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Shining a light on the GCC’s $890bn shadow economy

Shadow economy hawala money market Reuters
Money markets provide remittance options outside of the traditional banking system
  • Informal ‘shadow economy’ worth up to 22% of GCC states’ GDP
  • Fears tax reform may drive more SMEs to operate clandestinely
  • Experts say it must be made easier to set up SMEs officially

The Dubai Financial Services Authority this week imposed a penalty of $25,200 on a company for dealing in precious metals and stones from its base in the Dubai International Financial Centre.

The DFSA said the company had not been registered to carry out such activity.

While the authority did not allege that the company was involved in any criminal activity, it noted that “dealers in precious metals and precious stones are included in typical money laundering typologies”.

The move is part of the Dubai government’s aim to clamp down on unsupervised or unregulated activity, which is often classed as being part of the “shadow economy”.

This could be worth as much as $890 billion in the GCC, according to latest estimates.

The shadow economy – also sometimes referred to as the the informal sector, the black economy, the underground economy, or the gray economy – refers to business activity that is undeclared and for which taxes that should be paid are not.

The shadow economy is not included as part of a country’s official gross domestic product (GDP). Activities could include individuals forced to do unpaid labour, or work carried out in exchange for things other than money. 

An example is unregistered operators of “hawala”, which have existed in Gulf countries for decades and provide an alternative remittance channel that exists outside of traditional banking systems.

Hawala is an informal funds system that allows for the transfer of money from one person to another without the actual movement of money. For example, a person may pay $100 to an agent in Dubai and another agent would then forward $100 to a recipient in a foreign country. In return, the Dubai agent would repay the overseas agent as part of a separate undeclared transaction or as part of another service.

It is a simple process that requires no documentation and, therefore, is an anonymous way of moving money.

Experts say that while the recent introduction of new taxes in the Gulf – historically a very low tax region – could tempt more businesses over to the “dark side”, GCC governments are fighting back with ongoing business reforms aimed at improving the ease of doing business for the burgeoning small and medium enterprise (SME) sector.

According to first-quarter estimates from World Economics, the shadow economy makes up 16 to 22 percent of GCC countries’ GDP, although accurate calculations are difficult to make because of its secretive nature.

That is relatively small compared with other emerging regions of the world and below the global average.

But Stephane Ulcakar, associate director in the financial services practice of consultants Arthur D Little, said there is no complacency in the GCC where governments are “very serious” about tackling the issue.

Ulcakar said that integrating shadow businesses into the formal economy remains a top priority across the GCC through streamlined regulations, enhanced tax oversight, accessible financial services and providing a level playing field.

“These concerted efforts not only reduce incentives for individuals and businesses to operate in the shadow economy but also foster a more inclusive and sustainable economic landscape,” Ulcakar said.

Ali Metwally, an economist and risk analyst specialising in the Mena region at Infospectrum, agreed, saying that although the introduction of new taxes does carry the risk of potentially increasing the appeal of the shadow economy, GCC countries have implemented “significant business reforms” to encourage SMEs to stay in the open.

“Governments in the Mena region need to strike a balance between implementing fair and reasonable taxation policies while minimising the unintended consequences of driving economic activities into the informal sector,” Metwally told AGBI.

Stephane Ulcakar believes GCC governments are 'very serious' about tackling shadow economies

Saudi Arabia not only has the GCC's largest economy, but also the largest informal economy, estimated at $557 billion.

Outside the Gulf, the informal sector plays a major role in most economies in the wider Mena region, with agriculture the most prevalent industry.

As a percentage of GDP, Morocco has the biggest shadow economy in Mena at 36.6 percent ($153 billion) while Lebanon’s informal sector at 31.4 percent ($28 billion) is the largest in the Middle East.

The World Bank said countries with larger informal sectors generally have lower per capita incomes, greater poverty, greater income inequality, less developed financial markets and weaker investment.

Ulcakar added that the key to constraining shadow activity in the GCC lies in how easy it is for SMEs to set up in business.

In the UAE alone, SMEs represent 94 percent of the total number of firms. They provide jobs for 86 percent of the private sector's workforce and account for more than 60 percent of GDP, as of last year.

Meanwhile, Saudi Arabia aims for SMEs to contribute 35 percent by 2030, and Bahrain set a target of 50 percent to be achieved by the same year.

Scott Cairns, managing director of Creation Business Consultants in Dubai, said GCC governments have done well by promoting incentives to support local and foreign investors while also providing more options for visa and residency. 

“The evasion of taxes that comes with the shadow economy deprives GCC governments of considerable revenue," Cairns said.

"This revenue loss is significant as they continue to work on approaches to diversify away from its reliance on oil and gas."

He added that despite some ongoing red tape associated with incorporating companies properly within the GCC, his company has recorded an “overwhelming surge” in company formations in the first two quarters of 2023. 

“This is a fantastic indicator that formal businesses are strengthening the GCC economies rather than assisting the shadow economies,” he said.

The region’s leaders recognise the need for a thriving SME sector and have “positioned this need” at the heart of their policies, according to Ulcakar.

He also highlighted the role of fintech in limiting the impact of the shadow economy.

He said digital platforms such as STC Pay, established by Saudi Telecom Company to improve access to financial services, can help limit informal activity, such as the unregistered hawala system, by reducing reliance on cash transactions.

Initially focused on blue-collar workers in Saudi Arabia, the digital wallet now counts 8.5 million users. 

Cairns echoed this, saying banking and lending could be made easier to support SMEs that often struggle to get the funding support they need because of stringent lending requirements. 

Metwally also highlighted the moves by Egypt, Saudi Arabia and the UAE to modernise their insolvency frameworks, which can further encourage entrepreneurs to operate within the formal economy, knowing that there are mechanisms in place to address financial challenges. 

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