Saudi Arabia: From Here To Modernity

When prominent oilman Everette Lee DeGolyer, founder of applied geophysics in t h e petroleum industry, surveyed the Gulf as part of the war effort in 1943 he was quoted as declaring that “The oil in this region is the greatest single prize in all history.”

However, international investors may no longer agree. There is no getting away from the fact that Saudi Arabia has made some serious diplomatic faux pax in 2018. From squabbles with Canada and Germany to the incident in Istanbul that caused some of Saudi Arabia’s biggest foreign business partners to snub its headline conference in October 2018, it has been tainted by controversy.

Saudi Arabia is working hard to win back the world’s confidence and woo investors. In January, it advertised a SAR 1.6 trillion ($429 billion) investment opportunity in its infrastructure and industrial programme. “It is quite ambitious, but it is over a 10-year period, so we have the time to do it,” said Energy Minister Khalid al-Falih, at a press conference last month.

The Kingdom has also put the long-awaited listing of state-owned oil giant Aramco back on the table. At the time of DeGolyer’s survey, many thought he was exaggerating; however, his estimates have since proved quite conservative. A thorough audit by the petroleum consulting company later found that Saudi Arabia’s oil wealth is even more humongous than previously thought

Taking Stock

In a giant leap towards transparency, the Saudi authorities commissioned the independent assessment by DeGolyer and MacNaughton. The move paid off. The audit showed that state controlled Aramco, previously painted as a secretive giant, had 263.1 billion barrels of oil waiting to be tapped at the end of 2017—2.2 billion barrels more than it reported in its last annual review.

Aramco’s natural gas reserves stood at 319.5 trillion cubic feet, up from the 302.3 trillion cubic feet previously reported. “This certification underscores why every barrel we produce is the most profitable in the world, and why we believe Saudi Aramco is the world’s most valuable company and indeed the world’s most important,” Energy Minister, Khalid Al-Falih, said in a statement posted by Saudi’s state news agency.

Saudi Arabia has been dancing around Aramco’s IPO since Crown Prince Mohammed bin Salman first floated the plans in 2016. The historic IPO, which would be the largest in history, has been delayed by a series of indecisions about where to list it and a failed effort to attract an ambitious value of $2 trillion.

Saudi Arabia has silenced its doubters, the Crown Prince is hoping to raise $100 billion from the IPO to fund his ‘Saudi Vision 2030’, which has bought the Kingdom much positive press. However, with oil prices heading upwards, there is no rush and Aramco’s stock market debut has been pushed back to 2021.

Good budgeting

Saudi’s budget for 2019 also contained some crowd-pleasing surprises. It was announced that the Government would keep paying its citizens cost of living allowances and increase state spending by more than seven per cent to SAR 1.11 trillion ($295 billion) in 2019.

Mohammed Al-Jadaan, Minister of Finance, said, “the 2019 Budget illustrates the strength and resilience of the Saudi economy, and the continued efforts to improve government performance levels, enhance spending efficiency, adopt the highest standards of transparency and implement comprehensive reforms.

Saudi citizens are always the top priority in all government efforts to build a stronger economy and to promote economic and social development in the medium term.” Saudi Arabia’s Government can afford to be generous. It predicts that revenues will rise nine per cent to SAR 975 billion this year.

The 2019 budget deficit is estimated to amount to SAR 131 billion (4.2 per cent of GDP), which is lower than the expected 2018 deficit of SAR 136 billion (4.6 per cent of GDP). This has impressed observers.

Following the pre-budget statement in September, the IMF raised its projections for economic growth in Saudi Arabia to 2.4 per cent, 0.5 percentage points higher than it predicted last April, thanks to “a pickup in non-oil economic activity and a projected increase in crude oil production.”

Moody’s Investor Service has been even more enthusiastic, raising its GDP growth forecasts for 2018 and 2019 to 2.5 per cent and 2.7 per cent respectively, quite a jump from its previous expectations of 1.3 per cent and 1.5 per cent.

The rating agency’s revised numbers are even more optimistic than the Saudi Government’s, which estimates that real GDP will grow by 2.6 per cent in 2019 compared to 2.3 per cent in 2018. Both the IMF and Moody’s enthused about the Kingdom’s plans to diversify its economy away from oil. S&P noted a substantial improvement in projected current account surpluses.

It expects that Saudi Arabia’s liquid external assets, net of external debt, will average about 200 per cent of current account payments over 2018-2021. “This figure has weakened somewhat, because we expect an increase in public sector external debt, following the Public Investment Fund’s raising of an $11 billion syndicated loan in September 2018,” the rating agency said.

“Gross external financing needs will likely remain below 40 per cent of the sum of usable reserves and current account receipts over the same period, suggesting ample external liquidity. and higher foreign currency reserves than we had previously projected.” Early indications suggest that the Kingdom’s diversification efforts are already paying off.

In 2018, there was a 12.4 per cent increase in non-oil revenues. The contribution of non-oil revenues to the overall total has surged from 12 per cent in 2014 to 32 per cent in 2018. However, these figures may not be as pleasing to the citizens of Saudi Arabia, as the rise in revenues largely came at their expense.

Last year kicked off with the introduction of a five per cent VAT, a 130 per cent hike to petrol prices, increases to household electricity tariffs and an increase in levies on expatriates. Moody’s highlighted that revenues in the first half of 2018 rose by 43 per cent compared to the same period in 2017.

