Building strain of falling oil prices may accelerate GCC reforms

Published November 24th, 2015 - 12:03 GMT
Though GCC governments depend heavily on oil revenue, declining oil prices are pressuring them to diversify their sources of revenue. (Al Bawaba/File)
Though GCC governments depend heavily on oil revenue, declining oil prices are pressuring them to diversify their sources of revenue. (Al Bawaba/File)

With the current oil price being lower than the breakeven oil prices, the fiscal surplus of GCC countries, which stood at 4.6 per cent of the combined gross domestic product in 2014, is expected to turn into deficit to the tune of 7.9 per cent of GDP in 2015.

The impact of lower oil revenues has visibly impacted the deposit mobilisation process in GCC banks as government deposits account for sizeable portion, M.R. Raghu, Senior Vice President of Research at Markaz said.

"A continued pressure on bank liquidity will accelerate long-awaited reforms in the GCC region and augurs well for the long-term," Reghu said at presentation on "GCC Liquidity-Impact on Banks, Stock markets and Bond markets." The event was organised by Markaz in collaboration with Kuwait Banking Association.

With the fiscal situation amid the low oil price environment drastically changed, the GCC governments may have to reassess their spending patterns, he said. "However, the low debt levels of the GCC countries, which stand at nine per cent of GDP as against 117 per cent of GDP for G-7 nations coupled with higher sovereign ratings for most GCC countries, lend comfort in the short-term."

He pointed out that the recent fall in oil prices by over 61 per cent since June 2014 due to a host of factors such as shale oil revolution in US, Opec decision to retain their output levels amid signs of tenuous demand growth had spilled over into the GCC financial system through banking channels, leading to spurts in overnight lending rate.

Raghu maintained that the GCC countries continue to be heavily reliant on hydrocarbon revenues, despite their diversification efforts. IMF expects oil export revenues for GCC countries to decline by $250 billion in 2015 from 2014 levels.

He noted fall in banks' deposits growth coupled with governments drawing down on their savings has led to short-term pressures on the money market. "Though the banks are well capitalised, they may not be able to act as the sole source of funding avenue for the governments," he said.

Reghu argued that with most international organisations such as the IMF, the World Bank and leading investment banks expecting the lower oil price environment to persist, GCC governments have been drawing multiple strategies to plug the deficit, including liquidating their stakes held through Sovereign Wealth Funds. Saudi Arabia has already withdrawn over $70 billion of its reserves in the past year. Additionally, governments across the GCC region have cutback on non-priority spending and are working on tackling the increasing subsidy problem, he pointed out.

"Equity markets have fallen over the last year in line with the drop in crude oil prices. With GCC corporate earnings expected to be muted in the near term, and declining bank lending to invest in the equity markets, stocks in the GCC may face continued pressure," he said.

Indeed, the valuation of GCC markets as measured by P/E multiple has on an average declined by 25 per cent, since second quarter, 2014. International bond issues from the GCC countries (corporate and sovereign) have dropped 33 per cent from a year earlier to $22 billion in the first nine months of 2015 which is the lowest nine-month total since 2008, said Reghu.

He suggested additional funding routes such as local and international debt markets could be tapped. Saudi Arabia, for the first time in last eight years, raised debt to the tune of $27 billion in local debt market. Revenue augmentation measures such as introduction of Value Added Tax (VAT) across GCC is being widely discussed.

On the other hand, IMF has been advocating introduction of taxes in a phased manner, Reghu said.

"While the record low interest rates, higher sovereign ratings, low debt levels and higher opportunity cost for Sovereign Wealth Funds argue for the case to raise debt to plug the deficit rather than liquidating SWF assets, the actions of GCC government and its impact on the financial system at large, will be closely watched in the coming months," he added.

By Issac John

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