The GCC economies' high concentration and dependence on the hydrocarbon sector, which averaged about 30 per cent of GDP and 60 per cent of total exports over 2015-2016 could become a credit negative factor when not offset by substantial financial buffers, a report said.

Despite supporting the economy when hydrocarbon prices are high, a narrowly-based economy tends to be more vulnerable to key sector business cycle swings, amplifying the volatility of its growth, general government revenues, and current account receipts, explained the new report from S&P Global Ratings, a top credit rating authority.

The sharp decline in oil prices--to lows of $29 at the beginning of 2016 from highs of $115 in mid-2014--has resulted in a significant economic slowdown and deterioration in fiscal and external balances for net oil exporters in the Middle East.

Real GDP growth in the region fell to an average of 2.5 per cent for 2014-2016, half of its 2011-2013 rates. Likewise, some sovereigns in the region have also posted current account and general government fiscal deficits during this period, as opposed to consistent surpluses prior to 2014.

The depletion of hydrocarbon resources may not be imminent for most GCC members and their current economic models have functioned relatively well. “We assess the life of hydrocarbon production at current levels as ranging from a high of 98 years for Qatar to a low of nine years for Bahrain,” S&P said.

However, the benefits of diversifying away from a sector from which income is largely driven by volatile market prices are clear in terms of more stable economic growth, along with government and export revenues. Largely owing to the impact of sustained low oil prices on economic, fiscal, and external metrics, S&P has lowered its long-term foreign currency ratings on Oman (five notches), Bahrain (four notches), and Saudi Arabia (three notches) over the last three years. S&P has also recently lowered its long-term foreign currency rating on Qatar by one notch.

These rating actions also reflected our view that GCC sovereigns have made only marginal progress in diversifying their economies away from hydrocarbons, given the still sizable contribution of the sector to their economies. While non-oil real GDP has picked up in the region since 2000, the growth rate has gradually decelerated over the last three years in tandem with the decline in oil GDP, further highlighting that diversification efforts are yet to pay off.

GCC sovereigns have announced ambitious diversification plans, some of which have existed for several years. These plans have recently gained new impetus following the sharp and sustained decline in oil prices. By and large, governments have presented National Development Plans (NDPs) or 'Visions' with 20- to 25-year time horizons, usually incorporating five-year intermediate strategies, which help to assess whether the country is on track to meet its near-term economic targets.

GCC government strategies broadly target diversification through the expansion of sectors such as tourism, business, and financial services along with logistics. “In our view, it is likely to be a decade long or generational transition. We also believe that structural impediments will hamper the transition toward significantly more diversified economies,” S&P said.

However, that is not to say that the GCC sovereigns do not have advantages which they are already exploiting such as the central positioning of the region, at the crossroad between Asia and Europe. To this end, GCC sovereigns have targeted the aviation industry among other things, with large investments by Dubai, Abu Dhabi, and Qatar in airports, planes, and flight-services facilities. The region now acts as a global airline hub with connections to major tourism markets, with Dubai listed as the world's third busiest airport in 2016 and 2015 according to Airports Council International. The challenge now is to convert transit passengers into tourists.

Impediments to diversification

Foreign exchange regime

The dollar pegs hinder the GCC economies' ability to compete on price in non-oil export markets. As a result, the development of non-oil related activities is dampened, absent any offsetting of efficiency or technological capacity gains.

In the event that a significant non-hydrocarbon export market were to develop in the region, exchange rate flexibility would usually act as a shock absorber in response to terms of trade shocks, such as a sharp fall in oil prices.

Climate

The GCC states are mostly characterized by a desert climate with yearly average temperatures ranging from 15C -40C. On the one hand, the climate is supportive of tourism during most months of the year. On the other, the heat severely constrains the development of agriculture, with water and arable land scarce.

Education and skills

GCC governments are attempting to stimulate private sector-led economic diversification. This will require skills enhancement of Gulf countries' workforces. It is likely that only relatively high wage private sector jobs would be sufficiently attractive to entice national citizens away from the public sector.

Openness to doing business

The stagnation in the implementation of business-friendly reforms witnessed outside of the UAE is likely to constrain foreign capital inflows, limiting the Gulf countries' ability to spur private-sector driven economic growth.

Attractive public sector employment

Public sector workers currently benefit from substantial advantages compared to their private sector counterparts, with higher salaries and increased job security, contributing to limited labour market efficiency as public sector attractiveness reduces the incentives for nationals to apply for jobs in the private sector.

Similarities of the diversification plans

“In our view, the challenges to GCC economic diversification remain substantial and GCC governments' 20- and 30-year visions are aspirational, with significant progress to be made if they are to be achieved. In boosting private sector development, GCC economies will be able to mitigate their vulnerability to adverse oil price movements and enhance long-term economic growth, which we would view as supportive factors for their credit ratings,” S&P said.

“Both exchange rate rigidity and geography do not lend themselves to organic manufacturing sector-led growth witnessed when other hydrocarbon dependent countries have diversified. Improvements in education and broader societal changes may also support private sector development.

“To date, success in downstream activities has been significant, but outside of oil and gas, where the region's competitive advantage lies remains unclear. Dubai has shown what can be done, but to some extent further developments in financial services, logistics, transport, and tourism could cannibalize the success of established players,” it added. – TradeArabia News Service