## GCC: Economic Prospects and Policy Challenges (pp. executive summary, sections 7, 14, MTFF, Box 5, CPI, Appendix III) ## Source details **Canonical URL:** [GCC: Economic Prospects and Policy Challenges (pp. executive summary, sections 7, 14, MTFF, Box 5, CPI, Appendix III)](https://www.imf.org/-/media/files/publications/pp/2022/english/ppea2022052.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2022/english/ppea2022052.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2022/english/ppea2022052.pdf.json) --- ### Global developments and outlook - Global growth: - Global growth contracted in 2022 Q2 by 2 percent. - Projected to slow from 6 percent in 2021 to 3 percent in 2022 and 2.8 percent in 2023. - Key near-term shocks and dynamics: - Continued Covid-19 impacts, including lockdowns in China, affecting growth and supply chains. - Rapid U.S. monetary policy tightening contributing to slowing domestic demand, cooling housing prices, and U.S. dollar appreciation that has negatively affected capital flows to emerging and developing economies. - The war in Ukraine exacerbating vulnerabilities and pressuring oil, gas, energy and food supplies. - Inflation and commodity developments: - Inflation in advanced economies reached 8.3 percent in August in the US and 9.1 percent in the Euro area. - Wheat price remained 30 percent higher in June 2022 than in December 2021. - Fertilizer prices were 17 percent higher than in December 2021. - Oil: APSPs averaged $69.4 per barrel in 2021; oil spiked to highs of $117 per barrel in the first quarter of 2022. Futures project oil to peak in 2022 and then decrease gradually reaching $71 per barrel in 2027. - Oil demand: IEA estimates show global crude oil demand increased from 94.3 mb/d in Q2 2021 to 98.49 mb/d in Q2 2022 and is estimated to reach 99.7 mb/d by end-2022 and further increase to 101.8 mb/d in 2023. - Gas: IMF staff estimates indicate flows from Russia’s pipeline have declined by about 80 percent and volume is expected to decline further by mid-2024; Dutch TTF gas price jumped to an all-time high of $70 per MMBtu in August 2022. - Financial conditions and risks: - Monetary policy tightening has synchronized globally and financial conditions have tightened, especially in emerging markets. - Downside risks: active Covid-19 transmission and variants; risk of central banks overtightening; further disruption to Russian gas supplies and geopolitical risks. ### Regional (GCC) recent performance and outlook - 2021 performance and drivers: - GCC countries grew by 3.1 percent in 2021, with strongest recoveries in the UAE and Saudi Arabia. - Recovery supported by hydrocarbon price rebound, relaxation of social distancing, vaccination progress, liquidity and fiscal support, reform momentum, and non-oil rebounds (retail, trade, hospitality). - 2022 outlook and sector specifics: - GCC economies expected to grow by 6½ percent in 2022, with highest growth in Kuwait and Saudi Arabia. - Bahrain: growth projected to accelerate to 3.4 percent in 2022; non-oil GDP increasing by 4 percent. - Qatar: non-hydrocarbon growth expected to reach 4 percent in 2022; hydrocarbon growth projected modest in 2022. - UAE: rebound in tourism (Dubai World Expo) and spillovers from FIFA World Cup to boost non-oil growth. - Inflation: - Inflation picked up from 0.7 percent (y/y) in July 2021 to 3.2 percent (y/y) in July 2022. - Inflation expected to reach 3.6 percent on average in 2022 with country estimates: Saudi Arabia: 2.7 percent; Qatar and Kuwait: 4 ½ percent; UAE: above 5 percent. - Medium-term inflation expected to moderate to about 2 percent as global pressures abate. - External and fiscal balances: - Overall fiscal balances improved strongly in 2022 in line with higher oil prices. - GCC overall fiscal balances expected to improve to 7.3 percent of GDP in 2022 and remain positive over the medium term. - Cumulative primary balances expected to average 25 percent of GDP during 2022-2026. - Governments expected, on average, to save about 40 percent of their windfall oil revenues. - Fiscal breakeven prices for all GCC countries (except Bahrain) expected to remain well below observed oil prices in 2022. - Debt and debt service: - GCC average public debt ratio should decrease in 2022 to pre-pandemic levels of about 46 percent of GCC GDP. - Average debt service burdens remained elevated due to tighter borrowing conditions. - Current account and reserves: - Average current account surplus expected to improve by a further 8 ½ percent of GDP in 2022, before decreasing to an average of 13.7 percent in 2023. - Reserve accumulation and net foreign asset positions expected to improve as governments save hydrocarbon windfalls. ### Financial sector, corporate vulnerabilities, and monetary transmission - Financial soundness: - NPL ratios remain around 4 percent on average. - Provisioning near or exceeding 100 percent. - Banks’ capital adequacy ratios are well above regulatory requirements. - Profitability has improved slightly. - Corporate sector (363 firms, 2007–2021): - Median firm ROE fell from 15.2 percent in 2007 to 4.1 percent in 2021. - Total debt over total equity close to 40 percent. - Interest Coverage Ratio (ICR) has deteriorated since 2015. - Liquidity measures worsened as short-term liabilities grew faster than liquid assets. - Impact of global monetary tightening: - GCC central banks raised policy rates following the U.S. federal funds rate; further hikes expected. - Banks’ liability and asset pass-through to rate changes: - When U.S. rates rise by 100 basis points, GCC banks’ liability rates rise by about 40 basis points and asset rates by close to 35 basis points (coefficients 0.369*** to 0.433*** for liability rates; 0.320*** to 0.380*** for asset rates). - Bank profitability (NIM) impact from Fed tightening statistically insignificant (Δ Federal Funds Rate coefficients: -0.001, -0.002, -0.011, -0.025; not statistically significant). - Historical evidence: Fed tightening has limited effect on non-oil activity when oil prices are high. - When oil prices are below $45: a 100 basis points hike in the Fed rate reduces non-oil GDP growth by about 0.3 percent and equity prices drop by about 0.8 percent. - When oil prices are above $45: effect on non-oil GDP is negligible and equity prices increase by about 1 percent. - Banking structure implications: - Saudi Arabia: more than 60 percent of deposits are non-interest-bearing. - Kuwait, Qatar and Oman: percentage of non-interest-bearing deposits is quite low. - Banks with high share of non-interest-bearing deposits likely to benefit from rate hikes; banks with large wholesale funding shares (e.g., Kuwait, Bahrain) or FX/liability mismatches (e.g., Qatar) face different vulnerabilities. - Credit and asset quality: - Loan deferrals phased out; targeted support adopted in some countries. - Potential asset quality deterioration may emerge as support is withdrawn. - Bank-level regressions show Fed tightening does not significantly impact credit growth or Δ(NPLs) historically in high oil price environments. ### Inflation drivers, CPI composition, and international spillovers (GVAR results) - CPI composition: - GCC countries have lower shares of food in CPI baskets than other MENA countries; housing rental components large (example: housing rental ≈ 21 percent of Saudi Arabia CPI). - Recent inflation trends: - GCC inflation rose to 3.2 percent (y/y) in July 2022 from 0.7 percent in July 2021. - Country ranges as of July 2022: Oman: 2.6 percent (y/y); Qatar: 5 percent (y/y). - Food inflation rose from 2.2 percent (y/y) in April 2021 to 6 percent (y/y) in June 2022. - GVAR empirical findings: - A Global VAR covering 38 countries finds domestic inflation in the GCC mainly driven by imported inflation from trading partners. - Historical pass-through: an initial 1 percentage point increase in inflation abroad leads to a 0.22 percentage point increase in inflation in the GCC. - Higher food and energy prices mainly impact GCC inflation via the foreign inflation channel. - Exchange rate role: - Nominal effective exchange rate appreciation alongside the USD has reduced import costs and helped shield inflation. - Over the medium term, domestic currency overvaluation can hinder diversification and weaken