October 7, 2009

One Year On: The GCC Region’s Post-economic Crisis Prospects

The GCC escaped largely unscathed from the global financial crisis, but recognised vulnerabilities in the financial sector. As global economies recover, GCC policymakers can take proactive steps now to speed recovery, and shield their economies from future turbulence.

While largely shielded from the effects of the global economic crisis, Gulf Cooperation Council (GCC) countries were not entirely immune. As the global economy begins to recover from the financial turmoil triggered by the collapse of Lehman Brothers in September 2008, GCC policymakers can take their own steps to accelerate the region’s recovery—and protect it from future crises, according to a new study by Booz & Company.

“The crisis emphasized the need for further diversification in GCC economies and highlighted the vulnerabilities in the financial system, driven primarily by high rates of leverage,” explained Nabih Maroun, a partner at Booz & Company. To benefit from the global recovery and build a foundation for sustainable growth, GCC policymakers will need to consider a number of key reforms to reshape their fiscal and economic management practices and governance.

The Global Crisis and GCC Economies

Faced with the deepest global economic downturn of the post-World War II era, policymakers around the world responded with a series of unprecedented actions, including in the GCC. “The region seemed somewhat sheltered from the crisis, but by November 2008, it was clear that it would not ride out the storm entirely,” commented Richard Shediac, a partner at Booz & Company. The decline in GCC stock markets began to accelerate; oil prices dropped from $110 per barrel at the end of the third quarter to approximately $40 per barrel; and financing began to dry up.

Consequently, some states, including Dubai, Kuwait, and Bahrain were significantly affected by the crisis, as were certain non-oil sectors including financial services, real estate and tourism. “The region as a whole suffered from the slowdown in the global economy; the contraction in global trade, a decline in capital flows, sizeable losses incurred by sovereign wealth funds, and dwindling oil prices,” said Jihad Azour, senior executive advisor at Booz & Company.

Many GCC countries devised policy actions to respond to the crisis. Saudi Arabia, the UAE, and Kuwait announced stimulus packages, and the Saudi plan was one of the largest worldwide relative to overall GDP, representing 10.3 percent of the country’s 2008 GDP. The two successive UAE support packages, totaling AED 120 billion, exceeded 12 percent of 2008 GDP. Kuwait’s US$5.2 billion stimulus plan was designed to enable banks to lend about US$13 billion (KD 4 billion) within two years. GCC monetary authorities also took several measures to enhance banks’ liquidity, lower funding costs, boost confidence and mitigate tight credit conditions.

Measuring the Impact of the Crisis

Impact of the crisis on GCC economies can be measured along three dimensions: economic performance, financial sector stability, and key economic sectors.

Impact on GCC Economic Outcomes
Growth: With the global recession in 2009, real GDP growth rates are expected to decline to below 3 percent in the GCC region, while these averaged 6.4 percent between 2003 and 2008. To curb this negative trend, GCC governments undertook additional spending to stimulate local demand and maintain positive levels of economic growth. Governments also drew contributions from their reserves and from sovereign wealth funds to maintain financial stability and fund strategic projects.

Inflation: Substantial inflation in the pre-crisis years weakened economic performance and constituted the main economic risk faced by fast-growing GCC states. In 2009 inflation began to decline. This welcome effect will alleviate some of the pressure faced by governments in preserving macroeconomic stability.

External balance: Despite declining hydrocarbon export values, GCC economies were able to maintain a small trade surplus and positive current account balances. A number of GCC countries recorded a drop in international reserves, exacerbated by a reversal in capital flows that started in early 2008. The partial recovery of oil prices in the second half of 2009 will allow them to improve their external position.

Public finance: The sharp decline in oil revenues put pressure on public finance, eliminating the surpluses in government balances. Countries like the UAE and Bahrain face the risk of running budget deficits in 2009. “The sharp increase in spending prior to the crisis and massive public investment programs made governments’ budgets less flexible and limited the scope of any fiscal retrenchment in most GCC countries,” commented Maroun.

Impact on GCC Financial Systems
Banking system: The financial crisis revealed existing vulnerabilities in the Gulf banking system. In Kuwait and the UAE, the main vulnerability came from highly leveraged non-bank financial companies. Other banking systems, such as Saudi Arabia were more conservative and have proven to be more resilient. The downturn constrained credit growth and limited banks’ ability to lend.

Financial markets: GCC stock markets experienced significant decline between September 2008 and September 2009; in Dubai and Kuwait, the market index dropped by more than 50 percent. “Governments, however, intervened in a number of ways to avoid a crash: restraining trading, suspending short selling, and reducing the margin of fluctuation,” explained Shediac. These measures and a gradual return of investor confidence helped markets recover.

Impact on Key Economic Sectors
Oil and gas: The recession has had an adverse impact on new investments including in the hydrocarbon sector. Aside from planned investments in downstream oil projects, several large projects have been deferred or cancelled. Upstream projects are being rescheduled to benefit from lower input costs, the easing of inflationary pressure, and abundance in the supply of energy services and materials required to implement these projects.

