International evidence

12. As experience in many countries has shown, fiscal adjustments can have a favorable long-term macroeconomic impact. Fiscal adjustments that address imbalances and reduce inflation and debt are critical to ensure fiscal sustainability and macroeconomic stability, a prerequisite for long-term growth. An IMF empirical study of a large group of advanced, emerging, and developing countries between 1975–2013 shows that adjustments were followed by growth acceleration in the long term and that countries which relied on both revenue and expenditure reforms achieved better results (IMF, 2015a).⁹ Moreover, there is a well-documented supply side effect of fiscal adjustment on long-term growth if fiscal adjustment leads to higher efficiency and creates room from growth-enhancing spending.

13. There is, however, a direct adverse impact of fiscal consolidation on growth in the short term. The extent of this impact depends on a host of factors that relate to when and how adjustment is undertaken and the dynamic response of private consumption and investment to adjustment. Generally, when economic slack is large (during contractions), the cost of fiscal consolidation in terms of short-term output losses is larger. Empirical evidence, however, has shown that even in the short term, adjustment has a positive credibility-enhancing effect on private investment through lower risk premia and increased financing, helping mitigate the direct dampening impact of consolidation on aggregate demand. Other institutional and structural factors such as labor market flexibility and openness to trade also play a role in determining the impact of fiscal consolidation on growth.

14. The appropriate size and pace of adjustment in the GCC depends on country specific fiscal risks and vulnerabilities. While larger and faster adjustments are generally associated with lower growth, a strong positive impact of large adjustments on growth was found in a number of studies (Giavazzi and others (2000) and Giavazzi and Pagano (1990)). The Danish and Irish adjustment episodes of the 1980s provide examples of how sufficiently large and persistent adjustments alter expectations about future taxation, contributing to a consumption and investment boom. Countries that undertook sizeable expenditure cuts were also able to reduce taxes (Chile and Ireland), contributing to more favorable output developments.¹⁰

15. Recent evidence has shown that the design of fiscal adjustment matters for growth. A review of empirical findings (see Alesina and others (2016), IMF (2013a), Hauptmeier and others (2006), Gupta and others (2005), and Tsibouris and others (2006)), shows that growth outcomes improved when adjustments: (i) were sustained and part of a credible multi-year fiscal plan (which helps positively impact private sector confidence); (ii) relied on expenditure more than revenue (although revenue-based adjustments were found to be more sustainable with greater benefits for growth in countries that start from a low tax burden and weak revenue administration);¹¹ and (iii) led to improvements in the structure of revenue (away from direct to indirect taxation) and expenditure composition (away from current outlays such as wages and subsidies to more productive spending).

16. Some growth-enhancing fiscal reforms may have adverse distributional consequences that can be mitigated by appropriately designing the reform strategy. Measures targeting higher indirect taxation, a reduction in subsidies and social transfers, and cuts in public wages and employment might have a detrimental impact on equality. Many countries, however, were able to implement such reforms without increasing inequality, for example, by using the proceeds of a regressive, yet growth-enhancing tax reform, to finance higher health and education spending. Reducing evasion and tax expenditures or loopholes that largely benefit the rich can simultaneously benefit growth and income equality (IMF, 2014). Malaysia’s experience in the 1980s provides a successful example. A spending cut of about 10 percent of GDP was accompanied by measures that helped reduce inequality and poverty such as increasing the public provision of health and education services, in particular in rural areas, establishing a system of targeted transfers, and providing education and technical training to facilitate mobility from agriculture to higher-value added activities.

17. Supporting fiscal institutions and the implementation of structural reforms have a bearing on the durability of adjustment and growth outcomes. Country experience has shown that successful fiscal consolidation episodes were part of a comprehensive reform agenda that changed countries’ economic policy regime significantly, often moving toward more private sector led growth, and strengthened fiscal institutions and accountability. Most countries have strengthened their public expenditure management and revenue administration and implemented key structural reforms in labor and product markets to enhance the business environment.¹² Specifically:

• Research on large fiscal adjustments points also to the importance of strong monitoring and accountability of fiscal targets, building-up public support through communication strategies and enhanced public debate, as well as planning for unexpected shocks as measures do not always yield the expected savings or are not fully implemented (Mauro and others 2013). These are important issues for the GCC where there is scope to strengthen fiscal institutions including multi-year fiscal planning and fiscal transparency.

• Complementary policies to incentivize increased employment of nationals in high-productivity private sector jobs, closing the gender and wage gaps, and implementing product market reforms—for instance improving the business environment, reducing trade barriers, institutional reforms to the legal system and property rights, and privatization—would also be critical to boost sustainable growth (see IMF 2016c for further discussion on structural reforms priorities in the GCC).

GCC experience with fiscal adjustments

18. Fiscal policies and outcomes in the GCC have been shaped by oil price cycles since the 1980s (Figure 5). These include: first, the sharp decline in oil prices in the early 1980s and the resulting emergence of large fiscal deficits; second, low oil prices throughout the 1990s with persistent deficits, debt accumulation, and financial asset drawdown; third, a prolonged oil price increase in the decade to mid-2014 that saw the GCC countries run large surpluses, lower debt, and build substantial financial buffers despite the acceleration of expenditure and; fourth, the current oil price decline in which the fiscal positions shifted back to large deficits, financed by asset drawdowns and issuance of debt.

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GCC: Fiscal Indicators

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: Country authorities; and IMF staff calculations.