pegs’ credibility. ### Food security and agricultural policy priorities - Global context: WFP estimates up to 345 million people across 82 countries are acutely food insecure or at high risk (vs. an estimated 145 million in 2019). - GCC food dependence: - About 12 percent of all imported goods in the GCC are food products. - GCC countries import about 85 percent of their food consumption; cereal imports account for over 90 percent; almost all rice consumption is imported. - Russia and Ukraine combined accounted for 44 percent of wheat and 66 percent of barley imports for the GCC as a whole (2020). - Policy responses: - Financial exemptions and credits to farmers and agri-businesses; subsidies/regulated prices for selected food items. - Common food supply network announced April 2020; prudent advance stocking policies. - Arab Coordination Group announced financial support of US$10 billion for food security. - Medium-term priorities: lift agricultural productivity, accelerate climate-resilient agriculture, facilitate imports, reinforce supply chains, and encourage private sector climate-smart investments. ### Digital transformation (Box 5) - ICT and e-government: - UAE ranked 21 in the 2020 UN E-government survey; most GCC countries among top 50; Saudi Arabia, Kuwait and Oman moved to very high EGDI group for the first time in 2020. - Internet access moved to more than 95 percent for all GCC countries (above high-income country average of 89.6 percent). - Financial digitalization and CBDC status (as of May 2022): - Saudi Arabia and UAE: in the pilot stage of CBDCs. - Bahrain: in development. - Kuwait, Oman and Qatar: research stage. - Policy implications: - Develop regulatory frameworks for data protection, cyber security and consumer protection. - Monitor CBDC risks (monetary policy, technical security, socio-economic adoption). - Leverage digitalization to boost productivity and support diversification. ### Fiscal policy, MTFFs, debt management and governance - Fiscal priorities: - Avoid procyclical spending; use windfalls to rebuild buffers and strengthen policy space. - Privilege targeted support for the most vulnerable while leveraging digitalized social benefit systems. - Growth-friendly consolidation: mobilize non-oil revenue, phase out energy subsidies, contain public sector wages, and increase spending efficiency. - Revenue mobilization and tax measures: - Tax gap in the GCC estimated at 16 percent of non-oil GDP in 2019. - Measures include broadening tax bases, revisiting exemptions, introducing corporate income tax (UAE planned for June 2023), increasing VAT and excise tax rates (examples: Bahrain increased VAT), and developing other taxes (personal income, property). - Subsidy reform and social safety nets: - Gradually remove energy and utility subsidies; aim to eliminate energy subsidies by 2030 in Saudi Arabia; Qatar reducing diesel and gasoline subsidies. - Strengthen targeting, streamlining and digitalization of social benefits. - MTFFs, fiscal rules and SWFs: - Performance-based budgeting introduced in the medium-term (Saudi Arabia), but rollouts needed across the region. - MTFFs should align with long-term development strategies and be supported by sound fiscal institutions. - Enhance sovereign asset-liability management frameworks given the increasing role of SWFs. - Credible fiscal rules (e.g., permanent income-based anchors) recommended to delink spending from oil price fluctuations. - Debt management: - Recommended elements: lengthen maturities, reduce refinancing costs, pre-finance in favorable times, build domestic and international yield curves. - Develop frameworks to assess contingent liabilities linked to PPPs and GREs; build DSA capacity. - Transparency and fiscal governance: - Expand fiscal coverage beyond central government; greater transparency on SWF operations and flows; regular publication of pre-budget statements, quarterly outcomes and mid-year reviews; strengthen disclosure of fiscal risks. ### Structural reforms, labor markets and inclusive growth - Structural bottlenecks: - Over-sized public sectors in some countries; low female labor force participation; insufficient training/upskilling; low productivity; limited private sector activity crowded out by SOEs. - Labor market reforms and outcomes: - Female participation remains less than half of male participation; share of women in managerial positions: average 16 percent in the GCC vs. 27 percent in EMDEs; ministerial positions occupied by women: 10 percent in the GCC vs. 20 percent in EMDEs. - Reforms include changes to the Kafala system (Oman, Qatar, Saudi Arabia), visa and contract reforms to attract skilled expatriates (Bahrain, UAE), minimum wage and sponsorship abolishment (Qatar). - Policy recommendations to boost productivity and inclusion: - Raise female labor force participation and provide maternity/childcare support. - Increase expatriate labor flexibility for highly educated workers. - Improve education quality and vocational training aligned with employer needs. - Reduce public-private wage gaps; encourage private sector employment of nationals. - Enhance SME development, improve bankruptcy frameworks, and ensure public interventions (including SWF projects) are subject to rigorous cost-benefit analysis with exit clauses and sunset clauses. - Promote digitalization, improve governance, reduce foreign ownership restrictions and strengthen AML/CTF frameworks. ### Key policy priorities and risks - Priority actions: - Maintain reform momentum despite high hydrocarbon prices. - Save and manage hydrocarbon windfalls to rebuild fiscal buffers and reduce public debt burdens. - Combine revenue and expenditure reforms with greening the economy and scaling up productive and renewable investments. - Strengthen financial sector supervision, insolvency frameworks, deposit and liquidity monitoring, stress-testing and fintech regulation. - Upside risks: - Higher-than-expected oil production, sustained high oil prices, accelerated reforms and investments. - Downside risks: - Another COVID surge; lower oil prices from weaker global activity; much tighter global financial conditions; pressures to spend windfalls and deviate from fiscal prudence; risks to reform agenda from inflationary pressures; supply chain pressures; climate change and transition risks. *Source: ppea2022052 — International Monetary Fund (excerpts: Executive Summary; Section 7; Section 14; MTFF and performance-based budgeting; Box 5 Digital Transformation; CPI composition and GVAR analysis; Appendix III).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### A. Global Developments and Outlook - Global growth contracted in 2022 Q2 by 2 percent. - Global growth is projected to slow from 6 percent in 2021 to 3 percent in 2022 and 2.8 percent in 2023. - Key near-term global shocks and dynamics: - Continued Covid-19 impacts, including lockdowns in China that have negatively affected growth and put further pressures on global supply chains. - Rapid monetary policy tightening in the U.S., contributing to slowing domestic demand, cooling housing prices, and U.S. dollar appreciation that has negatively affected capital flows to emerging and developing economies. - The war in Ukraine exacerbated vulnerabilities, added pressure on oil and gas markets, and put additional pressures on energy and food supplies. - Inflation developments: - Inflation in advanced economies reached 8.3 percent in August in the US and 9.1 percent in the Euro area. - Wheat price remained 30 percent higher in June 2022 than in December 2021. - Fertilizer prices were 17 percent higher than in December 2021. - Commodity markets and supply chains: - Supply chain pressures have shown signs of easing (Global Supply Chain Pressure Index). - Oil: Average Petroleum Spot Prices (APSPs) reached an average of $69.4 per barrel in 2021; oil spiked to highs of $117 per barrel in the first quarter of 2022. Oil futures curves project oil to peak in 2022 and then decrease gradually reaching $71 per barrel in 2027. - Oil demand: IEA estimates show global crude oil demand increased from 94.3 mb/d in Q2 2021 to 98.49 mb/d in Q2 2022 and is estimated to reach 99.7 mb/d by end-2022 and further increase to 101.8 mb/d in 2023. - Gas: IMF staff estimates