On 8 June 2016 the IMF published a Middle East and Central Asia departmental paper on “Learning to Live with Cheaper Oil: Policy Adjustment in Oil Exporting Countries of the Middle East and Central Asia”.
The paper looks at policy challenges in view of the lower oil prices which have reduced growth, caused large budget and trade deficits and created risks for financial stability. A process of fiscal adjustment is required. Most oil exporters in the Middle East and North Africa (MENA) and Caucasus and Central Asia (CCA) areas have however built up large financial buffers that can be used to smooth out the adjustment for lower oil revenue.
In the Gulf Cooperation Council (GCC) region and in Algeria fiscal consolidation measures are being implemented in 2016 but an additional substantial deficit reduction effort will be required in the medium term. Deep structural reforms are needed to improve growth prospects and facilitate diversification. In the CCA region economic activity is at a two-decade low and stronger macroeconomic policy frameworks and better financial sector supervision are needed for financial stability. Structural reforms are required to increase potential growth, competitiveness and employment.
Fiscal adjustment measures adopted
Countries throughout the region are focusing on spending cuts and some are planning sizeable cuts in public investment. Most GCC countries have not yet significantly increased non-oil revenues but some policymakers have announced the adoption of a GCC-wide value added tax (VAT) system and other fees, charges and excises. Oman has increased corporate taxes and fees. There are however currently no plans to introduce personal taxes in the GCC countries. Other measures such as energy price reforms have been introduced in some of the GCC countries.
Further fiscal adjustment
Implementing a further large fiscal adjustment will not be easy because policy makers will need to minimize any negative impact on growth while maintaining social cohesion and essential spending. A comparison with other emerging markets and developing countries (EMDCs) shows that the GCC countries have the room to raise receipts in all areas. Revenue could be raised from VAT and property taxes; and from personal and corporate income taxes.
In the CCA region the taxation of non-oil income is already further developed but there is room to reduce tax exemptions and to strengthen tax collection. CCA countries spend rather more than the EMDC average on capital expenditures. For the GCC countries a broad-based 5% VAT would raise revenue amounting to around 1.5% of GDP in the GCC region. Increasing public investment efficiency could save around 2% of GDP with further savings possible from reducing non-essential investments.
Growth and diversification
In the GCC region and Algeria growth is expected to average around 3.5% in the period 2017 to 2021, around half the recent trend. There will continue to be headwinds from lower oil prices and fiscal consolidation will need to continue for many years. In the CCA oil exporting countries non-oil growth is projected at around 2.5% in the period 2017 to 2021, which is only one quarter of the previous trend, as a result of the lower oil price and other adverse factors.
The traditional growth model in the region based on redistribution of oil revenues through the government budget and public sector employment cannot be sustained in the era of lower oil prices. New sources of growth and fiscal revenue must be developed. Most of the MENA and CCA oil exporting countries have long term diversification strategies encouraging private sector development and non-oil growth. Progress is gradual and the role of the private sector needs to be deepened.
Diversification from oil will require more improvements in the business environment, stronger incentives to develop the public sector and better alignment of education and skills to market needs. The GCC countries generally benefit from high quality infrastructure but are held back by bureaucracy and by the remaining gaps in the legal and regulatory frameworks. In the CCA oil-exporting countries and Algeria institutional quality could be improved by reducing corruption, improving contract enforcement and expanding access to finance, as well as by improving the quality of the infrastructure.