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WorldApril 1 2015

How Saudi Arabia's non-oil private sector is fuelling growth

The non-oil private sector is playing an ever-expanding role in the growth of Saudi Arabia's economy. However, will it be able to help tackle the country's high unemployment ratio and low home ownership rates? James King reports.
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How Saudi Arabia's non-oil private sector is fuelling growth

The growth of Saudi Arabia’s non-oil private sector has been remarkable in recent years, the product of many years of government-backed initiatives to diversify the country's economy. Since 2000, the growth of the non-oil private sector has averaged 8.1%, compared with 4.3% in the non-oil public sector, according to ratings agency Moody’s. This is good news for the Saudi authorities and comes as a period of sustained lower oil prices looks set to normalise.

More importantly, this momentum is expected to be maintained over the long term. “The non-oil private sector [in Saudi Arabia] should continue to be the engine for growth in the economy, benefiting from elevated government spending as well as corporate lending and solid domestic consumption,” notes a Jadwa Investment research report.

A question of time 

The real questions facing Saudi Arabia’s non-oil private sector now concern the pace of its development. "The government is heading in the right direction on its path to economic diversification," says  Tariq Al Sudairy, managing director and chief executive of Jadwa Investment. "The challenge is time: how quickly and at what magnitude will we be able to move away from oil over the next five to 10 years?”

These questions are important because they relate to two of the biggest structural problems facing the country; employment and housing. Saudi Arabia is under pressure from a demographic bulge of young, and often educated, nationals who are now entering the workforce. According to the UN Department of Economic and Social Affairs, the proportion of working age Saudis (aged between 15 and 64) is close to 68%, a figure that is expected to rise to 74% by 2035. Yet unemployment rates remain high, and the capacity of the economy, in its current form, to absorb this cadre of young professionals is limited.

In addition, the cost of housing is preventing many young Saudis from entering the real estate market. National home ownership rates of 36% exclude the significant number of people who reside in low-quality housing, according to the International Monetary Fund (IMF). Recent real estate reforms designed to ease this home ownership deficiency have been somewhat stunted by the introduction of new loan to value caps for Saudi lenders (see main banking article). Moreover, while the authorities have pledged to build 500,000 new homes as part of an infrastructure development drive, as well as providing interest free loans to support purchases, progress has been slow.

Unemployment problems

Many of these issues are long-standing, and the window for addressing them is shrinking. The success of the Saudi Arabian private sector in offering opportunities for training and employment, as well as its economic capacity to pursue home ownership, will therefore be paramount. This objective has added significance given that the migration of public sector employees to the private sector would also help the government to rationalise spending costs in the future. 

For now, the most pressing issue is the unemployment rate which, for Saudi nationals, stands at 11.5%. Of this figure, the female unemployment rate is 32.1% while for males it is 6%. According to the IMF, the Saudi labour force has grown at an average rate of 4.75% over the past 10 years and is expected to maintain this momentum moving forward.

The Ministry of Labour has achieved some notable successes in addressing the unemployment challenge, particularly for women. In the first half of 2013, the female unemployment rate was as high as 35%, while the overall unemployment rate was at 12%. Government programmes, including the Nitaqat initiative aimed at the 'Saudisation' of the country’s workforce, have also been a source of positive change. Statistics from the Ministry of Labour indicate that rates of Saudisation in the private sector increased from 10.9% to 15.3% between 2011 and 2014, the highest in a decade.

Saudi Arabia economy

SME salvation?

Nevertheless, youth unemployment remains stubbornly high at 27.8%, according to data from Jadwa Investment. Here, the government, as well as many private sector observers, see the growth of small and medium-sized enterprises (SME) as an effective means of addressing these issues. "In meeting these challenges, there is a undoubtedly correct view that SMEs can be a significant source of potential employment,” says David Dew, managing director of the Saudi British Bank (SABB).

Yet, nurturing SMEs in Saudi Arabia is complicated by its own set of challenges. This is particularly true when it comes to generating employment for Saudi nationals. Frequently, these businesses can fall foul of Saudisation requirements in light of the extra cost this implies, or by virtue of the business structure whereby foreign nationals run an enterprise for a Saudi owner. Local press reports indicate a sizeable number of small businesses have faced closure over compliance issues in recent years.

Though these impediments are significant, a renewed energy on the part of both public and private sector players has emerged to find solutions, particularly for SMEs. “The whole country is pushing on the SME front, including the government, the banks and other private sector players," says Dr Bernd van Linder, managing director of Saudi Hollandi Bank. "Things are moving in the right direction but it is more complex than people thought. It's a high-risk aspect of banking in the country but one that offers substantial long-term growth prospects."

Building a future

Long-term government investments in major development and infrastructure projects are also starting to bear fruit, both in terms of employment and housing. The King Abdullah Economic City megaproject is now independently energised and is attracting a first wave of workers and residents. “Progress on King Abdullah Economic City has really accelerated. They have started delivering on the King Abdullah Sea Port, which is a world-class facility and for which there is a great need. Jeddah Islamic Port is almost fully utilised and a large proportion of goods that arrive at Dubai's Jebel Ali port transit into Saudi Arabia,” says Mr van Linder.

In tandem, the government’s economic diversification initiatives are also showing significant promise. According to SABB's monthly purchasing manager’s index for the non-oil private sector, employment growth had been sustained for 11 successive months to February 2015.

Within this milieu, the water and electricity sectors have enjoyed considerable growth, with a projected $36bn of projects coming online in 2015 to meet soaring demand, while telecoms, non-oil manufacturing, the wholesale and retail sectors, as well as construction, all remain strong contributors to the Saudi economy.

"The retail and wholesale sector employs about 1.7 million workers of which close to 80% are non-Saudis. This is a sector that the Ministry of Labour has been prioritising as a source of greater employment for Saudi nationals,” says Dr Said Al Shaikh, senior vice-president and group chief economist with National Commercial Bank.

Yet as Mr Al Shaikh notes, some important economic sectors, including manufacturing, are facing a labour shortfall from Saudi nationals as an educational mismatch develops. "The manufacturing sector is large, employing more than 800,000 workers. However, there's a mismatch between the skills of those entering the labour force and the technical jobs that are available in advanced manufacturing roles. This mismatch is gradually improving but it will take a few years before any real change is achieved," he says.

The Saudi government is clearly making excellent progress in the growth of the non-oil private sector. This will go a long way to ameliorating some of the structural challenges faced by the economy as a whole. But it is still unclear whether these changes can be implemented in time to meet the requirements of this rising demographic tide. Nevertheless, the country's political and economic model has proven itself resilient to various challenges in the past and for now, as non-oil growth accelerates, the momentum is on the side of the government.

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Read more about:  Middle East , Saudi Arabia