indicate flows from Russia’s pipeline have declined by about 80 percent and volume is expected to decline further by mid-2024; Dutch TTF gas price jumped to an all-time high of $70 per MMBtu in August 2022. - The disruption to Russian flows has increased energy security concerns and elevated the role of GCC producers in global energy flows (e.g., Qatar North Field East project to increase LNG output from 78 mn tons per annum (mtpa) to 110 mtpa by end-2027, and further to 126 mtpa by 2028; Saudi plans to lift oil production capacity by more than 1 mbpd to reach over 13 mbpd by 2027). - Global financial conditions: - Monetary policy tightening has synchronized globally and financial conditions have tightened, especially in emerging markets where weaker currencies and higher policy rates have increased borrowing costs and asset price volatility. - Downside risks highlighted: - Active Covid-19 transmission and potential variants. - Risk of central banks overtightening and abruptly slowing growth. - Further disruption to Russian gas supplies to Europe, increased geopolitical risks, and further fragmentation of energy markets. ### B. The Economic and Financial Outlook in the GCC Countries - 2021 performance and drivers: - GCC countries grew by 3.1 percent in 2021, with the strongest recoveries in the UAE and Saudi Arabia. - Recovery supported by hydrocarbon price rebound, relaxation of social distancing, vaccination progress, liquidity and fiscal support, reform momentum, and non-oil rebounds in retail, trade, and hospitality (e.g., UAE Expo 2020, Qatar FIFA World Cup preparation, Saudi Arabia Hajj resumption in mid-2022). - Bahrain: retail trade and hospitality performed well but remained below pre-crisis levels despite reopening of the Causeway to Saudi Arabia in May 2021. - Fiscal and balance-sheet developments: - Overall fiscal balances improved strongly in line with higher oil prices and receding pandemic effects. - The cumulative primary balances are expected to average 25 percent of GDP during 2022-2026. - The rise in expenditures—particularly on wages—has been contained so far. - Financial sector and liquidity: - Financial sectors appear overall sound; bank balance sheets have been shielded from tighter global financial conditions by a concomitant period of high oil prices and abundant liquidity facilitating credit expansion. - Continued careful monitoring of bank soundness is recommended. - Outlook risks and channels: - Russia’s invasion of Ukraine and tighter global financial conditions are expected to have a limited impact on GCC economies, but numerous risks remain, notably a slowdown in the global economy. - The impact channels include commodity price volatility, external demand shifts, and global financial tightening affecting capital flows and borrowing costs. ### C. Policy Priorities - Near-term fiscal policy: - Avoid procyclical spending; use windfalls from higher oil prices to rebuild buffers and strengthen policy space. - Given available fiscal space, privilege targeted support for the most vulnerable while leveraging progress in providing targeted social benefits. - Medium-term fiscal policy: - Aim for growth-friendly consolidation to ensure fiscal sustainability and increase savings for intergenerational equity through a credible rules-based medium-term fiscal framework while preparing for a smooth energy transition. - Support measures: non-oil revenue mobilization, energy subsidy phase-out, containment of public sector wages, and increasing spending efficiency. - Proper assessment of fiscal stance should incorporate operations of sovereign wealth funds, which are increasingly involved in national development. - Financial sector stability: - Maintain financial sector stability as essential for sustaining strong economic growth; continue close monitoring of bank soundness. - Structural policies to support private sector-led growth and diversification: - Accelerate ongoing structural reforms and reduce distortions, including: - Raising female labor force participation. - Increasing flexibility for expatriate workers. - Improving education quality. - Further leveraging technology and digitalization. - Enhancing regulatory frameworks, strengthening institutions and governance. - Deepening regional integration. - Addressing climate change. ### D. Concluding Remarks - GCC policymakers have quickly mitigated the economic impact of the twin COVID-19 and oil price shock. - While GCC countries have benefited from higher, albeit volatile, hydrocarbon prices, maintaining reform momentum established during low oil price years is important irrespective of hydrocarbon price levels. - A comprehensive policy package is needed to respond to near-term shocks and to firmly address medium- and long-term challenges, balancing buffer rebuilding, fiscal sustainability, financial stability, and structural reforms for diversification and inclusive growth. *Prepared by Jerome Vacher (Lead), Abdullah AlHassan, Yevgeniya Korniyenko, Charlotte Sandoz, Fei Liu, Aidyn Bibolov, Fozan Fareed, Weining Xin, and Dalia Aita under the guidance of Amine Mati. Editorial support was provided by Esther George.* ### 7. The recovery continues with cyclical ### 7. The recovery continues with cyclical ### Recovery and Growth - In the first half of 2022, strong hydrocarbon production has continued to support rapid economic growth in the region. - GCC economies are expected to grow by a strong 6½ percent in 2022, with the highest growth rates expected in Kuwait and Saudi Arabia, on the back of increased hydrocarbon production and dynamic non-oil GDP growth. - In the UAE, the rebound in tourism following the Dubai World Expo and potential spillover from the coming FIFA World Cup in Qatar should contribute to strong non-oil GDP growth in 2022. - Bahrain: growth is projected to accelerate to 3.4 percent in 2022, with non-oil GDP increasing by 4 percent mainly driven by strong manufacturing and the full opening of the economy. - Qatar: non-hydrocarbon growth is expected to reach 4 percent in 2022, supported by favorable hydrocarbon prices and the start of the North Field expansion project, as well as World Cup-induced buoyancy; hydrocarbon growth is projected to be modest in 2022 as Qatar is already producing at capacity. ### Inflation - Inflation picked up from 0.7 percent (y/y) in July 2021 to 3.2 percent (y/y) in July 2022, mainly driven by higher food prices. - Inflation is expected to reach 3.6 percent on average in 2022, with country ranges reported as: - Saudi Arabia: 2.7 percent - Qatar and Kuwait: 4 ½ percent - UAE: above 5 percent - Factors moderating inflationary pressures: subsidies and price caps on certain products (e.g., some food products, gasoline, electricity and water), a strong dollar reducing import costs, subdued rent prices in some segments (e.g., villas), a limited share of food in the CPI basket, and continued labor market slack (e.g., in Saudi Arabia). - Medium-term outlook: inflation is expected to moderate to about 2 percent as global inflationary pressures abate. ### Impact of the War in Ukraine (Direct and Indirect Spillovers) - Direct spillovers on GCC economies from the war in Ukraine have been small due to negligible direct trade or financial links to Russia and Ukraine, except potential limited losses from a few sovereign wealth funds’ investments in Russia. - The initial direct impact has been supportive mostly via higher oil prices that helped improve fiscal and external positions. - Only 2 percent of GCC food imports are from Russia and Ukraine; the region has stockpiled food items and begun to tap new markets to ensure food security. - Potential adverse channels exist: slower global activity reducing oil demand, higher and volatile international prices for food and energy, and additional supply chain disruptions. - Box 2 findings on trade and financial links: - Russia and Ukraine each accounted for about 2 and 1.4 percent respectively of total GCC agricultural and food imports in 2020. - Russia and Ukraine combined accounted for 44 percent of imports of wheat and 66 percent of barley (for GCC as a whole). - Country-specific exposures: - Bahrain: Russia and Ukraine represented less than 1 percent of food imports. - Qatar: Russia and Ukraine