Confidence interval: maintaining private sector optimism amid reform

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Undoubtedly, higher and more stable oil prices have buoyed the Gulf countries over the past year. As I have written before, this is in some senses good news for the region, where oil plays such an important role in terms of income. 

In other ways, though, this could mean that some of the thorny reforms enacted since 2014 could slow, or even be reversed. The much-talked-about diversification process was never going to be an overnight exercise, of course, but plummeting hydrocarbons receipts have certainly catalysed progress. 

For the time being, and probably well into the future, oil and gas and other related industries will remain the mainstays of Gulf economies. Of course, diversification has never meant severance from those industries entirely – it has always meant far less reliance on these sources of revenue and the concomitant development of non-oil sectors. 

Hand in hand with this is the increase of private sector participation in these economies, which have been long dominated by state and quasi-statal entities that have so often been favoured by sheer virtue of the way Gulf economies have evolved. 
It is no surprise, therefore, that nearly all of the region’s economic development plans and visions to some degree speak of creating an enabling environment for the private sector to flourish, and indeed the privatisation of state assets. 

More than a reliance on oil

But it is not just a reliance on oil that presents a challenge; the social contract in the region has traditionally dictated that the state provide not only employment to nationals, usually via the military or the public sector, but in some instances property, too. Combined with free health care and education, and a historically zero or negligible tax burden, this was all just about sustainable even with significant population increases – that is, until the all-important oil price plummeted. 

The reforms that so many of us – from ratings agencies to the IMF – spoke of took on a whole new urgency, but the recent stabilisation of oil prices – at least for now – has given governments some breathing space.

Not the time to quit

It is essential, though, that the often-painful reforms to policies such as subsidies are not reversed. That is the fear of some analysts, not least because they impact the nationals who can least afford it almost by default. The introduction of a goods and services value-added tax (VAT) has been partially rolled out in the region, and by and large passed off uneventfully. 

However, this is an ongoing process, and even the more diverse economies have much to do in terms of varying their revenue generation.
What impact has this all had on local CEOs?

But what has the past year’s rollercoaster meant to the CEOs and business leaders in the private sector who we at OBG meet? How has it impacted their near-term plans, and have they factored it into their own development strategies? 

It is precisely these types of questions that our OBG Business Barometer: Gulf CEO Survey explores. Our on-theground approach enables us to speak with hundreds of businesspeople face to face. Our survey results are deliberately anonymous, and not attributed to either an individual or organisation. 

Some 70% of our respondents have either positive (58%) or very positive (12%) expectations of local business conditions over the next 12 months. Only 16% are negative or very negative. Whilst some of the headlines this year have spoken of a downturn – most notably in regard to real estate, which is a proportionately large sector in terms of contribution to GDP – it’s clear that sentiment more broadly is strong. 

Indeed, this is largely backed up by the IMF’s forecast for real GDP growth in 2019, which sees across-the-board increases in all but one regional market. By these figures, Bahrain sees a moderate decline, whilst Saudi Arabia sees 0.2% increase and Qatar 0.1%. 

It is perhaps less surprising, then, that when we look to the question of how likely it is that a survey respondent will make a capital investment in the next 12 months, nearly 70% say they are likely or very likely to do so. 

Interestingly, higher borrowing costs on the back of US Federal Reserve interest rate increases seem not to have dampened appetite, nor indeed has increased talk of a trade war between the US and China – both important markets for Gulf countries. 
 

When asked what external factor beyond commodity prices could impact respondents’ domestic market most, US interest rate hikes came behind Chinese demand growth as a concern and ahead of increasing protectionism. Regional political volatility was the overwhelming worry, which is no great surprise. 

This time last year, as it became clear which Gulf markets would press ahead with the introduction of VAT and which would delay, there was much talk about its impact on businesses. By global standards, the tax burden in the Gulf is very low, and a number of businesses operate in free zones anyway. So our finding that 89% of respondents view their tax frameworks as either competitive or very competitive is hardly headline material. 
 

Digging down into the data, though, it’s clear that in the two Gulf countries where VAT has been enacted – Saudi Arabia and the UAE – sentiment surrounding tax competitiveness has taken a slight hit. Saudi Arabia and the UAE scored lowest overall in this metric, at 81% and 83%, respectively. And while in 2017 some 87% of combined respondents in those countries answered competitive or very competitive, by 2018 that figure had dropped to 79%. 

What will be interesting to see is where sentiment settles once the business community has had a chance to fully evaluate the economic impact of the new tax, and to see how it changes if and when further taxation is implemented. VAT is not only about raising revenues, though it is obviously the major driver. A tax on goods and services, where business are registered and audited on their compliance with the levy, enables governments to generate important and informative statistics, giving them greater clarity on how the economy functions through spending. 
 

According to our findings, though, it appears that businesspeople already gauge the level of transparency as significant, with some 70% saying they find it to be high or very high. About 18% feel it is low or very low, a figure no doubt that governments across the region would like to reduce. 

There is a common conception that private sector businesses in the Gulf rely on government spending to a greater extent than elsewhere. Whilst this may be true in some sectors and markets, the majority of respondents say that less than 40% of their business is spurred by it. Conversely, just 15% put the government’s share at more than 80%.
 

Of course, if the economic restructuring outlined in the reform plans of all these Gulf countries is successful, then this figure may well fall. However, this is not a particularly high level when so many sectors on the face of it appear to be very government reliant. 

While the creation of an enabling environment is vital for the private sector to grow, so too is access to human capital. I have often heard businesspeople I’ve met with bemoaning the fact that young nationals are graduating underqualified for the jobs available in the marketplace, and in some instances unwilling to take the jobs available, preferring public sector roles instead. 

The latter situation is indeed concerning, and the mindset shift that a job in government is a job for life with perks and security is gradually changing, but it will take time. 

The thornier issue is the mismatch between skills and need within the private sector. Of our survey respondents, 23% identify leadership as the skill in greatest demand in their market. This was followed by engineering with 18%, research and development (R&D) at 14%, and computer tech with 10%.

I was struck by leadership being most in demand, but on reflection this might well be explained by the fact that, until recently, many executive roles in the Gulf were occupied by expats, often on inflated packages. That has changed in the post-financial crisis era – and more so in the slowdown engendered by the oil price crash – so this finding is telling but explicable. 

The other areas of skill shortfall that struck me as interesting, particularly to investors and government planners, is the lack of expertise when it comes to R&D and computer tech – sectors which are often cited as a reflections of a maturing economy. 

All Gulf countries have bottom-heavy young populations, many with degrees. These young nationals are tech-savvy and often with higher-than-average expendable incomes. The creation of gainful private sector employment and entrepreneurship – which can maximise this population’s potential – are thus key targets for governments. 

We have found that CEOs in the Gulf remain largely upbeat in most of the areas we have asked them to comment on. The key for governments looking to increase the level of private sector engagement in their economies will be to continue chipping away at the reform and diversification process without knocking this positive confidence.