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19. Across GCC countries, however, fiscal outcomes have varied, reflecting the relative importance of oil revenue as well as the policy response. For instance, Bahrain has the lowest oil revenue as a share of GDP. Except for a few years after 2005, it has consistently run a fiscal deficit and its net debt has remained on an upward trend as a percent of GDP since the 1980s. In contrast, the UAE, where oil revenue is greater and diversification is more advanced, has maintained large surpluses including in the 1980s, and similarly for Kuwait except during the early 1990s (Figure 5). While the fiscal positions in most GCC countries were in surplus at the onset of the oil price decline, the net financial buffers as estimated by IMF staff vary considerably across countries, ranging from negative 50 percent of GDP in Bahrain to positive 460 percent of GDP in Kuwait.

20. Large fiscal adjustments have occurred frequently in the past. Table 2 summarizes these adjustments—defined as episodes with a minimum cumulative improvement in the non-oil primary balance in nominal terms of 5 percent over two consecutive years.¹³ Across the episodes, the median size of adjustment was about 7 percent annually (or about 6.5 percent of non-oil GDP annually).¹⁴ The size and duration of the consolidation are related to the magnitude and persistence of the oil revenue shock—adjustments were largest and across all countries in the 1980s and large and in most countries in the current downturn (total adjustment was 36 percent of non-oil GDP in the 1980s and 17 percent so far since end-2014). In the less severe and shorter-lived declines in oil prices, only Kuwait, Oman and Saudi Arabia adjusted in the 1990s, while none of the countries adjusted during the oil price decline in 2008. The adjustments were also larger when the initial underlying fiscal position was weaker at the onset of the episode (see the level of the non-oil primary balance in the year preceding the oil price decline in Table 2).

Table 2.

GCC: Fiscal Adjustment Episodes (1982–2016)

^1/Cases include: the 1980s (Bahrain between 83-87, Kuwait 82-87, Oman 85-88, Qatar 82-88, Saudi Arabia 81-86, and the UAE 81-88), the 1990s (Kuwait 91-97, Oman 94-96, and Saudi Arabia 92-94), and the current episode (all countries excluding Bahrain 2015-16).

^2/Level in years prior to adjustment (1981, 1991, and 2013).

^3/Cumulative improvement in NOPB in nominal term in at least two consecutive years with total not less than 5 percent (-) indicate improvement.

^4/Ratio above 100% indicates adjustment more than the decline in oil price.

Source: Country authorities and staff estimates

Table 2.

GCC: Fiscal Adjustment Episodes (1982–2016)

	Initial NOPB 2/	Consolidation size 3/			Duration	Contribution to NOPB change:
Period 1/	% of GDP	% change in NOPB	% of non-oil GDP	% of oil revenue decline	# of years	Expenditure (%)	Revenue (%)
1982-88	−90.2	−30.5	−36.2	51.4	5.0	88.5	11.5
1991-98	−51.0	−23.1	−14.0	120.4 4/	3.0	89.9	10.1
2015-16	−64.3	−20.9	−17.4	30.8	2.0	89.3	10.7
Median		−23.1	−17.4	51.4	3.0	89.3	10.7

^1/Cases include: the 1980s (Bahrain between 83-87, Kuwait 82-87, Oman 85-88, Qatar 82-88, Saudi Arabia 81-86, and the UAE 81-88), the 1990s (Kuwait 91-97, Oman 94-96, and Saudi Arabia 92-94), and the current episode (all countries excluding Bahrain 2015-16).

^2/Level in years prior to adjustment (1981, 1991, and 2013).

^3/Cumulative improvement in NOPB in nominal term in at least two consecutive years with total not less than 5 percent (-) indicate improvement.

^4/Ratio above 100% indicates adjustment more than the decline in oil price.

Source: Country authorities and staff estimates

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Table 2.

GCC: Fiscal Adjustment Episodes (1982–2016)

	Initial NOPB 2/	Consolidation size 3/			Duration	Contribution to NOPB change:
Period 1/	% of GDP	% change in NOPB	% of non-oil GDP	% of oil revenue decline	# of years	Expenditure (%)	Revenue (%)
1982-88	−90.2	−30.5	−36.2	51.4	5.0	88.5	11.5
1991-98	−51.0	−23.1	−14.0	120.4 4/	3.0	89.9	10.1
2015-16	−64.3	−20.9	−17.4	30.8	2.0	89.3	10.7
Median		−23.1	−17.4	51.4	3.0	89.3	10.7

^1/Cases include: the 1980s (Bahrain between 83-87, Kuwait 82-87, Oman 85-88, Qatar 82-88, Saudi Arabia 81-86, and the UAE 81-88), the 1990s (Kuwait 91-97, Oman 94-96, and Saudi Arabia 92-94), and the current episode (all countries excluding Bahrain 2015-16).

^2/Level in years prior to adjustment (1981, 1991, and 2013).

^3/Cumulative improvement in NOPB in nominal term in at least two consecutive years with total not less than 5 percent (-) indicate improvement.

^4/Ratio above 100% indicates adjustment more than the decline in oil price.

Source: Country authorities and staff estimates

21. In general, the GCC countries have tended to adjust partially to oil price shocks (Table 2). The median size of adjustment represented about half of the decline in oil revenue across all episodes. Adjustments were also sustained beyond the oil price downturn; only a third of the adjustments in the 1980s were reversed in the 3 years after the end of the consolidation period. However, the consolidation in all the episodes was not adequate to stem the deterioration in the overall balance, which remained in large deficit through the 1990s and shifted back to surpluses only when oil prices rose sharply in the early 2000s.

22. Fiscal adjustments have relied primarily on expenditure cuts as the role of revenue has been constrained by the underdeveloped tax system and narrow tax base. On average, expenditure has accounted for about 90 percent of the total improvement in the NOPB in the adjustment periods.

