ECONOMICALLY DIVERSIFYING THE GULF ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS COOPERATION COUNCIL (GCC): PROSPECTS & & CHALLENGES CHALLENGES

ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

TABLE OF CONTENTS Executive Summary

1

Introduction

2

Kuwait Country Profile

3

Potential Areas of Investment Challenges

Oman Country Profile Potential Areas of Investment Challenges

Conclusion

6 7 9 11 12

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

EXECUTIVE SUMMARY With the Organization of Petroleum Exporting Countries (OPEC) agreeing to extend the pledged oil production cuts till March 2018 in order to tackle the global glut and the corresponding slump in oil prices, the revenues from oil sales are likely to be hampered for the member countries, including majority of GCC countries, both members, and non-members of the OPEC. This, in turn, provides additional impetus to almost all the GCC countries to rigorously pursue their economic diversification plans which are in different stages of development and which are aimed at limiting the negative impact of the volatile oil market on their economy. The report is a follow-up of the previous Grid 91 report on ‘Overview of the business forecast for Saudi Arabia: Prospects & Challenges’. It focuses primarily on Kuwait’s ‘New Kuwait 2035’ initiative and Oman’s ‘Tanfeedh’ or ‘The National Program for Enhancing Economic Diversification’ and analyses the potential areas of investments and challenges that are posed by the two initiatives. Given that certain geo-economic factors remain common for the two GCC states, namely-strategic geographic location and proximity to a volatile region, for instance, Kuwait’s contiguity to Iraq and Oman’s proximity to Yemen, highlights the latent threat of militancy and threat of a spillover of the conflict in these areas. Similarly, lack of trained local manpower and dependence on expatriate population is another major issue, commonly shared by the two states. Secondly, the areas in which the two states seek to diversify, including tourism, manufacturing, construction, education and training, logistics and so on are some of the areas that will require high end marketing strategies and deliverables to draw in investments from foreign players at the expense of other regional states, which are eyeing the same source of investment and may require introduction of some regulatory mechanisms common across the GCC to safeguard against the risk associated with such competition. Finally, despite the geopolitical risks, if the aforementioned economic diversification plans work as expected the region is likely to be a lucrative area of investment in the next decade.

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

INTRODUCTION With the oil prices registering a volatile fluctuation from roughly 111.80 USD/ barrel in June 2014 to 47.76 USD/ barrel in January 2015 and stabilizing at roughly 52 USD / barrel in April 2017, has provided new impetus for the GCC states to pursue ventures to diversify their primarily oil based economy to better safeguard against the impact of these massive fluctuations on their respective economies. In this vein, the GCC countries have initiated their own versions on ‘Vision 2030’ similar to the one initiated by Saudi Arabia to achieve their aforementioned objective. Kuwait’s ‘New Kuwait 2035’ initiative and Oman’s ‘Tanfeedh’ or ‘The National Program for Enhancing Economic Diversification’ are notable examples. Broadly speaking some of the common business strategies primarily revolve around the following: Creating a favorable environment to attract FDI through the introduction of reforms, amendments, and regulations making the country favorable to the domestic and more importantly foreign investors.  The introduction of  Public Private Partnership (PPP) model in a host of areas aimed at increasing the role of the private sector by encouraging its involvement in developmental projects, thus reducing the burden on state expenditure, expected to facilitate management of fiscal deficit. The introduction of VAT and other forms of taxes, phased withdrawal of subsidies on electricity, fuel, and water to support government's expenditure on capital intensive projects aimed at keeping the economy afloat.   Increase bond sale and thus borrowing from the international market and thus limit the withdrawal from the central reserves and stemming the negative impact on the economy.

