Saudi Arabia’s new economy: Too much, too fast?

Saudi Arabia’s new economy: Too much, too fast?

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 second post takes a closer look at the risk environment, from the challenges of fiscal reform, to stewardship of the energy sector, and maintaining a careful social balance. Read Part 1 here.

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.

Policy continuity risks

Fiscal reform has been implemented quite rapidly, perhaps to the detriment of the economy, with the likes of the International Monetary Fund (IMF) even advising the Kingdom to slow down as economic growth halts to about 0% in 2017. A significant drop in consumer spending led to a reversal of public sector wage cuts within months of their implementation, and plans to phase out gas subsidies have been put on hold.

In light of this, the National Transformation Plan 2.0 will be unveiled by the end of this year and will adjust the timeline of implementation targets, extending from 2020 to 2025 and 2030. On the one hand, this is an example of prudence and recognition that some targets were overly ambitious and aggressive, thus having a potentially adverse effect on the economy. On the other hand, it may be an early indication of policy uncertainty that is anathema to investors, who likely are already concerned over the economic recession, pushback from the religious/conservative establishment and tensions within the royal family after the ouster of HRH Prince Mohammad bin Nayef from his role as Crown Prince in June 2017.

International bond offerings have bred confidence and plugged gaps in the fiscal deficit, while slowing down the decline of foreign reserves (that have fallen about 1/3 since the oil price crash). Deflation is a big concern as consumer prices have dropped and the economy stagnates. However, the implementation of VAT and taxes in early 2018 should spur inflation, while the exchange rate peg to the US dollar remains appropriate despite concerns that the Saudi riyal could fall in the forward foreign exchange market.  

The main risk in this scenario is one of policy continuity and execution, which will need to be tempered by a focus on initiatives to improve growth rather than strictly fiscal improvement measures (i.e. taxes, subsidies).

Aramco IPO

Saudi Aramco is the world’s biggest crude exporter and the crown jewel of the Saudi economy. The IPO of this state oil company, which could be the world’s biggest, is a key catalyst of Vision 2030, expected to fetch $100 billion (5% valuation by MbS) for the Public Investment Fund to invest in various sectors of the Kingdom’s economy, including domestic arms manufacturing, mining, tourism, housing and entertainment. However, there is some skepticism about the company’s valuation (McKinsey estimated $781 billion in 2015) and concerns about achieving the transparency needed for listing on the world’s largest stock exchanges, such as New York and London.

Recent claims that an IPO may be shelved for a private placement to Chinese investors has rattled the international community, requiring a swift denial from Saudi Energy Minister Khalid al-Falih and assurance that the IPO is on track. However, further delay to 2019 or foregoing international capital markets are plausible risks.

The Crown Prince is young and has the potential, once he ascends to the throne, to rule for decades to come, and therefore would be expected to eventually see an IPO through as part of a successful reform process, even if a private placement serves as a precursor.  The government is expected to shed more light on this during the conference the Future Investment Initiative Summit this week in Riyadh.

Russia saudi opec
Oil Prices and OPEC

The two aforementioned risks of economic stability and a successful Aramco IPO are predicated on oil prices and Saudi Arabia’s ability to steer OPEC. Saudi Arabia still relies heavily on oil revenues but are sticking to the output cuts pledged in the latest OPEC and friends deal (May 2017, extended to February 2018), where it has reduced output and exports to some buyers, including Asia where it has begun to lose market share.

The hope is to achieve higher oil prices/price stability and ensure the highest possible valuation for Saudi Aramco whilst reducing the budget deficit. However, the balancing act challenge is that higher oil prices would inadvertently assist shale producers from the US to continue producing oil at stronger margins. While it has been reported that $80 a barrel is the break-even price for the Kingdom, a “sweet-spot” for them is considered $60, where they can boost growth and the Aramco valuation whilst keeping the US shale producers second guessing whether to increase their own output.

The concern for oil price watchers is whether or not OPEC and non-OPEC members of the agreement will comply with their output pledges. Countries such as Iraq and Venezuela have domestic economic issues to contend with that may push them to renege on their voluntary pledges, whereas there are mounting calls for Nigerian and Libyan output to be capped as well (they are both currently exempt). Compliance has been problematic for OPEC over the years, but this year has already seen a strong improvement and maintaining 80%-100% compliance would be considered positive.

Conservative and Royal backlash?