23. A more detailed look suggests that the pattern and composition of expenditure adjustment has varied across countries and periods (Table 3). In most cases, expenditure was reduced in nominal terms. Expenditure cuts were large in the 1980s especially in Saudi Arabia, the UAE, and Qatar, all of which reduced spending by more than 30 percent and over a sustained period, while the smallest adjustment was in Bahrain. However, the median expenditure adjustment in the current episode (excluding Bahrain) is larger on an annual basis (about 7 percent in nominal terms and 11 percent of non-oil GDP annually). Expenditure consolidations in the 1990s and 2000s were smaller and short-lived except in Kuwait.¹⁵ Adjustment fell largely on capital expenditure in the 1980s in most countries (on average, capital spending was more than halved between 1982–86 and contributed 60 percent of the total decline in expenditure). In contrast, adjustment relied on current spending in recent episodes in Kuwait, Oman, and Qatar in all of which capital spending was increased in the current consolidation episode. On the other hand, Saudi Arabia has relied heavily on capital spending cuts in the current downturn (for all countries, the reliance on capital versus current spending cuts seems to reflect their relative share in total spending at the onset of the oil price shock; capital spending represented over 36 percent before the 1980’s shock compared to 22 percent before the oil price decline in the current downturn). Within current spending, a breakdown is available since 1990 and shows that the GCC have tended to reduce spending on goods and services and other current spending and contained wage and salaries growth.

Table 3.

GCC: Expenditure Consolidation During Adjustment Episodes, 1982–2016 ^1/

Source: country authorities and staff calculations Note: “…” indicates no adjustment

^1/Changes in expenditure during the consolidation episodes identified in Table 2. (-) indicate consolidation

^2/Consolidation in this period reflects Iraq invasion impact

Table 3.

GCC: Expenditure Consolidation During Adjustment Episodes, 1982–2016 ^1/

		Size of adjustment		Duration	Contribution to Adjustment		Frontloading
		% change	in % of non-oil GDP	# of years	Current(%)	Capital(%)	% of total in first year
1982-88
Bahrain		−15.1	−2.5	4.0	NA	NA	2.1
Kuwait		−29.2	−37.4	5.0	8.8	91.2	5.9
Oman		−22.4	−30.9	3.0	40.0	60.0	18.7
Qatar		−33.2	−50.1	7.0	55.3	44.7	19.6
Saudi Arabia		−41.0	−34.2	5.0	25.3	74.7	0.0
United Arab Emirates		−32.0	−23.6	7.0	61.9	38.1	20.8
	Median	-30.6	-32.5	5.2	40.0	60.0	12.3
1991-98
Bahrain		…	…	…	…	…	…
Kuwait 2/	−42.9	−148.0	6.0	100.6	−0.6	40.1
Oman		−4.2	−10.9	3.0	31.6	68.4	73.1
Qatar		…	…	…	…	…	…
Saudi Arabia		−18.3	−18.5	3.0	81.0	19.0	60.5
United Arab Emirates		…	…	…	…	…	…
	Median	-18.3	-18.5	2.5	81.0	19.0	32.9
2015-16
Bahrain		…	…	…	…	…	…
Kuwait		−9.8	−26.3	2.0	123.9	−23.9	86.5
Oman		−14.9	−26.1	2.0	120.7	−20.7	54.5
Qatar		−21.9	−21.9	2.0	134.5	−34.5	3.4
Saudi Arabia		−19.0	−18.7	2.0	−27.2	127.2	65.4
United Arab Emirates		−13.9	−10.4	2.0	95.1	4.9	86.2
	Median	-14.9	-21.9	2.0	120.7	-20.7	65.4

Source: country authorities and staff calculations Note: “…” indicates no adjustment

^1/Changes in expenditure during the consolidation episodes identified in Table 2. (-) indicate consolidation

^2/Consolidation in this period reflects Iraq invasion impact

View Table

Table 3.

GCC: Expenditure Consolidation During Adjustment Episodes, 1982–2016 ^1/

		Size of adjustment		Duration	Contribution to Adjustment		Frontloading
		% change	in % of non-oil GDP	# of years	Current(%)	Capital(%)	% of total in first year
1982-88
Bahrain		−15.1	−2.5	4.0	NA	NA	2.1
Kuwait		−29.2	−37.4	5.0	8.8	91.2	5.9
Oman		−22.4	−30.9	3.0	40.0	60.0	18.7
Qatar		−33.2	−50.1	7.0	55.3	44.7	19.6
Saudi Arabia		−41.0	−34.2	5.0	25.3	74.7	0.0
United Arab Emirates		−32.0	−23.6	7.0	61.9	38.1	20.8
	Median	-30.6	-32.5	5.2	40.0	60.0	12.3
1991-98
Bahrain		…	…	…	…	…	…
Kuwait 2/	−42.9	−148.0	6.0	100.6	−0.6	40.1
Oman		−4.2	−10.9	3.0	31.6	68.4	73.1
Qatar		…	…	…	…	…	…
Saudi Arabia		−18.3	−18.5	3.0	81.0	19.0	60.5
United Arab Emirates		…	…	…	…	…	…
	Median	-18.3	-18.5	2.5	81.0	19.0	32.9
2015-16
Bahrain		…	…	…	…	…	…
Kuwait		−9.8	−26.3	2.0	123.9	−23.9	86.5
Oman		−14.9	−26.1	2.0	120.7	−20.7	54.5
Qatar		−21.9	−21.9	2.0	134.5	−34.5	3.4
Saudi Arabia		−19.0	−18.7	2.0	−27.2	127.2	65.4
United Arab Emirates		−13.9	−10.4	2.0	95.1	4.9	86.2
	Median	-14.9	-21.9	2.0	120.7	-20.7	65.4

