S&P Global Ratings: Gulf Sovereigns Will Find It Hard To Diversify

Workers are seen at an oil exploration site.

The Gulf Cooperation Council (GCC) countries of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and Abu Dhabi (a member of the United Arab Emirates–UAE) currently benefit from sizable hydrocarbon resources, at close to 30% of global oil reserves and 20% of global gas reserves (source: BP Statistical Review of World Energy 2017) relative to their population size (less than 1% of the global population). This large hydrocarbon endowment and the high income it generates has resulted in past general government surpluses, low government financing needs, and net external asset positions for most GCC countries. S&P Global Ratings incorporates these key strengths in its sovereign credit ratings on these countries.

That said, the Gulf economies’ high concentration and dependence on the hydrocarbon sector, which averaged about 30% of GDP and 60% of total exports over 2015-2016–even considering subdued oil prices–could become a credit negative factor when not offset by substantial financial buffers. Despite supporting the economy when hydrocarbon prices are high, we believe 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.

Overview

  • GCC countries currently benefit from sizable hydrocarbon resources, but the large dependence on hydrocarbon revenues remains a key credit risk, in our view.
  • Despite the implementation of national development plans across the region, structural impediments in GCC economies will continue to restrict any attempts to diversify the economy away from hydrocarbons.

GCC Sovereigns Remain Dependent On Hydrocarbons

To illustrate this vulnerability, the sharp decline in oil prices–to lows of US$29 at the beginning of 2016 (Brent) from highs of US$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% for 2014-2016, half of its 2011-2013 rate. 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 (see table 3 of “Middle East And North Africa Sovereign Rating Trends Midyear 2017,” published on July 12, 2017, for a summary of some key indicators for GCC sovereigns’ exposure to hydrocarbons). 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, we have lowered our long-term foreign currency ratings on Oman (five notches), Bahrain (four notches), and Saudi Arabia (three notches) over the last three years. We have also recently lowered our long-term foreign currency rating on Qatar by one notch (see “Qatar Long-Term Rating Lowered To ‘AA-‘; On Watch Negative After Six Arab Countries Sever Ties,” published on June 7, 2017).

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, in our view.

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 (see Appendix 1 for a summary of the government’s plans).

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.

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

Climate

Education and skills

Openness to doing business

Attractive public sector employment

Similarities of the diversification plans

Diversification Remains Aspirational

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. 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.

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