The rapid ascent of Mohammed bin Salman to Crown Prince, and the manner in which he ousted his cousin HRH Prince Mohamed Bin Nayaf, has been met with some concern within the large Royal family. This has taken place just as the perceived rapid roll out of social reforms has faced pushback from conservatives, as the Shura Council’s power is eroded.

Social reforms, including the loosening of the male guardianship system, weakening of religious police and allowing women to drive by June 2018 have been met by support from the large youth population and some concern from the conservative populace.

The Crown Prince has sought to weaken opposition within the ruling family and religious establishment after upending decades of tradition, cracking down on dissent and arresting high profile critics, while defying conservatives by introducing entertainment initiatives and granting freedoms to women.

Herein lies a key battle between the Crown Prince and the religious clerics on the Shura Council. The Al Saud family came in to power in the early 1900s with the assistance of the Wahhabi establishment to legitimize its rule in the conservative Kingdom. These religious scholars would provide the formal legal justification for the Al Saud monarchy’s rule, thus carrying institutional power to check on the government’s compliance with Sharia law. Nowhere else has the authority demonstrated by the Shura Council been clearer than with the ban on women driving. Allowing women to drive undermines the authority of the religious establishment and consolidation of the Crown Prince’s power.

Risk of political turmoil

Thus, the clerics can either be flexible, be ignored, be arrested or decide to push back, perhaps working with disgruntled members of the royal family and stoking fears in the conservative populace to back a competing candidate. This could lead to immense domestic turmoil and put the whole transformation process at risk.

As Andrew Bowen of the American Enterprise Institute put it, “It’s essentially autocratic liberalization. On the one hand, he’s expanding social and economic freedoms, which are popular among the Saudi Youth, on the other hand, he’s narrowing the space for civil society and members of the royal family to criticize reforms.” The international community may welcome the country’s improvement in human rights on some aspects and condemn others, while the local liberal community may prefer the socio-economic liberalization and loosened grip of the conservative class at the expense of freedom of speech, as incongruous as it sounds.

If a conservative coup of sorts were to be mounted, would the Crown Prince have the means and support to thwart it, and what would it mean for investor confidence in the reform program?  

The Crown Prince has virtual control of all portfolios, from Defense to the Economy. Following the ouster of his cousin, Prince Mohammed established a new security department to consolidate his power further, called the Presidency of State Security. These measures and those preemptively taken to crackdown on subversive potential render any conservative fight a daunting task.

The youth factor

The sentiments on the ground in the Kingdom are a mixture of excitement, uncertainty and unease. A survey conducted by the King Salman Youth Centre late last year showed that young Saudis are optimistic about their future despite remaining concerned about employment prospects. On the question of reform vs fundamentalism, the adult public perception is about split on both sides.

The youth, now more connected via globalization and the internet than ever, are well aware of the social restrictions in their society relative to the rest of the globe. With one of the highest YouTube and Twitter engagement rates in the world, you can gauge the public reaction to reforms over the past couple of years instantaneously online – and the sentiment is generally positive, whether it was for Saudi Comicon, the Blue Man Group concert or the announcement of women driving. Indeed, one of the Saudi Twitterverse’s biggest influencers, @TurkiAldakhil (4 million followers) – though conservatively religious in some respects – spoke out in favour of allowing women to drive as early as 2009.

Saudi youth frequent malls and restaurants more freely, knowing they are no longer under scrutiny from religious police. They return from university studies abroad and are ready to become entrepreneurs, eschewing the traditional public-sector roles of their parents. Food trucks line the streets of Riyadh and Jeddah bringing in customers old and young, male and female, together to eat and take in an evening stroll. According to another poll this year, there is at least a quarter of Saudi adults who believe it is a “good idea” to “interpret Islam in a more modern, tolerant, and moderate direction.”

The young, bold leadership of HRH Crown Prince Mohammed bin Salman can count on grassroots backing for the Kingdom’s social reforms. As of now, the Saudi youth are content with the pace of social reform and will continue to support the Crown Prince’s reform efforts. However, if employment prospects don’t improve over the next year and youth unemployment continues to hover around 40%, it would be reasonable to expect the new generation to express their discontent online and potentially on the streets, emboldened by their newfound freedoms.

Watch for Part 3 tomorrow – our concluding segment on the outlook for economic reforms and the impact of regional conflicts.

About Author

Alex Damianou

Alex is an Analyst with over 5 years of experience conducting on-the-ground emerging market research and consulting across Africa & the Middle East, including Saudi Arabia, the United Arab Emirates, South Africa, Ghana and Kenya. He holds a Bachelor of Commerce degree from McGill University. Follow him @alex_damianou