Strategic Insight: Saudi Arabia Economic Reform

by Clive Newell

Saudi Arabia: Serious About Economic Reform?

With a budget deficit nearing 15% of GDP, oil prices staying low and military expenditure high, Saudi Arabia has little choice about embarking on a serious programme of economic reform. In part a grand strategy to reduce reliance on oil revenues, in part a series of urgent responses to alarming economic decline, Saudi economic reform has been formalised in recent months by a succession of government announcements. The most notable of these has been the National Transformation Programme outlined by Deputy Crown Prince Muhammad bin Salman in June, following on from his longer-term “Vision 2030” set out in April. The whole package is seen by most observers as an indication that Muhammad bin Salman is in a position of unprecedented power, with more control of policy and practice than any individual below the king since the state was founded.

The National Transformation Programme

Economic diversification has long been a stated goal in the kingdom, spurred by the realisation that oil reserves are dwindling. A series of measures were brought in under the late King Abdullah to stimulate the development of both downstream industries and non-oil sectors. The new programme, passed by the cabinet and the Council for Economic Development in early June, aims to achieve wider-reaching goals.

The programme, budgeted at over US$60 billion, contains around 500 new measures to promote revenue for the state. These include tripling non-oil revenue (currently around 30% of the total) and creating 450,000 jobs outside the public sector. The public sector wage bill is to be reduced by 5%, the budget deficit wiped out and the state's assets grown by 60%. Value- added tax comes in next January for the first time, expatriate remittances are to be taxed and levies are planned on tobacco and sweet drinks. The plan envisages a significant contribution from the private sector.

The programme follows on the heels of a number of reform and austerity measures introduced in recent months. Most of the increases in subsidies, benefits and public sector pay decreed in 2012 to forestall any “Arab Spring” protest have been reversed. Petrol prices have risen (to about 20p a litre), and domestic fuel prices are set to go up. Plans to sell off a small stake in Aramco were announced amid great fanfare in April. Further sell-offs of state assets are envisaged in the new five-year plan. And – perhaps the most telling indication of the dire state of the government's finances – a bond issue took place in October. The US$17.5 billion raised was immediately put into service to pay long-delayed debts to contractors on stalled state projects.

Politics

Unsurprisingly, the recent austerity measures have not been popular. The dismissal of the long- serving finance minister, Ibrahim Assaf, is seen by many as a response to the hostile public reaction to the measures, even though it was Assaf who championed the pay rises four years ago.

Assaf's successor is Muhammad al-Jad'an, the stock market regulator, who many Saudi- watchers say has become a loyal ally of the Deputy Crown Prince, like several other senior government figures appointed over the last 18 months. Muhammad bin Salman's stock has risen over that time in more or less inverse proportion to that of Crown Prince Muhammad bin Naif, who now looks increasingly marginalised. How long this state of affairs will last is difficult to predict. But few observers of the kingdom doubt that Muhammad bin Salman's control of the economy – and much else besides – hinges on the success of his five-year plan. If the present economic deterioration has not been significantly ameliorated in that time, the positions of the two princes are likely to be reversed.

King Salman himself seems to be a spectator in all of this; in poor health and, many say, struggling to keep his grasp on reality, leaving Prince Muhammad, his 31-year-old son, in day- to-day charge of much of the state apparatus.

Foreign Policy and the Price of Oil

The fall in oil prices is the root cause of Saudi Arabia’s economic difficulties, yet up until very recently almost nothing had been done to combat it. Interpretations vary but the underlying strategy seems to have been to try and weather the storm in the hope that low prices would drive many shale oil producers out of business, but at the same time sustain Western economic recovery enough to maintain both demand in the oil markets and political and military support for Saudi foreign policy.

While the second aim has largely been achieved, most shale oil producers have been able to keep going, bearing their burden of debt rather better than Riyadh has done. But there are signs now that the Saudis are about to change tack and agree to a modest cutback in production at the next OPEC meeting at the end of November. They hope that this will combine with winter in the northern hemisphere driving up demand to shore up prices at a level above US$50 a barrel.

There are also foreign policy factors driving Saudi Arabia’s oil strategy, not least its deeply ingrained fear of Iran. On the one hand, Saudi policy-makers see that preventing OPEC from curbing production has allowed the Iranians to recover some of the market share they lost during sanctions. On the other, they fear that Tehran may cheat on any future agreement to cut output.

The same distrust of Iran lies behind Saudi Arabia’s flawed policy towards Syria and Yemen. In the case of Syria, heavy Saudi investment in sections of the armed opposition to the regime, a major ally of Iran, has been undermined by Washington's tolerance (unlikely to diminish under  the  Trump  administration)  of  increased  and  probably decisive  Russian  support for

President Assad. In the case of Yemen, Saudi involvement first drove the Huthis into the Iranian camp and then led to a disastrous and massively expensive Saudi military intervention.

Implications for Investors

Overall, the new economic plans could well mean more opportunities for investors to find profitable roles in the Saudi economy. Sectors such as downstream, mining, electronics and white goods are likely to be seeking increased foreign investment in the relatively short-term. But continuing uncertainty over oil prices, coupled with a lack of inclination to rethink foreign policy, are inhibiting factors that might urge caution. The IMF forecasts 1.2% GDP growth in 2016, one-third of the 2015 figure, underlining the need for a long-term approach.

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Clive Newell
Clive draws on his extensive overseas experience in leading many of G3's assignments in the Middle East, South Asia and Africa

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