As the landmark Future Investment Initiative summit kicks off in Riyadh on 24 October, GRI presents a special 3-part series on risks and opportunities in the Kingdom. Our first post examines the state of the economy, and the top sectors ripe for investment.
The Kingdom of Saudi Arabia is well into its generational transformation of the economy and society. Vision 2030, an ambitious reform plan aiming to diversify the country away from oil dependency, was launched by the young Crown Prince Mohammed bin Salman in 2016 and has been executed by a framework and targets set out in the enabling National Transformation Plan. Since then, social and economic reforms have been announced and carried out at break-neck speed, almost too rapidly for the economy and society to absorb.
A new non-oil economy?
An economy that relied on its vast oil reserves and high oil prices to drive state spending was for decades able to function sustainably, with more than 60% of the labor force employed by the public sector and 80% of government revenues derived from oil proceeds. Yet, the halving of oil prices from their above $100-dollar barrel days in 2014 to the mid $50s seen today has given the Kingdom impetus to chart a new course, spearheaded by the ambitious, young, reform minded Crown Prince.
Saudi Arabia Export Treemap from MIT Harvard Economic Complexity Observatory
Austerity measures have been enacted and government spending reined in, in an effort to reduce the budget deficit that shot up to 17.2% of GDP in 2016 to an anticipated 9.3% of GDP in 2017 and 1% by 2022. This fiscal adjustment required cuts to utilities subsidies, slashing of public sector wages, and a reduction in capital spending that included the postponement of major public infrastructure projects. Excise taxes on soft drinks and tobacco, levies on expatriate workers and the impending introduction of a Value Added Tax (VAT) in January 2018 all signal the swiftness and seriousness of the government’s efforts to tackle the fiscal deficit. Additionally, the Kingdom has tapped the international bond markets for $39 billion over the past year through international bond issues and local sukuks, signaling investor confidence and utilizing another tool to bridge the budget deficit.
However, measures to improve non-oil growth to balance out the “Fiscal Balance Program” have not proven adequate. Along with persistent low oil prices, fiscal consolidation has lead the Kingdom to a recession in Q3 2017 and projected GDP growth of close to zero for the end of the year. Unemployment has jumped to 12.7% for Saudi nationals and that number hovers around 40% for the burgeoning youth population.
Accelerating social and economic reforms
The government has sought to ease the tough economic environment by accelerating social reforms, including women’s right to drive, loosening of the male guardianship system, establishing an entertainment authority that has already hosted concerts and festivals, diminishing the authority of the religious police and more. Bringing women into the workforce should also aid the economic recovery, with the driving ban removal alone expected to add about $90 billion of output by 2030, reducing the outflow of remittances from foreign drivers, thereby contributing to an improving current account balance.
Vision 2030 and the National Transformation Plan target service sectors such as tourism and entertainment as main drivers of economic diversification, along with mining and renewable energy. The plans set numerous initiatives (500+) and targets (300+), acknowledging the role the private sector must play in carrying out projects while setting out a large-scale privatization plan across industries such as transportation, healthcare and education. However, while big ticket tourism projects in Jeddah and on the Red Sea are announced, many are dependent on the Public Investment Fund and more importantly the funds expected from the impending Saudi Aramco IPO (5% stake for $100 billion if the Crown Prince’s valuation proves correct). Given the insufficient non-oil growth to offset the impact of lower oil output or to reduce unemployment, it is clear that the government must accelerate efforts to open up to foreign investment to fill the gap.
So, why should investors care about the Saudi market and which sectors would provide opportunities?
Industries ripe for foreign investment
Tourism & Entertainment
The Kingdom sees tourism as a big driver of diversification and job creation going forward, across numerous segments. Today, travel and tourism accounts for about 10% of GDP and under the Vision 2030 goals, the Kingdom aims to increase the number of visitors from 18 million in 2016 to 30 million by 2025, a significant amount of which are expected to be religious tourists visiting the Two Holy Mosques at Makkah and Madinah. Efforts to accommodate the new capacity are underway in the form of an expansion of the King Abdulaziz International Airport in Jeddah and the opening of the almost completed Haramain Rail Train, linking Makkah, Jeddah and Madinah. In fact, the PIF recently announced the establishment of two new companies – Rou’a Al Haram and Rou’a Al Madinah – to increase religious tourism revenues by developing residential and commercial areas around the Grand Mosques in Makkah and Madinah.
Leisure and business tourism are segments that are also being prioritized, especially on the Red Sea city of Jeddah. The recently announced Red Sea Project, which aims to transform 50 islands for luxury tourism, has garnered international attention, even prompting interest from billionaire Sir Richard Branson. Business visas are easier to come by as red tape is reduced.
