The Classic GCC “Expat” debate

This Article was written for the CFA Institute and was published in 

, Arab Times and Akhbar Al Khaleej 

Expats presently constitute about half of the total population in the GCC (52%), with a low of 37% for Saudi Arabia and a high of approximately 88% for UAE and Qatar. The increasing and large proportion of the expatriate population is a matter of concern for many GCC countries, as it slows down nationalisation goals. It also imposes costs, such as growing remittances, places a burden on public services, such as healthcare and infrastructure, and can result in illegal stay.

How will this evolve and impact certain sectors?

The GCC economic model is unique, as a large number of expats are involved in nation building. While the government tries to contain or reduce this number, in order to provide employment opportunities to nationals, it has economic costs and impacts key sectors. Before assessing costs, let us look at the benefits. A decreasing number of expats will lead to lower remittance. Nearly $100 billion leaves the GCC every year through remittance and hence is a burden on the current account. However, this argument only stands if there is no “qualitative” change in the profile of expats that are working in the GCC. 

Presently, a large majority of expats are blue collar workers (i.e. construction workers or domestic household helpers) whose per capita remittance is always lower than white collar workers. However, considering the weight given to economic diversification and the knowledge economy thrust by many GCC governments, it is reasonable to expect the expat profile to undergo a qualitative change from blue collar to white collar. This push is also likely to come from technological advancements in the construction industry, which will reduce the need for blue collar workers.

If this is indeed the case, remittances may increase, rather than decrease, due to the per capita effect. Recent research, published by Marmore, showed the average per capita remittance for a male expat in Saudi Arabia increased from $2,755 between 1994-1999 to $5,618 between 2011-2015; due to the significant increase in blue collar expats. A qualitative change in favour of white collar workers will also encourage GCC governments to work on labour market flexibility, immigration options and partial opening of markets to real estate investment by white collar expats. A lower expat population will reduce the pressure on public services like healthcare, transportation, infrastructure, water and electricity. Given that most of the public services are highly subsidised, this should be a welcome factor. On the back of lower usage, the need for spending on infrastructure also comes down.

The debate about public versus private sector is also relevant here. In the GCC’s public sector, around 9.6% of the workforce is comprised of expats, while in the private sector, 88% of the workforce is comprised of expats. Given this, displacing expats in the private sector can lead to efficiency loss and an increase in operational costs, as well as reduced margins. Industry associations and chambers will obviously resist more pressure coming from this factor. The private sector is already facing a slew of new taxes to disincentivize expat employment. However, the reduction in expat employment can happen in the public sector, which is currently dominated by local employment.

Sectors that will be impacted by this demographic shift include banking, financial services, real estate, retail, transportation, hospitality, food and beverages and tourism. In the case of banking, the impact will be more positive given the fact that on the retail banking side, GCC nationals are the major consumers of retail products, except for credit cards and personal loans. On the other hand, a qualitative shift in the expat demography will help banks expand their reach. Real estate will be impacted in terms of falling rental yields due to demand contraction. The impact on the retail industry will be mixed, as some aspects of retail catering to essential goods shopping by blue collar workers can suffer due to volume contraction. However, the wealthier segment of the expat population can create new demand for goods higher on the value chain and even open up new business opportunities for the food and beverage sector. The transportation industry, especially low cost airlines, may be impacted due to lower passenger growth and so will the generic food and beverages sector; which is dependent on population growth. Except for Dubai, other places in the GCC are still evolving as tourist destinations and hence the impact should be subdued.

In summary, it is likely that expats will continue to be a binding agent for GCC economic development but there will be a shift towards a more qualified and educated workforce that will not only focus on remittance but can also contribute to local economies as major consumers.

Indian Rupee ( INR ) – Three questions ?

This Article was Published in Market Express and Indians in Kuwait

The Indian Rupee (INR) is surprisingly strong proving many analysts wrong. In a world where emerging market currencies experience decline, the INR has been appreciating steadily. From a low of Rs.68.77/USD in Feb 2016, the INR value is now Rs.64.54/USD. In 2017 alone so far, the INR has appreciated by 5%. Three questions emerge in this context:

      1.       Why is INR so strong?

      2.       What is the outlook (medium term and long term)? &

      3.       What should NRI’s do?

Why is INR so strong?

In my view, there are 4 reasons why the INR currency is so strong.

Firstly the Modi factor. A lot of things seem to be just going right for him so far. His government is mid-way into its first five year term and he seems to be having a positive rating until now. The biggest and boldest gamble in the form of demonetization actually won him many praise from the same people that stood in queue to withdraw money from ATM. His recent budget has been well received. The Goods and Services Tax (GST) harmonizing all indirect taxes is a huge step taken with lot of political will. Finally a string of major election successes especially in Uttar Pradesh and other small wins in Delhi civic polls. Low oil price is the cherry in the ice cream. Modi is emerging to be a credible leader due to which economic and business confidence is moving up. There is clearly a Modi wave at play here.

