Insight archive for Bilal Khan | Standard Chartered

The oil-rich bloc that’s facing a new era

Bilal Khan — Wed, 07 Mar 2018 12:54:38 +0000

For years, the members of the Gulf Cooperation Council (GCC) successfully turned their natural resources – oil and gas – into material economic dividends, but how sustainable is this in the face of lower-for-longer oil prices

The members of the GCC – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE – are now among the world’s 30 richest countries in terms of GDP per capita and fared well compared with emerging markets, developed markets and the world economy throughout 2008-14.

However, the latest episode of falling oil prices that started in mid-2014 saw average growth rates plummet throughout 2015-16, reaching only 0.3 per cent in 2017, based on our estimates.

GCC’s three big challenges

The lower-for-longer oil prices – USD67 a barrel by the end of 2017 compared with an average of USD100 during 2008-14 – and subsequent lower growth are creating three big challenges for the GCC.

First, global oil prices have always played a major role in determining growth rates, and consequently income levels, of these economies. For instance, lower oil prices turned current account surpluses into significant deficits in most cases, putting pressure on foreign exchange reserves. Furthermore, fiscal balances turned into deficits, prompting GCC countries to tap international capital markets, leading to increases in government debt.

Second, the dominance of oil and gas has resulted in a phenomenon familiar to commodity-exporting countries. Non-tradable sectors, such as property, tend to flourish (these attract a large share of oil and gas revenue), while tradable sectors, especially manufactured exports, do less well.

"GCC’s current low productivity levels may translate into lower growth rates in the medium to longer term"

Bilal Khan Senior Economist, Middle East, North Africa and Pakistan

There are two key issues with this. First, higher oil prices can fuel asset price bubbles that could pose risk to the overall macroeconomic stability of GCC economies. For example, the high oil prices that prevailed before mid-2014 led to rapidly rising house prices in Abu Dhabi and Dubai, followed by a significant correction as oil prices started to fall from the second half of 2014.

To add to this, GCC economies are often characterised by stubbornly low productivity, with labour-intensive sectors such as construction and light manufacturing (less dependent on technology and high-skilled labour) taking the lead over more high-value-added sectors, such as finance and high-tech manufacturing. Given the importance of productivity for long-term growth, the GCC’s current low productivity levels may translate into lower growth rates in the medium to longer term.

"Policy makers face a third pressing issue in the near future: demographics"

Bilal Khan Senior Economist, Middle East, North Africa and Pakistan

Outside the distortions caused by overreliance on oil and gas, policy makers face a third pressing issue in the near future: demographics. An increasing number of young people will enter the labour market in the coming years. Traditionally, GCC nationals seeking employment have favoured the public sector, given it offers higher wages, better job security, shorter working hours and longer holidays than the private sector. However, the public sector has reached saturation point, which means the GCC must find new ways to attract people to other sectors, or develop new sectors to absorb excess labour.

How can GCC countries tackle these challenges?

In short, via reform. The question is, what type of reform?

To address their short-term imbalances, the GCC will need to continue with fiscal consolidation while structural reforms are needed to address longer-term issues.
The UAE and Saudi Arabia have led regional fiscal consolidation efforts to increase government revenue with the introduction of consumption taxes (value added tax – VAT) at 5 per cent at the turn of the year.

Other GCC countries appear to be lagging in this area. We believe that the potential revenue from 5 per cent VAT in GCC countries would be below the level needed to close the large fiscal deficits in many cases. Hence, introducing VAT will need to be accompanied by drastic cuts in current expenditure (especially subsidies and social benefits). Energy subsidy reforms introduced in 2015-16 were viewed as a positive step in this direction. However, further reform is likely in the future given that subsidies and social benefits are estimated to be equivalent to 8 per cent of total GCC GDP.

"A key development is the local debt market"

Bilal Khan Senior Economist, Middle East, North Africa and Pakistan

Also, GCC countries will need to implement measures to address deeper structural issues currently preventing them from reaching their long-term growth potential. Such reforms should aim to: improve the efficiency and conduct of fiscal policy; improve the business environment and reduce red tape; upgrade the regulatory system; address labour-market issues; introduce more ambitious industrial policies that aim to integrate GCC economies into the global supply chain; and continue to deepen the financial sector.

On the latter, a key development is the local debt market. This would provide these economies with new sources of financing, reduce pressure on local banks and the need to borrow from abroad at the same time as providing monetary authorities with effective tools to manage liquidity while preserving their currency pegs.

An example for other nations

GCC countries, to some extent, provide a good example of how successful a country endowed with natural resources can be. However, the continued reliance on oil and gas both on the fiscal and external fronts has exposed these countries to macroeconomic instability related to the fluctuations in oil markets and, going forward, will continue to bring challenges especially in a lower-for-longer oil price environment.

