Fine balance in Middle East needed with long view in mind

While Middle East governments have recently taken steps to address economic concerns, more needs to be done to ensure their impact lasts.

Recent events in the Middle East have led to a range of short-term responses from governments, especially increased expenditures to relieve cost-of-living pressures and to create jobs.

But medium to longer term fiscal policy matters still require major reform to be sustainable.

At present, there are two global phenomena at play that have profound impacts on budgets in the Middle East.

The rising price of oil can be a two-edged sword. On the one hand, it increases government revenues for the major oil-exporting Gulf states and Libya, Iraq and Algeria (although it also increases the cost of the subsidies related to local petrol prices, further distorting demand).

On the other hand, it also increases attention on government spending policies, along with demands for greater equity and transparency in national wealth. For oil-importing states such as Egypt and Jordan, it only increases fiscal and economic pressures.

The second phenomenon is the increasing cost of food which, unlike the rising oil price, is a problem for all Mena countries. They import more than half of their food, which often constitutes a high proportion of household spending (from averages of 15 per cent in the UAE and Qatar, where housing is the major cost, through to 30 per cent in Saudi Arabia and Kuwait, to more than 50 per cent in most Levant and North African countries).

For poorer members of society, food costs can often constitute more than 75 per cent of their incomes.

In the short term, this means that regional governments will be focused on balancing cost-of-living concerns with other fiscal imperatives.

A survey of chief executives by PricewaterhouseCoopers late last year identified three major challenges for governments: improving infrastructure; ensuring financial stability and access to finance; and creating a skilled workforce.

These priorities are fundamental to the creation of employment, enterprises and a sustainable economic growth model. To respond to these challenges, governments need to rethink the role of the state in the 21st century, develop policies to achieve "good growth", tackle their finances, and consider doing fewer things or doing them differently.

Governments in the region that have traditionally been oil or gas-dependent have been unsuccessful in their efforts to diversify their economies and create enough well-paid jobs or business opportunities to satisfy the needs of burgeoning young populations.

So how can fiscal diversification be achieved?

Ÿ Oil and gas wealth should be separated from annual budget revenues. Wealth should be placed in separate funds (such as sovereign funds), with a predetermined long-term rate of return established. This would allow a smooth revenue stream to the budget - not subject to market price volatility - and allow the separately administered fund to manage the volatility, maximise returns and, independent of the annual budget, invest for the future.

Ÿ Governments need to diversify revenue sources, including the introduction of alternative revenue streams from taxation together with dividend policies from government investment funds and trading enterprises.

Ÿ Greater reliance should be placed on private sector financing of infrastructure. The issuing of government bonds to fund longer-term assets would also assist in deepening regional financial markets.

Ÿ Distortionary subsidies, especially for energy use, should be phased out to address excessive over-consumption and waste of precious energy and water sources. This would also begin to tackle environmental sustainability and responsible resource management.

Finally, because of greater accountability and transparency pressures, governments in the region should consider the type and form of fiscal structure they wish to adopt for the longer term.

Do they want low taxes, small government with limited public service provision (such as in the US and much of Asia)? Or do they prefer more public provision and payment for services and infrastructure to be accompanied by higher and broader levels of taxation (such as in much of western Europe)?

This is a longer-term project. But with no certainty as to the future value of the existing oil and gas wealth in 10 to 20 years, now is the time to decide what future models are being strived for and therefore what planning for longer-term infrastructure and public service provision is required.

David Stevens is PricewaterhouseCooper's Middle East government industry leader and Simon Leary is its Middle East health industries leader