This brings us to the second reason which is foreign fund flows. On the back of Modi wave and in the last one year, the fund flows have jumped sharply. Fund flows can happen either through FDI’s (long-term and stable money) or through FII’s (short-term hot money). In India’s case, it is more of later though FDI’s have also picked up significantly. While in all of 2016, there was a negative flow of Rs14,000 crores (USD 2.17bn), so far during the first five months of 2017, the fund flows totaled Rs.100,000 crores (USD 15.49bn). Due to this the forex reserves at RBI are at an all-time high of USD 370 billion.

Thirdly, the Federal Reserve of US where after 8 to 9 years of ultra-low interest rates close to zero, the arrival of Trump and his policies are expected to reverse that course and increase interest rates. However, due to growth and inflationary concerns that increase is proving to be slow and painful. When interest rates in US do not go up as expected, money starts flowing out of US into other markets in search of yields. India is a sweet beneficiary in this process.

Finally, the Reserve Bank of India (RBI). With the change in leadership from Raghuram Rajan to Urjit Patel, RBI seems to have grown more tolerant towards a strong currency. RBI has decisively kept away from the Open Market Operations (OMO) leaving the rupee to settle down wherever the market forces decide. In the past such sharp appreciation in the Rupee would have forced RBI to intervene to protect the interests of exporters. Not this time around.

What is the outlook for INR?

At the beginning of 2017, almost all major investment banks had a negative call on INR. Year-end predictions for INR ranged from 70.8 (Barclays) to 65.5 (Mizhou). However, the continued strength of the currency has made many of them revise their forecast which now ranges from 64.5 (MUFG) to 68 (Nomura).

In the short term (meaning second half of 2017), the Rupee will weaken from the current levels if fund flows start to reverse on the back of some bad news on the Indian economy and Modi front coupled with Fed’s resolve to stick to interest rate increases as announced. Both of them look unfeasible as of now. In other words, the near term outlook for Rupee is one of continued strength and can even approach Rs.62/USD.

In the medium to long-term term (beyond 2017), we should be careful in assuming that INR will continue to be strong. Being an emerging market with all attendant problems, the long-term direction of INR is clearly one of weakening and not strengthening. Until and unless the fund flows into India are FDI and not FII, we should be wary of the hot money leaving the country at the blink of an eyelid. Also, the Modi magic will continue only if his administration moves beyond rhetoric and delivers results as promised. Increasing infrastructure, creating jobs and improving ease of doing business can be tough for an economy that languished for so long. Modi will need two or three terms to fulfill the promises not one.

NRI Strategy

The Kuwait Dinar (which is mostly pegged to USD) was quoting at nearly Rs.230/KD during Feb 2016 and is quoting now at Rs.212/KD which is an 8% reduction in value for NRI’s. Obviously the key question in their mind is whether they should wait for the value to rebound or send money now without waiting. Many of the NRI’s have a regular need to send money home. Hence, they will not have the luxury of timing the remittance. However, for those that enjoy this luxury, given the outlook for continued strength of INR for 2017, it may be a good idea to remit now than later. However as they step into 2018, they will have to turn cautious and expect rupee depreciation. 

PS: The author thanks Deepak Radhakrishnan for data assistance

GCC needs monetary policy independence

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

Typically, the topics in the business section of a newspaper in the GCC will almost always focus on issues such as the budget, deficits, subsidies, investment, etc. Meanwhile, a publication in the United States will dedicate more time towards speculating on the Fed’s imminent actions. Global financial markets gyrate to every move made by the Fed and hence are constantly trying to guess what its next one is likely to be. The GCC spends most of its time on fiscal issues since it has effectively outsourced its monetary policy responsibilities to the US Federal Reserve and therefore they are compelled to mirror the Fed’s policies regardless of its domestic economic underpinning. Fortunately, for most part of the arrangement, this worked reasonably well with business and economic cycles of the US and GCC being roughly synchronized. Additionally, strong oil prices throughout much of this period enabled GCC governments to build reasonable reserves; which also thwarted any occasional challenges which would pressurize the pegged currencies.

