Gulf States At A Crossroads

As the region’s oil-and-gas dominance faces new challenges, the monarchies are betting that foreign capital will help carry their economies into a more stable, diversified future.

Gulf Cooperation Council governments crave the economic elixir that diversification promises. But the GCC’s report card in attracting foreign investment paints a mixed picture, and even the region’s most varied economy, Dubai, is having to renew its relevance to investors. Government-related entities in the tiny emirate have racked up $60 billion of debt—equivalent to 50% of GDP—and around half of it matures in the next three years, according to Capital Economics.

What’s more, electric vehicles, emissions controls and fuel efficiency—not to mention the down-the-road prospect of “peak oil”—are existential threats to the longtime anchor of the regional economy. Almost every Gulf monarchy is offering up its own branded embrace of economic liberalization: Saudi Arabia’s Vision 2030, the United Arab Emirates Vision 2021, Kuwait Vision 2035. Yet liberalization is not something naturally found in the DNA of Gulf policymakers. For decades, the energy-rich states have kept a tight, introspective grip on their economies, cosseted by a global thirst for hydrocarbons. All GCC countries possess a bloated public sector and, with the exception of Dubai, a private sector that revolves around oil-and gas-related industries.

“Geopolitical and regional political issues are still a stumbling block to growth,” warns Cyril Widdershoven, director at Dutch risk consultancy Verocy.

That model is now in doubt. Growing populations thus far have enjoyed a cradle-to-grave social compact, but governments are increasingly rolling back expensive subsidies. That, coupled with data compiled in February by IHS Markit for Emirates NBD, showing UAE employers cutting jobs at the fastest rate in a decade, suggests that the region truly has reached a turning point. Almost uniformly, regional administrations are betting that foreign capital is part of the solution.

Economic Overhaul

All eyes are on Saudi Arabia, the Gulf’s largest economy, as it loosens regulations and chases foreign investment in an effort to overhaul its hydrocarbon-dependent economy. Maverick crown prince Mohammed bin Salman is inextricably tied to the success or failure of Saudi Arabia’s reforms and outcry over the murder of journalist Jamal Khashoggi refuses to fade. Investors may have short memories, but Riyadh’s ability to deliver policies that entice investors remains unproven, exemplified by Saudi Aramco’s long-delayed IPO.

Saudi Arabia’s grip on the energy market is loosening as well. Last year, the US became the world’s largest oil producer; only a decade earlier, American oil production looked to be in terminal decline. With the US less in thrall, Riyadh is increasingly inching toward Asia. Recent refining commitments in China, India and Pakistan demonstrate Crown Prince Mohammed bin Salman’s determination for a geopolitical realignment. During a recent trip to China, he ordered the Chinese language to be taught in all Saudi Arabian schools and universities.

Riyadh’s bid to attract foreign investment is clearly visible in the evolution of its capital markets. In May, MSCI is due to include Saudi Arabia in its benchmark emerging markets index, following a similar move in March by FTSE Russell and S&P Dow Jones. Theoretically, the decision means institutional investors will seek additional exposure to the kingdom’s equity markets. Egyptian investment bank EFG Hermes expects investment inflows of between $30 billion and $45 billion this year, of which $15 billion will be passive money.

In a further move to boost domestic liquidity, Saudi Arabia’s main bourse, the Tadawul, and its securities regulator, the Capital Markets Authority, are developing cross-listing regulations that will allow companies from other Gulf countries to list on the Saudi stock market.

Public-private partnerships (PPPs) are set to feature prominently as the kingdom seeks foreign capital for infrastructure projects. Yet, erratic progress in privatization of government-owned enterprises suggests investors will want to see improvements in governance and transparency before committing.

Concessions To Investors

Competition for foreign investment is intensifying and cost is rapidly becoming a major issue. Dubai is a longstanding magnet for foreign direct investment, but its model is under pressure amid complaints that the emirate has become too expensive. In a February report, management consultant KPMG said the total cost of doing business in Dubai and Abu Dhabi is now 50% to 55% higher than in Bahrain. Dubai has moved to quell growing unease, allocating $273 million for PPPs that benefit small to medium-size enterprises and a series of initiatives to reduce the cost of conducting business.