Large family businesses: Private investment suffered from the impact of the crisis and is projected to drop in 2009, relative to GDP. Large family-owned conglomerates were equally affected, due to their exposure to foreign markets and the broad scope of their operations. “Several family businesses are facing financial difficulties from deterioration in their asset quality, the increase of corporate risks, their lack of focus on core businesses, exposure to hard-hit sectors, and high levels of debt,” stated Azour.

Other non-oil sectors: Companies in the GCC’s largest non-oil sectors—real estate and tourism—witnessed a surge in size and capacity prior to the crisis, financed predominantly through high leverage. Real estate was significantly affected by the global crisis across the GCC, following a drop in demand and a decline in prices. As for tourism, the World Tourism Organization’s latest forecasts suggest international tourist arrivals in the Middle East will drop by 18.1 percent in 2009. GCC hotels have already seen less tourism revenue and lower occupancy rates.

What’s Next for GCC Economies?

GCC countries are expected to undergo a smooth recovery as global economy is recuperating and the oil price fluctuates between $60 and $95 per barrel in 2010. “A recovery in oil demand will enable GCC countries to strengthen their fiscal and external balances, and rebuild their international reserve positions,” Maroun explained.

Key Challenges in the Aftermath of the Crisis

The region’s positive economic prospects still face a number of challenges, requiring the attention of policymakers to establish the right balance between growth and macroeconomic stability.
In the near term, the region will rely on a few conditions to sustain its growth: the evolution of oil markets and prices, a recovery in global demand, and the positive outcomes of various stimulus programs and policy actions. Furthermore, recovery in the GCC’s private economies will remain subdued until the region’s financial markets return to normalcy.

Most important, structural changes in public policies will be needed to restore growth of the past years, and protect Gulf economies against future financial turmoil. Policymakers will need to expand and accelerate their efforts toward economic diversification. “In addition, they’ll need to reactivate their reform agenda, adopt modern fiscal management practices and stay on course for priority investments in social reforms such as pension, labor policies and subsidy programs,” stated Azour.

Policy Options for GCC Decision-makers

To benefit from the impending recovery, GCC countries have to reinvent their growth model, while preserving macro-financial stability.

  • Reinvented growth model: Policymakers must reposition their economies to benefit from the global recovery by attracting private investments in non-oil and high-value industrial and services sectors. They should improve the investment climate by implementing business friendly regulations and develop national competitiveness agendas to determine which economic sectors are best suited to their overall strategy.

  • Macro-financial stability: Policymakers should reduce the risk of a resurgence of internal inflation and modernize public finance management to attain fiscal sustainability. This requires a stronger fiscal-governance framework, modernization of the budget system, enhancement of state-owned enterprises’ governance structure and the reform of public procurement. Governments can also improve policy coordination to maintain macroeconomic stability. “The proposed monetary union should be accelerated to protect GCC economies from currency movements, to better maintain the financial stability of GCC country members, and to improve the depth and liquidity of financial markets,” Shediac said.

  • Financial sector robustness: GCC decision-makers should introduce a comprehensive set of policy measures to enhance the governance framework of the banking and financial sectors and strengthen coordination among regulators. In the medium term, they can broaden financial markets through the progressive introduction of new instruments to increase options for financing and deepen liquidity. They can also revitalize the insurance sector by modernizing its regulatory framework, thus enabling additional liquidity sources to fund economic development.

  • Economic enablers: In this present cash-dry period, GCC countries can create a competitive edge that will serve them in the upturn by investing in promising capital-intensive industries, as well as innovative sectors where they can leverage competitive advantages. Moreover, the right set of policies, infrastructure, and institutional set-up will be critical to promote the development of small and medium enterprises (SMEs); powerful engines of growth and employment in slow economic cycles. “In parallel, policymakers should rethink the legislative framework for reviving public-private partnerships, drawing on lessons learned from the crisis,” commented Maroun.

  • Structural reforms: Policymakers should accelerate the pace of key structural and social reforms and review public investment priorities in light of the challenges that emerged in the aftermath of the crisis. In particular, they should invest in regional infrastructure to increase economic integration and benefit from new markets. Continued liberalization and increased participation from the private-sector will be critical.


Even though a recovery is under way, most countries in the world will face severe macroeconomic imbalances and adverse effects on their social systems and living standards. GCC economies suffered mildly from the crisis and its consequences, due to their limited integration in the global financial system, the rapid recovery of oil prices and the various initiatives launched by respective governments. However, vulnerabilities in fiscal and economic management practices emerged in the last year, clearly calling for proactive policies to reduce risks and shield GCC economies from future adverse economic shocks.

Although their expectations for long-term growth remain positive, GCC governments need to accelerate the pace of their various structural reforms and put significant emphasis on strengthening their macro-financial stability. “They must invent a new growth model to help them achieve their potential output and retrieve levels of growth comparable to pre-crisis achievements,” stated Azour. The right path to recovery requires visionary leadership, swift planning, bold execution,, regional cooperation, and involvement in global governance initiatives.