However, the recent drastic fall in oil prices and oil revenues (on which the budgets are heavily dependent) and the near unanimous consensus of the new low oil price reality going forward has changed that scenario. Given the high and growing break-even oil price (the oil price required to balance the budgets), GCC governments will now either have to draw down on their reserves at a faster rate or resort to borrowings to fill the gap. Being modeled as welfare economies, the restructuring process to rationalize subsidies and stop providing pseudo-employment in the public sector can be painfully slow. Hence, GCC governments will focus on reducing their role as the main investor in their respective markets and dedicate resources towards diversification strategies. The private sector will be encouraged to play a larger role in this diversification effort, especially in sectors such as healthcare, education and transportation where the government is currently forced to commit significant funds and capital. Also, research and innovation will rightfully be granted a higher priority as it can quicken the transition from public to private sector-based economies.  As the shift happens, maintaining a positive business environment will take precedence over government expenditure. Improvements in ease of doing business ranking will have to be achieved in swift time as the economy faces liquidity shortfalls, increase in cost of capital and higher risk premium.

In such a scenario, where government spending and employment will reduce and private sector led diversification process takes center stage, an outsourced monetary policy model may be counterproductive and costly. The ability to set short-term interest rates in order to manage domestic cost of capital and inflation will become important in order to orchestrate the transition. Monetary policy independence would be a necessary requirement for this to be possible. Otherwise, a pegged currency dictated by US monetary policy, where the interest rate curve may be sloping upward going forward, can create serious frictions in  the GCC’s low economic growth environment.

GCC monetary policy independence is also warranted in an environment where the Fed is running out of ammunition. According to The Economist, in the 3 most recent US recessions the Fed slashed rates by 675 bps, 550 bps and 512 bps respectively. However, what is interesting to note is the time taken for rates to return back to normal levels. The Fed took 2.5 years and 3 years to return to normalcy in the first two recessions respectively. However in the most recent recession of 2008, it is 8 years and counting. Should another recession occurs, the Fed will not have the necessary tools at its disposal. It is generally opined that long-term problems which are enveloping in the global system like low economic growth, deflationary concerns and lack of business confidence cannot be solved using the Fed’s short-term monetary tools. For a variety of factors, sooner or later, the Fed will lose its role as the financial market’s sole saviour. Such factors include the fact that its short-term interest rates have already hit rock bottom, an inability to move back to normal rates for a long stretch of time and the long-term nature of many problems that the Fed do not have resources to provide solutions with.

It is therefore time for the GCC to have an independent monetary policy framework like its fiscal policy framework. Such monetary independence will provide the GCC with the ability to set short-term rates and help guide the capital allocation process more cost effectively. It will also enable better control of inflation and will reduce friction in a challenging low growth economic environment. 

FINANCIAL CHALLENGES FOR GCC

This Article was originally written for CFA Institute and published in several newspapers including Gulf News and Arab Times

The GCC is witnessing a period of rapid transformation as oil prices, which were once at a cushy $100 per barrel, has fallen below $50 over the past 18 months. The stable oil prices between 2012 and 2014 enabled GCC to earn more than $3 trillion in export revenues. Thanks to that, GCC governments are now sitting on strong cash reserves.

However, that is only a short-term comfort. Given the extremely high dependence on oil revenues of GCC governments and their lack of economic diversification, the depletion rate of those precious reserves has been highlighted as a major cause for concern. GCC countries now require the oil price to be much higher than $50 in order to balance their budgets. Since prices are still significantly lower than that rate, the region’s governments will face successive years of fiscal and current account deficits; which they will have to plug through additional reserve depletion or through borrowings. Given this context, I would like to specifically look at the financial challenges this period of low oil prices will pose to four specific stakeholders: Government, Banks, Corporates and Individuals.

Government

The biggest pressure is on governments, who face a bloated bureaucratic structure and increasing levels of expenditure largely comprising of salaries and subsidies. Therefore, there is little flexibility for them due to the current social welfare model and the strong social contract with nationals. While rationalising subsidies and reducing wasteful expenditure can be prioritised, this may not reduce deficits within the urgent time frame that is required. Hence, the biggest financial challenge for GCC governments will be funding growing deficits. The IMF estimates GCC countries to pose a fiscal deficit of about 12% of GDP or $150 billion in 2016. I expect this to be met through a judicious combination of reserves, local debt and foreign debt. Research estimates by Marmore point to the cumulative debt increasing from $250 billion to $390 billion by 2020, a significant jump from $72 billion raised cumulatively between 2008-2014. Such a massive growth in debt raising is bound to have an impact on the overall economy in multiple ways. Saudi Arabia, for the first time in eight, had to secure a loan of approximately $26 billion from domestic banks in 2015. It is also in talks to raise $10 billion from a consortium of international banks in an effort to address their growing budget deficit. Most notably the credit rating will be lowered as a consequence of the increasing Debt to GDP ratio. Sovereign ratings of Bahrain, Oman and Saudi Arabia have already been downgraded recently with further downgrades expected in the future. Another point of impact will be the Credit Default Swap (CDS) spreads. In the last six months, CDS spreads of Abu Dhabi, Qatar and Bahrain have doubled while Saudi Arabia’s has tripled. The current macroeconomic conditions will also increase the cost of capital for governments.