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

After almost 17 years of budget surplus, Kuwait registered a budget deficit of roughly 15.3 billion USD (KD 4.6 billion) in FY 15/16, following the depressed oil prices. This, in turn, has greatly facilitated the longpending measures of the government to accelerate the diversification of the economy and move away from the excessive dependence on oil revenues. As per OPEC, the oil and gas sector comprises roughly 60% of the Kuwait’s Gross Domestic Product (GDP) and about 95% of export revenues. Though previous attempts to diversify the Kuwaiti economy have been met with limited gains, the latest program under the aegis of ‘New Kuwait 2035’ launched in January 2017 has been the envisioned towards attaining the aforementioned diversification. The Kuwait Investment Authority (KIA) is the country’s sovereign wealth fund entity involved in the generation of foreign investment. The General Reserve Fund (GRF) is tasked with receiving the state revenue and all the government expenditure are paid through this body. In addition to this, the KIA also handles the Future Generations Fund (FGF) comprising of investments made by Kuwait abroad and forms a part of its strategic reserves. Though the information on the size of the KIA assets and their allocation is not publicly available, IMF estimates indicate that the total asset estimate of KIA is about 530 billion USD  by end-2015. Furthermore, an IMF report indicates that large financial buffers and low debt give substantial room to finance emerging fiscal deficit. Moreover, given the prolonged budget surplus, Kuwait has not borrowed from the international debt market. Additionally, though no external borrowing has taken place so far, preparation is underway to issue up to 10 billion USD in the international market. That said, according to the Kuwait Direct Investment Promotion Authority (KDIPA) government has launched a six pillar reform strategy aimed at achieving success in its initiative that revolves around multiple socio-economic, institutional and legislative reforms. It involves the following: Rationalizing government expenditure and increasing non-oil revenue It involves reducing the budget deficit over the medium term by raising non-hydrocarbon revenue by the introduction of  VAT and other taxes, phased withdrawal of subsidies and curtailing expenditure through rationalization of government agencies’ spending, further advancing subsidy reforms and reforming the pay structures. Modernizing the role of the state in the national economy It primarily revolves around measures that are aimed at encouraging and incentivizing the private sector to enter various production sectors; strengthening partnerships with the private sector and market forces as well as competition through the PPP model. Promoting private sector development This is aimed at increasing private sector participation in economic activity, the government plans several reforms in areas, such as the privatization of public enterprises; PPP projects; and soft financing for small and medium enterprises. It primarily focuses on phased reduction of the involvement of the state enterprise aimed at reducing the expenditure. Targeting small and middle enterprises is expected to be the first phase of this overall strategy.

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

Encouraging citizens’ participation This will ensure that the citizens become partners in enterprises offered through the PPP or privatization program. Making the labor market and civil service more efficient The reform of the labor market and civil service system will be carried out over two years. In the first year, the authorities aim to conduct wage reform; labor force planning in the private sector; and upgrading of labor force competence. In the second year, the implementation of a performance evaluation system; training of national labor; and upgrading of competence in the public sector will be completed. These measures are aimed at making the public sector competent, which in the long run will result in healthy competition with the private sector and enhance productivity. Legislative and institutional reforms These will cover, enhancement of the public financial management in the government; creation of a business environment that attracts private domestic and foreign investors; tax administration development;  elevation of the rating of the Kuwait Stock Exchange to place it among the main emerging market indices during 2016-2017 and  enactment, amendment, and updating of legislation. 

