Can the GCC Weather the Economic Meltdown?

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As the storms of economic crisis gathered throughout Europe, Asia, America, and the rest of the world in late 2007, one area alone seemed immune. By mid-July 2008, oil prices had skyrocketed to almost $150 per barrel (p/b), higher than ever before, and the Gulf Cooperation Council (GCC) states of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE) seemed set to benefit from a huge financial surplus.

This rosy scenario was short-lived; soon enough, the wave of economic disaster sweeping the world reached the shores of the GCC countries, damaging the petroleum export revenues as well as the oil-related and tourism businesses. But beyond having to cope with the dramatic economic turndown, the crisis has exposed an Achilles’ heel in the oil-based economies of the region. The GCC countries’ traditional reliance on foreign nationals for labor as well as their subsidization of the native population through make-work “white collar” jobs seems no longer sustainable.

Boom Time

By 2008, GCC travel and tourism activities contributed $113 billion to the Gulf states’ economies, namely, more than 10 percent of their total GDP. But following the financial crisis, there was a marked decline in tourism activities. As the tourism industry is inextricably linked to other industries and services, the slowdown in the tourism industry had an impact on many other sectors, including construction and building, banking and insurance, and transportation.

During the four years prior to the onset of the crisis, the economic growth rate worldwide was impressive with global gross domestic product (GDP) real growth rate amounting to 4.5 percent in 2005, 5.1 percent in 2006, and 5.2 percent in 2007. Those economies under the jurisdiction of the UNESCWA (U.N. Economic and Social Commission for Western Asia)—Egypt, Sudan, Jordan, the Palestinian Authority, Syria, Lebanon, Iraq, Yemen, and the GCC countries—exhibited slightly better growth. This increase, amounting to 6.9 percent in 2005, 5.9 percent in 2006, and slightly declining to 5.4 percent in 2007, led to a substantial improvement in the living standard of these countries.

The major factor for the rapid economic development in the Arab region as a whole, but particularly in the GCC oil economies, was the rapid rise in both oil production and oil prices. In 2008, crude oil production of the GCC countries skyrocketed to 16.4 million barrels per day (b/d), representing an increase of 7 percent from the previous year. This resulted from the rapid increase in consumption, rising from 84 million b/d in 2005 to 86.9 million b/d in the first quarter of 2008 because of burgeoning, worldwide oil demand led by the emerging economies of Asia, mainly China and India.

In addition to oil and gas revenues and their related petrochemical products, the GCC’s economic expansion since 2004 has also been driven by the rapid growth of the tourism industry. While the global tourism industry grew rapidly in the 2000s, this increase was marked with numerous setbacks, beginning with the devastating consequences of the September 11, 2001 terrorist attacks on the United States, through attempted and actual terrorist attacks in Europe and Asia during the decade, the U.S. invasion of Iraq in 2003, and culminating in skyrocketing oil prices in mid-2008 that affected air travel adversely. Despite this, GCC tourism industries expanded more than twice the worldwide average during the decade and were generally characterized by stability with only minor ups and downs, even during periods of regional tension.

In general, from 2002-08, the GCC economy tripled in size, reaching the unforeseeable amount of $1.08 trillion in 2008 with a surplus in the current account balance of $292.3 billion, representing 27.1 of the total GDP—an increase of 44.7 percent compared to 2007. Thus, by mid-2008, the economic situation in the countries of the GCC was better than ever with foreign assets having increased dramatically from $1,036 billion in 2006 to $1,352 billion in 2008; the Saudis’ foreign assets alone increased by 85 percent within that two year span.