Banks

The financial challenge for banks will come in the form of lower levels of liquidity. Banks, to a great extent, largely depend on government deposits for their liquidity; which have experienced significant decreases. With stagnating growth in deposits, banks will have lesser amounts to lend at a lower spread; which will have a negative impact on their profitability. On the other hand, the sovereign bond issuances will see high levels of subscription by banks because of the attractive yields and their risk free nature; this will crowd out lending to the private sector. The pressure this will introduce to the margins of banks will result in lower profitability. Additionally, the financial challenges for corporates will mean deteriorating asset quality and a rise in Non-Performing Assets. As a result, the credit rating for banks will remain on the downward trajectory.

Corporates

Banks being crowded out will directly impact the private sector, since fund raising will be increasingly difficult and expensive. Many companies have solely depended on government spending for projects. In this climate, project delays are inevitable and may affect working capital. Advance payments for projects have been slashed from 20% to 5% of contract value. Since corporates access banks for most of their short-to-medium funding requirements, access to funding may become difficult and expensive given the pressures banks face resulting from lower liquidity and tighter margins. Debt markets may be an attractive source of funding for governments but not for the corporate sector due to wider spreads demanded by lenders. We have already noticed a weak corporate issuance of debt due to the drying up of liquidity. Where funding is absolutely necessary, it will come at higher cost of capital which adds additional pressurise on margins and profits. Introduction of VAT may also impact corporate profitability. These developments will have a substantial impact on Small and Medium Enterprises (SME’s); who will be crowded out the most.

Individuals

Financial challenges for individuals will come in different forms. Firstly, the generous government policies in the form of subsidies will see cuts; especially for the three most highly subsidised amenities which are petrol, water and electricity. As subsidies are reduced, the cost of services will increase and lead to higher inflation. Individuals will also have less access to financing options from Banks as lending procedures are tightened. Simultaneously, borrowing costs will also increase. Such market conditions may lead to increased debt defaults. Also, governments employ a majority of citizens in the public sector more as a social contract rather than genuine need. The absorption rate will come down as a consequence of growing federal deficits.

Opportunities

As many experts say, challenges can also be viewed as opportunities. Increasing government debt will induce financial discipline, better management of fiscal expenditure and more importantly, the much needed development of debt markets and improvement of the yield curve. Efforts to reduce wasteful expenditure will improve productivity levels across sectors and banks will look for overseas expansion opportunities to improve profitability. The current economic conditions will also encourage the adoption of advanced technological products and services to reduce the cost of service offerings. Corporates will focus heavily on efficiency and productivity gains and align corporate planning with thoroughly researched market needs. Mergers and Acquisitions will be on the rise along with alternative financing avenues such as private equity, crowd funding and sukuks. It will be a period of financial reform to navigate through this challenging period for both the government and private sector!

Don't miss the trees for the woods

This is the editorial written by the author for Marmore Bulletin-a quarterly thought leadership publication focused on Mena region.

Let us accept it. The topic of oil price discussion has come to a tiring point now. Every other debate or discussion is around oil price predictions, outlook for oil price and predicting the future of GCC oil economies. Three questions predominate the narrative:

       1.       Is the current fall in oil price cyclical or structural?

       2.       When can we see a strong rebound? (2016 or 2017 or beyond) &

       3.       Can GCC survive a long spell of low oil price?

In fact, the second question is related to the first question. If the current fall in oil price is structural, then we cannot expect any strong rebound. So, may be implicitly we should pray that this is just a cyclical phenomenon. From a mean reversion perspective, a period of low oil price should be succeeded by period of improving strong oil price and hence it may not be out of place to expect a rebound since we have been suffering from low oil price for some time now. Also, with trillions of reserves earned during good times, GCC may be well entrenched to whither the oil storm for longer than we think. So why worry about oil price?

The answer lies in demography and welfare state model of GCC. Both of them will make sure that government expenditure is on the rise which implies requiring higher oil price to balance the budgets. As population grows at a healthy rate (emphasis youth population), the pressure on infrastructure investments, job creation and essential services (education and healthcare) increases manifold. Surround this with challenging geopolitical situation, you can guess the answer. The answer to the challenges enumerated above does not lie in high oil price as we have figured out by now. The answer lies in creating meritocratic institutions that focuses on nurturing innovation and creativity. The answer lies in fostering reforms across the board so that doing business even by local family businesses gets lot easier and cheaper. GCC should restructure their economic business model in such a manner that it no longer depends on just one commodity for its survival. We should use the oil industry to champion the change. We should focus on reduction of wasteful expenditure rather than augmenting non-oil income (through subsidy rationalization and taxes). While subsidy rationalization is essential (given the extremely low pricing of services), it should succeed efforts to augment efficiency in the existing model which can reign in extraordinary savings.

