WITH CHEAP PRICES LIKELY TO RULE GLOBAL OIL MARKETS TILL THE END OF 2016, THE TIME IS RIPE FOR THE GCC COUNTRIES TO DO AWAY WITH SUBSIDIES AS THEY ARE STRAINING PUBLIC FINANCES, EXPERTS TELL QATAR TODAY.
With cheap prices likely to rule global oil markets till the end of 2016, the time is ripe for the GCC countries to do away with subsidies as they are straining public finances, experts tell Qatar Today.
“The UAE’s move to deregulate fuel prices from August 1 is sensible but the positive and negative impacts, for the government and consumers, will be far more significant if oil prices move back up. For GCC countries, the decision on subsidies is not simply economic, but also has political and social considerations.”
AKBER KHAN Director, Asset Management Al Rayan Investment
The six GCC countries are said to have lost over QR1 trillion of hydrocarbon revenues due to the slump in oil prices since June 2014 and, despite predictions by several rating agencies, the prices did not pick up in the last eight months.
In its latest report released on August 8, Qatar National Bank (QNB) has forecast oil prices to average around $55 per barrel in 2015-16 before rising to $60 per barrel in 2017 due to a bear market in Chinese equities which has shaken confidence in the global growth outlook.
Also, the oil markets have been surprised by continued increases in global oil output, despite lower oil prices. “The current glut in world oil markets is likely to persist well into 2016. From 2017, as producers and consumers adjust to lower prices, the markets should begin to tighten, leading to gradually steadier prices,” the report says.
The latest report from the Internation Energy Agency (IEA) suggests that world oil markets will be oversupplied by around 1.9 million barrels per day in 2015 and based on the IEA projections, another supply glut of around 1.1 million barrels per day is likely in 2016, QNB adds.
All these projections should worry the GCC nations, except Qatar and Kuwait, as they need around $100 per barrel as a break-even price (BEP) to keep away from budget deficits from next year onwards.
While these nations have surplus reserves of nearly QR3.64 trillion to absorb the shocks, they cannot sustain this for a longer period and their economic growth will be impacted if the oil prices remain static for another year or two.
All six countries have been pumping billions of dollars to execute mega infrastructure projects as part of their economic diversification programmes and are looking at ways and means to cut down on wasteful expenditure by shelving and delaying some non-core projects.
The International Monetary Fund (IMF) has advised the GCC countries to do away with energy subsidies as “they are not considered particularly equitable or efficient ways of supporting low-income households and can skew investment incentives, as well as impose fiscal costs.”
Fuel subsidy is very high in the GCC and so is its consumption, says a report by British think tank Chatham House which says that the GCC consumes more primary energy than the whole of Africa despite its population being only one-twentieth that of Africa.
The energy subsidies in the GCC region have declined from 6.5% of GDP in 2013 to 3.4% of GDP in 2015 which will benefit their budgets directly to some extent as they offset the revenue loss due to oil prices, resulting in both fiscal cost savings and more efficient resource allocation and energy consumption.
Currently, the gap between domestic and international petrol prices is at its lowest since 2009, making a strong case to remove subsidies. Countries like Qatar, the top subsidiser in terms of per capita subsidies, along with Saudi Arabia, Kuwait, Bahrain, and the UAE in percent of GDP and in per capita subsidies, stand to gain the most from energy subsidy reforms. The benefits will mostly accrue at the local level, by reducing local pollution and wasteful use of energy and generating much-needed budget savings.
Low international energy prices have opened a “window of opportunity” for countries to move towards more efficient pricing of energy. However, a gradual approach may be desirable, particularly for industries which need to invest to adapt to higher energy prices; eliminating energy subsidies in a phased manner will also generate substantial environmental and health benefits by reducing carbon footprints.
Quoting IMF figures, Founder and President of Nasser Saidi & Associates and former Chief Economist and Head of External Relations at the DIFC Authority Dr Nasser Saidi says that the GCC spent close to QR779 billion ($214 billion) on post-tax subsidies in 2013, with the 2015 estimate closer to QR637 billion ($175 billion) due to lower oil prices.
“In some countries, spending on subsidies is higher than the allocation to education (as % of GDP),” he says, adding that the cost of energy subsidies went beyond the financial cost to governments. It included undercharging for domestic environmental damage, contribution to global warming, air pollution, and broader externalities from vehicle use like traffic congestion and resulting higher accident rates, says Dr Saidi.
