Implications of Declining Oil Prices on the Gulf States’ Economy

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Implications of Declining Oil Prices on the Gulf States’ Economy

The oil prices did not fluctuate much between 2010 and mid-2014 and during then, a barrel of oil was sold at $110 (Financial Post, 2014). However, the market price of oil suddenly declined by more than half price from June 2015, and this implied 52 dollars for each barrel. The problem continues to persist since then and thus reduce the revenue especially for those countries which oil export is the backbone of their economy. Economists predict that oil prices are to remain weak for at least the next three years. This will lead to further financial drawdown, increase in domestic borrowing, and fiscal pressure to cut down and scrape out projects that are viewed as of less importance and urgency. This discussion shall identify the impacts of falling oil prices on the economy of the Gulf States. The influences of this occurrence on the Gulf States differ regarding economic size, population, fiscal break-even prices, and level of diversification; hence, there are some losers who are likely to experience adverse effects. Due to the problem of declining prices of oil, the decision-makers in the producer countries need to open their eyes and address the issue of terrorism and militiamen to restore the control of resources to the government. Additionally, there is also the need for diversification of the economies to eliminate complete dependence on oil.

Economists argue that the main cause of the decline in oil prices is the existence of a sudden oil boom in the market. The reason is that the shale oil production in the United States releases a lot of oil into the market (Financial Post, 2014). This development has elevated the amount of oil in the market, therefore, increasing oil supply, and hence decreasing the demand. Other reasons include the retreat of the European economy, slowing down of the Gulf economy and the reintroduction of Iranian oil markets. Developing countries are becoming more energy efficient leading in lagging of oil demand (Krauss, 2015). Oil producing countries such as Iran, Nigeria, and Iraq might be unable to adjust to this period. The reason is that their huge domestic budgetary requirements on oil wealth and the large sizes of their populations; they have inadequate foreign currency reserves that they could use during oil shock periods (Guzansky & Even, 2015). These countries have a total foreign currency reserve of less than $200 billion that can barely sustain them during this period (Bowler, 2015).

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Gulf countries like Saudi Arabia, United Arab Emirates (UAE), Kuwait, and Qatar hold 30% of the worlds’ reserves, producing 28.6 million barrels each day (Lansac, 2015). Oil is their main export that they sell to the Asian market. However, fluctuation in oil prices and competition from the U.S. and even Russia that has come back into the market has led to the decline in their revenues. Drop in oil prices has greatly contributed to slow domestic economic growth in the Gulf States since they depend highly on energy exports for government revenues. The regions’ economic growth is forecasted to be as low as 3.25% and is expected to be much lower in 2016, 2.75% (Kerr, 2015)

Constant decline in oil prices may be favorable to consumers, but it has, in turn, contributed to cut in spending from these nations and a need for diversification in their economies. The UAE’s economy has been steady despite the flattering in oil prices due to diversification into hydrocarbons which earns the country more income, earning 25% of the nation’s’ revenue instead of relying on oil revenue only. This problem has emphasized the urgency of Gulf States to diversify their income revenue through non-oil private sectors like tourism (Kerr, 2015).

Nations that completely depend on oil wealth have raised their debt levels by slowing the rate of reserves depletion. Despite the Gulf States having foreign currency reserves to boost their economies during a deficit, they may run out of financial reserves if these oil shocks persist, which will have a great impact on their economies. The oil cartel OPEC is determined not to cut its production and is unwilling to intervene to stabilize the markets that are viewed as overpriced. According to Saudi Arabia, if they cut down on their production, and later the prices go up, they will lose their market shares to their competitors who include: the U.S., Nigeria, and Algeria. However, the continuation of the oil price drop may force the economies to enforce other measures to maintain their economies that include the increase in tax and cutting on their spending (Bowler, 2015).

Lower oil prices are eroding the long fiscal and external surplus of Gulf States, reducing the money these nations invest in other countries. It has also triggered the selling of major Middle East stocks in the market and until the oil prices became steady the Gulf States markets are expected to have further volatile and indiscriminate selling off their stocks. These nations have had to implement some reforms and macroeconomic policy framework that are aimed at mitigating their financial vulnerability. In an example, Saudi Arabia is one of the country’s that has engaged in net fiscal stimulus measures. However, the needed impact to balance their budget will occur in the long term and not in the medium term since funds have declined (International Monetary Funds, 2015).

Lower oil prices are weighing on the Gulf States macroeconomic stability and credit risks as they are forced to tighten their monetary and financial spending. Spending cutting measures taken by these nations includes the reduction in security-related expenditures and hiring fewer public servants to minimize an amount of revenues spent on wages. The latter has, however, impacted negatively the economies as it has led to increased unemployment rate. The move of curbing spending has led to saving more on their Gross Domestic Product. These nations economy will rise only after cutting public investments substantially which is mainly by deferring new projects that reduce the countries spending.

The increase in oil supply in the market and low demand has led to a drop in real estate prices while rent has increased. This issue has contributed to high inflation rates on commodities like water, electricity, and education impacting their economic activities (International Monetary Funds, 2015). A fiscal vulnerability has increased and if this persists there will be no sustainability and intergenerational equality. Slowing down in the economies of Gulf countries could lead to the reduction in their remittances while the increase in international interest rates could lead to higher borrowing costs affecting their emerging markets that also affect their exports (Sophia, 2015).

UAE (United Arab Emirates) has continued to benefit despite low oil prices due to their large fiscal and external buffers that arise from favorable economic policies and economic diversification. It is among the few that have been able to withstand this economic shakedown. This impact is attributed to their investment in hydrocarbons, which contributes to the countries revenue. This investment has helped limit negative spillover of low oil prices and dragging global growth. This reason necessitates places, puts emphasis on the importance of diversification of economies. Also, the government has placed efforts to strengthen their medium-term budget framework to boost their economy while allowing banking growth and investments, contributing to a stable economic growth.

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In conclusion, the above discussion has shown that the causes of the reduced oil prices are due to simple economics that is the increase in supply leads to decrease in demand. Gulf States are facing competition from the US in the already available Asian market. Economic retreat by European countries and the slowing down of the Gulf economy has also contributed to low export and revenue losses. Impacts caused by the decline in oil prices lead to slow economic growth, high deficits to the country and high inflation; socially it leads to increase in the unemployment percentage of the population, and politically it emphasizes the need for reforms. Implementation of macroeconomic policies aimed at cushioning negative effects on growth will strengthen the fiscal sustainability of these countries while economic diversification and rebuilt surplus will ensure that they can withstand future oil shocks. The Gulf States governments are also expected to invest in markets. Increase in regional value is a measure adopted by the regions’ governments to raise the GDP revenue. Reduction in oil prices is an advantage to the consumer but to oil producing nations it is a burden as their revenues decrease. Oil dependent private sectors in the Gulf are yet developed to the point where they can create jobs; governments should, therefore, use incentives to move the economies to a non-oil private sector and improve skills of its citizens into these markets. The Gulf States should, also, put more effort in opening up foreign direct investments and improving non-oil industries to ensure economic stability. It should be noted that stability in economic growth of Gulf States will occur if these nations stop relying solely on oil revenues and open their market and encourage investors to finance other areas of their economies; otherwise, every time oil prices change, their economies will be unstable.