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

POTENTIAL AREAS OF INVESTMENT INFRASTRUCTURE In a bid to make the country a business destination and as part of the efforts to increase the private sector’s and citizens’ role in economic activity, several State Owned Enterprises (SOEs) are expected to be privatized after the Amendment of the Privatization Law. These SOEs include the airports, the Port Authority, Railways among others. The development of an additional terminal at the Kuwait International Airport (KIA), Sheikh Jaber al-Ahmad Causeway connecting Kuwait City and al Subiyah area as well as the infrastructural expansion of the Mubarak al-Kabir port on the Bubiyan Island can be cited as examples. Furthermore, the government according to an IMF report has earmarked 10 billion USD and another 7 billion USD for a national railway and metro network respectively as part of its efforts to upgrade the public transportation sector. DOWNSTREAM PETROCHEMICAL SECTOR Though regulation barring investments in the upstream sector continues to remain, the downstream sector especially production and dissemination of petrochemicals is a lucrative area of investment. Although a partnership with local players is recommended, given Kuwait's abundant oil reserves, low domestic demand and concurrent high demand for chemicals like Ethylene, Polyethylene, Ammonia, Urea, especially from Asian markets led by China and India, investments in the petrochemical sector continue to remain an area of interest for Kuwait. EDUCATION & VOCATIONAL TRAINING Kuwait continues to rely on expatriate population which comprises roughly 70% (3.1 million) of the total workforce. Furthermore, given the existing gap between the market requirement, vocational training and skill development of the existing local workforce coupled with the government's drive to increase the employment levels of the local population and achieve a 60-40 ratio by 2030, the vocational sector becomes an interesting area of investment. In this regard, the government is expected to earmark 10.5 billion USD by 2019. Furthermore, according to IMF, as of 2015, Kuwaiti nationals account for just over 20 percent of the private sector employments and Kuwait’s labor market is characterized by the strong presence of nationals in the public sector. By investing in the vocational training sector tuned to cater to the requirements of the private sector, the Kuwaiti authorities aim to achieve a balance between employment of the local population in both the sectors.  INTEGRATED HOUSING PROJECTS & URBAN DEVELOPMENT According to the Kuwaiti Ministry of Public Works, the government has re-initiated works on the development of multiple large integrated housing projects including the Madinat Al-Hareer (Silk City) project, Khairan Residential City and Sabah al-Ahmad Future City, located in Subiya region in northern Kuwait, estimated to be around 88 billion USD. Given the limited presence of specialized development planning firms in Kuwait, most of the work is outsourced to foreign firms. That said the high volume of upcoming projects that are expected to be a part of the aforementioned multi-billion dollar development plans present themselves as profitable areas of investment. 

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

CHALLENGES LEGAL & BUREAUCRATIC  CHALLENGES As per the US state department’s Investment Climate Statement, 2016- some challenges to FDI in Kuwait continue to remain especially because of regulations barring foreign entities from the upstream petroleum and real estate sectors, bureaucratic hurdles that hamper start of new enterprises. Moreover, Kuwaiti law reportedly continues to resist foreign banks from offering investment banking services and prohibits them from competing in the retail sector. Moreover, the KDIPA is yet to be fully operational.   LOCAL OPPOSITION TO WITHDRAWAL OF SUBSIDIES The latest austerity measures aimed at the central authorities featuring wage cuts as well as the withdrawal of subsidies on water, fuel, and electricity along with the scheduled introduction of 5% VAT have met with stiff opposition from both members of the opposition in the Parliament as has resulted in instances of localized civil unrest. Moreover,  given that the population is accustomed to generous state handouts, any attempts by the central government to withdraw them are likely to face resistance. Though the possibility of any major civil disruptions remains unlikely at this juncture, the possibility continues to persist. LACK OF TRAINED LOCAL MANPOWER & DEPENDENCE ON EXPATRIATES The Kuwaiti population distribution is highly skewed with an expatriate population comprising roughly 70% of the total population. Furthermore,  the demands of the private industry and the level of the vocationally trained Kuwaiti population reduces the likelihood of significant deviation in such a short duration, that might significantly stall attempts to maintain or enhance productivity. Moreover, given that majority of the blue collar jobs have been secured by cheap laborers from Asia, replacement of these by local Kuwaiti nationals will have a bearing on the overall costs, as the local labor is likely to be more expensive. LATENT THREAT OF MILITANCY Though a high casualty sophisticated militant attack has not been recorded in Kuwait since the Al-Sadiq Mosque bombing in Kuwait City in June 2015, recurrent reports of arrest of militants as well as foiling of militant attacks continue to highlight the interest of militant groups like Islamic State (IS) and Al-Qaeda in Arabian Peninsula (AQAP) in attacking Kuwait, thus underlying the continued threat of militancy in the region.  

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

As precedent suggests that capital intensive projects like Madinat Al-Hareer have witnessed delays and also stalled as a result of lack of adequate funds. Moreover, given that the ‘New Kuwait Vision 2035’ is at a nascent stage of development it remains to be seen if the Kuwaiti government succeeds in gaining the  requisite investments over the coming years as it is clear that with current oil prices and budget deficit in place financing the projects from government treasury remains highly unlikely.   