GCC must embark on a path that will make those 3 questions redundant in the next 10 years.

Conflict of interest

In our day-to-day work we come across several situations where we face severe conflict of interest. If we are in a situation faced with a conflict of interest, ethics demand that we disclose and move away from the situation that creates the conflict. However  if you are faced with a situation where there is a potential  conflict of interest that you note but cannot do anything about it that would probably not be as simple to deal with because the ability to remove the conflict of interest is not within your hands. Here is a simple list of certain conflict of interests that I have observed mostly within finance/commerce space over time and it would be interesting to see how they play out in terms of business decisions.

Credit Rating

This is the mother of all conflict of interest that I have ever observed. The credit rater is paid by the credit rated. In simple words, you take money from a company to provide a rating to the company. This conflict probably was at the heart of global financial crisis. However the model continues to operate the same way. Even now the credit rating companies are paid by credit rated companies and not by any independent agency. Well, to an extent credit rating agency can appear to  be unaffected by this conflict of interest, but I am sure down the line there would be an impact of this direct conflict of interest between the rating agency and the rated company. The best way to resolve this is to create an independent credit rating agency fully funded by government. The government can impose some sort of tax on corporate on overall basis and try to do this as an independent exercise completely devoid of any conflict of interest. A credit rating borne out of such a process can definitely be more unbiased and objective. 

Sell-side research

The brokerage industry thrives on brokerage commissions. Brokerage commissions are derived by the extent of trading by clients (investment companies or asset management companies). In order to elicit the interest to trade, brokerage companies come out with a series of research notes on companies in what is now popularly known as sell-side research. The idea is to trigger either buying interest or selling interest about the client firms so that that the commission earned can be increased.  Obviously this sort of research is not going to be independent or objective because the purpose of this research is basically to trigger trade actions and not to enable unbiased objective investment decision.  There is still no way out of this sell- side research dilemma.  Investment communities still continue to depend hugely on sell-side research even though they see this conflict of interest very clearly. Of course, certain regulators mandate publishing details like investment banking business done in the past one year, number of sell call/buy calls and history of calls along with actual performance. More often than not, these disclosures come in small print! 

Media

Media is probably one of the best examples of a conflict of interest. The most popular newspapers and magazines literally thrive on advertising revenues almost completely. Nearly 90% of their total income accrues from advertising revenues rather than subscription revenues. So obviously this poses a limit on how far you can go to be independent about client companies lest your main source of revenue will be hit. This is true for print media, television channels and digital media too. We all know that views that are being aired about these companies that are their clients can never be independent or objective since their existence depend on continuation of their advertising contracts. And curiously enough, the client list can also include political parties! 

Audit and Consulting

Auditors normally are mandated to be extremely independent and they have to provide independent view on the financial status of the company. Like credit rating agencies, auditors are being compensated by the company that is being audited which itself is a potential conflict of interest, but by virtue of their access to almost all records and status of company, they are also in a position to see what type of consulting mandates can be obtained and executed by the audit firms. Technically they may not do it under the same name but there are ways to get around this. 

Board of Directors

Board of directors can either be independent businessman in which case they would try to push their business opportunities or they could be simply also be a client or vendor for the company. It may not be done directly but there is always conflict of interest between being on the board and trying to influence the company to use the services of the businesses that they are directly or indirectly connected with. 

Financial audit

There may be cases where senior partners of an audit firm can hold some sort of a stake (direct or indirect) in the client company for which they conduct financial audit. This will be definitely be at the back of their mind when they conduct the financial audit because their financial fortunes are tied to the audit opinion and they may not be having the courage to give true opinion about the firm since they hold a stake in the firm. 

Hospitals

Major hospitals and to an extent even clinics of a decent size have their own testing laboratories. These laboratories house expensive, often imported, medical equipment whose capital costs need to be recovered at the earliest. Hence, doctors have implicit incentive to refer patients to sometimes necessary but most of the times unnecessary tests in order to recover the capital investments. I believe in many hospitals doctors have targets when it comes to recommending tests! 

In summary, conflict of interest abounds and surrounds us in everyday lives. It may be a source of intense frustration when it impacts our personal lives (like hospital example given above). In corporate situations, it may affect our performance as investment or portfolio manager where we rely on credit ratings or equity research to make investment decisions. In most of the cases, the cost of conflict of interest is not straightforward or apparent though we know it exists. It may pay well to be conscious of this while making decisions though in many cases it cannot be avoided. By no means, this list is exhaustive. Feel free to suggest other apparent conflict of interest that you have observed.

