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Seeking longer term economic stability in Saudi Arabia

12, Apr. 2016 News

"Despite favourable signs of political will and economic progress from government efforts aimed at strengthening non-oil sectors, the economy remains vulnerable to oil price movements."

An article written by Mr. Nadim Kabbara, Head of Research at FFA Private Bank, and published by MENA Fund Manager April 2016 issue in which Mr. Kabbara discusses the economic stability in Saudi Arabia in light of today's challenges.

After a decade of energy driven growth, abundant job creation and generous public spending, helping to pave the way for Saudi Arabia to become one of the G20’s fastest growing economies as its citizens boast an improved standard of living, its longer term sustainability is being challenged from slower economic activity, weaker fiscal balances and rising geopolitical risks. With high national unemployment and an increase in the working-age population expected over the next decades in need of absorption into the labour market, energy revenues accounting for the majority of fiscal revenues are no longer sufficient to overshadow the domestic economy’s vulnerabilities that reflect an over sized public sector which is lacking private sector attractiveness, lesser skilled and productive labour force, and inefficient government spending in key strategic sectors including healthcare and education.

Despite favourable signs of political will and economic progress from government efforts aimed at strengthening non-oil sectors, the economy remains vulnerable to oil price movements. The IMF revised its economic growth estimates lower for 2015 and envisions this year at such low levels not seen in over a decade, as Standard & Poor’s recently downgraded its sovereign credit ratings with peers likely following suit. While the domestic banking system is so far coping, albeit in a more challenging operating landscape, and macro prudential policies are supportive of domestic socioeconomic stability, this new setting highlights the need for structural reforms and fiscal consolidation, necessary to ensure longer term economic sustainability irrespective of the future development in energy prices.

Although significant public spending has been earmarked towards the development of human capital in recent years with education ranking high in government budgets, economic returns on these investments remain below potential since the private sector remains highly dependent on low-wage, low-skilled foreign labour. The public sector, which employs the majority of Saudi nationals, continues to see discrepancies between skill level, productivity and costs. The dependence on oil revenues over the past years has biased the incentive structure in the economy and crowded out non-oil sectors which remain underdeveloped and could represent possible engines of growth for a more balanced and less petrodollar-based economy.

A decrease in public sector employment from a more energized private sector would also contribute to a much-needed adjustment in public spending. With the significant decline in oil revenues over the past 18 months or so, coupled with increased military and security spending in neighbouring Yemen and government employee bonuses following King Salman’s throne ascension, Saudi Arabia’s budget defi cit deteriorated significantly following years of surpluses. While the kingdom has already engaged on politically sensitive measures including subsidy cuts in energy and other utilities – which should help lower its fi scal breakeven oil price – and also tapped domestic credit markets to help cushion its public fi nances, there remains opportunity to continue on the road of fi scal consolidation ranging from new forms of taxation including VAT to the privatization of some state-owned enterprises.

The development of a comprehensive fiscal and structural policy is necessary to ensure economic sustainability in the long run, a plan in which a thriving domestic private sector would share the burden, constitute a larger share of the work pool, and ultimately increase breadth of the tax base. Liberalising markets and strengthening regulatory and legal frameworks to help promote trade, private-public partnerships,foreign investments, and development of capital markets. The recent oil crisis could provide the argument to institute much needed although not always popular reform while its sizeable foreign assets and limited sovereign indebtedness the scope to move forward towards greater sustainability of its finances and prosperity of its citizens.