II. Overview of Economic Developments and Policies, 1981-95
Since the substantial increase in international oil prices during the 1970s, economic developments and policies in the GCC countries can be broadly divided into four periods (Table 2):
• In the early part of the 1981-85 period, historically high--albeit declining--oil prices increased export receipts, allowing the GCC countries to record large external current account surpluses and to build up foreign reserves. The policy objectives of improving the social and physical infrastructure, diversifying the economic base, and containing inflationary pressures were addressed through a two-pronged strategy. First, with a view to insulating their economies from foreign inflation, the GCC authorities abandoned the link between their currencies and a depreciating SDR, and established a de facto peg with the U.S. dollar which led to a significant real effective appreciation of all GCC currencies (Chart 1). Second, expenditures on development projects increased, and some countries actively pursued policies to promote basic industries based on their vast hydrocarbon resources.
The sizable budget surpluses started to diminish from 1982 as expenditures continued to increase in some countries while revenues declined due to the steep slide in oil prices (Chart 2). While some countries had large budgetary deficits in 1984-95, the region as a whole recorded an annual average deficit of only 1 percent of GDP and an external current account surplus equivalent to 7 percent of GDP during 1981-85. Foreign reserves positions were very comfortable and inflation decelerated to an average rate of less than 1 percent per annum, but real output contracted.
• With the continued erosion of oil prices during 1986-89, economic conditions weakened further and large internal and external financial imbalances emerged. In response, the authorities implemented adjustment policies involving primarily cuts in expenditure, particularly capital outlays which declined from an average of 21 percent of GDP during 1981-85 to 13 percent of GDP during 1986-89. Adjustment was further facilitated by the significant real effective depreciation of GCC currencies.
Despite the expenditure cuts, and given the severity of the decline in oil revenue, the aggregate budget deficit increased to 4 percent of GDP during 1986-89, while the external current account position shifted to a deficit of 1 percent of GDP during the same period. External borrowing by some GCC countries limited the drawdown in foreign reserves.
• The adjustment process was interrupted by the regional crisis of 1990-91. Notwithstanding the sharp jump in oil prices in the initial phases of the conflict and the higher oil production in some countries, crisis-related expenditures and transfers created significant pressures on the budgets and external current account positions of the GCC countries.
Those countries directly involved in the conflict suffered the worst: the budget deficit in Kuwait exceeded an estimated 100 percent of GDP in 1990-91; that of Saudi Arabia increased to 17 percent of GDP in 1991; and the combined external account deficits of the two countries amounted to US$54 billion in 1991 alone. Excluding Kuwait, the aggregate external current account deficit of the GCC countries increased to 7 percent of GDP, and their combined official foreign reserves declined further.
• The GCC countries emerged from the Gulf crisis in a weaker economic and financial position at a time when the resumption of the adjustment process was further complicated by the continued downward slide in oil prices and a slowdown in global economic activity. Economic growth in the GCC moderated to an average of 2 percent per annum in 1992-94, real per capita GDP declined, and the lingering expenditures and transfers related to the conflict prevented significant reductions in the internal and external imbalances (Charts 3-5).
For the region as whole, the average budget deficit in 1992-94 (10 percent of GDP) was higher than that of the pre-crisis period (4 percent of GDP), despite the much lower levels of capital expenditure. Similarly, at 6 percent of GDP, the aggregate external current account deficit was higher than the average during the 1986-89 period (1 percent of GDP) and foreign reserves positions eroded further. By 1994, although the stock of external debt stabilized at about 12 percent of GDP, debt service payments had increased sharply.
From 1995 most GCC countries intensified their adjustment efforts in response, inter alia, to an unfavorable oil market outlook. In particular, Kuwait, Oman, and Saudi Arabia introduced medium-term plans incorporating balanced budgets by the year 2000, as well as measures to promote private sector growth and human resource development (see Boxes 2-4). In other countries, similar policies are under consideration or are being formulated.
While the recent initiatives have significantly strengthened the adjustment process that began in the mid-1980s, the nature and extent of emerging challenges are also different in at least two important areas:
• The fiscal deficits have become more structural in nature. In earlier periods, fiscal retrenchment was carried out through cuts in development expenditure without seriously affecting the growth prospects. In the meantime, the maintenance costs have increased, and there is a need to replenish the aging capital stock. In addition, the investment income, which in some GCC countries comprised a large share of government revenue, has declined while debt servicing has increased. Expenditure on social sectors has increased in line with a growing population, and outlays on defense and security have remained high. Pressures on expenditure also come from a large and growing government wage bill.
• The GCC countries are undergoing major demographic changes characterized by a rapidly growing and young population, with important implications for the labor market. Traditionally, the government sector has absorbed a large number of new entrants to the labor force, reflecting the policy of guaranteed employment, higher wages, and the social status and other benefits associated with government employment. Fiscal constraints limit this possibility at a time of increasing number of entrants into the labor market. The policy challenge in the period ahead therefore is to meet the dual objectives of maintaining high levels of employment while reducing the role of the public sector in favor of the private sector.