Source: country authorities and staff calculations Note: “…” indicates no adjustment

^1/Changes in expenditure during the consolidation episodes identified in Table 2. (-) indicate consolidation

^2/Consolidation in this period reflects Iraq invasion impact

24. The large fiscal consolidation episodes have been associated with slower economic growth. The adverse impact on non-oil GDP was more pronounced in the 1980s in Saudi Arabia, in part as adjustment was sharp and fell largely on capital expenditure. The accompanying decline in oil GDP also likely played a significant role as overall GDP declined in real purchasing power parity (PPP) terms by about 16 percent during 1982–86. In the 1990s and 2000s, fiscal adjustment did not take place in all countries and fell largely on current spending. This may have mitigated the impact on real non-oil GDP growth, which only slowed temporarily and remained above zero. During the current episode in which the bulk of the adjustment has fallen on current spending while capital spending has been protected in some countries, growth in the non-oil sector has slowed from about 6 percent in 2013–14 to 3.5 percent in 2015–16. However, the decline in growth is moderate considering the large size of fiscal adjustment, in line with empirical findings that the relationship between government spending and growth has weakened in the GCC since the 2008 financial crisis, likely reflecting higher import content and low spending efficiency during this period (Figure 6 and Box 1).

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GCC: Real GDP and Government Spending

(y-o-y percent change) 1/

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: IMF World Economic Outlook; and IMF staff calculations.1/ Growth rates weighted by PPP GDP.2/ For 1980-89, data covers only Saudi Arabia.3/ Deflated by domestic CPI.

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25. The foregoing discussion suggests there is scope to improve the design and composition of fiscal adjustment in the GCC to make it more growth friendly. In particular:

• While GCC fiscal consolidation efforts since 2014 have focused on a mix of expenditure and revenue measures, the emphasis on revenue generation has been relatively modest and non-oil revenue lags far behind, even in comparison with other oil exporting countries. At the same time, despite cuts to expenditure, current and capital spending remain significantly higher than comparator countries, and can be reduced in a way to not only help ensure fiscal sustainability and restore intergenerational equity, but also to minimize the adverse impact on growth, support the structural reform agendas being pursued across the GCC, and strengthen social safety nets. Credible medium-term consolidation plans are also needed to help reduce macroeconomic uncertainty and boost confidence.¹⁶

• The slowing growth and employment in the GCC requires careful balancing of fiscal consolidation needs against growth considerations. Another consideration is that as the GCC countries tap both international and domestic markets to finance the deficits, this could eventually increase the cost of financing and crowd out private sector credit. For countries where fiscal deficits are relatively high, the benefits of implementing large, frontloaded adjustment could be sizable in terms of lowering macroeconomic uncertainty and crowding in private investment. Hence, front-loaded consolidation may have a relatively small adverse—or even a net positive—impact on growth in countries where fiscal sustainability gains are significant. On the other hand, countries which have fiscal space—such as Kuwait, Qatar, Saudi Arabia, and the UAE—can reduce the negative impact of consolidation on growth by adjusting gradually and setting out credible medium term plans to restore intergenerational equity and build policy credibility.

Box 1.

Declining Expenditure Multipliers in the GCC

The size of multipliers varies across countries and depends on various country-specific and global factors. Multipliers are lower when exchange rates are flexible, public debt levels are high, and public expenditure management and revenue administration are weak, while they are higher when labor markets are rigid. Multipliers can also be affected by trade openness, state of the business cycle, the degree of monetary accommodation to fiscal shocks, and the type and quality of adjustment (IMF 2014; Alesina et al 2016). Fiscal adjustment is likely to have a direct dampening effect on aggregate demand. However, this impact may be mitigated or even reversed in countries where fiscal sustainability concerns and macroeconomic uncertainty imply that fiscal consolidation leads to lower risk premia and crowding-in effect on financing to the private sector, and credibility-enhancing effects on private consumption and investment (Hemming et al, 2002; Alesina & Ardagna 2013).

Updated estimates suggest that fiscal multipliers in GCC countries have fallen in recent years. Previous estimates have found current and capital spending multipliers to be similar and quite low in the short-term (in the range of 0.2–0.4), which is unsurprising because both have high import content (final products and intermediate inputs as well as labor). In the long-term, the current spending multiplier is between 0.3–1.2, while the capital spending multiplier is higher, between 0.6–1.4. However, this relationship appears to have weakened in recent years. While the variations in government spending appear to be closely related to changes in non-oil GDP prior to the global financial crisis in 2008, the large increase in government spending since then and until the fall in oil prices seems to have had a much smaller impact on growth. Updated estimations indicate that fiscal multipliers have declined after 2008 (Fouejieu, Rodriguez & Shahid, 2017, forthcoming).

The decline in fiscal multipliers suggests that fiscal consolidation efforts in the GCC could be less costly in terms of growth than before. The decline in the multipliers points to a fall in the efficiency of fiscal spending or crowding out of private sector employment and investment. Alternatively, as GCC fiscal spending increased and surpluses shrank, the private sector may have increased overall savings, reducing the impact of spending on aggregate demand.

