WHITHER SUB­SI­DIES?

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.

Qatar Today - - INSIDE THIS ISSUE - BY V L SRINI­VASAN

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.

Per­fect tim­ing

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

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.

VAT

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.

Cor­po­rate tax

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.

Ex­pat re­mit­tances

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

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