Four years after the launch of Saudi Arabia’s comprehensive development strategy, Vision 2030, the Kingdom’s non-oil economy is starting to see the benefits of sustained reform. The government’s decision to weaken the link between hydrocarbons and economic growth has seen a robust pipeline of projects across a range of sectors come to fruition. However, after a period of healthy non-oil GDP expansion, projections for 2020 have been cast into doubt by the onset of the global Covid-19 pandemic. Defending Saudi Arabia’s economy against the effects of the virus and enacting lockdown measures to slow its spread have therefore emerged as top priorities in the short term.
The low oil price environment that began in mid-2014 and the government’s determination to reduce public spending have resulted in a challenging economic backdrop over recent years. However, the Kingdom entered 2020 on the back of modest growth. Real GDP grew by 0.3% in 2019, down from 2.2% the previous year. While in September 2019 the IMF and the Saudi Arabian Monetary Authority (SAMA), the Kingdom’s central bank, had forecast GDP to expand by 1.9% that year, large cuts in oil output caused the energy sector to contract by 3.6%, dampening overall economic activity.
While this is a muted performance by historical standards, some areas of the economy showed more promise over the year. Non-oil GDP expanded by 3.3% in 2019, while non-oil private sector growth hit 3.8% – a five-year high. This performance resulted in an initial positive outlook for 2020, although volatile macro-economic conditions in the first three months of 2020 have led predictions to vary widely. The Ministry of Finance (MoF) originally forecast 2.7% GDP growth for the year, before moderating expectations to 2.3% in December 2019 due to falling oil prices and the ongoing trade dispute between China and the US. In March 2020 Riyadh-based Jadwa Investment predicted a 6.3% expansion for 2020, although this forecast was based primarily on sizeable rises in oil output that will no longer materialise. In April 2020 members of the Organisation of the Petroleum Exporting Countries and partner nations came to an agreement to reduce production by 9.7m barrels per day beginning in May in an effort to prop up oil prices that had fallen drastically since the onset of the Covid-19 pandemic, which took hold of Asia at the end of 2019.
Indeed, the virus has radically altered economic conditions, and countries around the world have been compelled to adjust their projections as they take mitigating action. Due to these measures the IMF expects the global economy to contract by around 3% in 2020. Giving the government an early indication of the challenges ahead, in March 2020 IHS Markit’s Purchasing Managers’ Index for Saudi Arabia dipped to 42.4 – below the threshold of 50 that separates growth from contraction – for the first time since the survey began in August 2009. The IMF’s latest “World Economic Outlook” report, published in April 2020, predicts a contraction of 2.3% for the Saudi economy in 2020, with non-oil GDP expected to shrink by around 4%.
The government was quick to respond to the altered circumstances, and in late March 2020 the MoF and the Ministry of Economy and Planning announced a $35.2bn emergency stimulus package to be divided into three initiatives. The first will see $18.7bn in funding to exempt or postpone government dues owed by citizens and residents. This includes Customs duties; value-added, income and excise taxes; and work and residence permit fees. The second initiative dedicates $3.2bn to propping up small business owners in priority sectors such as health care, as well as support for low-income families with the help of the Saudi Social Development Bank and the National Development Fund. The third initiative will provide special attention to small and medium-sized enterprises (SMEs), which are doubly challenged by recent lockdown measures and a traditional lack of financing. Around two-thirds of the SMEs and 90% of its micro-enterprises operate within the hospitality, retail and non-oil manufacturing sectors, which have been hit especially hard. “Commercial banks have always been cautious when it comes to lending to SMEs,” Homam Hashem, general manager of the SMEs Loan Guarantee Programme (Kafala), told OBG. “Therefore, government incentives and loan guarantee schemes are crucial to spur growth and protect the segment.”
Of the SR50bn ($13.3bn) allocated under the third initiative, SR30bn ($8bn) will finance a deferred payment programme, by which banks are compensated for postponing loan payments owed by SMEs for up to six months; SR13bn ($3.5bn) is earmarked for concessional financing for micro-, small and medium-sized enterprises for one year to boost employment and maintain operations; and SR6bn ($1.6bn) is to support a loan guarantee programme, which will reduce lending costs for beneficiaries throughout 2020. Some of the available money will also be used to cover charges normally levied by payment service providers, including SR800m ($213.3m) to cover fees for all privately run stores with point-of-sale machines.
