsimula- when they provide sufficient income to protect participants tions to support equity in the delivery of pension benefits from falling into poverty, if they become disabled or after they and to benchmark countries against their sub -regional, re- have retired, and provide a reliable mechanism for smoothing gional and global peers. consumption. Progressively broader coverage of a country’s labor force should be gradually targeted through: the formali- • Review national identification (ID) and information tech- zation of the labor market; better enforcement of contribution nology (IT) systems to support the delivery of public and compliance of employers and self-employed individuals, in- private pensions. Without good ID and IT systems, even a cluding informal sector workers; increases in behavioral incen- perfectly designed pension scheme will fail to deliver on tives; and, by making access and contributions as simple and its mandate. automatic as possible to workers in the informal sector through developments in national identification (ID), information tech- • Improve the sustainability, equity and affordability of pen- nology (IT), and through improvements with financial inclu- sions. The sustainability issues confronting the Arab pen- sions and in payment systems. sion systems are similar to those confronting other coun- tries globally. For GCC, the pension systems face a peculi- An efficient pension system achieves social protection objec- ar sustainability challenge – while contributions to cover tives without creating adverse behavioral incentives for partici- benefits have been augmented by government contribu- pants or employers, delivers the best-possible net-of-fee re- tions, the era of lower oil prices render benefit payments turns, meets reasonable standards for service delivery and en- increasingly unaffordable. Moreover, the continued use of forcement at reasonable administrative costs, and delivers a budgetary transfers crowd out other priority fiscal spend- supply of long-run stable capital. A well-run pension system ing. In all cases, there is a need for the GCC countries to will have a clear set of legal requirements that explains how review their pension system parameters including accrual pensions will be designed and delivered. It is also important to rates, contribution rates, retirement ages, and survivorship ensure that there is a clearly identified regulator and supervisor benefits, and disability provisions. The GCC may consider diversifying their pension systems to include public and private pensions and man- datory and voluntary pensions (retirement income pillars) • Expand the coverage of pensions in a way that improves supporting transitions from one job to the next, and there- the diversification of public and private pension provision. fore ensuring that human capital develop in the host coun- In all countries, the role of the employer is critical in im- try through on-the-job experiences and training remain in proving access to pensions. For the GCC countries with the country. Finally, MSAs are also a tool to increase sav- their large number of expatriate workers, one option for ings as more capital remains in the country for potential addressing the pension needs of expatriate workers could investments. be through the provision of mobility saving accounts (MSA). These are mandatory medium or long-term savings • Improve the efficiency of pension systems – by reducing schemes for expatriate workers that are partially co- costs and fragmentation, enhancing investment strategies financed by employers. The goal is to provide a tool to ex- and governance, and improving the capital market. It is pats to cope with contingencies usually covered by social important to address the fragmentation of pension schemes, insurance schemes but that are currently beyond the scope strengthen the governance of pension institutions, and en- of available end-of-service benefits. The balance in this hance the investment expertise and asset -liability manage- account might be used with more flexibility than normal ment in pensions funds to improve returns to pension sys- pension products, but only upon exit from job or leaving tem participants. Developing the capital markets is an im- the country. Upon termination of the work contract, em- portant task. Reforms are also needed to corporate govern- ployees may decide to leave the country and use their sav- ance, to help improve liquidity in the secondary markets. ings in their home country or they may use the savings/ balance to extend their stay in the country while searching • Enhance the security of pension systems through develop- for another job. Upon retirement, an expatriate worker ing or creating regulators and supervisors who can suc- would be able to use the balance as a source of financial cessfully supervise pensions. An Outcomes and Risk support during old-age. Such a scheme, accordingly, Based Supervision (ORBS) system helps ensure that a would reduce the economic vulnerability through financial regulator thoughtfully considers the long -run outcomes of support during resettlement periods and transitions be- a pension system. The introduction of an ORBS system in tween jobs or into retirement. It could also help foster la- the GCC will help regulators and supervisors to prioritize bor market mobility of expatriates within the host country, actions, manage headline risks, and otherwise choose the most effective tools for regulation and supervision --- new regulations, training, communications, on-site supervision, and enforcement. Conclusion Pension systems in GCC countries face a number of challeng- es, in particular with respect to financial self-sustainability and equity. These have become more urgent in the wake of the fall in global energy prices since 2014. While there is no best way to structure pension systems, policy makers should aim to keep a number of internationally accepted principles in mind. Finan- cial sustainability is one such principle; others are affordabil- ity, adequacy, equity, and economic and administrative effi- ciency. However, there are tradeoffs between these principles. For example, current very high pensions in GCC countries prioritize adequacy but compromise long-term sustainability of pension schemes and may create disincentives to work if early retirement allowances are too generous. Pension reforms should be driven by a clear objective for the pension system in the coming decades. This should focus on ensuring sustainable, adequate and equitable pensions, with broad coverage that are delivered in an efficient and secure way. This will require more than just a comprehensive review of system parameters including accrual rates, contribution rates, retirement ages, and survivorship benefits, and disability provisions. Strengthening the governance framework for pen- sion systems, for instance through the formation of supervisory bodies, enhancing the investment expertise and asset -liability management in pensions funds to improve returns to pension system participants, and reforms to deepen domestic capital markets also go hand in hand. It will also be important to strengthen the capabilities of pension administration bodies, including the quality of data, IT and national ID systems. Fi- nally, if the GCC countries are to attract the best of global tal- ent, they will also need to consider potential solutions such as mobility savings accounts, that help meet the long-term pen- sion and financial security needs of expatriates.