High oil prices to sustain GCC growth

The high growth in the economies of the six member states of the Gulf Co-operation Council (GCC) is set to continue given the continued strength in oil prices.

The total net foreign assets of these countries, both public and private, are likely to exceed $2 trillion (Dh7.3trn) by the end of 2008, after reaching an estimated $1.8trn at the end of 2007, said a report by the Washington-based Institute of International Finance (IIF).

“With oil prices likely to remain at robust levels, the GCC governments are set to sustain recent growth in capital spending and foreign investment,” said IIF Managing Director Charles Dallara in a statement.

“High oil prices are enabling the GCC governments to place a growing volume of resources into reserve and wealth management funds, which will play increased roles in international financial markets. We estimate, for example, that 2008 will see the GCC’s current account surplus exceed $250 billion – compared to an estimated record $215bn in 2007.”

George T Abed, the IIF’s special advisor to the managing director and director for Africa and the Middle East, said: “The economic boom now taking place in the Gulf oil-exporting countries is likely to be sustained well into the medium-term, although with an imminent slowdown in the US possibly affecting other regions, the price of oil could soften somewhat in the first half of 2008. In this case, oil revenues could pull back from recent peaks.

“However, the impact of this possible slowdown could well be mitigated by the significant number of major infrastructure projects that are already under way or are being pursued throughout the GCC. These will provide momentum for robust oil and gas production, as well as the development of other sectors, notably real estate, trade and finance, and tourism, for several years to come.

“We estimate that the GCC’s non-hydrocarbon sector will grow by around 14 per cent in nominal terms this year, mirroring the rise in overall GDP growth. At around $900bn, the area’s 2008 nominal GDP will be more than double recorded as recently as 2003.

“But a critical issue for the governments of these countries is rising inflation, in the face of a depreciating US dollar, to which five of the six countries’ currencies remain pegged.” He said the dollar peg has long served the countries well, contributing to macroeconomic stability and facilitating convergence towards a monetary union.

“However, if the dollar depreciates further beyond market expectations, and in the face of a slowdown, underlying pressures could eventually test the durability of the dollar peg.”

With regard to the region’s reserve and wealth management funds, IIF Managing Director Dallara welcomed their recent provision of capital to international financial institutions, and the more general role that they have played in smoothing global imbalances.

Several of the region’s funds have been active for some time, and their actions have been predominantly market-based.

As GCC governments continue to pursue high growth strategies in a bid to provide employment for their young and fast-growing populations their absorptive capacity is growing rapidly. Government spending has gathered pace over the past few years and in 2007 outstripped revenue growth for the first time since the current oil boom began in 2002.

PROMINENT PRIVATE SECTOR

The current boom is being led by the private sector, added the IIF report. This is evident from the declining share of public expenditure to GDP. In 2002, at the outset of the current oil boom, public expenditure accounted for an average of 34.4 per cent; in 2007 the average was a likely 28.9 per cent.

Meanwhile, the private sector has stepped up its investment, helped by robust inflows of debt and FDI, and the development of local financial markets. Nevertheless, the global credit crunch saw some falloff in debt inflows during the latter part of last year.

The IIF said serious inflationary pressures are being generated in some countries in the region. According to official data, which may understate price pressures, average consumer price inflation in the GCC reached a 15-year high of 5.3 per cent in 2006, and is likely to have risen to 6.7 per cent in 2007.

Inflation is trending upwards in most GCC countries and is most pronounced in Qatar and the UAE, where consumer price increases are in excess of 10 per cent.

Price pressures are being generated from a variety of sources, including robust domestic liquidity growth and supply-side bottlenecks in the context of rapid population growth.

The situation is being aggravated by policy challenges, said the report. The preference for fixed currency pegs leaves the region’s central banks with few monetary policy options to stem liquidity growth.

In the five states that have dollar pegs, the respective central banks have been obliged to follow the US Federal Reserve’s recent interest rate reductions at a time when domestic credit growth is rampant.

This has been compounded by some loosening in the fiscal stance of some GCC governments, it said.