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

Like other GCC countries, Oman also relies heavily on hydrocarbons as a chief source of its revenue. According to Central Bank of Oman’s Annual Report, 2015-  Oil and gas sector accounts for about 34 percent of its gross domestic product (GDP) and oil alone comprised about 62.4 percent of export revenues. Furthermore, as a result of a dip in oil prices, the 2017 budget deficit is projected to be roughly USD 7.8 billion (RO 3 billion). Furthermore, according to the CBO’s mid-year review of Omani Economy 2016, the projected oil revenue for 2017 is roughly USD 11 billion (RO 4.45 billion) which constitutes around 51 percent of total revenue. Moreover, according to a report by KPMG, a leading professional service company and one of the big four auditors, the 2017 deficit is expected to be financed from borrowing comprising roughly 84 percent and reserves covering around 16 percent. With an aim to diversify the economy as well as limit the budget deficit, reports quoting the Ministry of Finance (MoF) indicates that the government in order to enhance the non-oil revenue is expected to include measures involving raising corporate taxes and limiting tax exemptions, regulating customs duty exemptions and enhancing tax collection procedures, including strengthening their audit and control mechanisms, amending the electricity and water tariffs, visa and labor card fees, fees for real estate transactions, municipality fees for lease registrations, fees for car registrations and driver licenses, and other fees for official transactions. That said though previous attempts to diversify the Omani economy has met with limited gains, the latest programme under the aegis of ‘Tanfeedh’ or ‘The National Program for Enhancing Economic Diversification’ was launched alongside the Ninth Omani five year plan which was initiated in 2016 and has been the aimed at attaining the aforementioned diversification.  Among other things, with the implementation of Tanfeedh, the Omani authorities aim to introduce multiple legislative, economic, structural and administrative reforms and focuses on Accelerating the pace of executing economic plans Identification and incorporation of best economic and social planning practices with the aim of providing sustainable job opportunities for the Omani population Attract domestic and foreign investments in the country Increase the competitiveness in various economic and social indicators Enhance execution efficiency and cooperation with stakeholders Increase share of non-government revenues in capital investments Increase Oman’s GDP

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

POTENTIAL AREAS OF INVESTMENT MANUFACTURING The sector comprises roughly 10.9 percent of the GDP as on 2015 and 51.3 percent within the nonpetroleum industrial activities sector. Furthermore, reports indicate that apart from the catalyzing the Petrochemical downstream, other areas that are not linked to the oil and gas industry are likely to receive a boost. This involves fabrication of scaffolding & scaffolding parts, downstream aluminum, and steel products and boosting local cement production among others. It thus indicates that the sector is being geared to not only support the capital intensive construction and infrastructure projects within the Sultanate alone but also to provide exports to other GCC countries which has witnessed a significant uptick in multiple infrastructure development projects and which presents a promising market for these products and services. Additionally, it is not likely to be stipulated to the GCC alone but is also expected to find buyers in some Asian countries like India, which are in different stages of implementing large-scale construction and infrastructure projects. TOURISM Oman has a distinct geographical makeup as compared to other countries in the region along with a diverse culture and heritage sites. The Sultanate has also emerged as an upcoming tourist destination attracting tourist from around the world. Moreover, given the relatively relaxed religious and cultural norms and an established security record, the tourism sector shows promising scope for expansion. The project involves enabling niche and adventure sports and activities, effective management of heritage sites, the creation of iconic tourism projects, development of luxury hotels and theme parks as well as an introduction of liberal visa facilitation services for target markets. FINANCE According to the official Tanfeedh statement, the sector involves two primary work streams with one addressing the budget shortfall by seeking efficiencies in spending and new sources of revenue. The second will look for new sources and mechanisms to fund capital projects without public expenditure in both civil and commercial projects. This involves increasing the share of private sector across the spectrum. To achieve this, measures involving privatization of state-owned enterprises,  building project evaluation capacity of the government agencies and release government projects for a public-private partnership, establishment of credit bureau by the private sector are liable to be implemented by the Sultanate. EMPLOYMENT & LABOR MARKET With the aim of increasing the role of the private sector and to reduce the existing gap between the skill sets of the available workforce and the industrial set-up, measures and mechanisms are expected to be in different stages of the formulation to make the ends meet. The development of occupational standards, enhancement of training institutes governance are certain steps envisioned by the government. The ‘Omanization’ initiative featuring compulsory hiring of locals, and restrictions on foreign nationals is also a case in point. Private sector initiatives aimed at balancing the percentage of the workforce between the Private and Public sector are being undertaken. Like the case in other GCC countries, vocational training and education present itself as an interesting area of investment.