Meanwhile, more targeted assistance will be given to those companies adversely affected by the measures taken in Makkah and Medina. In late February 2020 entry into the holy cities was severely restricted, and by April the authorities were considering whether to cancel the annual Hajj pilgrimage, which is due to begin in July.
In early April the government also announced that it would assist struggling companies with salary obligations. Under the scheme, which came into effect via a royal order, employers can request monthly compensation of up to 60% of employee salaries. The measure is one of the most significant steps taken by the government to support the private sector, with an estimated 1.2m Saudis eligible for benefits.
While in the short term the government’s focus is on supporting the nation’s businesses through a global economic shock, its long-term goals continue as outlined in Vision 2030. First revealed in 2016, the overarching aim of the strategy is to reduce the Kingdom’s reliance on oil production and export, which accounted for 43.5% of GDP in 2018, according to SAMA.
Key initiatives include a privatisation programme that has already seen a partial sale of national oil giant Saudi Aramco; the outsourcing of a number of government services (see analysis); the creation of the world’s largest sovereign wealth fund; an expansion of private sector employment opportunities; and the increased participation of women in the job market. This reform process aims to establish Saudi Arabia as one of the 15-largest economies in the world, supported by a broader range of exports than today’s hydrocarbon-heavy portfolio, a more productive SME segment, and completely overhauled finance, tourism and industrial sectors. The Saudi population, meanwhile, will benefit from a revamped education system, a wider range of employment opportunities, and additional entertainment and cultural activities.
Long-term plans are divided into 13 Vision Realisation Programmes (VRPs) to provide detailed road maps for each sector. VRPs cover the entire socio-economic spectrum, from lifestyle initiatives to industrial, housing, fiscal and financial reforms.
The implementation of Vision 2030 is changing society in fundamental ways – most notably in the cultural sphere. The General Entertainment Authority and the General Cultural Authority were established in 2016 to oversee the development of a thriving entertainment sector. This has included sponsoring museums, artists, and traditional and contemporary music performances, as well as licensing cinemas for the first time in over 30 years.
Expanding access to entertainment will likely provide an array of investment opportunities. For example, US cinema operator AMC Theatres announced in 2018 that it would build up to 100 cinemas in the Kingdom by 2030. Jeddah was also chosen to launch the Red Sea Film Festival in March 2020 to showcase local and regional talent, although the event was postponed to protect public health. “Traditionally, there has been a lack of local content development in the region,” Rabih El Amine, CEO of media group Alef International, told OBG. “The private sector is now in a position to benefit from this untapped potential by focusing on producing and distributing Arabic content.”
Large projects such as the Qiddiya entertainment city outside Riyadh, NEOM in the country’s north-west, the Red Sea Project luxury tourism development, the Amaala mega-project and Media City in Riyadh are forming the base of a nascent leisure tourism and entertainment industry. “Saudi Arabia is becoming a regional centre for media industries,” El Amine told OBG. “The recently announced Media City in Riyadh will be a game changer for global industry players seeking to leverage the GCC’s economic growth.”
From Public to Private
Attracting private capital from outside the Kingdom is another key element of Vision 2030. Saudi Arabia has met considerable success in boosting passive inflows by opening up its stock market to foreign investors (see Capital Markets chapter), but foreign direct investment (FDI) has proven harder to come by. According to the UN Conference on Trade and Development, net FDI into the Kingdom fell from $7.5bn in 2016 to $1.4bn in 2017. However, FDI inflows rose to $3.2bn in 2018 as a result of the government opening four additional sectors to investment. Total FDI stock, for its part, has remained relatively static, standing at $231.5bn, $227.6bn and $230.8bn in 2016, 2017 and 2018, respectively.
One way for the government to boost private sector investment activity is to partially divest its assets or link foreign investors with state-owned companies through public-private partnerships (PPPs). The partial flotation of Saudi Aramco in late 2019 demonstrated the Kingdom’s determination to open up some of its most profitable functions to private capital. The offering valued the company at $1.7trn.
