The exodus of expat workers from Gulf countries in 2020, due to the economic fallout from COVID-19 and oil price shock, has accelerated a shift in the region's labor market that we expect will continue through 2023. These changes could have repercussions for the regional economy and pose additional challenges to diversifying away from its heavy reliance on the hydrocarbon sector in the long run, if not met with economic and social reforms that foster human capital.

We expect the population will have declined by just over 4% on average last year across the six members of the GCC, mainly due to migrant outflows. While some expats will return as the economic cycle recovers, we project the proportion of foreign workers in the region will decline, particularly in Kuwait and Oman. The overall GCC population is unlikely to return to the 2019 level of 57.6 million until 2023, owing to weaker economic conditions and labor nationalization policies.

We do not expect these shifts will have an immediate impact on our ratings on GCC sovereigns though, given that the majority of foreign workers returning home filled low-income positions, limiting their contribution to the economy.

However, the GCC's high dependence on expat labor, especially in the private sector, has stymied its development of human capital in the national population. The majority of the local workforce is employed by the public sector, which weighs on governments' fiscal positions, especially in times of lower oil prices. GCC governments are increasingly implementing policies to boost nationals' participation in the private sector, mainly through measures that restrict the hiring of expats. We believe these nationalization policies could hamper economic growth and diversification if they impede productivity, efficiency, or competitiveness.

The GCC's longer-term economic trajectory will depend on the strength of governments' balance sheets as well as their willingness and ability to implement reforms that support a dynamic private sector. Specifically, we see reforms that improve national populations' education and skills, the participation of women in the workforce, labor market flexibility, and competition as paramount to unlocking sustainable growth in the region.

GCC Population Won't Return To 2019 Levels Until 2023

The economic fallout from the pandemic and plummeting oil prices has accelerated broader demographic shifts in GCC countries. After years of waning population growth, we estimate a material population decline across most of the GCC for 2020, largely due to expat outflows. While we expect a return to muted population growth in the coming years, the proportion of foreign workers will likely steadily decline.

Once-strong population growth has been on a downward trend

After peaking at about 6% in 2007, the GCC's average population growth more than halved to about 2.3% over 2015-2019 following a sharp drop in oil prices in late 2014. The decline was underpinned by decreasing migrant inflows in most countries, owing partly to government spending cuts and lower employment growth as fiscal pressures mounted on the back of lower hydrocarbon receipts, and slightly falling birth rates among citizens.

The current recession has caused an expat exodus

For 2020, we estimate that the population across the GCC contracted by 4% on average, with the sharpest decline in Dubai, followed by Oman, Qatar, Abu Dhabi, and Kuwait (see chart 1 below). The majority of this drop is due to an outflow of foreign workers. In Oman, the expat population took a hit of about 12% (close to 230,000 people) in 2020, with the contraction skewed toward lower-income South Asian workers employed in construction and agriculture. According to the General Authority for Statistics, in Saudi Arabia close to 260,000 foreign workers lost employment during the third quarter of 2020. In Kuwait, local media reported that 110,000 expats left the country between March and June 2020. Our estimate of the population contraction in Dubai in 2020 is more pronounced than for other GCC countries, given the pandemic's significant negative impact on the key employment sectors of aviation, tourism, and retail, and our expectation of negative employment trends in Dubai's real estate sector.

Chart 1

Gradual recovery should support a return to muted population growth from 2021

Our base-case assumption is that population growth will return in GCC countries, with the exception of Kuwait, from 2021, but slow relative to pre-2020 levels. Additionally, we expect the region's proportion of expats will continue to decline from about 50% currently. We forecast GCC population growth will average only 1.3% annually over the next three years, which incorporates about 0.7-1.0 percentage points of growth from birth rates in the national population and the remainder from the partial return of expats as the economic cycle gradually recovers. However, we forecast continued outflows of foreign workers from Kuwait and Oman, albeit at a much slower pace than in 2020, because of more stringent workforce nationalization policies and higher socioeconomic pressures, respectively.