GCC countries should prioritise reforms to help bring their fiscal and external balances back to more sustainable levels. Efforts targeting fiscal consolidation in the short term should continue alongside long-term structural reforms, to help sustain high growth in the future.

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Pakistan’s economy is turning a corner

Bilal Khan — Thu, 03 Dec 2015 08:48:49 +0000

Could substantial Chinese investment be a game changer for Pakistan’s economic prospects?

Some might be surprised to learn that, in purchasing-power parity terms, Pakistan’s economy is bigger than the Netherlands, South Africa and the UAE. However, the country’s growth potential has been overshadowed by political and security risks for much of the past decade.

It was during the visit of Chinese president Xi in April that China announced projects worth USD45 billion in Pakistan until 2030. Part of President Xi’s ‘One Belt, One Road’ initiative the mega-project, known as the ‘China-Pakistan Economic Corridor’ (CPEC), is significant at around 17 per cent of Pakistan’s GDP. It promises to help policymakers shift gears from stabilisation to growth.

Investment is only the start

Bottlenecks such as energy shortages mean Pakistan’s growth has been sluggish – just 4.2 per cent in 2014. CPEC promises to change this. USD34 billion is earmarked for power projects to add nearly half of the country’s current total energy generating capacity – 10 gigawatts of power – by 2018-20. An additional 6.5 gigawatts of power is to be added later. This should improve production and support the country’s struggling export-oriented sectors, such as textile.

The remaining USD11 billion is intended to link Pakistan’s southern port of Gwadar to western China. This ‘corridor’ could see Pakistan emerge as a regional trading hub by significantly reducing the current shipping distance from China’s eastern seaboard to the Arabian Sea en route to the Gulf and Africa. And beyond a bilateral undertaking, its benefits to Pakistan could be even greater if it becomes a route for wider connectivity across the south and central Asian region.

But for Pakistan to realise the full benefits of CPEC, alongside the creation of this ‘hard’ infrastructure, transparent policymaking, improving governance and cutting red tape is just as important to boost growth in our view. Pakistan slipped two places in the World Bank’s Ease of Doing Business 2016, ranking 138th out of 189. This shows there is a clear role for structural reforms outside the ambit of physical infrastructure.

"Pakistan’s macro fundamentals are brighter today than at any time since the global financial crisis"

Successful execution of projects at the CPEC-scale will also test Pakistan’s bureaucracy. The government will have to stay the course of fiscal reforms to increase the country’s tax-to-GDP ratio from around 11 per cent to make room for development spending. Also, its reliance on financing fiscal deficits through borrowing from banks has crowded out private sector borrowing – this will have to change if banks are to play a meaningful role in meeting any local-financing needs arising from CPEC-related projects.

It’s not just capital inflows from China boosting Pakistan’s growth potential. Thanks to stabilisation policies adopted under an IMF reform programme agreed in 2013, Pakistan’s macro fundamentals are brighter today than at any time since the global financial crisis.

"Investors searching for yield are viewing Pakistan in a more positive light"

Efforts to stabilise the economy since Pakistan suffered a near balance of payments crisis in 2013 have been helped by tailwinds from lower global oil prices: its foreign reserves recently reached an all-time high of USD20 billion up from under USD8 billion, giving better capacity to repay foreign debt. Although this is partly due to loans received by the IMF, international rating agencies have endorsed the country’s progress: Moody’s upgraded Pakistan’s credit rating to B3 in June and S&P revised its outlook to positive.

This helped Pakistan tap global bonds markets after a seven-year hiatus. The most recent issuance in September came amid emerging-market turmoil, suggesting that investors searching for yield are viewing Pakistan in a different, more positive light.

Investors will, of course, be keeping an eye on whether the balance of payments can remain stable longer-term. A boost to exports from better energy supply would help; as would an increase in foreign direct investment as infrastructure across the country improves.

Brighter future

Pakistan’s demographics also give reason to be optimistic. The country has the world’s sixth largest population, about the size of the UK, Turkey and Spain combined. Around 60 per cent of Pakistanis are of working age – this fuels a vibrant domestic market. Private consumption, Pakistan’s biggest driver of GDP growth, makes the country less vulnerable to sluggish demand in overseas markets than in other Asian countries.

We believe Pakistan has a genuine opportunity to raise productivity and break out of the supply-side bottlenecks that have constrained growth, leaving it vulnerable to commodity-price shocks. But for growth to really take off, Pakistan needs timely execution of the new energy and infrastructure projects, and policymakers must maintain reform momentum past the conclusion of the IMF programme, which ends in 2016. If this happens, we think growth could rise from an expected to 4.4 per cent in 2016 to 5.5 per cent in 2018.

Important disclosures can be found in the Global Research Terms & Conditions