In 2017 the National Centre for Privatisation (NCP) was established to govern and supervise the privatisation process by developing policies, strategies, bylaws, plans and tools needed to fulfil privatisation objectives. These include a new Privatisation Projects Manual that acts as a roadmap for the Kingdom’s PPP projects, as a well as a new PPP law that was being amended in the first half of 2020 in preparation for final approval. There are nine sectors targeted by the NCP: environment, water and agriculture; transport; energy, industry and mineral resources; labour and social development; housing; education; health care; municipalities, telecommunication and IT; and the Hajj and Umrah industries. In 2019 the Kingdom closed seven PPP transactions for the provision of medical services and the construction of container terminals and wastewater plants (see analysis).
Key reforms were also aimed at improving the business environment to encourage greater private sector investment. Saudi Arabia was named the most improved country on the World Bank’s 2020 ease of doing business index. The Kingdom placed 62nd out of 190 countries with an overall score of 71.6 points out of 100 – representing an advancement of 30 places on 2019. Saudi Arabia improved on all indicators to rank third globally in terms of protection for minority investors, 18th for getting electricity, 19th for registering property and 28th for dealing with construction permits.
According to the World Bank, Saudi Arabia achieved these results by boosting efficiency and reducing costs. Starting a business in Saudi Arabia now costs just 5.4% of income per capita, which is considerably lower than the MENA regional average of 16.7%. Local businesses are also able to obtain all authorisations to build a warehouse in 100 days at a cost of 1.9% of the warehouse value – half the regional average of 4.4%. Similarly, the time it takes businesses to obtain electricity connections was halved in 2019. Resolving insolvency was also an area of improvement, and the Kingdom introduced a new bankruptcy law to strengthen the position of investors. Three legal cases were settled under the legislation in 2019, and around 12 more were being handled by the courts.
The government also has considerable public resources at its disposal. The most important of them is the Public Investment Fund (PIF), the Kingdom’s sovereign wealth fund, which was established in 1971 to support the development of strategically important projects. The fund controls assets worth around $320bn, according to the Sovereign Wealth Fund Institute, of which one-quarter are held overseas. The PIF is playing a leading role in the implementation of Vision 2030, and the government plans to provide it with extra investment muscle by boosting its asset base with the proceeds of its privatisation programme. According to the government’s strategy, the PIF will be transformed into one of the world’s largest investment vehicles, managing $2trn in assets by 2030. The PIF can also raise funds by selling its stakes in Saudi-listed companies or by borrowing from banks to invest in diversification efforts. The PIF has already shown its willingness to raise debt: in September 2018 the fund revealed it had secured $11bn in its first international loan after the floatation of Saudi Aramco was delayed.
Looking abroad, in October 2019 the PIF revealed that it would invest $10bn in Brazilian infrastructure. While the specifics have yet to be announced, potential investment targets include a proposed 960-km railway to connect the agricultural area of Mato Grosso to the northern state of Pará, as well as various projects in the energy, sanitation and tourism sectors. Authorities hope that this will lead to other investment projects in the Latin American market.
The government’s ability to tap the PIF to support capital spending means that it is able to reserve public funds. This capability is likely to prove particularly useful over the coming year, as the government adjusts its fiscal position in response to the global economic slowdown. In recent years the government’s principal financial concern has been reducing the fiscal deficit. It met with considerable success in 2019, reducing the shortfall from 5.9% of GDP in 2018 to 4.7% of GDP. The quickly evolving economic circumstances of 2020, however, make an increase in the fiscal deficit likely, although estimates vary. The government anticipates a budget deficit of SR187bn ($49.9bn) for the year, or 6.4% of expected GDP, despite a SR50bn ($13.3bn) cut in public spending. A Bloomberg survey of economists, meanwhile, put the median fiscal deficit at 7.1% of GDP in 2020. The eventual result will depend largely on the movement of oil prices during the year. According to JPM organ Chase & Co, Saudi Arabia could potentially run a budget deficit of 23% of GDP if Brent crude prices average $20 per barrel throughout 2020, while its current account shortfall would reach 15.6% of economic output, or $122bn. In February 2020 Samba Financial Group predicted that oil prices would recover from the initial plunge caused by the pandemic and heightened supply – which resulted in prices of $25-30 per barrel in mid-March – to average $62 per barrel over the course of the year. This would contribute to a 5% increase in capital spending and 9% growth in the public sector wage bill, driving an overall 4% gain in government spending.