Our population forecasts are underpinned by our expectation of muted growth in the nonoil sectors and a likely continuation of restrictions on hiring expats in some countries. Through 2023, we expect slow economic recovery that will largely depend on increased hydrocarbon production from 2022 (see "GCC Economic Activity Held Back By Its Hydrocarbon-Heavy Economic Structure And OPEC-Related Production Cuts," published Dec. 7, 2020, on RatingsDirect). We assume that oil prices will remain relatively low at $50 per barrel (/bbl) over 2021-2022 and $55/bbl from 2023 (see "S&P Global Ratings Revises Oil And Natural Gas Price Assumptions," published Sept. 16, 2020). As these levels are below the fiscal breakeven oil price for all GCC sovereigns except Qatar, we expect governments will moderate public investment spending, which is the main impetus of nonoil growth in the region.

The changes also reflect that natural birth rates in the GCC have slowed since the 1980s. In Saudi Arabia, for example, the annual growth rate of the national population has dropped to 1.8% on average since 2015 from about 4% in 1980. Oman, which has the highest natural birth rate in the GCC based on available data, has seen national population growth slow to 3% in the past three years, from 4% on average over 2011-2015. Nevertheless, these rates remain high compared with about 0.5% for Organization for Economic Cooperation and Development (OECD) countries.

Reliance On Expat Labor Is A Double-Edged Sword

While bringing in foreign workers has supported the Gulf region's rapid economic development since the 1970s, continued heavy reliance on expats, particularly in the private sector, has had repercussions for the productivity and skills of its citizens as well as the governments' fiscal positions--which workforce nationalization policies now aim to alleviate.

Given its small domestic workforce and skill and expertise gaps, GCC governments brought in foreign workers during periods of high oil prices and rising hydrocarbon production (1973-1982, 2003-2008, and 2010-2015). This allowed GCC governments to invest in infrastructure, improve human development indicators, and accumulate fiscal buffers. Migrant workers supported the burgeoning requirements for construction and domestic labor, while a smaller-but-significant number filled white-collar positions. Until now, the national labor force has been largely employed in the public sector, which has provided higher wages, as well as better benefits and job security than the private sector. The fiscal pressures related to the public sector wage bill have increased in recent years as oil prices dipped.

Chart 2

Chart 3

Foreign workers make up more than 80% of the GCC's total labor force and almost 90% of private sector employment on average based on the latest available data for GCC countries (see charts 2 and 3). This dependence on expat labor is even more pronounced in Qatar and Abu Dhabi (as well as the United Arab Emirates [UAE] more broadly) where migrant workers make up more than 90% of the labor force. We see this reliance on migrant workers as having both advantages and consequences for GCC countries:

The benefits of relying on a foreign workforce

• It allows the GCC countries to import skills as and when needed based on evolving economic priorities.
• Expats are temporary residents, with visas tied to employment. This allows GCC governments to effectively export some of the impact of recessions, because they do not have to bear the fiscal cost of social welfare for foreigner workers during an economic downturn.

Weaknesses in GCC labor markets from reliance on foreign workers

• Reliance on lesser paid and more productive foreign workers has stymied progress on increasing nationals' productivity and skills and reduced the attractiveness of employing nationals, as suggested by their relatively limited representation in the private sector of some GCC countries.
• Absorbing nationals into the public sector has resulted in a large and expensive civil service. The public sector wage bills are high as a percentage of GDP. In Bahrain and Oman, for example, these wages comprised about 10% of GDP in 2019, weighing on the governments' fiscal positions. With limited fiscal headroom implying low prospects for further employment growth in the public sector, these two countries have instituted voluntary and mandatory retirement schemes to ease the future wage burden. Even for higher rated GCC sovereigns, the fiscal cost of maintaining the social contract via hiring in the public sector will likely constrain future fiscal flexibility.
• The national working population increasing at a time of weaker job creation could lead to higher unemployment rates and rising social tensions. The high birth rates of the past decades have led to a large youth population (25%-28% of the total population in Saudi Arabia, Kuwait, Bahrain, and Oman in 2019), requiring substantial new job creation to absorb the influx of locals into the labor market. Saudi Arabia's sizable youthful population, which will require up to 150,000 new jobs per year, will exceed the total number of positions available in the public and petroleum sectors.
• Poor working conditions for manual laborers and strict labor laws (linked to the 'Kafala' [sponsorship] system) have earned GCC countries a weak reputation on social indicators of development. The Kafala systems are slowly being reformed in most GCC countries.