reportedly represented half of the grain imports before the war (vs. 0.1 percent in Kuwait). - Oman: 60 percent of wheat imports from Russia and Ukraine. - Sovereign wealth fund exposures and financial links: - Saudi PIF exposure to Russia: less than ½ percent of its assets under management. - Bahrain’s Mumtalakat: 1½ percent of assets exposure (mainly through RDIF). - Kuwait Investment Authority (KIA): 0.1 percent. - UAE’s Mubadala: less than 1 percent. - Qatar: investments reportedly representing the equivalent of 9 percent of its GDP in Russian companies (mostly Rosneft and VTB). - Local financial markets were not affected in a major way; inflows and stocks initially surged on the back of higher oil prices. - Anecdotal evidence: only the UAE has a large share of tourists from Russia and Ukraine. ### Food Security (Box 3) - Global context: WFP estimates up to 345 million people across 82 countries are acutely food insecure or at high risk, compared to an estimated 145 million in 2019. - GCC context and vulnerabilities: - About 12 percent of all imported goods in the GCC are food products, with Kuwait and Saudi Arabia having higher shares. - GCC countries import about 85 percent of their food consumption; cereal imports account for over 90 percent and almost all rice consumption is imported. - Policy responses in the GCC: - Financial exemptions and credits to farmers and agri-businesses. - Subsidies or regulated prices for selected food items, such as wheat and other cereals. - A common food supply network among member states announced in April 2020. - Prudent advance stocking policies (e.g., for wheat). - Institutional responses: Saudi SALIC (majority owned by the PIF) established to achieve food security via investments, including abroad. - International and regional support: - The Arab Coordination Group (ACG) announced financial support of US$10 billion to overcome regional and international food security challenges. - Medium-term priorities: lift agricultural productivity, accelerate climate-resilient agriculture, increase productivity of local farmers, facilitate imports, reinforce supply chains, and encourage private sector involvement in climate-smart investments in agriculture and food production systems. ### Labor Markets - Despite increases in unemployment during Covid-19, GCC labor markets have weathered the pandemic relatively well; employment of non-nationals seems to be rebounding in some countries, while employment of nationals has held up better or increased. - Structural challenges persist: fragmented labor markets, large public sectors as employment vehicles for nationals, and private sectors dominated by expatriate workers. - Female labor market outcomes: - Female participation remains less than half of male participation and is well below emerging markets averages. - Share of women in managerial positions: average of 16 percent in the GCC vs. 27 percent in EMDEs. - Ministerial positions occupied by women: 10 percent in the GCC vs. 20 percent in EMDEs. ### Fiscal Developments and Outlook - Overall fiscal balances have improved strongly in 2022 in line with higher oil prices and receding effects of the pandemic. - GCC overall fiscal balances are expected to improve to 7.3 percent of GDP in 2022 and are expected to remain positive over the medium term. - Non-oil primary fiscal balances to non-oil GDP are projected to improve in 2022 and then decrease in 2023 in line with medium-term consolidation plans, notwithstanding commitments for additional subsidies and incentives. - Commitment to growth-friendly fiscal consolidation: - Cumulative primary balances have sharply increased and are expected to average 25 percent of GDP during 2022-2026. - Governments have used hydrocarbon windfalls to increase social outlays to mitigate inflationary pressures and support recovery; the rise in expenditure has been contained so far. - Public sector wages and government capital expenditure increases have remained prudent, with caveats about potential additional capital expenditure undertaken by SWFs and SOEs outside general government accounts. - Energy subsidies are often recorded off budget, which can distort the assessment of the fiscal stance. - Saving of windfalls and medium-term stance: - Governments in the GCC are expected, on average, to save about 40 percent of their windfall oil revenues despite projected declines in oil prices. - Fiscal breakeven prices for all GCC countries (except Bahrain) are expected to remain well below observed oil prices in 2022, reflecting progress in fiscal reforms. - Risk: expenditure increases in response to spending pressures from higher hydrocarbon prices could limit gains and raise breakeven prices again. - Public wage bill estimates (2021 IMF staff estimates for central/general government): - Bahrain, Oman, Qatar: around 9-10 percent of GDP. - Kuwait: 19 ½ percent of GDP. - Saudi Arabia: close to 16 percent of GDP. - UAE (general government): estimated at 7 ½ percent of GDP. *International Monetary Fund — GCC: Economic Prospects and Policy Challenges for the GCC Countries (section 7).* ### 14. The pick-up in hydrocarbon prices has improved somewhat debt sustainability ### 14. The pick-up in hydrocarbon prices has improved somewhat debt sustainability prospects but continued commitment to fiscal discipline remains key ### Hydrocarbon prices, fiscal positions, and debt sustainability - The GCC average public debt ratio as a share of GDP should decrease in 2022 to pre-pandemic levels of about 46 percent of GCC GDP. - Average debt service burdens (amortization and interest payments) remained elevated as a result of tighter domestic and external borrowing conditions. - High hydrocarbon prices support healthy fiscal buffers in most GCC countries, though staff estimates suggest that they could deteriorate over the medium term if fiscal reforms are delayed, particularly given the challenges of adjusting to a low-carbon global economy. - Fiscal policies will have to play a key role in addressing mitigation costs (e.g., by at least eliminating energy subsidies in the next few years) and support a smooth transition; GCC countries are also particularly affected by adaptation needs. ### Financial and monetary developments - Private sector credit continues its strong recovery at a pre-pandemic level on average. - GCC asset markets have been performing strongly. - Financial soundness indicators appear healthy, benefiting from strong buffers before the crisis and pandemic support measures: - NPL ratios remain around 4 percent on average. - Provisioning near or exceeding 100 percent. - Banks’ capital adequacy ratios are well above regulatory requirements. - Profitability has improved slightly. - Loan deferrals, initially rolled out as a blanket moratorium on total debt service, have been phased out in all GCC countries and in some cases (e.g., Qatar), replaced by more targeted support. - Potential asset quality deteriorations that could have been masked by pandemic support measures may yet emerge. - The strong recovery in the non-oil economy is particularly welcome given corporates’ pre-Covid deterioration in financial performance. ### Corporate sector vulnerabilities (Box 4) - Analysis covers 363 GCC corporates over 2007–2021. - Corporate performance (revenue growth, profitability, leverage, liquidity, capital expenditure) has deteriorated over time. - Profitability: median firm ROE fell from 15.2 percent in 2007 to 4.1 percent in 2021. - Leverage: total debt over total equity close to 40 percent; some build-up in 2020. - Interest Coverage Ratio (ICR) has deteriorated since 2015, increasing vulnerability to tighter financial conditions. - Liquidity: current assets over current liabilities worsened as short-term liabilities grew faster than liquid assets. - Capital expenditure as a share of revenue has been declining, though it strongly recovered after the pandemic in communication and health care sectors. - A strong economic recovery and favorable outlook, including high oil prices and planned investments and reforms, should improve corporate performance; however, a sharp decline in oil prices or prolonged low growth would risk pockets of corporate distress. ### Impact of global monetary tightening - GCC central banks