Bridging the Gap
The Kingdom’s long-term financial strategy remains focused on narrowing the fiscal deficit, and the government has reaffirmed its commitment to achieving a balanced budget by 2023. In 2019 total financing requirements for the 2020-24 period were estimated at SR763bn ($203.4bn). This compares to the SR1.24trn ($330.6bn) required for 2015-19. Foreign exchange reserves in excess of SR615bn ($163.9bn) and total reserves of over SR1.8trn ($479.9bn) as of February 2020 will provide a useful cushion as the Kingdom seeks to meet its spending commitments. The government’s ability to bridge the fiscal gap without depleting its reserves is considerably stronger than it was as recently as 2016.
Since that time the National Debt Management Centre has overseen a rapid expansion of the Kingdom’s sovereign debt programme. The nation’s first international bond sale in 2016 raised $17.5bn in a heavily oversubscribed offering. Another milestone was passed in 2017, with the issuance of Saudi Arabia’s first dollar-denominated sukuk (Islamic bond), which was sold in two, $4.5bn tranches with tenors of five and 10 years. In 2019 the Kingdom offered $13.4bn in euro- and dollar-denominated bonds. This is more than any other emerging market aside from Turkey, according to a report by Bloomberg.
While credit ratings agency Fitch downgraded Saudi Arabia’s sovereign credit from “A+” to “A” in September 2019, citing rising geopolitical tension in the region following an attack on its oil facilities and a deterioration of the Kingdom’s fiscal position, appetite for Saudi debt has remained strong. The first eurobond issuance of 2020 came in January, with a $5bn offering that was heavily oversubscribed. The MoF indicated at the time that $32bn of local currency and international debt would be sold over the year, although these plans are subject to change due to the rapidly changing environment in the first half of 2020. The government’s debt portfolio includes conventional and sharia-compliant instruments, denominated in dollars, riyals and euros. The string of issuances has also established a 30-year yield curve from which the corporate sector can more accurately price its offerings.
Inflation & Monetary Policy
The Kingdom’s inflation rate has remained relatively static over recent years, despite the introduction of value-added tax (VAT) in January 2018. Consumer prices rose gradually in the second half of 2019, and in December they nudged into positive territory for the first time in a year. Inflation data for 2019, however, shows a negative trend of around -1.2%. This is largely explained by the distorting effects of implementing VAT and a shrinking expatriate rental market. Taking these factors into account, most concur that inflation followed a modest upward trend for most Saudi nationals in 2019, with education costs, furniture, restaurant meals and recreation showing the steepest growth. Forecasts for 2020 fall between 1.3% and 1.4%, with downward pressure coming from lower prices in the transport, restaurant and hotel segments.
The currency peg between the Saudi riyal and the US dollar means that Saudi Arabian monetary policy is coordinated closely with that of the US Federal Reserve. One of SAMA’s main priorities is avoiding currency flight by ensuring that no sufficient discount emerges between the US dollar and the riyal. When capital outflows become a possibility, SAMA may pre-empt the Federal Reserve by altering its repurchase (repo) and reverse repo rates, but in general its rate actions follow those of its US counterpart. SAMA also uses the deposits it places with local banks as a tool to control the level of liquidity in the banking system, with the aim of maintaining parity between the local interbank rate and the US dollar equivalent.
In light of rapidly deteriorating risk assessments caused by the Covid-19 pandemic, in early March 2020 the Fed announced an emergency rate cut of 50 basis points (bps). SAMA followed suit by effecting a cut of 50 bps to key interest rates. As of April 2020 the repo rate stood at 1.75% and the reverse repo rate at 1.25%.
Public spending has traditionally been a key driver of economic growth. Any decrease in revenue caused by lower oil prices is therefore a significant challenge and presents a downside risk for the economy. Actions taken by the government to mitigate the effects of both the oil price scenario and Covid-19 are substantial. These will support non-oil growth and ensure a social safety net for citizens in the short term, while in the longer term the Kingdom’s increasingly diverse economy is expected to benefit from the implementation of Vision 2030 objectives. The ability of the government to nurture domestic investment and increase inflows of foreign capital will be an important test of its strategy over the medium term, and success here will allow it to carry out plans to reduce public spending. The spending cuts announced in early 2020 are subject to change over the year, as the government responds to developments in the global and domestic economies. The government has also planned spending cuts in 2021 and 2022 on the assumption that an increasing amount of economic growth will be accounted for by the private sector. The population growth rate of 2% will place upward pressure on public spending commitments and – as Samba has pointed out – countries undergoing privatisation phases have generally seen state spending rise in the short term.
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