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Government Spending and Non-Oil GDP Growth in the GCC

(y-o-y percent change, GCC simple average)

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

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Compensation and employment policies

26. GCC countries have some of the highest public sector wage bills in the world. Long standing policies in the GCC to ensure low unemployment among nationals through public employment and pressures to increase wages of nationals during oil price booms have increased the wage bill over the past decades. The wage bills have especially gone up since 2011, from an average of 7.6 percent of GDP to 12.2 percent of GDP in 2016 (about 60 percent nominal increase on average across the GCC), with the highest increases recorded in Oman, Kuwait, and Bahrain (Figure 7). Compared to other regions, the high wage bill in the GCC countries reflects both higher public sector employment as a percent of total national labor force as well as generous compensation.

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Government Wage Bill in the GCC

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Source: IMF FAD Expenditure Assessment Tool (EAT), IMF FAD Government Wage Bill and Employment Dataset

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27. The wage bill is likely to increase further in the coming years in the absence of policy measures to control it. Pressure on the wage bill could increase in the coming years due to a young and growing national population¹⁷ and rising labor force participation rates unless private sector job creation increases (IMF, 2013, 2014). Current compensation systems where wage increases are based primarily on the length of service will also contribute to pressures, unless reformed—for instance by implementing performance-based remuneration measures that incorporate effective incentives, within a specified cap on annual wage bill growth.

28. Reforms to public sector employment and compensation policies would help manage the wage bill and help address distortions in the labor market. The large public sector wage gap (Figure 8) provides a strong incentive for nationals, especially the low skilled, to prefer employment in the public sector, which absorbs the majority of employed nationals (ranging from 35 percent in Bahrain to close to 90 percent in Qatar (Figure 9)). The private sector mostly employs low-skilled expatriate workers at significantly lower wages. Such a duality discourages movement of (national) labor to the private sector and keeps the government wage bill high. Other benefits, such as fewer working hours, job security, and guaranteed pensions further incentivize nationals towards looking for jobs in the public sector. Reforms are needed to reduce the public-sector wage premium over time and would be critical to reallocate talent to the private sector and enable private sector led growth. Such reforms would also decrease the rent seeking associated with public employment and put a downward pressure on reservation wages. Additionally, education and vocational training reforms that equip the labor force with skills demanded in the market will help boost private sector employment.

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Ratio of Public to Private Average Wages ^1/

(Latest available, percent)

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: IMF 2017 (forthcoming), “Managing Public Wage Bills in the Middle East and Central Asia Region”.^1/ Average public sector wage over average private sector wage, except for Tajikistan, Iraq, and Djibouti w here the numbers represent wage premium estimates obtained after controlling for employee characteristics (IMF 2016).

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GCC: Nationals’ Public Sector Employment, 2015

(In percent of total employment of nationals)

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: Country authorities.

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290 Across-the-board wage freezes or reductions in wages can address high and growing public wage bill, but may not be sustainable. Several GCC countries (Bahrain, Oman, Saudi Arabia) have tried to adjust their compensation outlays through temporary wage and employment freezes and reduction in some allowances. While these measures typically deliver almost immediate budgetary savings, their short-term gains may be offset by policy reversals.¹⁸ To make these gains last, the measures need to be supported with structural and civil service reforms that require careful planning and effective implementation (IMF 2017a). GCC countries can also consolidate employment levels by limiting new hiring and relying on attrition-based employment reductions in overstaffed areas (IMF, 2016d). These reforms to public sector employment would need to be accompanied by measures to increase job opportunities in the private sector.

30. Reforms to the compensation schemes can lead to significant fiscal savings and economic benefits. These reforms — for example reducing and consolidating some allowances and bonuses into base pay — have not been implemented in the majority of GCC countries. While the introduction of such measures can bring about many benefits such as improved wage bill management and oversight, simplified wage bargaining, improved employer-worker matching, and strengthened transparency and fairness, they require adequate administrative capacity and time for planning. Furthermore, when implementing such reforms, it is important to ensure that they do not sidetrack from the objective of delivering fiscal savings and should lead to a reduction in the wage premium to facilitate employment in the private sector. A first step could be tightening eligibility and reducing the number and size of allowances over time in a phased manner to mitigate the social and financial impact of these measures.

31. Public sector restructuring would help make a lasting adjustment in the wage bill. Restructuring should be preceded with a functional review of the public sector which will help design civil service reforms by effectively assessing the staffing levels needed to provide government services. Restructuring requires time, capacity, and political will, and the saving from which materializes only over the medium term. To avoid an increase in unemployment, any downsizing should be approached gradually and in tandem with efforts to increase employment of nationals in the private sector. This will be a difficult challenge given the slowing economy and will require effort to encourage greater participation in vocational training opportunities and updating education curricula to address any skills mismatch. Active labor market policies such as job search and matching services, wage subsidies, as have been implemented in many GCC countries, can play a key role.

32. Increasing spending efficiency in the education and health sectors could help achieve a sizable reduction in the wage bill without compromising outcomes. The health and education sectors have the largest share of public employees. There is considerable potential to achieve efficiency gains and redeploy public employment to the private sector, and at the same time reduce the dominant position of the state in these sectors. Programs to support better performance of teaching and non-teaching staff could help reduce the number of public employees in the education sector and reduce the teacher to student ratio which is high in the GCC compared to other countries (Box 2). In the health sector, there are apparent inefficiencies and a review of staff needs and compensation systems could lead to substantial saving (Box 3). Greater involvement of the private sector could help unlock efficiency gains by opening up sectors for competition, privatization programs, and the use of Public-Private Partnerships (PPPs). In considering privatization and PPPs, the government should carefully assess the fiscal impact of these programs in the short and long term. The contingent liabilities and fiscal risks they may create need to be fully internalized into the decision-making process.

Box 2.

