IMF harps on sustained structural reforms in GCC

With continued improvements in energy-saving technologies, adoption of renewable sources of energy, and a stronger policy response to climate change, the energy-exporting countries in the region may need to be ready for a post-oil future sooner rather than later, alerted IMF. The urgency of continued reforms is greater in the GCC countries with more vulnerable financial positions, the Fund noted in its latest policy document on the region.

The report “Future of oil and fiscal sustainability in the GCC region” said the countries with larger financial savings like Qatar, Kuwait and UAE are rather less vulnerable to possible future fiscal challenges vs that of peer economies.

The ongoing reform efforts in the region will provide momentum over the next five years, but they need to be accelerated. The IMF document noted that faster economic diversification will not resolve the fiscal challenge on its own. Countries will need to increase their non-oil fiscal revenue.

The fiscal revenue GCC governments generate from the hydrocarbon industry (about 80 cents from a dollar of hydrocarbon GDP) is much higher than what is generated from nonhydrocarbon industries (about 10 cents from a dollar vs. 14½ cents globally). Thus, even full replacement of the hydrocarbon industry with non-oil activity would still create a significant revenue shortfall.

While this has begun to change with the recent introduction of VAT and excises in some countries, there is significant potential to build on this progress. As the region transitions toward a nonhydrocarbon economy, moving from wide-ranging fees toward fewer broad-based taxes, for example, could provide much-needed revenue diversification while also reducing distortions and facilitating SME development.

Governments will likely need to downsize further. Wider reforms, spending restraint and optimization toward areas with highest economic impact will be critical.

Additional non-oil revenue could help alleviate future fiscal pressures, but this alone will not be sufficient. Replacing the declining oil revenue in the long term would require eventually raising the effective tax rate on non-oil GDP to a prohibitively high level of 50 percent in the long term (assuming continued non-oil GDP growth of 3 percent)—on par with the top five most heavily taxed economies in the world. This may not be feasible and could be too disruptive to growth.

The IMF document noted that progress has already been achieved in some areas, such as reduction of energy and water subsidies in several countries. But there remains significant scope for rationalizing other categories of spending, including reforming the region’s large civil service and reducing public wage bills which are high by international standards. Besides strengthening public finances, these reforms would also reduce labor market distortions and facilitate private sector development.

IMF recommend that the countries should re-evaluate their approach to saving. In the past, a significant portion of oil proceeds were used for public investment which created nonfinancial wealth and supported rapid economic development. But the impact on nonhydrocarbon growth has been typically short-lived and, as the economies have developed, growth multipliers from these investments have begun to decline. Therefore, from the optimal portfolio allocation and wealth preservation perspectives, financial saving will be more important going forward. Meanwhile, emphasis could be made on sustained structural reforms to generate lasting non-oil growth momentum.

Source from: Peninsula Qatar