raised policy rates following the U.S. federal funds rate; further hikes are expected in line with the US monetary policy tightening cycle. - Banking structures with low wholesale funding and a large share of non-interest-bearing deposits are expected to improve banks’ net interest margins, particularly as corporate sector borrowing is at variable rates reset every 3 to 6 months. - Qatar’s banking sector has a large exposure to foreign liabilities (though have declined recently) and could be more susceptible to tightening global financial conditions. - Staff analysis indicates further tightening is likely to have a limited impact on non-oil GDP growth, banks’ profitability, credit growth and asset quality in the GCC in a high oil price environment that increases liquidity in the system. ### External sector developments and vulnerabilities - The average current account surplus for GCC countries is expected to improve by a further 8 ½ percent of GDP in 2022, before decreasing to an average of 13.7 percent in 2023. - Higher oil and other commodity prices (gas and aluminum) more than offset rebounding import demand and increased prices for some imports (food and non-hydrocarbon commodities). - Real effective exchange rates (REER) only slightly appreciated. - Reserve accumulation and net foreign asset positions are expected to improve as governments save a large share of hydrocarbon windfalls; net foreign asset positions have significantly strengthened though in some countries’ outflows (e.g., Saudi Arabia, Qatar) have contained the improvement. - External bond spreads remain overall significantly lower and more resilient to shocks than the average of emerging markets, despite strong movements in capital flows. - Positive external spillovers include recovery of outward remittance flows and increased GCC financial support to vulnerable countries in the MENAP region: - Outward remittances in Saudi Arabia (equivalent of 5 percent of Saudi Arabia’s GDP) increased by 16 percent in 2021 compared to 2020. ### Risks to the outlook - Upside risks: higher than expected oil production, sustained high oil prices, accelerated implementation of structural reforms and investments. - Downside risks: - Another COVID surge, domestically or abroad. - Lower oil prices due to lower global activity if the war in Ukraine has lasting effects. - Much tighter-than-expected global financial conditions. - Pressures to spend oil windfalls and deviate from fiscal prudence (including outside central government budgets). - Risks to the reform agenda including from inflationary pressures. - Further global supply chain pressures could constrain imports of capital equipment and hamper diversification and investment strategies. - Climate change and mitigation policies add risks: - Physical risks (high temperature, drought) and substantial adaptation costs. - As global demand for fossil fuels declines in the long run, GCC countries face transition challenges. - Achieving GCC emissions targets likely requires a combination of supply and demand policies. - During the energy transition, imbalances between constrained oil supply and gradually declining demand may increase oil price volatility; if supply constraints remain binding, oil prices could remain persistently high. ### Policy priorities — fiscal sustainability, potential growth, and financial stability - Maintain reform momentum achieved recently; avoid derailing reforms due to high hydrocarbon prices. - When fiscal space allows, prioritize targeted support for shocks (e.g., high energy and food prices) that affect the most vulnerable, while leveraging pandemic-era modernization and digitalization of social benefit provision. - Carefully manage higher hydrocarbon proceeds to rebuild or stabilize fiscal buffers and reduce public debt burdens, avoiding past procyclical patterns. - Additional fiscal efforts may be needed for climate change, energy transition, and diversification. - Growth-friendly medium-term consolidation should combine revenue and expenditure reforms and greening the economy. Priority reforms include: - Mobilizing non-oil revenue: - The tax gap in the GCC was estimated at 16 percent of non-oil GDP in 2019. - Measures include broadening the tax base by reducing exemptions, revisiting regressive fees, introducing CIT (such as planned to be implemented in the UAE for June 2023), introducing (such as envisaged in Qatar, Kuwait) and increasing (such as done in Bahrain) VAT and excise tax rates, and developing other forms of taxation (e.g., personal income taxes, property taxation). - Strengthen tax administration and digitalization to improve tax collection efficiency. - Containing the wage bill: - Proceed with planned public wage and employment reforms (UAE). - Rationalization of public wage bill (Qatar). - Streamlining resources and increasing manpower efficiency (Bahrain). - Saudi Arabia’s early efforts to rationalize the wage bill are already bearing fruits and should be sustained and well anchored. - Revisiting and gradually phasing out poorly targeted subsidies, alongside measures to strengthen social safety nets: - Energy subsidies are fiscally costly and crowd out spending on education, health, and other social expenditures critical for inclusive growth. - Gradually removing energy and utility (e.g., water) subsidies will help promote efficient energy and water usage and support GCC mitigation targets in reducing greenhouse emissions. - Examples: aim to eliminate energy subsidies by 2030 in Saudi Arabia; Qatar’s energy subsidy reform to reduce subsidies on diesel and gasoline. - Leverage progress on targeting, streamlining, modernizing and digitalizing social benefits. - Scaling up productive investments and investments in renewables by improving targeting of expenditures that achieve climate mitigation objectives. - Structural fiscal reforms should be underpinned by rules-based credible medium-term fiscal frameworks (MTFFs) with fiscal anchors; some GCC countries have developed MTFFs that incorporate multi-year revenue initiatives and spending priorities (e.g., Qatar, Saudi Arabia). *Source: ppea2022052 - 14. The pick-up in hydrocarbon prices has improved somewhat debt sustainability prospects but continued commitment to fiscal discipline remains key (IMF).* ### introduction of performance-based budgeting in the medium-term (Saudi Arabia), but more ### introduction of performance-based budgeting in the medium-term (Saudi Arabia), but more ### Medium-term fiscal frameworks (MTFFs) and performance-based budgeting - Performance-based budgeting has been introduced in the medium-term (Saudi Arabia), but more complete rollouts are still needed across the region. - MTFFs should be closely coordinated with medium and long-term government development strategies and plans and supported by sound fiscal institutions. - Stronger linkages are required between MTFFs and budget planning and execution. - Given the increasing role of GCC Sovereign Wealth Funds, there is a need to enhance sovereign asset-liability management frameworks closely aligning them with MTFFs. - Regular public communication of fiscal plans and outcomes, and of the government strategy on oil revenue management and its impact on reserves and domestic liquidity, would further enhance the credibility of fiscal policy. ### Fiscal rules and long-term fiscal sustainability - Credible fiscal rules can help delink government spending from oil price fluctuations and support an appropriate medium and long-term fiscal policy path. - These rules should ideally be derived from a long-term fiscal anchor – e.g., based on the permanent income hypothesis – and offer clear guidance for policymakers and economic agents on long-term objectives (i.e., achieving intergenerational equity, supporting development and diversification strategies, while taking into account transition risks related to climate change). - A risk-based fiscal framework that accounts for long-term challenges will be critical to ensure long-term fiscal sustainability. - Identifying specific measures aimed at achieving levels of non-oil revenue targets can help make the transition less disruptive. - In the near term, spending pressures tend to move in tandem with the global commodity cycle; fiscal rules