Businesses operating in GCC countries should brace themselves for further government action to raise non-oil revenues, according to a new ICAEW report.
The accountancy and finance body said that given the weak outlook for oil prices, imposing tax measures, along with subsidy reforms, spending cuts, and a freeze on public sector recruitment and pay, will help to close the fiscal gap.
Its Economic Insight: Middle East Q4 2016 report – produced by Oxford Economics, ICAEW’s partner and economic forecaster – warns oil prices will not return close to the $100 per barrel averaged in 2010–2014. Brent crude is forecast to average $50.3 per barrel in 2017 and remain below $60 per barrel until 2019.
“While GCC countries can cover the revenue shortfall in the near term by borrowing as well as drawing down sovereign wealth funds and foreign exchange reserves, they will not be able to do so in the long term without raising taxes,” the report said.
It noted that the projected 2016 breakeven prices – at which oil must sell in order to balance the budget – put Qatar and UAE in the most preferable position at $44 and $57 per barrel respectively, followed by Kuwait at $60 and Saudi Arabia at $77.
It added that Oman and Bahrain are under the greatest pressure with break-even prices at $104 and $97 per barrel respectively.
Tom Rogers, ICAEW economic advisor, said: “The need to significantly increase non-oil government revenues to maintain financial steadiness is clear. But few tax policies are free of wider economic consequences, so it will be important for governments to ensure that tax policies are considered as part of broader economic diversification strategies, such as those in Saudi Arabia’s Vision 2030.”
A GCC-wide VAT of 5 percent is already due to be implemented in 2018 and the IMF estimates suggest this could raise GDP as much as 1.5–2 percent across the region.
“While this presents a start to addressing deficits, it also contributes to a rise in cost of living, which in turn could raise wage demands and thereby undermine organisations’ competitiveness,” he said, adding that other possible tax measures include the broader application of corporation or profits tax, or personal income tax, the latter of which is typically the major contributor to government revenues in high-income economies.
However, the report said that since social security systems treat nationals and non-nationals differently, it seems unlikely in the near term that personal income tax would be applied unilaterally.
The report highlighted that raising non-national workers’ wage demands as a result of personal income tax could be consistent with government targets to ‘nationalise’ workforces, and might be preferable to quota systems that force companies to employ locals regardless of the availability of suitable employees.
Michael Armstrong, ICAEW regional director for the Middle East, Africa and South Asia (MEASA), said: “Businesses in the GCC need to brace themselves for a long-term effort by governments to close fiscal deficits and raise much more substantial revenues from the non-oil economy. In addition, they can expect the implementation of other offsetting populist policies like the drive to increase the national share of the workforce, especially in the private sector.
“To ensure that the adjustment in public finances is consistent with ongoing growth, businesses should make the case for accompanying measures that will allow tax increases to be absorbed with minimal impact on activity. Offsetting measures could include welfare reforms to incentivise more citizens to compete for jobs with migrants, more flexibility to negotiate wages, and deductions from profit taxes to protect investment spending.”
Pressure on oil prices is also a key worry for business from the perspective of exchange rate stability. Beyond Kuwait which manages its rate against a basket of other currencies, all GCC economies operate a pegged exchange rate regime.
The report said that over 2015-2016, all GCC countries have seen current accounts deteriorate sharply, requiring central banks to draw upon foreign exchange reserves to meet demand for foreign currency.
It added that while across the GCC weaker exchange rates look to be a necessary part of any longer-term plan for diversification, any depreciation will have a short-to-medium term impact on business costs, output prices, and ultimately household spending power.