GCC in drive to ease exposure to foreign markets

Gulf oil producers are taking measures to ease their heavy exposure to external markets that have played a key role in the region’s economic volatility and in soaring inflation over the past two years, a Saudi investment firm has said.

The economies of the six-nation Gulf Cooperation Council (GCC) have been highly vulnerable to external shocks given their heavy reliance on imports and crude exports, NCB Capital said in a study.

As a result, the six members have one of the highest commercial levels relative to their gross domestic product, with trade volume in the UAE accounting for as high as 119 per cent in 2009. It constituted about 70 per cent in Saudi Arabia and 55 per cent in Kuwait, according to the study.

It showed the GCC’s trade dependency is substantially higher than that of the United States where it was 18.3 per cent or even in leading exporter nations such as Japan and China where it was 21.3 and 44.5 per cent respectively.

“This state of affairs creates a number of complications for GCC policymakers. On the import side, spikes in global commodity prices can erode foreign exchange reserves while pushing up imported inflation,” said NCBC, an affiliate of Saudi Arabia’s largest  bank, National Commercial Bank.

“The GCC countries are already taking steps to reduce their exposure to external price fluctuations in a number of ways…..there are a growing number of efforts to build up strategic reserves, especially in agricultural commodities.”

It noted that Oman has already built up a strategic reserve buffer for three-four months and both Saudi Arabia and the UAE are in the process of setting up similar systems.

Having sensibly abandoned their costly food self-sufficiency goals, the GCC nations have started investing in agricultural projects in fertile countries rather than promoting self-sufficiency at home by depleting precious water and land resources, the report added.

Heavy reliance on food imports allied with weakening US dollar and soaring domestic rents boosted inflation rates in the GCC to record high levels in 2007 and 2008 before they tumbled in 2009 following the global fiscal crisis.

“In spite of a subsequent reversal, inflation is again on its way up even with the global economy far from having returned to trend growth. Inflation has been primarily caused by rising housing and food costs,” NCBC said.

It said that while house prices in Saudi Arabia were pushed up due to excess demand coupled with underinvestment, the increase has also contained an element of commodity price appreciation.

“By contrast, a large part of food price inflation has been imported. Additional risks exist because of the possibility of political disruptions. Already during the recent food price pike, many governments, faced with domestic shortages, imposed restrictions on exports,” the study said.

“More generally, domestic inflationary pressures in commodity producer countries can result in pressures to impose restrictions on trade, leaving importers in an uncomfortable situation.”

On the export side, the GCC economies remain heavily vulnerable to oil price volatility due to global economic conditions, according to NCBC.

It noted that crude prices plummeted to only $31 in December 2008 although they climbed to an all time high average of more than $95 through that year.

“This resulted in significant economic dislocations and had profound implications for market confidence. Even as the regional governments have become highly effective at managing the macroeconomic implications of oil price volatility, with interventions during the crisis serving as a source of remarkable continuity, the oil dependency creates additional risks for the management of oil revenues.”

The report said that although the oil windfall offers the necessary means for the transition to the region’s post-oil future, much of the oil windfall ends up being mobilised for short-term demand management purposes instead of being saved.

“The effects of misallocations have been reduced by especially the Saudi government’s tendency to use government stimulus money to support necessary capital spending but, nonetheless, the debate on fiscal policy reform is likely to gather momentum going forward,” it said.

The study said economic diversification plans in the GCC also involve efforts to boost industrial sectors for which a large domestic or regional market exists.

It said salient cases in point involve the growth of the regional cement sector, rise of metals extraction, and the strides made in petrochemicals.

“There are a number of efforts underway to boost the regional supply of base metals, for instance through the aluminum smelter plans for Saudi Arabia’s economic cities. The key challenge with these endeavors is to ensure their economic viability in the event of significant changes in input costs due to possible policy shifts from the current widespread use of subsidies,” it said.

“In spite of this progress, the regional public and private sector players have not yet joined in the race for commodities on the same scale as the Chinese and increasingly other emerging market counterparts. Nonetheless, it is likely that the intensifying competition for resources will necessitate more reserve buffers at home and arrangements outside of the region designed to secure supplies.”
 

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