that limit spending growth can be particularly helpful to build buffers during the upcycle of commodity prices. - GCC countries should work towards establishing such credible fiscal rules and, where rules are being devised (as in Saudi Arabia), strengthen them for better enforcement and credibility. ### Debt management and fiscal risk coordination - Sound debt management should continue to support fiscal policy and capital market development. - Recommended strategy elements include: - Lengthening debt maturities. - Reducing refinancing costs. - Pre-financing in favorable times. - Building a yield curve in domestic and international markets. - Developing frameworks for assessing and monitoring guarantees and other potential contingent liabilities linked to increased private sector participation, including through PPPs, are important (e.g., in Saudi Arabia). - Building capacity in debt sustainability analysis is important. - Improved coordination among fiscal authorities (central and local governments, GREs, and SWFs) and central banks would help improve cash flow management (including through treasury single accounts) and strengthen risk management practices. - Example: The UAE’s new Dirham Monetary Framework (DMF) and recent federal debt issuances will support domestic capital market development but will require strong coordination between the CBUAE and the federal government. ### Transparency and fiscal governance - Further progress in transparency is needed to strengthen fiscal governance through: - Fiscal coverage expansion beyond central government operations in some GCC countries to reflect a more comprehensive picture of fiscal sustainability; data limitations on general government statistics and public sector balance sheets (including off budget subsidies, contingent liabilities, GREs’ debt, PPPs, and SWFs) limit accurate assessment of the underlying fiscal stance. - Greater transparency on SWF operations and flows with the central government to fully account for investment strategies and realizations of SWFs and strengthen governance and policy making. - More regular publication: pre-budget statements, quarterly budget outcomes, mid-year reviews and year-end reports (as in Saudi Arabia) and fiscal adjustment targets (e.g., Bahrain) significantly increase transparency. Continue providing additional details on revenue and expenditure items, extend institutional coverage, and report on deviations between budget outcomes and plans. - Strengthened disclosure and management of fiscal risks, including risks related to contingent liabilities, PPPs, and commitments beyond the central government, ideally integrated in an asset-liability management framework. - Improved transparency in public procurement (significant progress in some countries, e.g., Saudi Arabia) to enhance fiscal management and anti-corruption efforts. ### Financial sector stability and reforms - As financial sectors expand with high oil prices and liquidity, maintaining bank soundness is essential to contain systemic risk. - Overall, GCC financial sectors appear sound and able to accompany recovery in the non-oil sector and structural transformation, but legacy risks, current stresses and emerging vulnerabilities need to be managed and anticipated. - Key vulnerabilities and policy priorities: - Withdrawal of policy support measures could reveal pockets of vulnerabilities (e.g., SME financing, real estate and mortgage lending). Close monitoring of credit standards among SMEs and corporations and intense supervision of banks and financial institutions are required, including detailed on- and off-site inspections, adequacy of credit risk assessments and provisioning, and stress-testing. - Regular reporting on loans under remaining deferral schemes and the stock restructured after support measures are lifted will be important for monitoring asset quality. - Rapid development of mortgage and real estate financing and banks’ growing exposure to construction and real estate loans warrant development of real estate price indicators to assess financial stability risks (e.g., in Bahrain). - Reduced corporate profits and tightening global financial conditions raise credit risk, requiring enhanced supervisor scrutiny, thematic inspections, and in-depth assessments of loan portfolios and provisioning practices. - Address pre-existing vulnerabilities, including reducing loan-to-deposit ratios where they remain above regulatory norms, significant FX mismatches, or reliance on wholesale and nonresident funding (e.g., Qatar). - Insolvency and resolution frameworks: - Expediting strengthening of insolvency and resolution frameworks should be a priority. Progress achieved in some countries (e.g., UAE, Bahrain and Saudi Arabia). - Policies should ensure recognition of impairment and resolution of bankrupt borrowers (targeting distressed but viable borrowers) and ensure adequate bank buffers remain in place. - Fintech and digitalization: - Continued support for fintech and digitalization can provide sources of financial sector growth but must be balanced against risks to financial stability. - Examples of fintech developments: - UAE: regulatory sandboxes (2016 Abu Dhabi, 2017 Dubai); federal development of comprehensive legislative framework; 7 digital banks licensed; 10 Fintech accelerators in place. - Saudi Arabia: Fintech Saudi initiative (2018); licenses to three digital banks as of February 2022; cybersecurity framework to address cyber risks. - Bahrain: Central Bank’s Fintech & Innovation Unit and Regulatory Sandbox. - Qatar: National Fintech Strategy and Qatar FinTech Hub (QFTH) launched in 2019. - Kuwait and Oman: fintech regulatory sandboxes introduced in 2018 and 2020 respectively. - Authorities should apply a mix of activity- and entity-based regulation proportionate to the size, complexity, and risk of fintech firms. - Financial market development and inclusion: - Continued reforms needed to develop financial markets and the non-bank sector and increase financial inclusion. - Priority reforms include developing a yield curve, increasing market liquidity through secondary markets trading, and developing domestic corporate bond markets. - Stock market reforms should focus on enhancing corporate governance and investor protection, removing restrictions on foreign ownership, and encouraging financial market competition. - Green and sukuk market segments (e.g., green bonds and green sukuk) have potential to contribute to local market development and have been recently developing. ### Exchange rate policy, competitiveness, and diversification - Pegged exchange rate regimes remain appropriate for GCC economies despite global volatility and shocks, providing a credible monetary anchor. - Pegs should be reviewed regularly to ensure appropriateness and avoid hindering competitiveness. - Indications to date show limited impact of the USD appreciation on competitiveness as REERs have held relatively steady, largely thanks to relatively lower inflation in GCC countries. - Overall external positions remain broadly in line with or slightly weaker than medium-term fundamentals and desirable policies, and GCC countries have overall adequate buffers to maintain their pegs. - Reforms to deepen money and capital markets and strengthen monetary policy frameworks should continue to ensure institutions are in place to support more independent monetary policies if appropriate. - Fiscal consolidation and competitiveness-enhancing structural reforms will help strengthen the external position and support exchange rate pegs. ### Structural reforms to revive diversification, growth, and competitiveness - GCC countries have accelerated diversification efforts across output, export and revenue dimensions, though FDI inflows remain relatively low. - Sovereign wealth funds’ interventions in domestic economies (including Giga projects) should be subjected to rigorous cost-benefit analysis to ensure risk-adjusted returns remain high and generate greater private sector involvement. - Structural weaknesses and bottlenecks include over-sized public sectors in some countries, low female labor force participation, insufficient training and upskilling (particularly in innovative sectors), low productivity, and limited private