The Saudi Arabian economy is sputtering back to life after a sluggish couple of years. This sentiment, at least, is the consensus view among senior banking and private sector leaders in Riyadh. Backed by an expansionary 2018 budget of almost SR1000bn ($267bn), as well as an improving oil price environment, the government expects economic growth to reach 2.8% for 2018.
But this improving economic outlook is coming at the expense of fiscal discipline. Rating agency Moody’s expects the country to experience a budget deficit equivalent to 7.6% of gross domestic product in 2018, while the authorities have had to push back their target for a balanced budget from 2020 to 2023.
Supportive budget
Nevertheless, for Saudi Arabian banks and corporates, these developments are welcome: the economy contracted by about 1% in 2017 as a result of relatively tighter government spending and lower oil production. “The government has unveiled a highly supportive 2018 budget [even if] it will take some time before this spending translates into meaningful economic activity,” says Soren Nikolajsen, managing director at Riyadh-based Alawwal Bank.
In 2018, total budget spending is expected to hit SR978bn, with a further SR130bn in off-budget spending from the Public Investment Fund, Saudi Arabia’s sovereign wealth fund, and the National Development Fund. To finance this expenditure, the government has in recent years turned to the international debt markets. In April 2018, the country raised $11bn in dollar-denominated bonds, bringing the total value of its international debt issuances to $50bn since the end of 2016, according to Bloomberg. The latest transaction attracted more than $50bn in bids.
These numbers matter because they point to a massive degree of international investor interest in Saudi Arabia. Even as it pushes ahead with its far-reaching reform agenda, packaged under Vision 2030 and the objectives laid out under its National Transformation Plan, it seems the near-term difficulties facing the economy are not deterring investors.
“I think Saudi Arabia is more relevant than it has probably ever been. It has always been an important oil supplier and exporter. What is going on here now has attracted the world’s attention. The level of interest has never been greater in Saudi Arabia. Opportunities are here in spades,” says David Dew, managing director of the Saudi British Bank.
Clampdown on corruption
That Saudi’s latest bond issue was so oversubscribed just months after the authorities instigated a vast anti-corruption purge, by detaining prominent leaders in the business community, is a case in point. In November 2017 the authorities, led by crown prince Mohammed bin Salman, rounded up hundreds of leading business figures, including members of the royal family, in an effort to stamp out corruption. Those detained were effectively accused of corrupt business conduct stretching back over many years.
While some observers have pointed out that this initiative served the dual purpose of consolidating the crown prince’s power, it nevertheless achieved its stated objective. The authorities have since claimed the exercise generated $106bn in settlements.
The new bankruptcy law is a big step forward. The absence of this law was always a massive barrier to attracting FDI and in particular securing the interest and investments of medium-sized businesses
“It did create a period of uncertainty and investment decisions were put on hold. But that, I think, is behind us. Life in the future will be different. The old ways of doing business are no longer acceptable,” says Mr Dew.
Indeed, the effects of the reform are starting to permeate every aspect of life. From a societal perspective, Saudi Arabia is liberalising swiftly. Gender segregation in certain locations is relaxing, and from June women will be legally permitted to drive. An entire entertainment industry is now in the pipeline with the rollout of cinemas across Saudi Arabia offering the earliest example of this development.
Middle Eastern hub
In terms of the wider economy, Saudi Arabia is becoming globally integrated in a way that was inconceivable a decade ago. Among other things, this includes a push to position it as the de facto capital market for the Middle East. This reform programme is expected to open up an abundance of new investment opportunities.
“Naturally when an economy is undergoing reform it experiences an adjustment period. With that adjustment period it typically experiences a J curve of disruption and dislocation. Then it moves on to the recovery and growth phase,” says Tariq Al Sudairy, chief executive of Jadwa Investment. “We have continued to invest very actively in the local economy because we believe it is during this adjustment period, if you have that local insight and understanding, you can identify the right opportunities.”
But having laid out a vision for what Saudi Arabia is aiming to be by 2030 – essentially a non-oil-dependent, diversified private sector-led economy – the government is now facing the difficult task of achieving it.
On its side is a young, energetic and ambitious new generation of public sector leaders. This emerging leadership cadre has extensive private sector experience and is shaking up various agencies and ministries in the pursuit of reform. The recently appointed minister of economy and planning, Mohammed Al Tuwaijri, and the chairman of the capital markets authority, Mohammed El Kuwaiz, both fall under this umbrella
“The attitude and the capability of government ministers has improved and they are much more proactive than they ever were. You can’t put the cart before the horse and you have to have the right people in place to make reform happen. That has been the most encouraging aspect of the country’s reform story so far,” says James Reeve, chief economist at Samba Financial Group.
Legal changes
Progress has been made already. The approval of a new bankruptcy law in February 2018 is a case in point and should help to attract foreign investment while stimulating small and medium-sized enterprises. In the past, there has been no single mechanism or law to handle businesses in financial distress.