It is estimated that about $25 billion was spent abroad by Saudi tourists looking for leisure and entertainment destinations that have been lacking in the Kingdom. It is the hope that new initiatives, spearheaded by the recently established General Authority for Entertainment, will recoup some of this spending and drive domestic tourism. Concerts, festivals, exhibitions and more have already been held across the Kingdom, and plans for cinemas as well as new theme parks such as a Six Flags within an entertainment city outside of Riyadh, are on the table.
BMI Research reports that Saudi Arabia is likely to compete with the UAE for leisure, entertainment, and luxury tourism over the long term, with the firm forecasting the Kingdom’s growth in tourism arrivals of 12.8% in 2017 to 15.6% annually by 2021 and over 41 million arrivals. There are over 60,000 hotel rooms in the pipeline across Saudi Arabia today, with half expected to open in 2017 alone.
Retail
Household spending in Saudi Arabia is relatively high given disposal incomes, lack of taxes and a dearth of entertainment options. For this reason, restaurants and malls have become destinations of not just shopping but family outings, serving as a main source of social and cultural entertainment. As a result, super-regional malls are in the pipeline in major cities such as Jeddah, Riyadh and Dammam, adding hundreds of thousands in gross leasable area to meet the rising demand of retail space in the Kingdom. In Jeddah for example, there is a clear shortage of retail offerings, as GLA per capita is a meagre 0.36 sqm compared to UAE’s 0.60 sqm per capita and Qatar’s 0.5 sqm per capita. As Jeddah positions itself as a tourism hub, the retail market is forecasted to reach $50 billion by 2025, from $20 billion in 2015.
Jeddah Tower, March 2016
Real Estate
The real estate sector has been a very profitable tool for locals and GCC residents over the years, as plots of land would be traded daily for millions of dollars without any subsequent developments, leading to inflated land prices. This practice has waned, and as a way to spur development, the government introduced a White Land Tax in 2016 that places a 2.5% tax on undeveloped plots of land. There is actually a shortage of middle income housing units of 1.5 million units that may reach 4.5 million within a decade if new stock doesn’t start rolling in.
Furthermore, there are numerous large scale mixed-use urban developments across the Kingdom that are either under development or in the pipeline and open to alternative sources of capital, such as King Abdullah Economic City, King Abdullah Financial District, Knowledge Economic City, Prince Abdulaziz bin Mousaed Economic City, Entertainment City, Al Faisaliyah, Jeddah Economic City (home to the world’s tallest Jeddah Tower at over 1 km and currently under construction) and more. The government has realized the need for diverse funding sources, with Real Estate Investment Funds and Real Estate Investment Trusts recently introduced, as part of the Kingdom’s efforts to improve real estate contribution to GDP from 5% to 10% annually and allow non- resident foreign investors to trade in REIT units and invest in REIFs.
Healthcare & Education
The fundamentals of any society that wishes to transform to a knowledge based economy are healthcare and education. Both have been predominantly state run to today, however, they are now targeted from privatization by the government. All hospitals are to be privatized and new schools from primary to university are encouraged to be privately funded. Currently, only expatriates are required to hold health insurance but new legislation is expected to allow nationals in the private sector to obtain coverage as well.
Renewable Energy, Nuclear Power and Mining
As Saudi Arabia weans off its “addiction to oil”, it has the potential to diversify its energy sources by tapping in to the huge potential of solar and wind energy that showers the Kingdom daily. The government aims to move from the immaterial amount of installed capacity today to 9.5 gigawatts (GW) by 2023 and 41GW by 2032, with a mix of solar and wind. The renewable energy program expected to be launched by the end of the year will require between $30 – $50 billion in investment by 2023 and $109 billion by 2032. Additionally, the Kingdom is seeking out partners to develop nuclear reactors with a tender to be issued by 2018 and an eye on reaching 17.6GW of nuclear capacity by 2032, according to the government agency tasked with nuclear plans, the King Abdullah City for Atomic and Renewable Energy (KACARE). As for mining, Saudi Arabia has identified significant mineral deposits across the desert Kingdom and plans to invest $35 billion in a mining and minerals processing complex.
Going forward
The Kingdom has the demographic fundamentals (see Part 3) and the political will to see out a reform program that investors will find appealing and reassuring. If efforts to liberalize the Kingdom are executed effectively, investors can stand to gain in the long run by contributing to the Kingdom’s transformation. However, this will require maintaining social stability, balancing conservative and progressive elements, and successfully boosting oil prices.