sector activity crowded out by dominant SOEs. - Opportunities for transformation include digitalization and climate-related investment. ### Labor market reforms and productivity-enhancing measures - Good progress in labor market reforms has occurred, but more is needed to foster higher productivity and diversification. - Recent reforms and measures: - Changes to the Kafala sponsorship system in Oman, Qatar and Saudi Arabia to enhance expatriate labor job mobility. - Reforms to raise female labor market participation, including “doubling Saudi Arabia’s woman labor force participation rate in the past three years”. - Legislations prohibiting gender-based discrimination in employment (Saudi Arabia, Bahrain and the UAE) and gender balance initiatives (UAE). - Measures to attract highly skilled expatriates via visa reforms and employment contract changes (Bahrain and UAE). - Digital residency services and employment and training portal (Bahrain). - Introduction of a minimum wage and abolishment of the sponsorship system for foreign workers (Qatar). - Further reforms needed to boost labor productivity include: - Encouraging private sector labor force participation of nationals, particularly females, by removing barriers and providing maternity and childcare support. - Adopting more flexible policies for expatriates, including highly educated workers, to avoid abrupt declines in labor supply and reduce the wage gap between nationals and expats. - Improving education and training quality and alignment with employer needs, including vocational training for middle-aged workers, to reduce structural mismatches and skills gaps. - Reducing the public-private wage gap to boost private sector employment and addressing the productivity-wage gap to ensure competitive wages. ### Additional measures to lift inclusive potential growth - Reduce distortions from public sector interventions that hinder resource reallocation and market development; ensure large-scale public-sector interventions (primarily through SWFs) are based on appropriate project selection to avoid low-multiplier spending or crowding out private investment. - Facilitate resource reallocation within and across sectors, including through improved bankruptcy frameworks and training/education policies. - Enhance SME development (e.g., Saudi Arabia’s efforts on SME and local content development; Bahrain’s Economic Recovery Plan initiatives including credit and movable collateral registries, American Free Trade Zone, aluminum downstream park, and revamped National Employment Plan). - Minimize inefficiencies of industrial policies by designing transparent, accountable incentives focused on export orientation and diversification, with strict performance criteria, exit clauses, and sunset clauses to limit fiscal risks. - Enhance regulations, governance and anti-corruption frameworks to mobilize private and foreign investment in the non-oil sector and raise productivity. Measures include reducing restrictions on foreign ownership, aligning tax treatments of local and foreign firms, reducing preferential treatments for GREs, improving transparency and accountability, and strengthening AML/CTF frameworks. - Promote digitalization to prepare for the future of work, enhance productivity and protect macro-financial stability; the pandemic accelerated digital transformation with substantial progress in public and financial sectors. *International Monetary Fund — GCC: Economic Prospects and Policy Challenges for the GCC Countries (excerpts)* ### Box 5. Digital Transformation in the GCC ### Box 5. Digital Transformation in the GCC ### Overview - Digital technologies are transforming the economic and financial landscape and have the potential to generate efficiencies and greater productivity, spur innovation and improve services. - The COVID-19 pandemic has accelerated the digitalization agenda and created new opportunities as activities shifted to online platforms (e.g., e-education, tele-health, digital banks, virtual courts, and e-businesses). - Digital adoption can help improve education and health outcomes, and strengthen households’ resilience to future shocks by allowing governments to quickly scale up social assistance programs or enhance education system preparedness for future pandemics. - It is crucial to ensure proper regulatory frameworks to tackle challenges pertaining to data protection and cyber security. ### ICT Adoption and E-Government Progress - Continued increase in E-government is evident in the region: - UAE ranked 21 in the 2020 UN E-government survey. - Most GCC countries are among the top 50 in the 2020 UN E-government survey, with Saudi Arabia, Kuwait and Oman moving to very high EGDI group for the first time in 2020. - Internet access: - The number of individuals with internet access has moved to more than 95 percent for all GCC countries. - This is above the average for high-income countries, which is 89.6 percent. ### Digitalization of the Financial System and CBDCs - Digitalization of the financial system is proceeding at a fast pace with the number of active fintech companies increasing rapidly. - Regulatory priorities include developing frameworks that keep pace with the Fintech ecosystem and ensuring adequate consumer protection without stifling innovation. - Central Bank Digital Currency (CBDC) status (reported as of May 2022): - Saudi Arabia and UAE: in the pilot stage of CBDCs with the plan for a possible full launch. - Bahrain: in development. - Kuwait, Oman and Qatar: research stage. - Risks associated with CBDC projects to be monitored: - Monetary policy implications (non-interest bearing CBDC). - Technical constraints (cyber risks and data protection). - Socio-economic challenges (low adoption and financial illiteracy). ### National Visions and Digital Initiatives - Saudi Arabia: - Implemented National Digital Transformation Strategy. - Accelerated digitalization during COVID, leading to adoption of e-Health (Sehati), virtual court (Najiz), distance learning (Madrasati), and ease of doing business tools for enterprises (Etimad and Fasah). - UAE: - Launched several digital projects as part of its Vision 2030, including Dubai Internet City acting as a hub for technological innovation to attract ICT companies. - Qatar: - TASMU Smart Qatar emphasizing cooperation across sectors as part of its national vision. - Bahrain, Kuwait and Oman initiatives: - Bahrain’s Digital Government Strategy 2022. - Kuwait’s digital roadmap as part of its Vision 2035 and increased focus on Internet of Things (IoT) systems. - Oman’s e.Oman strategy focusing on e-Government and ICT infrastructure. ### Policy Implications and Recommendations - Develop and maintain proper regulatory frameworks to address: - Data protection. - Cyber security. - Consumer protection in digital financial services. - Prioritize monitoring of CBDC-related risks: monetary policy, technical security, and socio-economic adoption challenges. - Leverage digitalization to boost productivity given the young and tech-savvy population in the GCC. - Use digital transformation initiatives embedded in national visions to support diversification and attract ICT investment. *Source: Box 5. Digital Transformation in the GCC (extracted content).