“The new bankruptcy law is a big step forward. The absence of this law was always a massive barrier to attracting FDI and in particular securing the interest and investments of medium-sized businesses. It will certainly level the playing field between Saudi Arabia and other regional markets,” says Mr Reeve.
What we need to do is enhance the productivity of the Saudi workforce and create an economy that generates high-skill job opportunities that meet the aspirations of the Saudi youth
Despite this early progress, the scale of the reform challenge remains significant. “The real catalyst for economic reform will be FDI inflows connected to Saudi Arabia’s privatisation programme. There is enormous scope for private sector involvement in the provision of services such as health and education,” says Mr Reeve.
If the privatisation of state assets has been slow, the government has had even less success in reforming the labour market. Meeting the employment needs of its young and growing population is arguably Saudi Arabia’s most pressing challenge. The unemployment rate of Saudi nationals has hovered somewhere between 11% and 13% in recent years, according to the International Monetary Fund (IMF). For Saudi women, this number has been closer to 30%, though the legalisation of female driving in June should help to address this. More problematic still is the level of youth unemployment among nationals of nearly 40%.
The IMF estimates that, for the unemployment rate to remain stable, about 1 million private sector jobs will need to be created in Saudi Arabia between 2017 and 2022. This would be equivalent to doubling the number of jobs created between 2007 and 2016. There are serious risks facing the government if it fails to address this challenge. For one, the authorities are starting to remodel the Saudi social contract. The introduction of VAT and the reform of some subsidies is starting to hit the wallets of Saudi nationals more accustomed to cradle-to-grave economic comfort in exchange for their political acquiescence.
Indeed, the economy today is structured around an abundance of cheap imported labour. As a result, companies operating in Saudi Arabia have had little incentive to improve their efficiency and create the kind of employment opportunities better suited to highly skilled graduates. “Given the current incentive structure, the Saudi economy is largely generating low-skill, low-pay jobs. What we need to do is enhance the productivity of the Saudi workforce and create an economy that generates high-skill job opportunities that meet the aspirations of the Saudi youth,” says Mr Al Sudairy at Jadwa Investment.
Though expatriates are now leaving the country in response to fees and levies imposed by the government, they are for the most part vacating low-skill occupations, including construction or retail sector work. As a result, over the short to medium term the government will face a growing surplus of educated Saudi nationals with minimal job prospects in the private sector.
A domestic drive
Over the long term the government is pushing on several fronts to solve this problem. Investments in mega-projects with strong non-oil credentials, as well as the liberalisation of the business environment, are being accompanied by a drive to boost advanced economic sectors, projects and companies overseas to produce meaningful reform at home. The government’s objective is to transfer knowledge, skills and technology back to the domestic market.
The Saudi Public Investment Fund has, for example, partnered with its Russian counterpart to establish a new joint $1bn technology fund. A similar but much larger arrangement has been reached with Japanese conglomerate SoftBank to create the world’s largest technology investment fund. Meanwhile, at home, the government has announced plans to develop a new $500bn city called Neom on the country’s Red Sea coast. With a total area of 25,900 square kilometres, the city will be linked via bridge to Egypt and boast direct ties to neighbouring Jordan. It is also likely to operate under an independent legal and administrative system akin to a free zone.
Developments of this scale are being accompanied by more granular changes to the business climate. The introduction of a new companies law has minimised the regulatory burden on small companies, while additional capital has been pumped into the Kafala loan guarantee programme which is designed to boost bank lending to small and medium sized enterprises. Taken together, these steps, and others, will go some way to answering Saudi Arabia's long-term socioeconomic challenges.
Time is tight
Nevertheless, it is far from clear that Saudi Arabia will reach the destination it has laid out for itself under its Vision 2030 ambitions. The development of a genuinely competitive, diversified and non-oil economy could take much longer than the authorities hope. “The Saudi reform plan is ambitious and the government is unlikely to hit all of its targets by 2030,” says Mr Reeve at Samba Financial Group.
Despite these challenges, an air of cautious optimism prevails over Riyadh. This is because, in general, the reform programme’s direction of travel is widely supported by the private sector. Senior business leaders in Saudi Arabia used to talk of the government ‘kicking the can down the road’ when it came to reform, but now acknowledge the authorities are addressing the structural problems facing the local economy.
Undoubtedly this will be difficult, and a new set of winners and losers will emerge from these changes. But even if the current administration only hits half of its objectives of 2030, Saudi Arabia will emerge as a regional growth engine over the coming years.
“Today I am very optimistic 2018 will be better than 2017. The government’s reform plans are being translated into projects and the city of Neom is an example,” says Abdulmohsen Al Fares, chief executive of Alinma Bank. “In addition to that, we are seeing an improvement in the oil prices so that helps us to be optimistic.”
