Oil prices and government spending

By Lo’ai Batainah — The oil price hike for more than 30 per cent in 2003, which pushed the oil price to more than $100 per barrel, led many Gulf countries to expand their spending by more than 20 per cent CAGR. This shows the strong correlation, and may be the only one, between revenues and expenditure. This means that improving socioeconomic conditions is linked to oil price and revenues. The global financial crisis, which hit many countries in the world with varying degrees from mid 2007 until date, led to a decline in oil prices, many countries were forced to revise their fiscal and spending policies. Many of such governments resorted to their fiscal reserves to meet their obligations towards their peoples. It should be noted that the fluctuation of oil prices and preparing state budgets as per oil price estimates make the fiscal policies , reserves and surpluses subject to fluctuation in oil prices.

It is a truth universally acknowledged that oil price is closely linked to the status of the global economy especially most of the oil importing countries are industrial countries.

Since 80s, most oil exporting countries, especially the Gulf and Arab countries, started creating sovereign investment funds that serve as safe haven in case oil prices decline below the levels estimated at the state budget. There has been a hot debate among politicians and economics whether the decline in oil price will force the Arab and Gulf governments to reduce their spending or not? It has been the norm of Arab and Gulf governments to get loans from the local banks (these loans have now become very high) or from the sovereign funds when the oil price is down. This has been the case with many Gulf countries, Oman, Bahrain and Kingdom of Saudi Arabia, just to name few.

It is true that there is a close correlation between oil price decline and the high borrowing levels (bother internal and external) andwithdrawal from reserves. There is also close correlation between the high oil prices and the high spending levels and high credit balances at the sovereign funds of the Arab and Gulf countries. We are all aware that the spending levels at the GCC countries throughout the past 10 years grew by more than 20 per cent CAGR. What will be the case if oil prices — Allah forbid — rebound to 2003 levels ( about $50 per barrel) at a time the current expenditure levels for all Gulf Countries grew by 150 per cent during the past 10 years taking into consideration elements such as inflation rates , unemployment and other liabilities to be shouldered by these governments?. Will Gulf countries be forced to reduce expenditure immediately or withdraw from their reserves for periods that may stay for long? What the case will be if such decline will continue for long as Canada announced that from 2015 onward it would supply China with oil. USA is also developing a very sophisticated technology for extracting oil from hard rocks. What the case will be if China and the US (major importers of Gulf and Arab oil) stopped their oil imports from Gulf countries?

In such scenario, the Arab and Gulf government will have no other option but to curb their expenditure plans and programs, which will be restricted only to important areas. This in turn will reduce the growth rates and may drag them to the negative area. The question now is what are the plans and programme that we should initiate to address any sudden and quick tumbling of oil prices? We should enhance our reserves and sovereign funds. We should also invest in building investment and financial plans to may serve as parallel economy to the oil-based economies. This does not mean that we should increase our spending in a sharp manner to build plants and industrial complexes that may not be feasible during recession periods. We should rather build a sector of parallel services for each sector such as transport, tourism, insurance, logistic warehouses and others.

We should maximise the benefit from our strategic location between East and West, South and North. We should be more focused on diversifying sources of national economy and enhancing government revenues from non-oil sectors on the short and medium term (5-10 years). The estimates point out that the Gulf countries spending will reach record levels in 2013 with the salaries and wages for the civil servants swallowing almost 40 per cent of the current spending. The remainder part of the current spending goes to items other than salaries and wages such as public administration, external services and debt service allocations. The public administration takes the bulk of current expenditures followed by expenditure on defence, security, education and health. A report for Gulf Investment Corporation 2013 and other research tanks pointed out that despite the fluctuation of oil prices during the last period, the Gulf governments managed to continue their expenditure plans; thanks to the huge financial surpluses and the ability of the Gulf investors to maintain defence stances.

The Gulf investors prefer sectors that focus on local economies such as banks, retail, communication and cement. They are somehow reluctant to venture in petrochemical sectors in a bid to avoid the risks associated with the world stock markets. The report said that Gulf countries and oil-exporting countries in general seek to maintain relatively high growth rates with prospects of oil price going down due to lower demand, higher supply coupled with decline in economic growth rates. It should be noted that oil production witnessed a significant increase especially from countries such as Iraq (3.4 million bpd with plans to increase production to 3.8 million bpd this year) and Libya with increased its production to 1.7 million bpd. On the other hand, the increase in gas production by countries such as USA led to a reduction of liquid fuel imports to 45 per cent in 2011, compared to 60 per cent in 2005.