Impact of the Global Financial Crisis

The economic situation in the GCC countries during the first half of 2008 was enviable, with all projections indicating high oil prices and steadily increasing foreign direct investment (FDI) as the two major factors for continued, rapid economic expansion for the foreseeable future. Analysts continued to predict a glowing future for the GCC economies not only after the onset of the financial crisis in the United States but also after its spread to other countries.” Regarding the Middle East and North Africa (MENA) region as a whole, the World Bank’s 2008 MENA Economic Developments and Prospects report predicted: “Average growth of about 5.6 percent is expected over the next three years. Oil prices are expected to remain buoyant, leading to high levels of investment.” Similarly, in late July 2008, The Saudi Gazette quoted an optimistic report from the Gulf Finance House (GFH), one of the leading Islamic investment firms in Bahrain:

The strong economic and investments boom in the GCC region will also continue apace for the medium term. With oil prices expected to remain in triple digits for the remainder of 2008, and several major capacity expansions in the pipeline across oil and non-oil sectors, the GCC states remain firmly on course for strong, broad-based economic growth for the medium term.

Despite the spread of the global financial malaise, these positive projections continued, largely based on the assumption that this worldwide crisis would be quite similar to that of the oil crisis of 1973-74. During that period, developed economies were severely affected as a result of sharp increases in oil prices while the GCC oil economies expanded rapidly through growing oil revenues. In fact, this scenario did actually recur in the second half of 2007 and the first half of 2008.

However, all of these optimistic forecasts suddenly collapsed following the crash of oil prices from their peak of $131.2 p/b on average in July 2008 to $69.2 on average in October 2008, and then to less than $40 toward the end of the year. The collapse of Lehman Brothers in mid-September 2008 increased the worldwide panic, and the GCC economies could no longer escape the global recession. The huge financial liquidity that existed in the GCC economies since 2004 evaporated almost immediately. A gloomy economic atmosphere spread as well; in March 2009, the Financial Times quoted an employee of Dubai International Capital: “It’s a nightmare. We go into the office unsure if we will have a job at the end of the day.”

In 2009, GCC oil revenues amounted to $302 billion, a decline of 42 percent from 2008 and even lower than that of 2007 and 2006. Consequently, the real GDP growth rate in all the GCC countries (with the exception of Qatar, which continued to enjoy high growth rate) stagnated, with a negligible contracted growth rate of -0.2 percent on average, translating into a decline of at least 2.8 percent in per capita terms.

The sudden slump in oil revenues has had a ripple effect on oil-related industries. For example, Saudi Arabia Basic Industries Corporation (SABIC) had a net loss of $260 million during the first quarter of 2009, its first quarterly loss in seven years. The sharp decline in SABIC’s profits was the result of the drop-off in both the production scale and the prices of the products due to stagnation in the automotive and electronic industries worldwide. RAK Steel, based in the UAE, stopped production in fall 2008 at its 500,000 ton-a-year plant. The downturn in raw material demand led not only to a decline in profits but to a delay in the planned capacity expansion.

The decline in profits in private sector companies led, naturally, to cuts in wages. During the first quarter of 2009, for example, the salaries of construction workers in GCC states fell by 15 percent on average. This fall in wages was mainly due to the decline in demand for labor as many projects were cancelled completely or their implementation was delayed. Further, across the Gulf, there was a marked decline in tourism activities beginning in the third quarter of 2008, with the worst situation in Dubai. As the tourism industry is inextricably linked to various industries and services, the slowdown in the tourism industry had an impact on many other sectors as well, including construction and building, banking and insurance, and transportation.

From the onset of the crisis up until April 2009, an estimated $364 billion worth of projects (28 percent of the $1.3 trillion projects in the pipeline) have been put on hold or cancelled in the UAE alone, almost all of them in construction. In Bahrain there has been a significant reduction in private investments since the third quarter of 2008. In Saudi Arabia, U.K.-Australian mining giant Rio Tinto announced in December 2008 that it was unable to finance its 49 percent stake in a $10 billion aluminum joint venture with the Saudi Arabian Mining Company (Ma’aden). In general, it seems that about half of the “mega-projects” in the GCC came to a halt due to the recession.

The first to suffer from the diminishing scale of economic activities in the GCC states were foreign laborers as a large percentage of them were employed by the construction and building sector. However, the crisis affected the national workforces as well because the recession actually damaged a fundamental pillar of the GCC’s current employment policy—the massive use of cheap foreign labor for low-end employment needs in order to provide higher-end job opportunities for nationals. At the fifteenth annual conference of the Emirates Centre for Strategic Studies and Research in February 2010, Bahraini labor minister Majeed al-Alawi declared, “The GCC employs seventeen million foreign workers, but has more than one million unemployed citizens.”