How to Tackle Subsidies in the GCC?

This Article was Published in Arab Times, Gulf News, Akhbar Al Khaleej, Al Qabas, Zawya

Subsidies are easy to roll in but difficult to roll back. The vexed issue of tackling subsidies comes to the fore in difficult times and hence this topic assumes importance in a low oil price situation. According to IMF estimates, GCC countries will spend roughly USD 60 billion on energy subsidies in 2015. While subsidies are offered under various categories, the major one is always energy subsidies. Very high amounts of energy subsidies in the GCC have led to wasteful consumption, which is reflected in the high per capita burden of these subsidies.

This issue is a topic of importance not only to the GCC, but also to the wider MENA region. Arab countries spend nearly 7.2% of their GDP on energy subsidies (pre-tax), while the comparative figure for advanced economies is just 0.03% and about 0.9% for emerging markets. Hence, the scale of subsidies is relatively too large to ignore. Also, given the high subsidy rate in the GCC (averaging nearly 70 to 80% of the cost), it often promotes wasteful consumption and encourages energy intensive industries rather than labor intensive industries.

Before we tread the subject of how to reduce the impact of subsidies, it is important to understand the context of subsidies in the GCC vis-a-vis other Arab countries. In the GCC, subsidy is a form of “wealth distribution,” while in other Arab countries it is more a form of support to poor people as a poverty alleviation tool. Therefore in the context of the GCC, where subsidy is more of a wealth distribution mechanism, the factor of demography plays an important role. In economies like the UAE, where expats are super dominant as a share of total population, the role of “wealth distribution” takes a back seat while that may not be the case in other GCC economies where the share of expats is more or less balanced.

Hence, it is no wonder that UAE recently launched the bold initiative of ending the energy subsidies. In July 2015, the UAE announced linking gasoline and diesel prices to global oil markets staring August 2015. It became the first country in the GCC to remove transport fuel subsidies. The move is expected to result in a savings of about $7 billion for the UAE. Given the large expat population (of over 90%), the burden of such roll back on nationals can be minimal. Hence, we must not assume that all other GCC countries will also follow a similar path.

While the intention behind energy subsidies is to relieve the burden on the poor, such an argument may not be valid for the GCC given the high per capita income and the classification of the GCC as rich rather than poor. It is important to note that in the context of other Arab countries, though subsidies are directed to help the poor, it is often the rich that benefits from them.

What steps should the GCC take now?

It is not a question of “If”, but rather a question of “how” to reduce subsidies and gradually lessen its impact on the fiscal situation. The following can be proposed as ways to tackle this  this vexing situation.

     1. Find alternative methods to distribute wealth: Since in the context of the GCC, subsidies are more of a “wealth distribution” mechanism than a “poverty alleviation” mechanism, it may be a good idea to come up with alternative methods of wealth distribution and replace such methods gradually over time to reduce the burden of subsidies. Direct cash transfer is being proposed by some scholars as an example of this route. The main advantage of such an idea is that it shifts the burden of rational decision making from the State to  individuals and families directly.

     2. Introduce innovative strategies: GCC states can think of introducing various concepts surrounding the subsidies rather than a strait jacket approach of providing the service almost free of cost. The concept of “Tiered subsidies” linked to consumption (low price up to a certain point and high price thereafter) can reduce wasteful consumption. “Smart subsidies” can link subsidies to certain KPIs like national employment or training new graduates. The idea of “Targeted subsidies” can also be tried when promoting certain sectors (say SMEs) becomes more important and therefore can be linked to subsidies provided. Innovation in subsidies can produce better results.

     3.  Aim for efficiency in production: The subsidy burden is simply the difference between price and cost of production. While the suggestions in introducing innovative strategies can work on the price side, it may also be a good idea to focus on how to reduce the cost of production by improving the efficiency of the production of energy. Development of alternative sources of energy fits nicely into such a scheme of thing.

      4.  Launch effective communication: The factor of high subsidies in the present time can disproportionally increase the burden onto future generations. An effective communications strategy that explains the long-term burden of high subsidies and how it crowds out investment in infrastructure can go a long way in gaining support forthe idea that subsidies should be reduced over the long term. 

Chinese Crisis: 3 Questions for NRI’s

This Article was Published in Indiansinkuwait.com

Sensex fell by 1,624 points (5.94%) on August 24, 2015 to reach 25,741 in what is now termed as Black Monday. That was unprecedented given the normal movement of say 100 to 200 points in a day. Though Sensex subsequently recovered to 26,392, the unease continues amongst many of us. So, what has caused this sudden panic and how should we (NRI’s) prepare ourselves. The following questions may be appropriate to answer.

