INVESTING IN NEW REALITIES: GCC CHALLENGES

This Article was published in Arab Times, Akhbar Al Khaleej, Gulf News, Alqabas

The year 2014 will count to be a momentous year for the GCC region. The year witnessed both a strong rally in the stock markets during the first five months followed by bloodbath during Q4 2014, thanks to oil price swings and its pass through effect. As we enter 2015, there is lot of panic, trepidation and uncertainty. What this means for investing?

In panic, it is always possible to miss the big picture. And the big picture is quite strong. Years of strong oil price has enabled GCC economies to increase spending and build reserves. Saudi Arabia, being the largest, can serve as a proxy to study. Contextually, it may be relevant to compare three time periods to appreciate the big picture i.e., 1998, 2008 and 2014. During the last 15 years, the region witnessed three inflection points where it has braced the lowest oil price (1998), suffered collateral damage inflicted by the global financial crisis (2008) and experienced steep oil price decline (2014).

KSA	1998	2008	2014
Oil Price (Brent, $/bbl, average)	13.04	98.3	106.1
BEP ($/bbl)	20.4	57.6	94.8
Fiscal Balance as a % of GDP	25.90%	29.80%	5.60%
CAB as % of GDP	-9.00%	25.60%	15.30%
Govt Spending- Current Exp (USD bn)	45.7	103.8	179.0
Govt Spending - Capital Exp (USD bn)	5.0	35.1	80.4
Index Level (Tadawul)	1,413	4,803	7,905
Stock Market Cap (USD bn)	42.7	247	422
GDP (USD bn)	146	520.5	764.1
M.Cap/GDP	29.2%	47.5%	55.2%
Turnover velocity (tot value traded/avg. m.cap)	26.9%	137.8%	119.9%
Population (in million)	19.51	25.79	30.67
GDP / Capita (USD)	7,483	20,182	24,914
Foreign Reserves (USD bn)	46.9	442.2	793.2
Source: IIF, World Bank

However, compared to 1998, the GCC region is today well poised to weather any storm given the large surpluses that it has built during this period. Saudi Arabia’s foreign reserves at close to $800 billion is nearly 17 times larger than what it was in 1998. The period marked an increase in the overall economy (GDP) and the attendant increase in stock market capitalization and liquidity. During this period, the population has also increased. However, the GDP growth outpaced population growth resulting in higher per capita. It may be interesting to focus on spending for Saudi Arabia. From a modest $50 billion in 1998, overall spending increased fivefold to $260 billion. In this, the current expenditure increased by a factor of 4x while that of capital expenditure increased by 16x. This probably explains the lower fiscal balance today compared to earlier inflection periods.  The stock market soared from an index level of 1400 to 7900 though in the interim it reached 20,000! Measured in GDP terms, the market cap/GDP ratio is still a modest 55% providing room for significant market cap expansion.

The growing demographics punctuated by young population is triggering demand boom for several goods and services including banking, telecom, housing, retail products and capital goods. Increase in current expenditure has unleashed a consumption boom while increase in capital expenditure has resulted in infrastructure spending focused on power, roads, aviation, water, ICT, education and healthcare.

The period also marked significant developments on the regulatory aspects with several countries including Saudi Arabia launching independent capital market regulators to modernize the capital markets and attract new players. Several other sectors like telecom, insurance, etc also witnessed launch of independent regulators.

However, the economic and investment expansion is not accompanied by improvement in business environment as reflected by the WEF ranking on various parameters. While performance on issues like starting business, infrastructure and access to loans were better, critical parameters like ease of doing business, health and primary education, labor market efficiency and capacity to retain talent deteriorated from 2008 to 2014.

Saudi Arabia - Ranking on a Global Level	2008	2014
Ease of Doing Business	23	49
Number of Days to Start Business	30	20.5
Number of Procedures to Start Business	34	9
Health & Primary Education	51	50
Infrastructure	41	30
Labor Market Efficiency	63	64
Ease of Access to Loans	39	27
Country Capacity to Retain Talent	16	22
Source: World Economic Forum –Global Competitiveness Report 2008-09 & 2014-15 Note: 2008 ranking is based on 134 countries, 2014 ranking is based on 144 countries

The GCC economies must therefore prepare themselves for oil price swings and should use their enormous reserves to rapidly diversify their economies by improving the business environment. While the big picture is very strong thanks to years of strong oil price, GCC needs qualitative change in the global rankings to tap the vast potential in several key sectors including banking, telecom, infrastructure and services. Improvements in these indicators call for a variety of reforms at various levels and their successful implementation. They should form the Key Performance Indicators (KPI’s) for the relevant ministries. The need to accelerate reforms and diversify the economy is acute given the ever increasing break even oil price required to balance the budgets of GCC economies. This then  is the new reality!