Education Sector Reforms

The GCC countries have invested considerable resources in public education and have made significant progress in raising literacy and enrollment rates in recent decades. Education spending in the GCC countries per student is higher than levels in OECD and emerging market countries (EMs). However, education outcomes have been lagging and graduates often do not possess the skills needed for a 21st century global economy (Alfadala, 2015). Different indicators of education inputs and outputs—teacher-student ratios (TSR), education spending per student (in PPP$ terms), net school enrolment, and secondary-education overall PISA scores (where available)—suggest there is potential for enhancing education spending efficiency, although the extent of possible efficiency gains most likely varies between GCC countries.

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Government Education Expenditure

(Latest value available)

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: IMF FAD Expenditure Assessment Tool (EAT); World Bank; and country authorities.

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Government Education Expenditure per Student

(PPP $ adjusted, latest value available)

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

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There is scope to improve the allocation of education resources. In GCC countries, staff compensation represents a much larger share of the education recurrent expenditure compared to the OECD average¹ (OECD 2016). This suggests that financial resources allocated to quality-enhancing inputs such as teacher training and teaching and learning materials may not be sufficient.

High staff levels are likely to be the primary factor explaining the relatively high per-student cost in GCC countries. On average, the TSR (per 100 students) for GCC countries is around 9, while in OECD and in EM countries the ratio is around 7 and 6, respectively. While the TSR varies amongst the GCC countries, all countries fall well below the efficiency frontier (i.e. given the number of teachers per 100 students, net school enrollment should be higher to reach the frontier). In addition, a high nonteaching staff to teaching staff ratio (e.g. close to a third of staff in Oman are non-teaching staff) and high growth in total staff compensation and allowances explain the relatively high costs.

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Teacher Ratios and School Enrollment

(Primary, latest value available)

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Source: IMF FAD Expenditure Assessment Tool (EAT); and World Bank.1/ Vertical dash lines and horizontal dash lines are the average of the GCC.2/ There is no data on net school enrollment for Bahrain.

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A reduction in the teacher and non-teaching staff headcount can be an effective measure to increase the efficiency of education spending. This could be achieved by redirecting the ensuing savings towards programs that improve teacher performance and quality of educational materials and other learning resources while maintaining the TSR close to the levels observed in OECD countries. Implementing a per-student financing formula such as in the Netherlands could ensure that wage costs remain in line with the number of students (IMF, 2014f).

¹ For example, in Oman, this share is close to 90 percent.

Box 3.

Health Sector Reforms

GCC countries have achieved substantial improvements in health outcomes during recent decades. An increase has been recorded in life expectancy and infant mortality rates have fallen substantially. In terms of infant mortality, GCC countries have narrowed the gap with the OECD average substantially, but the life expectancy gap remains broadly unchanged.

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Health Spending and Outcomes

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: World Health Organization; World Bank, World Development Indicators; and IMF staff calculations1/ GCC per capita spending is based on national population. GCC data does not include Qatar or UAE. It also does not include Kuwait for years 1995-96 and 2014.

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Improvements in major health outcomes in GCC countries were accompanied by increased health spending. Per capita health spending has been on an upward trend and spending in percent of GDP has recently picked up in most GCC countries. Still, both indicators remain substantially below the OECD averages, possibly reflecting the young demographic structure and the large size of the expatriate population which usually do not benefit from some of the health services provided by the government.

GCC countries, however, appear to have non-negligible health spending inefficiencies. Their distance to frontier suggests scope for potential savings without compromising health outcomes. The average healthy life expectancy (HALE)¹ in the GCC region is close to 67 years, marginally above the average for the emerging markets and below that for the OECD countries. Total per capita health spending (in PPP adjusted terms) varies amongst the GCC countries, but all countries fall below the efficiency frontier (i.e. given the amount of health care spending, life expectancy should be higher to reach the frontier).

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Health Efficiency Frontier

(Latest value available)

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Source: IMF FAD Expenditure Assessment Tool (EAT); World Bank; and World Health Organization.

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Health systems in GCC countries are dominated by the public sector and provide strong financial protection for nationals. The out-of-pocket health spending accounts on average for 13 percent of total health spending. Except for Bahrain, this is below both emerging market and OECD averages as well as below the range of 15–20 percent that some studies have suggested as a threshold in terms of excessive financial burden on households (WHO 2010).

An aging population will increase demand for more costly health care services in the future. Leading health-related risk factors in GCC countries are linked primarily to unhealthy diets and physical inactivity (Aljefree et al., 2015), problems that will become more acute as the populations age and may create additional cost pressures. Introduction of excises on tobacco and carbonated/energy drinks will help to reduce consumption of harmful products.

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Out-of-Pocket Health Expenditure, 2014

(Percent of total health spending)

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: World Bank, World Development Indicators; IMF staff calculations.

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¹ Healthy life expectancy (HALE) is a measure of health expectancy that applies disability weights to health states to compute the equivalent number of years of life expected to be lived in full health.

Energy subsidies, social benefits and transfers

33. Energy subsidies in the GCC countries are high, accounting for almost a quarter of global subsidies. In 2015, energy subsidies on fuel and electricity by the GCC were estimated to be at $94 billion out of $432 billion total world-wide (or about 6 percent of their GDP).¹⁹ Accordingly, GCC countries also display the largest subsidies per capita. On average, subsidies in GCC countries are much larger than other oil exporters, as their price gaps are wider due to their typically very low level of domestic energy prices (IMF, 2015c). The total cost of the subsidy includes both explicit expenditure outlays in the budgets and implicit subsidies arising from forgone revenue and profits from energy companies (oil, gas, and electricity).