Director of Asset Management at Al Rayan Investment, Akber Khan, says that the best time to withdraw subsidies would be when they cost the least and therefore
the impact on consumers will be minimised. With oil prices having halved over the last nine months, the cost of fuel subsidies for GCC states has plunged at present.
“The UAE's move to deregulate fuel prices from August 1, 2015 is sensible but the positive and negative impacts for the government and consumers will be far more significant if oil prices move back up. For GCC countries, the decision on subsidies is not simply economic, but also has political and social considerations,” he says and adds that changing levels of subsidy will affect the competitive advantage versus other GCC countries.
Fiscal reforms are nothing new in the GCC region which has been contemplating to phase out subsidies and introduce a tax structure to augment revenues, but fearing domestic discontent, particularly in the wake of mass protests in the region since 2010, these proposals were kept under wraps. However, the crashing oil prices and falling revenues have revived these plans.
In November 2013, the Majlis Al Shura in Oman proposed to collect a 2% tax on all remittances by expats in the country. If approved, it would have brought in an additional $155 million per year to the government.
However, it was rejected by the economic committee of the State Council which felt it was ill-timed, impractical and would affect foreign investments.
The UAE has deregulated fuel prices from August 1 due to which the petrol price has gone up from AED1.72 to AED2.24 per litre (an increase of 24%) and the government says that it would save an estimated QR105.6 billion ($29 billion) per year.
Qatar raised petrol prices by 25% and diesel by 30% in January 2011, and diesel prices were raised again in May 2014 by 50%. Alarmed at mounting state expenses, Kuwait too announced a similar move in January this year but withdrew the proposal after countrywide protests.
Bahrain announced cutting subsidies for goods and services to reduce state spending on its foreign population as low oil prices pressure its budget. Its citizens will receive cash payments from the state to offset price rises when subsidies are removed but expats will not be entitled to such payments.
The fuel prices are lowest in Saudi Arabia but its rulers have issued local bonds worth QR14.56 billion ($4 billion) in July this year, the first one since 2007. The world's largest oil exporter also plans to raise QR98.3 billion ($27 billion) through bonds by December (QR19.3 billion per month) in tranches of five, seven
“Fiscal reforms should be on the agenda of GCC countries in view of the large decline in oil and gas revenues. The governments should introduce broad-based taxation, in the form of consumption taxation, to compensate for the loss of oil revenue and for revenue diversification.”
DR NASSER SAIDI Founder and President Nasser Saidi & Associates
and 10 years, clearly indicating that there is pressure on its budget due to low oil prices.
Abu Dhabi too increased power tariffs to curb consumption and asked consumers to pay for water for the first time, while Oman hiked natural gas prices for businesses from January 1, 2015. In neighbouring Iran, the government has raised petrol prices by 75%.
The first and foremost thing the GCC nations have to do is to step up efforts in promoting public awareness and adoption of the price adjustment policy, which will help them in achieving their goal of conserving resources. This will not only take the pressure off their annual budgets but also suit their policies to reduce wastage of utilities like electricity and water.
Besides making efforts to increase the share of non-hydrocarbon revenues, the GCC region is also planning other measures like introducing Value Added Tax ( VAT), which is likely to come into force from 2016.
Ernst & Young Qatar, Partner Tax Advisory, Finbarr Sexton says that VAT will come into force soon. The standard tax rates are likely to be low initially but can be increased over time, thus contributing positively to government revenue collection.
“Indirect tax will be a tax on consumption and will inevitably be borne by the end consumers. As a result, it will be passed on by the businesses to the end consumers and this will not affect businesses planning to establish in the region,” Sexton says.
Dr Saidi too supports the proposal as it would be the most stable revenue source as it tends to grow with GDP and consumer spending, while it has the least detrimental effects on investments.
“A broad-based consumption tax such as VAT would raise revenue proceeds at a low efficiency cost. At the same time, its equity implications would be relatively insignificant and tax administration would receive a significant and positive boost. A VAT rate of about 5% with few exemptions could generate revenue of some 3% of GDP,” Dr Saidi says.