It should be noted, however, that despite the worsening of the employment situation, many nationals still do not want to work in many occupations.

Coping with the Crisis

The governments of the GCC states are dealing with the consequences of the crisis in a number of ways. One approach is to implement expansionary fiscal policy by increasing public spending to counter the slump in private sector activity. This has been carried out in the main by raising the budget for public works, primarily in the infrastructure arena for electricity, water desalination, transportation, and in the tourism sector. This policy has three goals: to maintain the economic activity level, to create new job opportunities for the national workforce, and to prepare for the end of the crisis. Thus the Qatari 2009-10 budget is expected to be the largest ever with the launch of large-scale infrastructure projects such as construction of the New Doha International Airport and the Sidra Hospital, expansion of the Ruwais port, large-scale road-building, expansion of drainage systems, and improvements in educational and vocational facilities. Overall by early 2010, more than $229 billion worth of projects were planned or under way in Qatar alone. The 2009 Omani budget was 10.8 percent higher than that of 2008 despite the sharp decline in governmental revenues. Saudi capital spending for 2009 is also projected to be 36 percent higher than in 2008 and includes $7 billion for a railway linking Damman and Jeddah through Riyadh. Overall, total GCC budget spending in 2010 is likely to increase by 14 percent to a record of $354 billion, boosted mainly by high oil prices.

In addition, each of the GCC countries without exception has adopted extraordinary measures in order to restore confidence and to stabilize the financial sector, among them, cutting interest rates, providing bank deposit guarantees, reducing requirements on bank deposits, and introducing new credit facilities in order to strengthen bank liquidity. The GCC governments have also injected capital into private banks to encourage them to lend more to the private sector.

Riyadh took an additional step to spur private sector hiring of nationals. In April 2009, the Saudi Human Resources Development Fund offered to pay half of the first year’s salary in advance for Saudis who were newly hired by private firms. The aim of the advanced payment was to tempt companies to increase the number of employed nationals since getting credit from banks had become more difficult since the onset of the financial crisis.

Increasing oil production spare capacity in order to sustain moderate prices for the long-run was another measure adopted by many GCC members. There were two goals for this increase: First, stable and moderate oil prices constitute a major tool for global economic recovery, which the GCC economies need for their own recovery. The second aim has been to maintain a long-term demand for oil at the expense of alternative energies. Maintaining the level of the current global oil demand is viewed as insurance for long-term governmental revenues, also enabling the GCC governments to maintain high expenditure levels.

Despite considerable damage to the GCC economies resulting from the global crisis, the situation in these countries was and still is much more favorable than that of the rest of the world’s economies.

Dubai Proves the Exception

The exception to all this was Dubai due to its unique economic structure. Since its modern beginnings in the early twentieth century, Dubai has had a cosmopolitan economic philosophy. In the 1930s, Dubai’s port and suq (market) were the largest in the Gulf with a quarter of its 20,000 inhabitant’s foreigners. Despite the discovery of oil in 1966, Dubai’s rulers developed an economic diversification policy. With a current oil production level of about 240,000 b/d and proven oil reserves only sufficient until 2030, Dubai’s oil revenues were, from the start, considered a temporary tool to promote economic diversification.

As a result, prior to the crisis, Dubai was an example of an oil-based economy that had succeeded in achieving economic diversification. In 2008, the tourism industry, for example, contributed (directly and indirectly) about 30 percent to Dubai’s total GDP while oil and oil-related industries constituted only 2.1 percent. Overall during the 2000-08 period, Dubai’s GDP growth rate amounted to 13 percent on annual average—higher than all of the other GCC economies and even higher than that of China and India.

The downside to this was that Dubai had less substantial financial reserves from oil export with mega-projects financed through massive loans. Dubai had gambled that its tourism industry, the largest in the Gulf area and characterized by such landmarks as the Palm Islands, Dubailand, and the Burj al-Arab hotel, would continue to expand.