* ### 3. The composition of the CPI baskets can ### 3. The composition of the CPI baskets can ### CPI composition and low inflation in the GCC - GCC countries have lower shares of food in their CPI baskets, based on their consumption patterns, compared to other countries in the MENA region. - Contained rental prices and their high share in the CPI basket contributed to low inflation levels in GCC in recent times. - Example: the housing rental component is about 21 percent of the overall CPI basket in Saudi Arabia, which has either stayed constant or even declined slightly recently due to higher supply, increased home ownership and changes in housing demand (e.g., less for villas and more for smaller units and apartments). ### Recent inflation trend and category drivers - Inflation in the GCC increased from 0.7 percent (y/y) in July 2021 to 3.2 percent (y/y) in July 2022. - A mid-2020 pickup was mainly driven by Saudi Arabia where inflation jumped to over 6 percent (y/y) after the tripling of the VAT rate to 15 percent in July 2020. - As of July 2022, inflation in the GCC ranged from 2.6 percent (y/y) in Oman to 5 percent (y/y) in Qatar. - Main drivers of the recent increase: - Food: food inflation rose from 2.2 percent (y/y) in April 2021 to 6 percent (y/y) in June 2022. - Despite the upward trend, food inflation has remained below MENA peers, explained by administered prices, subsidies on certain food products, stockpiling of basic food items (e.g., wheat) and low share of food imports. - Transport: prices of cars saw a sharp international increase and transport services (mainly international transport by air and travel by sea) also picked up. ### GVAR analysis of global inflation spillovers to the GCC - Model description: - A Global VAR (GVAR) model covering 38 countries (about 90 percent of world GDP). - For each country the GVAR includes five domestic variables: real GDP, inflation, growth of money supply, nominal effective exchange rate (NEER), interest rates — endogenous to each economy. - Foreign variables: a weighted average of trade partner's domestic variables entered as foreign variables (weakly exogenous following Dees et al. (2007)), except for the US model where only foreign CPI and foreign growth of money supply are included as foreign variables. - Global variables: oil price and the price of agricultural materials included as global variables endogenous to US foreign variables but weakly exogenous to all other countries. - Key empirical findings: - Domestic inflation in the GCC is mainly driven by imported inflation from main trading partners, recently pushed upwards by rising oil and food prices, supply chain disruptions and labor market tensions. - Historical pass-through: an initial 1 percentage point increase in inflation abroad leads to a 0.22 percentage point increase in inflation in the GCC. - Higher food and energy prices mostly impact GCC domestic inflation through the foreign inflation channel (higher costs of trading partners); for some countries (e.g., Saudi Arabia) estimated pass-through shows that a rise in oil and food prices does not translate, on average, into an increase in domestic inflation. - Projection: - Given recent global developments—foreign inflation driven by pandemic-related shocks and the war in Ukraine—inflation in the GCC is expected to increase in the coming months. ### Exchange rate and medium-term considerations - The recent appreciation of the nominal effective exchange rate in line with that of the USD appears to shield GCC countries against inflationary pressures by reducing import costs. - Over the medium term, domestic currency overvaluation can hinder economic diversification efforts and weaken the credibility of the pegs. --- ### Appendix III. Impact of U.S. Monetary Policy Decisions on the GCC Economy and the Banking Sector ### Monetary policy stance and objectives in the GCC - Primary objective: ensure exchange rate stability anchored by a fixed exchange rate of the national currency to the U.S. Dollar (Kuwait: undisclosed basket tilted towards the U.S. dollar) and open capital accounts. - Exchange rate pegs are maintained by managing short-term interest rate differentials with U.S. interest rates. - Central banks in GCC move policy rates broadly in line with the U.S. Federal Reserve; banks’ liability and asset rates also tend to move strongly with policy rates. ### Baseline empirical approach - Analysis uses a panel vector autoregression (panel-VAR) and bank-level panel regressions. - Baseline panel-VAR dependent variables: non-oil GDP growth, stock market indices and long-term sovereign bond yields. - Control variables: U.S. effective Fed Fund rates, VIX, domestic inflation and oil prices. - Estimation sample: quarterly data covering 2018Q1-2021Q4; report 6-month average responses. - Long-term sovereign bond yields proxied by bonds ranging from 5- to 13-year maturity (average time to maturity in the sample is less than 10 years). ### Panel-VAR results: Fed tightening and non-oil growth - Fed tightening has limited effect on non-oil economic activity, particularly when oil prices are high. - Estimated effect when oil prices are below threshold ($45): - A 100 basis points hike in the Fed rate reduces non-oil GDP growth by about 0.3 percent in GCC. - Equity prices drop by about 0.8 percent when oil prices are low. - When oil prices are above the $45 threshold: - The effect of Fed tightening on non-oil GDP is negligible. - Equity prices increase by about 1 percent when oil prices are above the $45 threshold. - Statistical significance: results statistically significant at a 5 percent level except when oil prices are high for non-oil GDP. ### Transmission channels and liquidity - Transmission of U.S. monetary policy to GCC economies depends on oil prices via their effect on domestic liquidity. - High oil prices (abundant liquidity) could dampen the impact of policy rate changes on non-oil growth. - Low oil prices (reduced liquidity) could amplify monetary spillovers, leading market interest rates to increase more than policy rates and slowing credit demand. ### Banking sector structure and implications - Deposit and liability structures vary across GCC banks: - Deposits dominate Saudi banks’ liabilities; non-deposit liabilities (wholesale funding) relatively important in Kuwait and Bahrain. - Heterogeneity in share of non-interest-bearing deposits: - Saudi Arabia: more than 60 percent of deposits are non-interest-bearing. - Kuwait, Qatar and Oman: the percentage of non-interest-bearing deposits is quite low. - Implications: - Banks with high proportion of non-interest-bearing deposits likely to benefit from interest rate hikes. - Banks with low proportion of loans repricing are more likely to be adversely affected by U.S. monetary policy tightening. ### Bank-level panel estimates: pass-through from U.S. rates to bank rates and performance - Liability and asset rate pass-through: - When U.S. rates rise by 100 basis points, GCC banks’ liability rates rise by about 40 basis points and asset rates by close to 35 basis points (regression results show coefficients 0.369*** to 0.433*** for liability rates and 0.320*** to 0.380*** for asset rates across specifications). - Log (Uncertainty Index) has positive and significant coefficients for liability and asset rate regressions (e.g., 0.495***, 0.499***, 0.479***, 0.482***). - Observations: 919 for liability rate regressions; 973 for asset rate regressions. R-squared ranges from 0.131 to 0.176. - Profitability (Net Interest Margin, NIM): - Impact of tighter U.S. monetary policy on banks’ profitability is statistically insignificant. - Δ Federal Funds Rate coefficients in NIM regressions: -0.001, -0.002, -0.011, -0.025 (not statistically significant). - Observations: 919; R-squared up to 0.039 in specifications with controls. - Credit growth and asset quality: - Historically limited impact of tightening on credit growth when oil prices were high; credit growth remained strong during 2004-2007 despite tightening. - Bank-level regressions suggest Fed tightening does not impact credit growth (Δln(Credit)) or non-performing loans Δ(NPLs). - Table 4 estimates: Δ MP coefficients for Δln(Credit) and Δ(NPLs) not statistically significant; interactions with liability/asset pass-through (LPT Dummy) and oil dummy also not showing significant adverse impacts. - Observations: 778 for credit regressions; 934 for NPL regression. R-squared around 0.11. ### Synthesis of implications - In an environment of high oil prices and liquidity, U.S. monetary policy tightening would have a limited impact on the non-oil economy and the banking sector in the GCC. - High oil prices mitigate spillovers from U.S. monetary policy normalization to GCC economies. - Banks’ profitability appears insulated from shifts in U.S. policy rates; funding cost pass-through occurs but is often transmitted to asset rates and customers given variable-rate loan shares. - Credit growth and asset quality show limited sensitivity to U.S. monetary policy tightening historically, including for banks with higher liability pass-through. *Source: IMF staff estimates and calculations as presented in the chapter.* --- _Source: https://www.imf.org/-/media/files/publications/pp/2022/english/ppea2022052.pdf_