34. Energy subsidies—whether explicit or implicit—tend to disproportionately benefit the well-off and crowd out spending with much broader and fairer benefits. The cost of explicit energy subsidies in the GCC countries is usually in the form of transfers to utilities to compensate for the difference between production cost and the low domestic selling price. Even excluding classification issues, explicit subsidies in the GCC (excluding Saudi Arabia which is the only country that does not have explicit energy subsidies) accounted for about 3 percent of GDP in 2015 and were particularly high in Kuwait and Bahrain. There is considerable evidence that the wealthy benefit disproportionately. Further, subsidies detract resources from socially fairer expenditures including infrastructure spending, social spending (health and education), paying down of public debt, as well as pro-poor spending. As an example, Bahrain and Kuwait were spending more on subsidies than on capital spending in 2014 (IMF 2015c). Besides energy subsidies, the generous system of social benefits and transfers, which is not well targeted, is not only expensive, but also likely results in disproportionately small share of such spending reaching those most in need and may have an adverse impact on the incentives for nationals to work.

35. GCC countries have continued to make progress with addressing the critical issue of reforming domestic energy prices. Removal of subsidies in GCC countries can have a growth enhancing impact over the long-term (IMF, 2017 and IMF 2015c).²⁰ While energy price reforms are well advanced in some countries, the pace of reforms could be accelerated in others. Gasoline and diesel subsidies have been largely eliminated in the UAE and Oman as their prices were brought close to the international level.²¹ While significant price increases have also taken place in Kuwait, Saudi Arabia, Qatar and Bahrain, fuel prices remain well below international levels (Figure 10). Electricity and water prices are being increased in Bahrain and Saudi Arabia under a multi-year plans, while Kuwait and Oman have increased electricity prices for businesses and other big consumers in the first half of 2017. Bahrain, Qatar, and Saudi Arabia increased water prices during 2015–16, while Kuwait increased the rates in 2017 for businesses and expatriate workers. Some countries plan to further rationalize water prices to cost recovery over the medium-term (e.g., Saudi Arabia).

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GCC: Gasoline Prices

August 2017 or latest available, USD per liter 1/

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: Country authorities and IMF staff calculations.1/ Prices are averages for 90 and 95 octane gasoline.

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36. Key further steps include a formula-based approach or a complete liberalization of energy prices and introducing a means-testing approach to support a robust social safety net. Automatic price mechanisms help depoliticize the reform process, help avoid reform reversal, and facilitate the transition to a fully liberalized pricing system (IMF, 2017).²² The costs and benefits of the reform should be clearly explained and communicated. To build public support, it is also important to design mitigating measures to protect the most vulnerable households from the impact of reforms to the extensive system of subsidies, social benefits and transfers. Such schemes should be income-tested and well targeted (as are being designed in Oman and Saudi Arabia). These reforms should be introduced in a gradual manner to make them more durable.

Streamlining capital expenditure while safeguarding growth

37. Public investment can raise the economy’s productive capacity and growth potential. However, not all public investment creates productive capital. In countries where public investment management frameworks are weak, public investment is unlikely to translate fully into productive capital and growth. For example, in a recent study, IMF (2015b) finds that the average country in the study sample loses about 30 percent of the value of its public investment to inefficiencies in the investment process. Moreover, every capital investment generates its own current spending in the short and long term.

38. Public investment in GCC countries has been positively correlated with oil prices. Average investment as a share of non-oil GDP was almost 4 percentage points lower during the lower oil price period (1991–2002) than during 2003–14 (Figure 11). In terms of its share, average public investment during the last decade has amounted to 22 percent of total government spending. Since end-2014, public investment as percent of non-oil GDP has declined from 15 percent to 13 percent, but remains high by international standards.

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Public Investment

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: WEO; and IMF staff calculations.1/ In UAE a large part of public investment is implemented by government related entities, data for which is not available.

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39. GCC countries have built up a relatively large public capital stock and the quality of their infrastructure is on par with OECD countries. However, the high average ratio and scores mask notable variation amongst the GCC countries. In particular, capital stock in percent of GDP appears to be the highest in Oman, followed by UAE and Saudi Arabia. At the same time, in terms of the quality of overall infrastructure, UAE ranks first, followed by Qatar and Bahrain, suggesting that very high capital spending and stocks in some GCC countries may not necessarily have translated into high infrastructure outcomes (Figure 12).

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Capital Stock and Infrastructure

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: IMF FAD Expenditure Assessment Tool (EAT), IMF Investment and Capital Stock Dataset; and World Economic Forum.1/ GCC average does not include UAE2/ In UAE a large part of public investment is implemented by government related entities, data for which is not available.

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40. Streamlining public investment can be an important component of the fiscal adjustment in GCC countries. While protecting essential public investment is important, Albino-War et al. (2014) find that there is substantial room to improve public investment efficiency in MENA oil exporters, including in the GCC region. IMF (2016b) finds that high growth in the GCC has been the result of factor accumulation, both labor and capital, rather than improvements in productivity. The economic dividends from closing the “efficiency gap” could be substantial. Most efficient countries get twice the growth dividend from investment compared with the least efficient countries. Therefore, curtailing some public investment projects in the GCC could be appropriate and may have limited impact on domestic activity and long-term economic growth if their efficiency is low (Danforth et al., 2016).