The tourism industry was perhaps hit hardest. From its beginnings in the mid-1980s, Dubai’s tourism industry never relied on the sun, sand, and sea model aimed at the middle class but focused almost exclusively on top-end tourism. Dubai was the area’s entertainment hub and a destination for congresses and international competitions. A large percentage of the industry was based on working meetings and seminars of the largest multinational companies and banks, the same firms most damaged by the crisis, which would naturally cut expenses by eliminating such costly gatherings. Thus, Dubai’s room occupancy rate declined through 2008 with continued deterioration through 2009. Indeed, the latest IMF report on the UAE stated that “even though Dubai has achieved an impressive degree of diversification and has become a major trading and services regional hub, recent events call into question the sustainability of enhancing growth through large-scaled and highly leveraged property development.”

Recovery and the Dilemma

It appears that timely responses by the GCC governments to the worldwide financial crisis brought about stability in their economies when most other worldwide economies were still shaken by it. Since the second quarter of 2009, the GCC economies have gradually returned to solid growth. Much higher than expected oil prices—above $70 p/b on average during the second half of 2009 compared to $41-$50 in early 2009 — were a major contributor to the recovery, allowing the continuation of aggressive spending plans. The GCC economies have thus far managed to weather the global crisis reasonably well. Only Oman and Bahrain suffered from public finance deficit in 2009, but even there the deficits were minimal.

A major sign of the area’s economic recovery is the increasing recruitment of foreign workers since March-April 2009. Hence, workers’ remittances from the GCC countries in 2009 increased by almost 8 percent, compared to a decline of 6 percent of the global remittances. Similar signs are seen in the recovery of many GCC companies’ performances since the third quarter of 2009, and many companies based in the GCC are using current low prices for raw materials and real estate to develop new projects.

According to the World Bank, the growing trend is expected to continue in 2010, based on high oil prices and the GCC’s expansionary budgets. A major contributor to the GCC’s current economic growth is the rapid recovery of Asia’s emerging economies, particularly that of China and India. A critical economic risk for the GCC countries would be a sharp decline in oil prices below the fiscal and current account break-even point. As oil prices are much higher than this, Gulf economies are largely secure from falling into a deep recession.

Historically, the GCC elites encouraged labor policies that enabled private employers to recruit as much foreign labor as needed with little restriction on minimum wages. Meanwhile the vast majority of the national workforce was employed by the public sector under lucrative work conditions and high salaries.

Gulf rulers, it should be noted, are fully aware of these problems. With some minor differences between the countries, they are trying to cope using three parallel mechanisms.

The first approach is to steadily increase oil production capacity to ensure the financial resources needed to maintain the rentier system. This also helps to continue demand for oil as the world’s primary energy source at the expense of pursuing alternative energy sources.

The second strategy is to withdraw gradually from their prior pro-natalist policies (adopted mainly by the two most populous countries, Saudi Arabia and Oman) while simultaneously diversifying the ethnic and national composition of the foreign labor population. The strategy here is to inhibit large group cohesion and a potential demand for citizenship by foreign workers.

Finally, in contrast to the previous policy of trying to replace foreign workers with nationals, Gulf leaders now emphasize the creation of as many suitable job opportunities as possible for the national workforces, particularly for educated, first-time job seekers. This is to be accomplished through economic diversification and the development of new areas, which, while demanding a large foreign workforce also provide many job opportunities for higher-end nationals, particularly in the financial sector and the tourism industry.

by Onn Winckler

Can the GCC Weather the Economic Meltdown?


About Georges Abi-Aad

CEO, electronic engineer with MBA in marketing. Multicultural; French citizen born in Lebanon working in the Middle East and fluent in French, English and Arabic. I have more than 30 years of proven experience in the Middle East with European know how. I am good in reorganization and in Global strategic management business. I am a dependable leader with an open approach in working with people, forging a strong team of professionals dedicated to the Company and its clientele. Perseverance is my key word. Married to Carole and having 2 children: Joy-Joelle and Antoine (Joyante!).
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