UAE authorities have made other concessions to sustain investor confidence, including a law allowing 100% foreign ownership in certain industries. That, however, is counterbalanced by a “negative list” total of 14 sectors that will remain off limits to foreigners. These include banking, oil and gas, defense, and telecommunications. Visas of up to 10 years for investors, entrepreneurs, and specialists working in medicine, science, or research are also available as part of the economic liberalization effort.

Tim Watkins, partner at law firm Coffin Mew, says this marks a first step in longer-term deregulation. “The new law is being seen as the first step toward a broader relaxation of the onshore law that has required, for several decades, at least 51% of a UAE company to be owned by UAE nationals,” he says.

Abu Dhabi has signaled it will actively leverage its energy-centric economy to draw foreign investment. In February, state-owned oil company ADNOC announced a $4 billion pipeline infrastructure partnership with global institutional investors KKR and BlackRock. According to ADNOC, the deal is the first midstream infrastructure partnership between global institutional investors and a national oil company in the Middle East.

Qatar, responding to a boycott by Bahrain, Egypt, Saudi Arabia and the UAE, has gone even further in loosening regulations to entice foreign capital. In January, Doha countered the UAE’s qualified decision on foreign ownership by allowing 100% foreign ownership across all sectors. The move follows publication of a proposed law liberalizing foreign direct investment. Qatar also eased visa restrictions for nationals of 80 countries ahead of Qatar’s hosting of the 2022 FIFA World Cup.

Bahrain’s and Oman’s determination to attract foreign capital is driven by the poor state of their balance sheets. Both are expecting to see deficits in their budgets and current accounts again this year, and their limited foreign-exchange reserves have heaped pressure on currency pegs. Still, Bahrain secured a five-year, $10 billion rescue package from Kuwait, Saudi Arabia and UAE in return for spending cuts and a pledge to eliminate the budget deficit by 2022.

The island kingdom’s Economic Development Board, charged with channeling foreign investment, is focusing on five sectors including financial services, fintech, information and communications, manufacturing and tourism. Once home to the Gulf’s international banks, Bahrain is hoping to capitalize on its cost advantage and reclaim business lost to its increasingly expensive neighbor, Dubai.

Oman’s policy of neutrality toward Iran suggests an aid package from GCC neighbors is less certain. But the sultanate has deepened ties with China, the expectation being that the relationship will support both Oman’s economic-diversification goals and China’s Belt and Road initiative, according to Fitch Solutions Macro Research. With oil exports accounting for around 50% of government revenues, Oman may become more assertive in seeking foreign investment in other sectors, as well. The government is aiming to earn $1.8 billion from privatizations between 2017 and 2022, Fitch says.

Kuwait’s huge foreign-exchange reserves and the probability of both budget and current account surpluses this year cushion it from the impact of lower oil prices. Efforts to diversify the economy and attract foreign capital beyond the oil sector are continually hampered by resistance from the National Assembly. However, MSCI is considering upgrading Kuwait to emerging market status in this year’s annual review, which could improve capital flows.

Regional economies could also get a foreign-capital boost following J.P. Morgan’s decision to include Bahrain, Kuwait, Qatar, Saudi Arabia, and UAE in its benchmark emerging market government bond indexes. Sovereign and quasi-sovereign debt issuers could see borrowing costs reduced after the phased entry of the five Gulf states is completed by September. Dubai-based Arqaam Capital estimates the decision could bring inflows of $30 billion and deepen regional capital markets.

Taken together, reforms to legal and financial frameworks provide a pathway to more foreign direct investment in the GCC. But there is still apprehension, and oil will remain a key factor going forward. “The link between oil prices and economic growth is strong,” Widdershoven says, “resulting in economic constraints if government budgets are directly linked to oil price revenues.”