Workforce Nationalization Will Likely Be Gradual Amid Structural Constraints

We believe labor nationalization policies will likely continue to see only measured success because of structural constraints, namely the skills and productivity gap between nationals and expats; and the lack of demand for private sector jobs among citizens. A rapid attempt to expel expats could create market inefficiencies or, in the worst case, economic stagnation if nationals are unwilling or unqualified to fill positions.

While GCC-wide investment in education has increased since the 1990s, averaging 14% of government expenditure in 2018, the quality of education is relatively poor. According to the World Bank Human Capital Index (HCI), which quantifies the contribution of health and education to human capital outcomes, GCC countries have higher scores than the broader Middle East and North Africa, but still rank below countries with similar income levels, such as Singapore and Germany. The HCI scores ranged from 0.563 in Kuwait to 0.673 in the UAE in 2020 (compared with an average of 0.739 for OECD countries), suggesting that a child born today in the GCC can expect to reach between 57% and 68% of his or her full health, education, and labor potential by the age of 18. In our view, these gaps lead to underutilized skill potential and a lack of innovation in the economy.

Another major obstacle in achieving the governments' nationalization targets is that nationals may not want jobs they deem as inferior, due to lower wages or worse working conditions than they can get in the public sector. Most GCC governments pay significantly more than the private sector for similar jobs: for example, monthly wages for nationals were close to $4,000 higher in the Kuwaiti public sector than the private sector. The large wage differential and size of the public sector in the GCC has led to a high proportion of nationals employed as civil servants, ranging from about 30% in Bahrain to 90% in Qatar. GCC governments have distributed their oil and gas income to citizens partly through public sector wages. This social contract will likely continue, though governments will face tough choices as fiscal pressure increases.

Demographic Shifts Are Unlikely To Tip Ratings In The Near Term

Economic impact: Weaker population growth is not the key driver of our near-term growth forecasts

When rating sovereigns, we directly capture population shifts in our economic assessment, which uses GDP per capita as a measure of economic wealth level, and the government's potential taxable base, supporting government revenue and its debt-bearing capacity (see "Sovereign Rating Methodology," published Dec. 18, 2017).

We expect the decline in economic activity to outweigh the effect of shrinking populations, reducing GCC countries' GDP per capita in 2020. Over 2021-2023, we forecast weaker growth trends on a real GDP per capita adjusted basis relative to 2010-2014 across the region. This is largely because of our expectations of a slow global recovery from the pandemic and weak government spending in the region linked to hydrocarbon revenues. Kuwait is the exception where we believe growth will be supported by a significant ramp-up in oil production. These economic trends suggest employment growth will remain weak, and demand for expat workers low. We expect lower population growth will in turn have some impact on domestic demand and private investment (given skills shortage and inflexible labor markets). That said, a large portion of the migrant workforce returning home was in the low-income segments (such as the construction or service sectors), and contributed only about 30% of the region's total consumption, according to the International Monetary Fund.

Chart 4

Historically, population trends have followed economic cycles in the GCC (see chart 4). Lower government spending on infrastructure projects required less foreign workers, leading to a decline in population growth since 2008. The link between consumption and population, however, is more tenuous. While lower population growth broadly has resulted in weaker domestic demand, other factors such as oil prices and disposable incomes could be more strongly linked to consumption patterns.

External impact: Hydrocarbon prices remain the key determinant of the GCC external positions

The large expat populations contribute to the high level of imports and send a high portion of their earnings back to their home countries. Lower imports and remittance outflows because of a smaller proportion of expats could strengthen GCC countries' current account positions. However, the current account balances of GCC countries are primarily based on movements in hydrocarbon prices and production, and we therefore do not expect material changes to external liquidity and debt metrics from shifts in the population.