In Deloitte Middle East's recent report "VAT in GCC- Old news or new chapter?", the experts say that while the GCC countries are increasingly facing pressure on their national budgets, each government understands the urgent need for fiscal-sustainability in the longterm. “This can be addressed if GCC governments could commit to the domestic implementation of VAT on goods and services,” the report says.
VAT is considered efficient, cheaper to operate, less open to fraud, and less likely to distort investment decisions by businesses than any other form of direct tax, according
to the report. This latter point is significant, as governments do not want to generate new revenue at the expense of investment by the private sector. Also, since the majority of the cost of VAT falls on the consumer rather than on businesses, it is capable of balancing these potentially competing requirements.
“Faced with a need to raise additional government revenues, implementing a VAT would be a rational response by government. That is not to say that the implementation of corporate or personal income tax can be ruled out; rather it is a reflection on the fact that a VAT seems to tick more of the boxes than the others,” says Nauman Ahmed, Partner and Regional Tax Leader at Deloitte Middle East.
“Compared to a VAT, a corporate income tax is more likely to act as a disincentive to businesses considering investment in the region and hence more negatively impact GDP growth as a result. On the other hand, a personal income tax presents an obvious challenge to the “tax-free” branding that has served the region so well in the past,” Ahmed feels.
Besides VAT, the GCC regimes are also looking at corporate tax as another source to raise funds.
Qatar has already imposed a general flat rate of 10% as corporate profits tax and with a 35% rate applying to oil and gas operations. The relatively low profits rate tax does not impact companies which want to kick-start operations in Qatar, notably in view of Qatar's extensive double taxation treaties.
“Fiscal reforms should be on the agenda of GCC countries in view of the large decline in oil and gas revenues. The governments should introduce broad-based taxation, in the form of consumption taxation, to compensate for the loss of oil revenue and for revenue diversification,” Dr Saidi says.
Akber Khan says that Qatar's corporate taxes are among the lowest in the region and corporate tax levels, as well as requirements for domestic ownership, influence the attractiveness of the country for international companies.
“Some countries have set up special economic zones which offer partial or complete exemption from these requirements,” he says.
The GCC governments have concentrated less on the remittances by their expat workers. The amounts these expats have been sending back home have doubled – from QR182 billion ($50 billion) in 2010 to QR364 billion ($100 billion) in 2014. The corresponding figures for Qatar were QR20.39 billion ($5.6 billion) and QR36.4 billion ($10 billion), respectively, according to World Bank data.
This is basically due to the low interest rates being offered by the domestic banks and expats never being given permanent citizenship by their respective governments.
Dr Saidi says that interest rates in the GCC banks are tied to US interest rates given the peg of the GCC currencies to the US dollar. Monetary authorities in developed markets (US, UK, EU and Japan) have been maintaining historically low interest rates and injecting liquidity (Quantitative Easing) in order to help their countries recover from the Great Recession.
“Banks in the GCC have limited scope in raising interest rates unless they have profitable lending and investment opportunities. However, to the extent that they can raise rates this would provide a financial incentive for expats to retain their savings in the country,” he argues.
But given that expatriates can stay in the country only so long as their job visa allows them, even higher interest rates might fail to entice them to hold their earnings in the country.
One method to facilitate this might be through a policy of giving permanent residence (i.e. a visa that enables one to stay in the country as long as one wants, with less than full citizen rights); another would be to initiate social security and/or pension schemes whereby both employer and employee contribute a fixed percentage of salary which then goes into a dedicated fund that could be investing locally, regionally or eventually internationally, Dr Saidi adds.
Akber Khan feels that a number of factors impact the level of remittances from a country and they include income and savings levels, the ability and attractiveness of local real estate and the ability or desire of an expat to stay for an extended period, etc. “As long as GCC economies have monetary policies pegged to the USA, they will offer comparable returns on deposits. A few years ago, Qatar took action to become less attractive to so-called ‘hot international money' which fuelled Qatari inflation when local deposit rates were significantly ahead of those in the US,” Khan says
“Indirect tax will be a tax on consumption and will inevitably be borne by the end consumers.
As a result, the taxes will be passed on by the businesses to the end consumer, therefore it is not expected to be a deterrent to businesses planning to establish
in the region.”
FINBARR SEXTON Partner Tax Advisory Ernst & Young, Qatar