Saudi Arabia’s drive towards economic diversification has entered a critical phase. After years of articulating a vision for the development of a knowledge-based economy, the government is making a serious attempt to bring about lasting economic change. This transformation is needed to ensure that the country's growth trajectory meets its longer term challenges, including generating sufficient levels of private sector jobs, boosting worker productivity and diversifying government revenues.
With the prospect of long-term fiscal deficits looming, the incentive to change is high. “The Saudis are going to have to adjust to a sub-$100[-a-barrel] oil environment and they are looking at another double-digit fiscal deficit this year, as well as sizeable deficits for the next few years,” says James Reeve, deputy chief economist of Riyadh-based Samba Financial Group.
In the 2016 budget, the Saudi government maintained its accommodative stance to spending, with education and health and social development collectively accounting for SR297bn ($79bn) of the total SR840bn expenditure for the year. For the first time in its history, Saudi Arabia has disclosed its commitment to military and security spending, which at SR213bn makes up 25% of the budget.
Forecasts from local investment and financial services firm Jadwa Investment predict that the budget deficit will reach 12.6% of gross domestic product (GDP), equivalent to SR313bn based on $47 a barrel for oil. Yet, while spending has remained high the government has acted quickly to cut or reduce a number of subsidies. The price of 95-octane petrol was raised from SR0.60 riyal per litre to SR0.90. Meanwhile, price hikes for diesel, gas and kerosene, as well as for utilities including water and electricity, were also imposed.
“I think the most important element of the 2016 budget was the increase in the price of gasoline, which was achieved very quickly, and I understand that that will continue. Stemming the domestic consumption of oil is one of the most important issues facing the country,” says Mr Reeve.
Planning for growth
Beyond this year’s budget, a much grander vision of reform is being constructed in Saudi Arabia. The so-called National Transformation Plan (NTP), which is expected to be released in the first half of 2016, will act as the blueprint for the next stage of the country's economic development.
The NTP is expected to build on the government’s previous five-year reform plans, with the emphasis likely to be on boosting non-oil revenue, increasing labour productivity, privatisation initiatives, further subsidy reforms and the promotion of key economic sectors including mining and religious tourism.
“There is a great deal of excitement and anticipation around the new National Transformation Plan, which I think will shed light on many of these opportunities, whether it is privatisation, religious tourism or the ease of doing business,” says Tariq Al Sudairy, chief executive of Jadwa Investment.
The social contract
In many ways, these reforms will require a substantial restructuring of the Saudi state. Notably, the long-standing social contract, whereby Saudi citizens are offered a lifelong social welfare programme, will be changed in favour of a more market-based system. In a December 2015 report entitled Saudi Arabia Beyond Oil: the Investment and Productivity Transformation, the McKinsey Global Institute writes: “In Saudi Arabia, the government has long been the determinant factor for society. But the potential economic transformation [of the economy] hinges on all parts of society taking greater responsibility for their own economic destiny, and relying less on the state to do it for them. In that spirit, the transformation itself will need to be a collective effort.”
Enacting this kind of systemic reform will not be easy. But the McKinsey report projects that if the government implements the necessary policy changes and associated reforms by 2030, an additional 6 million Saudis could enter the workforce, while the country's GDP could increase by $800bn, backed by $4000bn-worth of investment coming mostly from private sector sources.
“This is a medium- to long-term transformation of the economy and it is not going to be a quick fix. I think government policies in this regard should be sustained for a long period of time and so far there is every indication that the government understands that and that is how it is going to proceed,” says David Dew, the managing director of Saudi British Bank.
Optimistic mood
In Riyadh today, most players in the country’s financial sector remain upbeat about the prospects for the Saudi economy, as well as the opportunities for growth on the road ahead. The government’s emphasis on the development of certain economic sectors, including religious tourism and mining, are likely to offer substantial scope for economic development in the coming years.
“We are bullish on the retail sector, on energy, on water and on opportunities related to housing and religious tourism,” says Bernd van Linder, the managing director of Saudi Hollandi Bank.
Meanwhile, as the government looks to fund its anticipated fiscal deficit in the coming years, an emphasis on privatisation and public-private partnerships is expected to come to the fore. In an interview with The Economist in January 2016, Muhammad bin Salman, Saudi Arabia’s deputy crown prince and defence minister, revealed that an initial public offering (IPO) of Saudi Aramco, the national petroleum and natural gas company, was under review.
If an IPO were to be executed, most private and public sector participants believe it would involve a discrete downstream unit of the state energy giant. Nevertheless, such a listing would point to the momentum behind the government’s reform initiatives and a new raft of opportunities for the wider financial services sector.
“I think opportunities will arise in the programme of economic diversification, including public-private partnerships and IPOs. There will be significant potential there and it very much plays to our skillset and it plays to our core strategies,” says Mr Dew at Saudi British Bank.
Opportunities abound
The country's financial services sector is now bracing itself for these opportunities as this changing landscape unfolds. While privatisation efforts will take time, in order to prepare public entities for a private placement or public listing, existing and successful models of public-private partnerships already exist.
“I expect public-private partnerships to gain traction, especially in the energy and water sectors. Historically, projects in these sectors have been very successful, not just in financial terms for the entities running the associated facilities but also in terms of their effectiveness and efficiency,” says Mr van Linder.
As such, over the coming years the opportunities are expected to be abundant for banks, investment banking subsidiaries and other financial services firms.
“I think with all these initiatives you will see more mergers and acquisitions and advisory mandates and you will see more IPOs because one of the government’s objectives is to increase the depth of the Saudi market. I think privatisation offers both advisory as well as private equity opportunities,” says Mr Al Sudairy.
Yet, many of these opportunities will depend on the government’s ability to stick to its reform programme. Much will also depend on the blueprint for this change – the NTP itself. The government has spent significant sums in previous decades on measures to improve education and stimulate employment. But, in some respects, a mismatch has developed between educational output and labour market demand.
“There has been an awful lot of investment in education infrastructure over the past few decades. But, looking ahead, priority sectors such as mineral resources will require a large number of Saudis working in labour-intensive jobs in order to fulfil their employment potential. This could be difficult to achieve,” says Mr Reeve.
These pressures are matched only by Saudi Arabia’s rising youth bulge, its yawning infrastructure funding deficit and the challenge of growing domestic energy consumption, which is threatening to turn the country into a net oil importer by the 2030s. As such, the coming years will not be easy. But the government, as well as the private sector, are in a good position to achieve a genuine transformation of the economy.
