Saudi Arabia’s economic reforms have to beat the clock
Unlike economic transformations spread over 20 years, it needs to do so in much less
London , United Kingdom of Great Britain & Northern Ireland - 7 Oct 2016 - Gulf News
Saudi Arabia has long relied on oil to fuel its economic growth and development. Last year, oil accounted for about three-quarters of the Kingdom’s total export revenues and around 90 per cent of government revenue. But the recent collapse in oil prices highlighted what should long have been clear: Saudi Arabia, like the other oil and gas rich nations of the Middle East, needs a more diverse development model.
Since oil prices began to drop in mid-2014, Saudi Arabia has experienced a sharp decline in GDP growth, as well as lower liquidity and credit growth. Fiscal and current-account surpluses were transformed into deficits. This year, the two deficits are expected to reach 13 and 6.4 per cent of GDP, respectively.
Moreover, despite past growth, the Kingdom’s real national wealth has declined. Oil revenues, as is the case elsewhere in the region, were not efficiently transformed into human capital, infrastructure, and the innovative capacity needed to generate productivity growth and diversify economic activity.
So, beyond adjusting to the “new normal” in oil prices, Saudi Arabia must design a radically new economic model that addresses structural impediments to productivity and growth.It is a tall order, one that most governments would pursue gradually.
But Crown Prince Mohammad Bin Salman’s National Transformation Programme (NTP), announced last June, suggests that Saudi Arabia will take the opposite approach, subjecting the economy to a kind of shock therapy.
In a 110-page list of policies and targets for ministries and governmental bodies to pursue in 2016-20, the NTP identifies 543 specific reforms, with a price tag of SR270 billion ($72 billion), excluding adjustment costs by the private sector. And, in fact, the crux of the proposed reforms is to expand the private sector’s role in the state-dominated economy, thereby creating more employment in higher-productivity areas.
Financing the reforms – not to mention a massive $2 trillion public investment fund to support a post-oil economy – will require improved efficiency, rapid privatization, effective public-private partnerships, broad-based taxation (including a value-added tax of 5 per cent, to be introduced in 2018), and spending cuts on existing infrastructure projects.
All of this will need to be achieved efficiently, in order to facilitate the government’s other key goal: a balanced budget by 2020.
The specific policy targets are tremendously ambitious. Saudi leaders will first partly privatize the Saudi Arabian Oil Company (Aramco), and establish the investment fund. They will also gradually reduce energy subsidies, in order to promote a shift away from energy-intensive activities.
The plan includes specific targets to increase the contributions of real estate, information technology, services, tourism, and the defense and pharmaceutical industries to GDP.
If the NTP is to deliver greater economic diversification, Saudi Arabia will need to harness high value-added, export-led growth and, eventually, greater regional and international integration. The programme lays the necessary groundwork with plans to reform education to promote innovation and meet the needs of a changing labor market.
Specifically, the NTP includes plans to achieve a 15 per cent increase in mathematics and English-language attainment levels within five years, to be followed by an increasing focus on “STEM” subjects (science, technology, engineering, and mathematics).
The NTP also aims to increase female labor-force participation, from 22 per cent today to 28 v by 2030. That, together with improved support and opportunities for the fast-growing population of young people, should reduce the unemployment rate from 11.6 per cent to 9 per cent in the next five years.
From subsidy cuts to a lower public-sector wage bill, the NTP reforms effectively represent a new social contract for the Kingdom. The plan is thus a kind of “long march”, requiring effective public-private cooperation, broad public buy-in, and an explicit communication strategy to implement deep economic restructuring supported by fiscal and other macro-policy reforms.
There is some precedent for this strategy: the oil-rich countries of Norway, Malaysia, Indonesia, and Mexico have all diversified their economies. But the external context in which those countries reformed – characterized by surging globalization and rapid growth – was very different from that prevailing today. And the transformations still took up to 20 years.
However, The first year of Saudi Arabia’s drive to reduce its oil dependence may end with the opposite result.
A flurry of cost-cutting measures will likely push the non-oil economy into recession, analysts say. That means that any overall growth in 2016 will be largely due to record crude output. Efforts to manage the fallout from cheap oil gathered steam over the past two weeks. Policy makers have suspended bonuses and trimmed allowances for government employees. Ministers’ salaries were cut by 20 percent. The central bank also said it’s injecting about 20 billion riyals ($5.3 billion) into the banking system to ease a cash crunch.Austerity will help Saudis reduce a budget deficit that reached 16 percent of gross domestic product last year. But it will also likely exacerbate the economic slowdown as consumption falls. A recent Bloomberg survey showed overall growth at 1.1 percent this year, with Capital Economics and BNP Paribas both predicting the first contraction since 2009.
The implementation of the NTP, by contrast, will be a race against time and a fight against the external headwinds of low oil prices, a weaker global economy, and retreat from globalization. Moreover, short-term domestic growth is likely to be stifled by policy uncertainty, fiscal consolidation, the immediate impact of reforms, and the needed reversal of the country’s monetary- and fiscal-policy stances, from pro- to counter-cyclical.
Whether Saudi Arabia can meet these challenges remains uncertain. Success will depend, for example, on the economy’s absorptive capacity and the government’s institutional competence. It will also depend on the country’s ability to galvanize the energies and ambitions of impatient young Saudis and unleash private investors’ “animal spirits.”
The growing pessimism about Saudi Arabia’s short-term outlook highlights the challenge facing Deputy Crown Prince Mohammed bin Salman, the architect of economic policy, as he seeks to prepare the kingdom for the post-oil era without provoking a backlash from a population accustomed to state largesse. Even before announcing his so-called Vision 2030 in April, the government had raised the prices of fuel and utilities. It’s also weighing plans to cancel more than $20 billion of projects, people familiar with the matter have said. The International Monetary Fund expects the budget shortfall to drop below 10 percent of GDP in 2017.
To succeed, Saudi Arabia will have to take additional steps. It should liberalize the foreign direct investment regime, allowing 100 per cent foreign ownership in select cases, attract and retain foreign talent through the proposed “green card” immigration policy, and promote openness and tourism through an “open skies” policy.
Prince Mohammed in April acknowledged the short-term challenges to growth. “We don’t expect it in the early years because they are years of reform, but after the years of reform we will expect very high growth,” he said.His plan targets increasing the number of nationals seeking private-sector jobs to 50 percent by 2020, compared with a “regional benchmark” of 40 percent. The kingdom also aims to sell stakes in several state-run entities.
Commenting on the recommendations given by the IMF to Saudi Arabia, Masoud Ahmad, the IMF's Middle East and Central Asia director said.
“It is an easy task for foreign countries to give orders… the announcement of Saudi reforms and Vision 2030 were an impressive step; all the bold procedures taken by the Kingdom serve … help control public spending.”
Moreover, domestic capital markets are needed for financing infrastructure and government deficits. And the country should embrace the disruptive power of financial technology and establish a second-tier stock exchange, which would advance financial inclusion and facilitate access to finance for dynamic small and medium-size firms.
As if these macro-reforms were not enough, the NTP will also require a gradual move to a civil law system for managing the economy and business. And the new social contract will need to be accompanied by increased transparency and accountability from the public sector and greater public engagement.
The NTP embodies the Saudi leadership’s awareness of the challenges it faces – and its willingness to tackle them. But the only certainty is that there will be many a slip twixt the cup and the lip on the long road to Saudi Arabia’s economic transformation.