IMF calls for Middle East fuel subsidy reductions

Middle East governments will spend up to US$300 billion subsidising fuel costs this year, according to new IMF calculations – equivalent to almost a third of all government revenue in the region.

Such large-scale energy subsidies make little economic sense as producers find themselves increasingly strapped for cash after a significant decline in the price of oil, the IMF argues.

Global energy subsidies are set to total $5.3 trillion this year, more than 6 per cent of global GDP, and more than the world spends on health care, the IMF says. Estimates of global pre-tax subsidy expenditures usually run into the hundreds of billions, but the report authors include health, pollution and energy consumption impacts in their estimates.

The UAE has taken steps to reduce energy subsidies, with Abu Dhabi Distribution Company raising energy and water tariffs, but the IMF has called for further progress to be made to phase out subsidies completely.

With Deutsche Bank predicting that the UAE will run a small fiscal surplus next year, the urgency of public spending cuts is likely to decrease.

The UAE’s break-even price is forecast to stand at $65.50 per barrel this year and to edge down to $62.30 next year, according to a Deutsche Bank report. This means that only a slight increase in the price of oil would be enough for the country to generate a surplus next year.

“In 2016, the recovery in oil prices to about $70 per barrel should be enough to bring the fiscal accounts back into surplus,” the bank said.

With the oil price hovering above $60 per barrel since mid-April, and futures markets predicting a slow oil price rally to 2020, the UAE may be able to put the worst of the oil price slump behind it by the middle of next year, the Deutsche Bank report implied.

The break-even price indicates the price of oil at which a hydrocarbon exporter's government revenue equals government expenditure.

Arabian Gulf break-evens have been drifting upwards for the last five years, with the oil price following suit – right up until late last year, when Saudi Arabia vowed to keep pumping even as global demand for oil fell away.

Regional governments are now forecast to run budget deficits over the next few years as state-led infrastructure investment plans collide with lower export earnings.

Deutsche Bank’s forecasts imply that the UAE’s reserves could last for more than a century, and the bank expects the country will run a deficit of just under 2 per cent this year. This looks small compared to the country’s estimated foreign assets and currency reserves equivalent to about 275 per cent of GDP, analysts have said.

Estimates of this kind can vary significantly, with the IMF, for example, claiming that the UAE’s financial reserves will last for about 25 years.

Estimates of the size of the country’s deficit, future spending plans and the net present value of a country’s reserves are subject to considerable uncertainty, and because statistics agencies need to make a host of small assumptions that can have major effects.

The IMF and Deutsche Bank agree on the upshot of these figures, however – the UAE’s reserves mean there is very little short-term pressure to cut spending, and Abu Dhabi has more fiscal room to manoeuvre than Riyadh.

The IMF and Deutsche Bank expect Saudi Arabia’s reserves to last for just the next six years at current spending rates. The kingdom has reserves equal to about 100 per cent of GDP, while it is set to run a budget deficit of 13 and 15 per cent of GDP this year and next year.

Whether or not Saudi Arabia’s reserves will last that long depends on the oil price – and on how quickly the country trims public spending.

The kingdom has been burning through its foreign currency holdings at record rates over the past few months as it bets that a low oil price will discourage North American shale producers from investing in new capacity.

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