      1.       What is this crisis?

The Chinese stock market has been on a roll since November, 2015. The Shanghai index increased from 1,924 to 4,098, representing a gain of 113%, within a matter of 8 months. This was due to easy money available through banks which lured retail investors into the market. Everyone from fishermen to laundry cleaners were busy making money in the stock market. However, as we all know, such a sudden increase in the market through mindless buying can only go on for some time and not for ever. Companies have become extremely over valued and smart investors started exiting the market. This created a panic among retail investors and they were rushing out of the market creating further slide. The government tried to intervene and prop up the market but it failed. The Chinese stock market fell 35% within a span of 2.5 months. On August 24 (Black Monday), the Chinese market fell by a whopping 8.96% and immediately on the next day all global markets fell including India.

But the question is why a Chinese stock market collapse should cause such a global panic. This is because there is a larger worry among global players than the Chinese stock market. That of Chinese economy.

Since 2008 when the last financial crisis hit the world, there have been fears about slowing global growth. While USA has been trying to recover, Europe is in shambles with only Asia left to support. China is not only a significant part of Asia but also the world. It contributes heavily to the global growth in terms of trade (exports and imports). Before 2008, Chinese economy was growing at the rate of over 10%. Today, the growth has slowed down to 6-7% with fears that it will be even lower. When economic growth is low, countries will find it difficult to create employment which will lead to social unrest. It will also find it difficult to attract foreign money which will hamper investments. Business confidence will fall and businessmen will not make any new investments. Hence, it is important for any country to enable economic growth.

China was predominantly depending on exports for its growth. After 2008 financial crisis, the overall growth of trade (exports and imports) reduced thereby reducing China’s growth. Hence, this panic all over the world. In short, today when China sneezes, the world catches a cold!

      2.       How is India affected by this?

The impact on India is more symbolic than real. Many emerging markets (Indonesia, Brazil, and Russia) are highly dependent on China as commodity exporters. China is one of the largest consumers of many commodities to run its global factory. When China signaled a slowdown in growth, many emerging markets (dependent on china) started feeling the heat and this heat has spread to all other markets including India. Even countries like Germany and Australia (not part of emerging markets but part of developed markets) fell as they have strong links and dependence on China.

India’s economic link with China is very limited. India is not a commodity exporter (like Russia). The only risk India faces is that it can be swamped by cheap imports from China that can threaten local companies. With Yuan devaluation, this threat is real.

The main impact on India will be through its currency. As a fallout to Chinese crisis, many emerging market currencies hit their lows during 2015. (Brazilian Real -26%, Turkish Lira -20%, South African Rand -13%). India is among the least affected currency where the INR fell only by 4% so far in 2015 against the USD. If the Chinese crisis deepens, it will further impact emerging market currencies and we can expect India also to feel the heat in terms of further depreciation of INR.

On the positive side, continuous strain on China can open doors for India as one of the fastest growing economies in the world with least linkages to external world. With America not showing any great signs of economic rebounding and Europe in a limbo state, only very few destinations for investments in the world are left and India can definitely count as one.

      3.       What should NRI’s do?

In this Chinese crisis, NRI’s experienced both good news and bad news. The good news came in the form of lower currency. For eg., the Kuwait Dinar spiked to Rs.224/KD and seem to be hovering around Rs.217/KD now. NRI’s that remit money regularly back to India will certainly be smiling and would hope for even more depreciation of the Rupee!

On the other hand, the steep fall in Sensex/Nifty caused their stock portfolio values to plummet and they were left worried on what the future course of Sensex could be.

For NRI’s, the following observations can be helpful:

     a.       The current Chinese crisis is not just a China issue but a global issue that can affect all markets including India.

     b.      If China slows down (as is feared), it will result in global slowdown, and may negatively affect stock markets and currencies.

    c.       However, India’s fundamental strength (Strong economic growth, ample forex reserves, less linkages to outside world, new government that is reform minded, and a prudent RBI) will make it as one of the safest destinations for investments for foreign investors

      d.      The long-term story of India remains solid

     e.      NRI’s should benefit from the depreciating rupee by regularly remitting money back home and invest in various avenues.

      f.        Diversify your investments by spreading your savings among risk-free fixed deposits/bond funds, and volatile equity funds with some exposure to gold (as insurance). The RBI governor is likely to decrease interest rates in response to lower inflation and hence presently FD rates are looking attractive. Also, when interest rates come down, bond funds will do well. In equities, for those that do not have time to follow markets on a daily basis, invest regularly in well performing diversified mutual funds. If you have the time to select sectors/stocks, favor healthcare, auto, FMCG, infotech and banks. Avoid Realty, metal, power, PSU’s and small cap.