As GCC expat population growth has generally declined in recent years, imports and remittance outflows have fallen in tandem (see charts 5 and 6). According to the World Bank, GCC countries still accounted for 24% of remittances flows to the world in 2018, with Oman topping the region in relative terms (nearly 12% of real GDP) and the UAE in absolute U.S. dollar terms ($45 billion) in 2019. However, remittances are also closely tied to shifts in oil prices that affect disposable incomes. Imports are also dependent on government spending and projects. As the GCC economies slowly recover and oil prices slightly increase from 2021, with a subsequent improvement in disposable incomes, we expect imports and remittance outflows will gradually rise as well.

Chart 5

Chart 6

We note that population trends are also likely to have fiscal implications in terms of future infrastructure needs for example. We view these trends as having more of a gradual impact on our fiscal assessment.

Reliability of data constrains ratings on GCC sovereigns

We note that the level of statistical disclosure and transparency is relatively weak in the GCC compared with similarly rated peers. We incorporate this weakness into our ratings on GCC sovereigns via our institutional assessment, which acts as a rating constraint, particularly for the higher rated GCC countries. One aspect of this is the availability of population and labor force data. The latest available census data and nationality definitions vary widely across the GCC. Oman, Saudi Arabia, and Kuwait publish population and labor force breakdowns on a monthly, quarterly, and annual basis, respectively, but have deficiencies in other areas such as the full disclosure of government assets. Statistics for the UAE and Qatar are less frequent and detailed. More specifically, Abu Dhabi's most recent official population data was as of mid-2016, and the individual UAE emirates provide no private/public sector breakdowns of the workforce by nationality. Qatar also does not publish the breakdown of its population data by nationality. The lack of current data and breakdowns of population segments limits our analysis on the composition of the labor force and population movement. In some cases, inadequate data could distort our analysis of income levels and trends.

The Path To Economic Diversification Is Uncertain

The GCC countries' reliance on the hydrocarbon sector remains high at close to 40% of real GDP on average in 2019. This concentration was the highest for Kuwait (53%), followed by Abu Dhabi (50%) and Qatar (47%). In our view, the energy transition, price volatility, and weaker profitability for oil companies could increase economic and fiscal pressures for oil- and gas-producing countries in the long term. All GCC countries have formed national development plans to diversify their economies; however, progress has been slow and the path to diversification will vary among the countries.

In terms of population growth and labor market trends, we see three different economic scenarios that could unfold for GCC countries beyond 2023.

Scenario 1: Relatively low public spending and weak job creation continue

In this scenario, economic growth remains subdued in the GCC because of lower growth in government investment, partly due to relatively low oil prices and the limited need for further infrastructure projects. Unless there is significant additional private and foreign investment to replace government spending, employment growth is likely to stagnate. As a result, unemployment levels could rise for the national population (particularly youth) and the number of expats will continue to decline. We believe GCC economies facing this predicament may struggle to diversify away from the hydrocarbon sector and see rising risks from the energy transition over time (see "The Energy Transition: The Clock Is Ticking For Middle East Hydrocarbon Exporters," published Feb. 16, 2020).

This scenario could particularly apply to sovereigns facing high fiscal pressure, such as Bahrain and Oman, or a near-term peak in public projects, such as Dubai, following construction for Expo 2021, and Qatar for the World Cup 2022. We note, however, that the Qatari government has accumulated large fiscal buffers above 100% of GDP that it could draw on to sustain the local economy and population.

Scenario 2: A return to higher government capital spending and migrant inflows

In this scenario, GCC governments ramp up investment to achieve their economic diversification targets and support growth and job creation. For example, Saudi Arabia's Vision 2030 has set ambitious targets to develop sectors including manufacturing (particularly petrochemicals), tourism and entertainment, renewable energy, and IT. Other countries' development plans target largely similar sectors, as well as financial services, logistics, and agriculture. This economic growth model would likely require an influx of foreign workers to support construction and infrastructure development, and could result in population growth across the GCC returning to the 2006-2016 average levels of up to 6%.

