Qatar: Diversification efforts real, but hidden

Last month, we discussed the fact that Kuwait has done little in terms of reform due to the fact that its huge natural resources will ensure a high standard of living for decades to come - something reinforced by the recent find of an additional 13 billion barrels of oil and 35 trillion cubic feet of gas, its first commercially viable gas find. As far as natural reserves are concerned, Qatar is in a very similar position.

In Qatar's case, it is gas reserves that dominate the country's wealth of natural resources. However, Qatar is clearly not resting on its laurels in the way that Kuwait is. True, while every other country is focused on diversification away from the hydrocarbon sector, in the short-term Qatar will become more concentrated on gas sales. However, this will only hide the fact that the government is making good progress on helping to nurture a stronger private sector.

In the short-term, the focus is going to be on the development of the country's hydrocarbon sector. This strategy has three thrusts. The first is to expand its sustainable level of oil production to 875 kbpd by the end of this year, up from actual production levels of 777 kbpd in Q2 2005 - good news for Asia as the majority of the country's oil is exported to Japan with Singapore, South Korea, Thailand and India also major importers of Qatari oil.

However, this is small fry compared to its plans for the gas sector. Qatar has the world's second largest proven gas reserves after Iran. There are two liquefied natural gas (LNG) projects; Qatargas and RasGas and Qatar Petroleum, which runs both projects, has set aside USD 33.5bn (almost equivalent to 2005 GDP) for a five-year plan starting in 2005 to expand the utilisation of its gas reserves. Under current Sales and Purchase Agreements (SPAs), this will result in almost a 60% increase in LNG exports over 2005 levels in 2010. If you assume all of other Heads of Agreement result in SPAs then the rise becomes over 250%.

The third area of expanding its short-term reliance on the hydrocarbon sector (although most countries in the region would list this amongst diversification strategies), is the industrial spin-offs from having an abundance of natural resources. Qatar also has the region's largest fertilizer company, a steel company, a petrochemical industry and a vinyl company, all of which are looking to significantly expand their operations in the coming 18 months.

In this backdrop, it is hardly surprising that the economy is expected to expand. Indeed, we expect the economy to more than double in the next five years, after tripling in size from 1998-2005. Meanwhile, the economy is expected to generate significant excess liquidity both for the government, in the form of tax and non-tax revenues, and for the country, in terms of huge current account surpluses.

Of course, such an economic performance would probably be good enough for most governments. However, in Qatar the government is also trying to put in a framework that will encourage activity in the private, non-hydrocarbon sector, particularly in the area of services. The foundations of this have been the usual business-related reforms that propelled Qatar to be being ranked first in the 2005 Arab World Competitiveness Report's competitive index.

On the harder side of the infrastructure requirements, the decision to build a new airport, along with the rising profile of the national air carrier, Qatar Airways, and the large investment into niche luxury hotel accommodation, signals the country's intent in the tourism industry. However, this is not the limit of the aspiration. The country is already viewed as the leader in the region's media industry.

Meanwhile, efforts are picking up in terms of helping to provide excellent education and health facilities. Finally, the government has set up ASPIRE, which aims to help athletes from the poorer nations of the world to pursue their dreams of competing in the major athletic competitions. The hosting of the Asian Games this year is also a signal of intent for the country to create a brand that is unique to that of Dubai.

Of course, there are always things that could be improved upon. For instance, the recently-announced Energy City is a positive development, but it will initially focus on hydrocarbon research whereas we believe there is a good case for this to be extended to non-hydrocarbon energy sources.

Indeed, we believe the way forward is for Qatar to aspire to be a knowledge-based economy. The region has a general lack of research and development capabilities. The move into establishing quality education facilities could be the first step in this direction.

Meanwhile, such a rapid development cannot be seen without some teething problems. The most obvious of these has been a dramatic increase in the cost of living as the country experiences a huge shortage in housing. This has resulted in accelerating inflation pressures with inflation rising at an annualised pace of 16% in Q4 2005 and 14.9% y/y.

This raises the question of the appropriate response to inflationary pressures. Clearly, with the major issue being the lack of availability of housing, significant construction of residential real estate is the key issue that needs to be addressed. The population is growing at a rapid pace.

The 2004 Census shows an average 5.3% increase in the population in recent years, and there is good reason to believe this has accelerated in the very recent past. Of course, the very fact that over a third of the increase in workforce from 1997-2004 was in the area of construction indicates that this issue is being addressed.

Rising inflation also highlights the issue of having a currency peg to another currency, in this case the USD. This means local monetary policy settings are in line with what the US Federal Reserve believes is appropriate for the US economy and clearly does not take into account what is happening in the Qatari economy.

Conventional wisdom is that the economy is too small to have a flexible currency as it would be at the whim of speculators. This in itself is debatable, especially given the country's solid financial position. However, once you add in the likely doubling of the domestic economy and the proposed Gulf Cooperation Council single currency in 2010, then the risk of more independent monetary policy settings being adopted via the removal of the rial's peg to the USD will increase with time.

Indeed, we believe such monetary flexibility to respond to developments affecting the region, together with increased diversification efforts, would be an important step in helping to reduce the volatility of economic activity that has been seen in the past, not just in Qatar, but for the GCC region as a whole.