Hardly surprising, as average oil prices were around 37 per cent higher than in 2017, and proceeds from tax revenues on goods and services tripled. Efforts have also been made to improve the business environment and promote SMEs and financial sector reforms, the World Bank cheerfully noted in its Economic Outlook for the Kingdom.

A draft law on private sector participation was published for public feedback in July 2018, a good move towards greater transparency.

Labour pains

Critical reforms are also underway in the labour market. A large quota-based policy for Saudi nationals has shown positive results in terms of increasing employment of Saudi nationals, including women, in the workforce; however, it faces broader questions in terms of its impact on private sector growth and productivity.

Some consequences are already painfully clear. Levies on expatriate labour in Q1 2018 and other disincentives for expatriate employment have resulted in nearly a quarter of a million foreign workers leaving Saudi Arabia, especially in construction. “A key challenge relates to the provision of adequate labour to support sustained growth,” the World Bank wrote in a recent study.

“There is significant churn in the labour market with the ongoing departure of expatriate labour, but job creation for nationals has been lagging, and the number of workers in the private sector has declined for the first time since 2005.” However, Fitch believes the pain will be short-term.

“These reforms are targeted at recharging the Saudi economy by finding ways to reduce the high levels of unemployment by giving women and Saudi nationals, rather than expats or migrant workers, a greater opportunity to enter the labour force,” it said. In particular, the government is focusing on retail and consumer facing sectors for job creation, as the country aims to add 1.2 million jobs to the economy by 2022.

The first phase of Saudisation went into effect in September 2018, when car dealerships and sellers of clothing and furniture were required to employ locals for 70 per cent of jobs. The second phase started in November 2018, which covered electrical and electronics shops, watch shops and optical stores.

The third and most recent phase went into effect in January 2019, with jobs in building material shops, medical appliances and equipment shops, autos spare parts shops, carpet shops and confectionery shops and patisseries, becoming nationalised.

“While these measures will increase labour costs for companies over the short-term, and will likely result in scaling back expansion or even closures of stores owned by expats, the Saudi nationalisation agenda will reduce unemployment, particularly among youths, boosting job and wage prospects for the Saudi population,” Fitch said.

The sweeping socio-economic reforms are partly rooted in efforts to boost the Saudi economy, including encouraging Saudi citizens to spend their money domestically rather than travelling to neighbouring UAE and Bahrain for their retail therapy.

Furthermore, the social liberalisation and reforms are also a way to soothe its large young adult population, whom the Crown Prince is counting on for support. The Government has also been making efforts to nurture its small businesses, which are the lifeblood of its economy.

SMEs account for around 95 per cent of registered businesses, 38 per cent of jobs (of which 80 per cent are held by expatriate workers), 20 per cent of GDP, and only about two per cent of bank lending. The IMF hopes that the expansion of private equity and venture capital, including through the recently established Fund of Funds and SME investment fund, and the restructuring of the Kafalah loan guarantee programme will help improve SME access to finance.

Two become one

There have also been exciting developments in Saudi Arabia’s banking sector, with the first merger in nearly two decades signed and sealed. In October, the boards of Saudi British Bank (SABB) and Alawwal Bank approved a binding agreement to merge the two institutions, creating what will be Saudi Arabia’s third largest bank.

Moody’s said it should be a happy marriage, which will provide increased diversification and lending opportunities in a slow economic environment. Although banks in Saudi Arabia are sparser than in other GCC countries, they have struggled to drum up business.

Credit and deposit growth remain weak, according to the IMF, but both are expected to strengthen due to higher government spending and non-oil growth. “Bank profitability should increase as interest margins widen, and banks remain well capitalised and liquid,” the IMF said. Consumer confidence continues to grow across the Kingdom, according to Fitch.

Overall, consumers are now more optimistic about the state of the economy than they have been in the past year. This is reflected in the growth in point of sales transactions, with the second half of 2018 reporting significantly high growth rates, reaching a high of 28.1 per cent y-o-y in December 2018.

Consumer loans rose by 5.1 per cent in in the third quarter of last year, having returned to positive territory in the second quarter following five consecutive quarters of either flat or negative growth. Total credit card loans have also seen significant growth, with growth rates above 20 per cent for the three quarters in 2018.

“Although factors such as expat outflows and political uncertainty may offset these positive trends to some extent, we still expect higher confidence levels and rising credit uptake to support an acceleration in private consumption growth over the coming years,” Fitch said.

Nonetheless, Saudi Arabia still has its work cut out convincing the world that it is a safe bet. “In our view, political risks are high compared with peers and historical norms, due to Saudi Arabia’s prominent role in a volatile region, the country’s increasingly assertive and unpredictable foreign policy and the rapid pace of change domestically,” Fitch said.

S&P has also voiced concerns. “We expect the longstanding tension with Iran to remain high,” it said. “Saudi Arabia’s war in Yemen contributes to military and security services being the single largest spending item, at about 30 per cent of total government expenditures. We do not expect any of these foreign policy challenges to significantly impact the domestic economy.

Rather, we believe that they add to the government’s already heavy policy programme, which could weaken its commitment to its fiscal adjustment plans.” Higher oil revenues could also distract the Government from its diversification efforts.

“Going forward, more favourable oil prices may weaken the drive to tackle public-sector compensation, which distort labour market incentives in the country,” the World Bank said. Saudi Arabia also needs to attract vast investments to stoke its Vision 2030. To do this, it needs to keep up the momentum for political and social reforms. Otherwise, the world may decide that what was once the greatest prize in history is now the booby prize.