FISCAL ADJUSTMENT IN THE GCC

Peter Thurlow,

MENA SBO Meeting,

Kuwait, October 12, 13, 2016

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OUTLINE

Preliminaries

The Challenge Ahead

Fiscal Response

Structural Reform

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THE CHALLENGE AHEAD A Sisyphean Task

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THE DEMOGRAPHIC ISSUE Many countries in the region have similar demographic profiles

Huge numbers of young Nationals will be entering the labour force over the coming decade.

How will meaningful jobs be generated?

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5-9

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20-24

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80+

Population

Age

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up

National Population by Age Cohort

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THE TAPPED OUT PUBLIC SECTOR

• In the past: • The traditional approach, with rising and high oil prices has

been to absorb large numbers of young nationals into the public sector.

• This, and relatively high public sector salaries meant that many

distained the private sector

• Now: • But with the crash in oil prices, this is not longer viable. The

private sector is the only hope. • The task before us is to cut expenditure, maintain public

services, maintain employment and support private sector development.

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THE FISCAL RESPONSE Issues and Dilemmas

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THE FISCAL SHOCK IS HERE TO STAY! By now it is clear that the fiscal shock is long-term, and fiscal adjustment is necessary.

The shock was due to US shale oil producers raising production, with insufficient offsetting conventional oil disruptions.

Shale producers are scaling back now, but with an increase of price they will be back, forcing the price down to their marginal cost of about US $ 50-60/bbl.

Brent Oil Price

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120.00

USD

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SMOOTH ADJUSTMENT VERSUS SHOCK TREATMENT

• How rapidly should the fiscal adjustment take place?

• Textbook macroeconomics says a smooth, gradual adjustment is best to minimize the economic shock, but the deficits are larger.

• Political economy might suggest rapid adjustment • people can see oil prices and understand the need,

• “austerity fatigue” can set in, and

• deficits are smaller.

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ACROSS-THE-BOARD VERSUS TARGETED CUTS • Across-the-Board cuts give the appearance of “fairness” to government

entities.

• If the objective is to maintain public services, targeted cuts are essential.

Target low priorities, and efficiency gains.

Spending Reviews are essential – (see your friendly OECD team about this!)

Ensure that government entities provide agreed upon services.

Easier if proper Performance or Program Budgeting is in place.

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OBVIOUS AREAS TO CONSIDER CUTTING: • Defense and Foreign Aid – limited domestic economic impact, but there may

be political impacts. • Subsidies – leads to more efficient use of subsidized products. A long-term

schedule of future cuts should be released to facilitate adjustment. • No new major projects. • Entry Salaries of Nationals – makes private sector employment more competitive.

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INCREASING NON-OIL REVENUE

• Please be very careful about this!

• Acts as a strong disincentive to economic diversification, and private sector development and investment. This is the very sector that needs to be developed.

• A major competitive advantage of GCC countries is low tax rates.

• Where externalities exist, excise taxes (fuel, tobacco, alcohol) may be warranted.

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THE TEMPTATION OF USING ARREARS • Going into arrears increases uncertainty and costs for suppliers, and their suppliers.

• Suppliers face Increasing and unknown working capital requirements.

• Suppliers will pass the increased costs back through future pricing and some

suppliers might exit altogether.

• Seriously damages the reputation as being a good place to do business, and

private sector development.

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FINANCING THE DEFICITS

• Limited set of options: • Sovereign Wealth Funds (for the lucky ones) • Foreign Debt • Domestic Debt • Cash Reserves

• Domestic debt can help support local financial market development.

• Be careful of domestic debt or cash reserves. • Exacerbates the negative economic impact by creating a domestic liquidity shortage.

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STRUCTURAL REFORMS The Essential Companion of Fiscal Consolidation

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WHAT IS STRUCTURAL POLICY?

• The legal and regulatory framework that balances the necessary protection of investors, workers and consumers against the need for businesses to be competitive.

• Structural Reform refers to adjustments to the frameworks which may allow businesses to be more competitive without unduly affecting the protections.

• Focus on individual markets like labour markets, capital markets and goods markets.

• Essential for private sector development and investment.

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STRUCTURAL POLICY BY INTERNATIONAL RANKINGS

• Some international rankings are well known. Examples are: • World Bank’s “Ease of Doing Business”,

• WEF’s “Competitiveness Report”)

• Dubai targets specific improvements in certain indices. This may be a useful innovation.

• However, the acid test is the increase in private sector investment and employment.

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IMPORTANCE OF SMES

• SMEs can be a major creator of employment! In Canada, SMEs account for over 70% of private sector employment.

• Need to reduce the time and cost of setting up a business, of bankruptcy, and ease access to capital. • Development of an entrepreneurial culture can help.

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THANK YOU AND GOOD LUCK!

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