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

CHALLENGES OMANIZATION PLAN, VISA RESTRICTIONS & LACK OF TRAINED MANPOWER The Omanization process was launched since 1988 aimed at reducing the country’s dependence on expatriate manpower and substituting Omani nationals for foreign labor. Currently, expats comprise of roughly 2.1 million or roughly 45.80% of the total population as per Oman’s National Center for statistics and information. Furthermore, in an attempt to further enforce the Omanization plan the concerned authorities in November 2016 increased the fees payable by employers to obtain or renew visas for expatriate workers coming to Oman by 50 percent from RO 201 (520 USD) to RO 301 (780 USD). Additionally, independent research reports by the International Labor Organization (ILO) indicate that availability of a trained local force is a major challenge in the country.  The fact that the gap between the skill sets of the existing local workforce and the requirements of the industry continue to exist has hampered the productivity of the industry and the existing education and training system has failed to train the population to meet the industrial requirement resulting in continued reliance on imported labor.

LATENT THREAT OF MILITANCY & SPILLOVER OF YEMEN CONFLICT Oman refused to join the Saudi-led coalition operations in Yemen aimed at restoring the UN-backed Hadi government and ouster the Houthi rebels from Sanaa. Given that the operation has entered into a stalemate with territories shifting hands at frequent intervals, leading to a re-emergence of the Al Qaeda in Arabian Peninsula (AQAP) as well as the Islamic State (IS). These groups have succeeded in establishing an operational presence in the region. Though no militant attack has been recorded in the country in the recent past, the increasing operational capabilities of the extremist groups in the neighborhood hint towards a latent threat of the conflict spilling over into Oman. COMPETITION FROM OTHER GCC STATES FOR FOREIGN INVESTMENTS As mentioned before given that the neighboring GCC states namely Saudi Arabia, Kuwait, UAE, Bahrain, and Qatar have parallelly initiated their own versions of the economic diversification plan aimed at curtailing the share of oil in their GDP's, there remains a high degree of competition for foreign investments which form a critical element in the mega projects initiated by these countries aimed at fueling economic growth. Moreover, areas like construction, tourism, downstream development, infrastructure, logistics are areas which have witnessed an overlap and may receive the requisite investments given the geopolitical concerns like militancy, civil unrest and other factors that are likely to hamper business continuity in the region. 

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ECONOMICALLY DIVERSIFYING THE GULF COOPERATION COUNCIL (GCC): PROSPECTS & CHALLENGES

CONCLUSION Given that the ambitious ‘Tanfeedh’ and ‘New Kuwait 2035’  plans are in the initial phases of development, it provides a host of opportunities for investments and growth, especially in the infrastructure, logistics, tourism, integrated housing and the vocational training & education sector among others. Moreover, most of these ventures being capital intensive, are likely to feature employment of the Public-Private Partnership model with a major emphasis on the effective utilization and employment of local population and resources. However, precedent suggests that attempts at diversification of the economy have been met with limited success and measures aimed at increasing the share of the local population in the total workforce if not introduced in a phased and calculated manner may hamper the productivity of the economy. Finally, given that almost all the oil-dependent economies of the  GCC have initiated their respective economic diversification plan and many sectors seeking foreign investment like infrastructure, construction, downstream and logistics sectors may create a conflict of interests. This in the mid to long term may require a development of mechanisms common across the GCC states to regulate foreign investment in the region.

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