This model is ultimately unsustainable, in our view, because it places a significant burden on public finances and relies primarily on government spending of oil revenue. However, unless oil prices rise sharply to above the respective fiscal breakeven prices (ranging from above $100/bbl for Oman to $40/bbl for Qatar), most GCC sovereigns will need to rely on additional debt or asset drawdowns to fund investments, worsening their balance sheets. Kuwait, Abu Dhabi, Qatar, and Saudi Arabia possess significant liquid assets, from 100% of GDP in Saudi Arabia to 500% in Kuwait, which they could tap to fund future projects. Oman and Bahrain, however, have less fiscal headroom, though Bahrain benefits from a more diversified economy and higher participation of nationals in the private sector. Kuwait has the weakest infrastructure quality in the region according to the World Economic Forum, implying that there are some infrastructure and service shortfalls remaining to be addressed. However, the government's policy priority appears to be saving for future generations, which could lead to continued underinvestment in the economy.

The cost of creating and maintaining new economic activity will also likely become more expensive for governments. When estimating how much investment it takes to generate one percentage point of economic growth (the incremental capital output ratio), productivity of investment is declining (see "The Energy Transition: The Clock Is Ticking For Middle East Hydrocarbon Exporters," published Feb. 16, 2020). This could be partly because some sectors of investment are already saturated, such as real estate, and would not necessarily yield additional value. In the five years to 2013, it took 6% of GDP in investment spending to generate one percentage point of real output growth in the GCC. For the five years to 2018, this had climbed to 11% of GDP, and we expect it will likely rise further.

Scenario 3: A new phase of economic development that relies on a smaller base of skilled expats, while building productive domestic human capital

The current economic shock could present an opportunity to accelerate diversification of GCC economies toward higher value-added sectors, such as business services, health care, fintech, and artificial intelligence, and provide well-paid jobs for GCC nationals. In our view, this scenario would likely entail further economic and social liberalization and labor market flexibility to increase flows of investment and skilled expats. This shift in the economic model would help GCC countries move away from a large base of lower-income foreign workers.

For example, the UAE's economy is relatively more diversified and the government has introduced several measures to increase its attractiveness to foreign investment and residents, including a new path to citizenship (albeit for a very limited number of individuals), five-year renewable retirement visa for high-net-worth individuals, and some relaxation in the application of Sharia law to foreigners. Several countries also aim to increase foreign direct investment from the current low levels by allowing 100% foreign ownership in specific sectors.

Improvements in education and broader societal changes would also support private sector development. There is significant potential to tap by increasing the participation of women in the economy. The workforce participation rate for women aged 15 and above was about 30% in Oman and Saudi Arabia, as opposed to 50% in high-income countries as of 2020. At the same time, the region's enrollment rate in higher education (tertiary) for women aged 15 and above exceeds that of men, according to the UNESCO Institute for Statistics, which suggests that GCC talent utilization is currently restrained.

We believe this scenario remains aspirational though. While GCC countries have certain advantages--such as strategic location and advanced infrastructure and basic technology--there are structural impediments to the transition toward a diversified, knowledge-based economy like that of Singapore, for example. These include skill shortages among nationals, geopolitical tensions, which among other things can result in unexpected and significant changes in trading relations, nontariff trade barriers, restricted financing options for small and midsized companies, and shallow domestic capital markets. Attracting high-quality foreign talent may also be challenging in some states because of restricted social freedoms compared with more secular countries, uncertainty with regard to the cost of living due to the relatively recent introduction of value-added tax in some GCC states and the potential for income taxes to be introduced, and the limited ability to get permanent residency or citizenship in the GCC. However, the latter may change over time; for example, the UAE is the first country to offer citizenship to foreigners, and Saudi Arabia and the UAE introduced permanent residency schemes for select individuals in 2019.

Long-term productivity and diversification prospects, and strong GDP per capita trend growth by extension, will likely hinge upon GCC governments' efforts to invest longer term in human capital while concurrently enabling private sector activity and labor market flexibility.

Related Research

• EMEA Emerging Market Sovereign Rating Trends 2021, Jan. 27, 2021
• The Energy Transition: The Clock Is Ticking For Middle East Hydrocarbon Exporters, Feb. 16, 2020
• GCC Economic Activity Held Back By Its Hydrocarbon-Heavy Economic Structure And OPEC-Related Production Cuts, Dec. 7, 2020
• S&P Global Ratings Revises Oil And Natural Gas Price Assumptions, Sept. 16, 2020