© curraheeshutter, kone | iStockphoto

28.11.2017

GULF STATES ON THE VERGE OF CHANGE

The Gulf States want to achieve independence from oil prices by changing their economic and domestic policies. A drop in oil prices since 2014 has resulted in many investment projects put on hold. This also has effects on the export figures in mechanical engineering. Despite political tensions in the region, however, reform efforts are generally perceptible.

By Dr. Alexander Koldau

© kodda / iStockphotoGeographically speaking, the Gulf appears to unite the states in this region. However, it is divided along political and religious lines: on the one hand, there are the Arab states in the west, which are mostly Sunni, while on the other hand there is Shiite Iran in the east. Iraq lies between the two, with only limited access to the sea. This state cannot be culturally allocated to either the Persian or the Arabic region.

Deficits in state budgets

Economically, the states are united by their great oil reserves. However, in times of low oil prices and a global energy transition, economists also see this as a negative factor. This is because the drop in oil prices since 2014 has resulted in deficits across the entire region, with the various countries' governments having discontinued most investment projects, at least temporarily.

This is also clearly reflected in the figures for mechanical engineering exports. In particular, exports to Saudi Arabia, which was by far the most important market in the region for German machinery between 2012 and 2015, have dropped by almost 50 percent since 2015.

Gulf States accelerating reforms

Since efforts to increase oil prices have been almost entirely ineffective, the Arab countries in particular are increasing their economic and financial policy reform programs. Saudi Arabia has been forced to play a leading role in this area. Despite its immense oil reserves and steadily increasing oil extraction, the country's strongly increasing internal consumption has made it clear that even significantly higher oil prices will not result in oil revenues that would guarantee the desired standard of living of its growing population.

Over the last two years, the Kingdom of Saudi Arabia has considerably increased the pace of its reforms, which began more than a decade ago. To this end, the royal house announced the "Saudi Vision 2030", an extremely ambitious development program, in the summer of 2016. It not only encompasses economic reforms, but also comprehensive social change. This may even be a precondition for successful reform. It remains to be seen, however, to what extent this very conservative society will be able to meet these expectations.

The first signs that this program has been implemented are already evident. Local companies have noticed them in a positive way, for example in the form of benefits granted for producing within the country. However, increasing requirements such as the integration of Saudi employees have proved to be problematic.

Gulf States bringing in value-added tax

From 2018 onwards, all Arab Gulf States will be introducing value-added tax. From a European point of view, this is a trivial issue. However, people in this region will consider it a cultural breach which will most probably not be very well accepted. This is why European suppliers should be prepared accordingly.

As industrial diversification is an elementary component of reform efforts, there will be increased investment in the near future, thus providing market opportunities for German machine manufacturers. Local market participants expect many suspended projects to restart soon.

The Gulf States want to become more independent from oil revenues. <br>© curraheeshutter | iStockphotoThis also applies to infrastructure investments, which are required to contend with the growing population and industrial development. It is not expected, however, that investment will once again reach the same levels as during the boom period from 2012 to 2015. However, the type of project financing is expected to change. Euler Hermes is currently establishing a base in Dubai to provide local sales support to German companies.

Iran: Business possible once again

The situation in Iran is somewhat different. The Nuclear Deal Framework and the associated easing of EU sanctions in January 2016 have made it possible to resume numerous business transactions. "The government is endeavoring to bring about new investment in the widely diversified Iranian industry, thus improving business relations with Europe," says Klaus Friedrich, who is responsible for foreign trade with Iran at VDMA. Forecasts of a boom are now obsolete, but there has been progress, despite some difficulties. The reelection of President Hassan Ruhani has served to dispel insecurity in Iran. The Iranian market has every opportunity to resume its leading place in the region in the medium term, with a machine export volume of over 1 billion euros, although political risks persist.

Iraq on the brink of a new beginning

The military success against Islamic State (IS) in Iraq has raised hopes of positive economic development in the near future. However, the political and religious tensions in the region are more concentrated in this country than in any other in the region. This could further delay positive development.

Overall, political tensions in the region have clearly increased in recent years. The temporary strengthening of the radical Sunni IS in Syria and in Iraq poses both a political and a religious/ideological challenge to the predominantly Sunni Gulf States. It also constitutes a direct threat to Shiites in both Iraq and Iran.

Moreover, the economic opening up of Iran by the Nuclear Deal Framework has shaken the balance of power that has existed for decades, especially between Iran and Saudi Arabia. This also increases religious tensions between Sunnis and Shiites. The repositioning of the USA's foreign policy has increased the uncertainties faced by the major players.

Political tensions continue

An alleviation of tension in the medium or even short term is not expected: Even if IS soon becomes history, both Syria and Iraq will still have to find a peaceful and stable order. It is also doubtful whether IS-invoked Islamic terror in the region will come to an end as a result.

In the same way, there has been no easing of tension between Saudi Arabia and Iran. Now that the Kurds have significantly pushed back IS, they want to be rewarded with further autonomy. This may well have a destabilizing effect in Syria, Iraq, Iran and Turkey. The Israeli-Palestinian conflict, which has cast a shadow over the region for decades, has taken a back seat as a result of the numerous other conflicts, but has in no way been resolved.

This means that the economic opportunities identified are also offset by risks. This is nothing new in the region.

Further Information

VDMA Foreign Trade   |   VDMAimpulse 06-2017: "Saudi Arabia: 'Vision 2030' for the economy"   |   VDMAimpulse 06-2017: "Challenges to production in Saudi Arabia - Using local opportunities"   |   VDMA impulse 01-2017: "Iran: Back to the future"   |   VDMAimpulse 05-2016: "Low oil price forces Arab countries to reform"

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Contact
Dr. Alexander Koldau, VDMA Foreign Trade.