Euro-Gulf Information Centre
Fiscal Policy Considerations
During Volatile Economic Conditions:
The Case of Rising Public Debt Stock in the Gulf Cooperation Council (GCC)
by Rashed Albinali
The COVID-19 pandemic has had both wide-ranging and far-reaching consequences. From disruptions to education and the straining of public healthcare systems, to the crippling of global supply chains and an ensuing economic downturn. While it is still too early to measure the full impact of the pandemic in the medium and long runs; it is safe to say that the pandemic has led to the deepest recession since the Great Depression.[i] Globally, central banks have coordinated efforts to slash interest rates to record lows in order to promote demand, and government spending has increased to offset health and economic needs. This fiscal relaxation has led to dramatic increases in public debt ratios in both advanced and emerging market economies. The Gulf Cooperation Council (GCC), faced with the double impact of both the pandemic and low oil prices, tapped into the international debt market to issue over $60 billion (USD) to meet rising financial needs, above the total issuance of $44 billion (USD) in 2019.[ii] This has led to a ballooning of publicly held debt within the GCC. However, this is not an altogether new, as debt ratios within the region have already been in steady incline for much of the past two decades. Table 1 showcases this trend via public debt ratios within the GCC in the year 2000 compared to 2020, as well as the ratio of public debt maturing in 12 months or less in both 2011 and 2020.
Public debt ratios have increased in most GCC countries, with figures ranging from 20% to over 100% of GDP over the past twenty years, and over US$100 billion in debt is maturing between 2021 and 2025 which will increase financing needs in the short term.[iii] The question is, with fiscal dependence on oil and historically volatile oil prices, is the public debt within the GCC sustainable? This paper aims to assess public debt sustainability in the GCC and discuss possible fiscal policy considerations in light of this increase in debt.
When is Public Debt Sustainable?
The question of public debt sustainability has dominated macroeconomic discourse since post-WWII reconstruction efforts led to a sharp increase in public debt across advanced economies. Theoretically, public debt is considered sustainable as long as economic growth rates remain firmly above real interest rates;[iv] which would make it feasible for economies to service mounting debt and organically reduce the debt-to-GDP ratio via economic growth. Researchers have also presented other criteria such as debt-to-GDP thresholds as a form of debt sustainability, whereby economies exceeding such thresholds would experience slower growth making it harder to service debt and organically reduce its ratio to GDP. These thresholds range from 77%[v] to 115%[vi] of GDP. Other researchers believe the ratio of external debt to GDP to be more pressing, with some suggesting thresholds between 20-25%[vii] and 35-40%[viii] as ceilings beyond which there is significant impact on economic growth prospects. Some researchers claim that public debt can only be considered sustainable when it is proven that policymakers adjust fiscal policy to changes in the primary balance.[ix] In a working paper for the International Monetary Fund, Pescatori, Sandri and Simon (2014)[x] refute the existence of debt thresholds by showing that economies with high debt-to-GDP ratios can still experience solid growth performance, and instead, stress a country’s debt trajectory as the key indicator. That is, a country with decreasing debt will experience a higher growth rate than a country with increasing debt regardless of debt level.
Debt sustainability is, thus, a complex and multifaceted issue. A host of other indicators such as the size of the fiscal multiplier, the degree of trade openness and the marginal propensity to import can change public debt dynamics within an economy. Other country-specific factors such as the accumulation of public capital, infrastructure needs and levels of private demand are equally important factors to consider when making public debt tradeoffs. Research has shown that the context in which borrowed funds are used plays an important role in understanding debt sustainability largely because certain spending either pays for itself or more than pays for itself in the long run.[xi] Even then, sustainability is difficult to measure for the simple fact that policymakers must rely on forecasts, which are inherently uncertain.
The wide consensus, then, is that under most conditions, possessing, maintaining and especially increasing public debt is undesirable. Most major advanced economies, however, continue to live with permanent deficits and increasing public debt ratios. Empirical results have shown that the rate of public debt growth in member countries of the Organisation for Economic Cooperation and Development (OECD) far exceeds economic growth rates.[xii] Public debt exceeds over 100% in both the United Kingdom and the United States, and is over 200% in Japan. Yet the narrative around public debt in advanced economies is seldom as consequential as it is for the GCC, who, despite maintaining lower, and relatively more manageable public debt ratios (see Table 1), have been the target of multiple credit rating downgrades in the past decade. Are public debt management dynamics different for the GCC, and has the sustainability of public debt within the region become compromised?
The GCC’s Rising Public Debt Stock
To assess public debt sustainability, one must first understand the context with which public debt stock has risen within the region. While sustainability issues vary by country, the GCC is discussed collectively in this paper because, among other aspects, they share similar economic make-up, coordinate monetary and fiscal policies, and possess synchronised business cycles.[xiii] Figure 1 below showcases fiscal balance within the GCC between the years of 2000 and 2020.
During the time of rising oil prices throughout the mid-to-late 2000s, the GCC amassed large surpluses despite announcing ambitious diversification plans. Widening fiscal deficits began, in earnest, after the financial crisis of 2007-2008. Figure 1 also shows that fiscal balance has been largely dependent on oil prices, and with each GCC country having different oil-price breakeven points, some countries were affected more so than others. Following the Oil Glut of 2015, however, the GCC experienced chronic fiscal deficits (with the exception of Kuwait) as oil prices settled on a new, lower, equilibrium. This, coupled with current account deficits, led to a sharp decline in public finances that necessitated debt issuance to cover recurring costs. Consequently, the GCC coordinated the implementation of substantial fiscal consolidation measures such as subsidy cuts, public (often current) spending cuts, and value-added-tax (VAT) to offset debt accumulation.
Some researchers have claimed that these measures were implemented too quickly and have not only negatively impacted growth in the short term, but also stalled diversification plans necessary for long-term sustainability.[xiv] Yet the International Monetary Fund (IMF) as well as leading sovereign credit rating agencies remain skeptical about the GCC countries’ fiscal sustainability and continue to call for more substantial and sustained consolidation measures.[xv] So why is the GCC’s fiscal position so compromised? Ultimately, it boils down to the GCC’s fiscal dependence on non-renewable natural resource rents. Oil prices have been all but reliable in the past, and with global green energy initiatives already underway, they are likely to remain volatile in the foreseeable future. Until diversification measures bear their fruit, and until the private sector becomes the primary driver of growth, then there will always be heightened fiscal sustainability risks. This, perhaps, is why, as displayed in Figure 2, real interest rates within the region have generally been volatile. Unlike major developed economies, the GCC contends with relatively higher interest rates on average that make their bonds both inherently riskier and more expensive. International demand for GCC bonds have not weakened, however, despite aforementioned skepticism.[xvi]
This shows that, while fiscal dependence on oil weighs down on GCC public debt sustainability, it is not the only thing international investors and creditors consider. The GCC’s low debt exposure (especially when compared to other high income economies), sizeable sovereign wealth funds, reliable foreign reserves and — as showcased by Table 2 below — relatively low debt service ratios (with notable exceptions in Bahrain and Oman) have helped retain international business confidence and allowed for a steady flow of capital to the region.