41. GCC governments should review project appraisal, selection, and evaluation processes to ensure they are sufficiently robust. The aim for policymakers would be to examine whether the primary objectives of the project are being met in the most cost-effective way. The focus should be on: (i) project selection to be better aligned with development plans; (ii) more robust appraisal including consistently applied cost-benefit analysis and careful consideration of recurrent costs; and (iii) regular ex-post assessment of investment projects to inform future selection and implementation. Also, a periodic review of existing projects to check whether they are closely linked to, and efficiently meeting, developments goals could be helpful with a view to making additional savings in the capital expenditure budget.²³

42. Governments can also use Public-Private Partnerships (PPPs) to procure investment projects that are produced more efficiently by the private sector. Well-designed PPPs can generate significant efficiency gains in the design, construction, and operation of assets and services and can offer greater value for money than traditional investments (IMF, 2016a). PPPs have been generally underutilized in GCC countries compared to other regions, but have recently picked up and there is growing interest in the region to increase the volume of infrastructure investment in partnership with the private sector. However, PPPs can also create significant fiscal risks, and reaping their full benefits will require strong legal and institutional frameworks to help limit and manage associated fiscal risks.

Strengthening the Expenditure Management Frameworks

43. Medium-term expenditure frameworks (MTEFs) could help the GCC have better control on expenditure and delink it from oil revenue volatility. MTEFs are part of a broader set of fiscal institutions that extend the horizon of fiscal planning and budgeting beyond the annual budget exercise which often leads to suboptimal fiscal outcomes. MTEFs integrate top-down macro-fiscal objectives, derived from a medium-term fiscal framework, with bottom-up sector programs and detailed multi-year expenditure plans. The reliance on MTEFs has increased in recent years including among resource-rich countries and their introduction has helped countries improve their fiscal performance. For the GCC, exposure to oil price volatility has led to high expenditure and growth volatility in the past (Figure 13). In this context, an MTEF is particularly important to delink spending decisions from short-term movements in oil prices and help address the challenge arising from the exhaustibility of the oil resource.

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Expenditure and Oil Price

Citation: Policy Papers 2017, 065; 10.5089/9781498346214.007.A001

Sources: IMF, World Economic Outlook; and IMF staff calculations.1/ Includes Chile, Indonesia, Malaysia, Mexico, Nigeria, and Norway and Singapore.

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44. The GCC countries should build on the progress achieved in recent years to strengthen the fiscal policy frameworks. Saudi Arabia has announced fiscal objectives for the medium-term under the Fiscal Balance Program and Kuwait has approved three year rolling expenditure ceilings. The creation and strengthening of macro fiscal units (Kuwait, Oman, Qatar, Saudi Arabia, UAE) and public debt management offices (Bahrain, Kuwait, Oman, Saudi Arabia, UAE) are also key steps to upgrade capacity and support policy making.

45. Medium-term expenditure frameworks can be introduced gradually and should be properly sequenced with other fiscal reforms. Given existing budgetary weaknesses and capacity constraints, priority should be given to strengthening the annual budget process and expenditure management systems, starting multi-year planning with a simple medium term fiscal framework, and eventually moving to medium-term expenditure frameworks:

• A strong annual budget process is the starting point for effective medium-term budgeting. At present, the GCC annual budgets are a relatively poor guide to actual fiscal outcomes because spending outcomes are typically far above the initial estimates, although there has been some improvement since 2014 (Figure 13). Extending the budget horizon to two or three years only makes sense if there is a reliable point of departure—i.e., a firm annual budget. From a technical point of view, this means that the ministry of finance should include in the budget the best possible estimates. Good estimates require a sound understanding of how parameters drive annual expenditure, but also involve making repeated comparisons between the budget and the actual budget execution outturn—both in-year and soon after the end of the fiscal year. For GCC countries, there are three main areas for improvement in the budget process:

  1. ➢ Strengthening the capacity to cost existing and new policies to ensure that the budget is an adequate reflection of expected costs.
  2. ➢ Avoiding expenditure overruns by adherence to the adopted budget if oil prices turn out to be higher than budgeted.
  3. ➢ Enhanced fiscal reporting (frequency, timeliness, and analysis) on in-year budget outturns. Furthermore, while the use of lower than actual/expected oil prices in budget preparations provides policymakers with a useful buffer, using more realistic oil price assumptions would enhance policy planning and budget transparency.

• Developing rolling MTFFs by setting the overall fiscal objectives for three to five years with quantitative targets for the main fiscal aggregates. The framework should also specify how these objectives will be achieved. The fiscal objectives should be consistent with the governments’ policies (and the recently announced economic reform strategies and visions) given projected macroeconomic variables, oil prices, and demographics. This would set the stage for top-down budgeting.

• Establishing the link with the annual budget through a simple multi-year budgeting process by providing guidelines (envelopes) to line ministries to prepare medium-term spending plans. The spending ceilings for the following years can be treated as indicative targets until further reforms to build capacity and make the framework more binding take place.

• Developing comprehensive MTEFs. This final stage entails extensive organizational adaptability and technical capacity to implement MTEF not only at the ministry of finance but also at other government agencies who will be charged with expenditure strategy, costing programs, determining priorities within sectors, and measuring and evaluating programs. Their effective implementation also needs to be supported by sound public financial management practices.

46. The GCC countries would benefit from conducting comprehensive public expenditure reviews (PERs). PERs are a key diagnostic instrument used to evaluate the effectiveness of public finances and help countries develop more effective and transparent budget allocations. They typically analyze government expenditures over a period of years to assess their consistency with policy priorities, and what results were achieved. PERs may analyze government-wide expenditures or may focus on particular sectors such as healthcare, education, or infrastructure, and identify where there is room to increase efficiency or rationalize spending in areas that are more promising in terms of fiscal savings. The review could cover the central government operations as well as the extra-budgetary institutions and state-owned enterprises.