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Saudi Arabia embarked on a program of reforms


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OBG, 29 December 2015

Falling oil revenues and an expanding budget deficit were the hallmarks of Saudi Arabia’s economic activity in 2015, as heavy investment in development projects widened the Kingdom’s spending gap.

The country also embarked on a programme of reforms aimed at broadening its economic base and increasing the flow of private investment. Results of the move, however, are not expected to be felt immediately, with growth set to ease in 2016 on the back of reduced government outlays.

The year began with the sad news of the death in January of King Abdullah bin Abdulaziz Al Saud. In the following months, his successor, King Salman bin Abdulaziz Al Saud, made several significant reforms, led by the replacement of the former government councils with two cabinet committees tasked with overseeing economic development and internal security, respectively.

The reform process comes at a time when Saudi Arabia’s economy is slowing on more modest energy earnings.

In addition to the paring down of government bodies, which is aimed at improving government services, officials are also looking at reducing energy and water subsidies, and imposing value-added taxes on consumer goods like cigarettes and soft drinks.

The Kingdom maintained high levels of oil output throughout 2015, which contributed to lower international energy prices. While per-barrel prices fell by 20% over the year, Saudi output averaged 10.2m barrels per day during the first nine months of the year, up from around 9.7m in the first nine months of 2014.

The strategy is thought to be aimed at shoring up market share against competition, though some analysts also view it as a tactical move to put pressure on US shale oil producers, whose production drove down Saudi exports to the US by more than 30% in 2015.

Late in the year, the government hinted that it might step back from this policy, and issued a statement in November announcing a desire to work with other producers to reverse the fall in energy prices.

While a scaling back of production could be one response to lower oil prices, the Kingdom is likely to be wary of any strategy that permits competing producers, such as Russia or Iran, to strengthen their market share.

Fiscal focus
The IMF expects Saudi Arabia’s GDP to expand by 3.4% in 2015, though growth is projected to ease somewhat in 2016, slowing to 2.2% as government spending is scaled back and several big-ticket development projects reach completion.

According to estimates from credit ratings agency Standard & Poor’s (S&P), the Kingdom’s fiscal deficit is expected to reach 16% of GDP in 2015, a marked increase from the 1.5% recorded in 2014. The finalisation of several of its one-off investment projects ¬– such as the new Prince Muhammad bin Abdulaziz International Airport in Medina, completed in 2015 – should allow the government to rein in its fiscal deficit in 2016.

To help bridge the spending gap, the government turned to capital markets, offering a SR15bn ($4bn) sovereign debt issue in mid-July, its first since 2007. As of November, the government had raised at least SR55bn ($14.7bn) through bonds sold to local banks and institutions, according to media reports.

Concerns over falling oil revenue and a widening budget deficit prompted some international credit ratings agencies to revise their assessments in the second half of the year. In late August Fitch downgraded Saudi Arabia’s outlook to negative, while S&P lowered its long-term foreign currency sovereign credit rating from “AA-” to “A+” in late October, with a negative outlook. Moody’s, however, maintained its “Aa3” rating with a stable long-term outlook in November.

Opening up to investment
Although fiscal pressures are expected to continue into 2016, financial and tax reforms are poised to attract private investment across other areas of the economy.

On June 15 new regulations came into effect permitting approved foreign banks, brokerage houses, fund managers and insurance companies based outside of the GCC to directly invest in the Saudi stock exchange. Previously, only GCC investors had been able to trade directly on the Tadawul, with others forced to do so indirectly through swaps or exchange-traded funds.

However, restrictions on the types of investors that can participate have partly limited the influx of investment to date. Currently, international investors looking to enter the Kingdom are required to have at least $5bn of assets under management and a five-year investment track record, though officials suggested in October that the bar could be lowered. This could help the exchange’s efforts to join global indices, such as the MSCI Emerging Market Index.

Another reform, a proposed 2.5% levy on undeveloped land in urban areas, could help generate new revenue for the state, while also stimulating building activity. According to some estimates, the measure would raise up to SR75bn ($20bn) in the first year. This could also help cut down on land hoarding and speculation, and encourage residential construction, thereby easing the current housing shortage.
Oxford Business Group
29 December

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