One final note of caution to NRI’s in the Gulf. GCC has more linkage to West than to East. Oil prices have fallen from a high of $140/barrel some years before to $40/b now and are expected to remain at this level for some time. Hence, government spending on projects will likely come down which will put pressure on many companies. Hence, restructuring, cost cutting and job retrenchment can be expected. Job security for NRI’s can come only through increased training and further qualifying. Job security should not be based on the hope that oil price will rebound. 

Four Insights To Reduce GCC Remittances

This Article was published in Arab Times, Al Qabas, Khaleej Times, Arab News, Financial Express, All Pinoy News, Daily Star, The Peninsula, The Sen Live, Gulf News, Egypt Independent, AME Info, Economic Times; Gulf News

During 2014, GCC countries experienced an outflow of over $100 billion in the form of remittances from expatriates that work in the region. The amount is an estimated 6.2% of GDP, a significant cost compared to the United States (0.7% of GDP) or the United Kingdom (0.8% of GDP). The figure was roughly $50 billion in 2010, implying steady and strong growth in remittances.

S.No	Net Outflow  (2014-USD Billion)	Country	GDP  (USD Billion 2014)	Net Outflow as % of GDP
1	124	United States	17,418	0.7%
2	44	Saudi Arabia	752	5.9%
3	29	United Arab Emirates	401	7.3%
4	23	United Kingdom	2,945	0.8%
5	21	Canada	1,788	1.2%
6	16	Hong Kong SAR, China	289	5.8%
7	14	Russian Federation	1,857	0.8%
8	13	Australia	1,444	0.9%
9	12	Kuwait	172	6.9%
10	9.5	Qatar	210	4.5%
Source: World Bank, IMF

There are several factors that contribute to this remittance pattern, as described below:

Home Bias: The majority of Gulf expatriates originate from India, Egypt, Philippines, Bangladesh, Pakistan, Indonesia, Sri Lanka, and Yemen. These countries have a large diaspora population living and earning income off-shore, most often in low paid jobs that require them to leave their families behind in order to save money and support them.

Closed Market: GCC countries have restrictions on what foreigners can own and invest in, which crowds out investment opportunities for expatriates. While some markets such as Dubai have opened up for foreigners, most of them are still out of bounds.

Absence of Tax: GCC countries charge no income tax on salaries paid to expatriates, which is a huge factor that attracts expatriates to opportunities here. However, the model that other countries follow (like the US or the UK), where the local population is taxed as well as provided with social security, actually increases the “engagement quotient” and motivates them to invest in local markets. The required tax also reduces the savings pot, and thus the money available to remit. Therefore, the absence of tax on income acts as a huge attraction towards remittance in the GCC.

Strict Labor Laws: In the GCC, expatriates are able to legally work for a significant period of time, but cannot claim citizenship. As opposed to the US and UK where the possibility of obtaining citizenship is high, the lack of securing citizenship for expatriates in the GCC encourages them to concentrate their investments back home.

Remittances represent a huge lost opportunity for the GCC countries. While GCC countries enjoy high liquidity, attributable to oil revenues, this state of oil dependency is neither assured nor desirable.

I believe the following are ways in which the GCC can curb the growth and outflow of remittances:

Create Jobs/Reduce Unemployment: The GCC is highly dependent on an expatriate labor force, primarily due to the economy size (requiring large scale labor) and a skill shortage among nationals. The expatriate population comprises 49% of the total population in the GCC; additionally, nationals are highly concentrated in the public sector, often as a result of a wealth distribution process rather than actual job needs. Therefore, there is genuine need to create jobs and enable the nationals to secure and retain those positions. This will reduce local unemployment and shift the balance away from expats in the long term, which may then reduce the remittance flow impact.

Incentivize Domestic Investments: GCC countries can incentivize local investments for expats by launching specialized products that cater to their needs and preferences. This will allow the region to tap into the 25 million expats that reside in the region and maximize investment potential.

Open the Markets: GCC countries can start opening up their markets to foreigners, especially expats. Real estate is a great example of an untapped opportunity. Investment by expatriates should be differentiated from foreign investment, as the former provides a more stable source of investment given the length of time they spend in the region. The toughest obstacle would be reaching out to low-wage workers, who constitute the bulk of remittance. An employer engagement strategy (similar to 401k) can be implemented to tap into this segment.

Improving Hard and Soft Infrastructure: The GCC should strive to improve their infrastructure, including  airports, roads, and railways to consistently provide state-of-art lifestyle avenues. This can attract new expat groups that view infrastructure sophistication as important criteria. Areas like healthcare and education should be elevated to best in class, so that expats are motivated to bring and live with their families.

In conclusion, remittances offer a low hanging fruit to GCC governments to implement strategies that can stem and reverse the flow. It is in the long-term interest of GCC countries to reduce at least some of them through proper incentives and investment opportunities.