Global player: Backed by healthy growth and oil revenues, the government is seeking to diversify the economy

While some Western countries may be seeing a return to cautious optimism and leading emerging economies are weighing the potential impact on capital flows of tapering in the US Federal Reserve’s quantitative easing programme, Saudi Arabia is seeing sustained growth buoyed by high global oil prices and internal investment in its own infrastructure. Some 15 years after Saudi Arabia attended the inaugural meeting of G20 countries, its key economic indicators make it the envy of many other member states.

Indicators

In 2013 the IMF published G20 comparators based on selected economic indicators between 2008 and 2012. These showed Saudi Arabia’s average real GDP growth rate of 6.25% placed it third in the grouping behind China and India, but the three most striking measures of its performance were apparent when taken as a percentage of GDP. Saudi Arabia had by far the healthiest fiscal account balance of any G20 country, a measure which saw the US, India, Japan and the UK at the bottom of the table. Second, Saudi Arabia’s current account balance dwarfed that of any other nation, placing it at the opposite end of the spectrum from the US, Australia, South Africa and Turkey. The third measure covered gross government debt, and in this instance Saudi Arabia had the lowest total, while Japan, Italy, the US and the euro area occupied unenviable rankings at the head of the table. The country has used its position as the world’s swing producer of oil to help temper price volatility caused by supply disturbances elsewhere, and in doing so has helped to sustain global growth.

Sustained Growth

The impact of these interventions on global oil supply, coupled with the average price of Brent crude, are reflected in Saudi Arabia’s GDP figures, with the result that increased stability in global oil supply has led to a softening of the country’s economic output. Provisional estimates put real GDP growth at 3.8% in 2013, compared to 5.8% in 2012 and 8.5% in 2011, according to Ministry of Finance (MoF) data. This is in keeping with earlier IMF estimates of 4% and compares well to other countries, according to figures published by the IMF in January 2014, which showed average global growth of 3%, growth in advanced economies of 1.3%, and growth in developing and emerging economies of 4.7%.

In its 2014 budget, the MoF expected total GDP for 2013 to be SR2.8trn ($746bn), compared to SR2.73trn ($728bn) in 2012. Crude oil prices fell over the same period, with the average price of Brent crude declining from $112 per barrel in 2012 to $108 per barrel in 2013, according to the US Energy Information Administration (EIA). However, statistics from the Joint Organisations Data Initiative (JODI), an international oil database, show that while the total volume of Saudi Arabia’s exports of oil went up in 2013, overall production slowed. The JODI figures put the Kingdom’s 2013 exports at 7.54m barrels per day (bpd) on average, up from 7.41m bpd in 2012. In August 2013 exports peaked at 7.84m bpd, a level last seen in May 2003. Meanwhile, average crude oil production fell from 9.76m bpd in 2012 to 9.63m bpd in 2013.

These record oil sales contributed to healthy annual government revenue of SR1.13trn ($301bn), albeit down from SR1.24trn ($331bn) in 2012. MoF figures show total exports of goods were SR1.38trn ($368bn) in 2013, a drop of 5.5% on 2012, but it estimates nonoil exports of goods were worth SR197.6bn ($52.6bn) in 2013, up 3.9% on 2012. Jadwa Investment reports that oil made up 86% of all exports, accounting for revenues of SR1.18trn ($315bn). At the same time, increased consumer spending and continued investment in infrastructure projects boosted Saudi Arabia’s imports by 8% compared to 2012, with a total spend on foreign products of SR574bn ($153.02bn). This left a trade surplus of SR802bn ($214bn), a 13.3% drop from the year before. Also down by 21.2%, the current account surplus totalled SR486.8bn ($129.7bn) in 2013, compared to SR617.9bn ($164.7bn) in 2012.

Government expenditure on infrastructure projects had an impact on the non-oil private sector as well, with the MoF estimating it grew by 9.4% in 2013, compared to 7.2% in 2012 and 8% in 2011. All segments of the private sector recorded growth in 2013. Construction went up 8.1%; transport, storage and communication recorded a 7.2% rise; wholesale, retail, restaurants and hotels saw growth of 6.1%; and finance, insurance and real estate expanded by 4.8%. Overall, preliminary figures indicated government sector growth of 3.73% and private sector expansion of 5.5%.

Fixed Exchange

With oil prices measured in dollars, Saudi Arabia has felt it wise to peg the exchange rate of its currency, the riyal, to its US counterpart since 1986. The rate is set at SR3.75:$1. Thus, while Saudi Arabia maintains an independent fiscal and monetary policy, the peg limits its freedom to act to a degree. This arrangement has been largely beneficial to date, but as China’s economy grows and its influence on global oil prices increases, it is possible that the dollar rate may become less influential.

The riyal-dollar peg has become a subject of considerable debate in economic circles in Saudi Arabia, given that economic conditions in the US and Saudi Arabia are not always aligned. For instance, when the US Federal Reserve slashed rates in 2009 to counter the impact of the credit crunch, Saudi Arabia followed suit, even though its domestic economy was thriving and curbs on inflation might have been a greater domestic concern. Similarly, with global oil prices forecast to decline marginally after 2014 and the Fed expected to announce a 25-basis-point rise in its rate, an increase in Saudi Arabia might exacerbate any slowdown caused by a reduction in oil revenues.

The official repo rate, the rate at which the Saudi Arabian Monetary Agency (SAMA) lends to other banks, and the reverse repo rate, the rate at which other banks lend to SAMA, have remained fixed at 2% and 0.25%, respectively, since January 2009. The Saudi inter-bank interest rate saw more volatility over the course of 2013. In January 2013 it was 0.996%, but by January 2014 it had dropped to 0.811%.

Substantial Surplus

Growth in public spending slowed in 2013, but Saudi Arabia’s fiscal position in recent years has been characterised by prosperity rather than austerity, which has been the hallmark of fiscal policy in Europe and North America. The Kingdom has enjoyed a budget surplus in all but one year since 2006. In 2013 the budget surplus was SR206bn ($54.9bn), equal to 7.4% of GDP. This may have fallen from the SR386bn ($103bn) surplus in 2012, equal to 14% of GDP, but it still leaves the country with a current account surplus of SR486.7bn ($129.8bn).

The second-highest revenues on record of SR1.13trn ($301bn) in 2013 were 36% above the budget forecast, but a 2.3% drop in oil production during 2013 meant income was 9.3% lower than in 2012. However, non-oil revenues increased by 11% on 2012 and totalled SR113bn ($80.2bn). Spending was up by 5.9% compared to 2012, reaching a record high of SR925bn ($247bn), which was SR105bn ($27.9bn) higher than originally budgeted, with the MoF explaining the overspend was related to projects at the Two Holy Mosques and other developments in transport, housing and education. Despite exceeding the budget target, the pace of increase in annual spending has slowed after averaging 14% per annum since 2008. In the five years since the collapse of Lehman Brothers, Saudi Arabia’s government has boosted spending by 78%. According to the MoF, the government signed a total of 2330 projects with the private sector in 2013 worth some SR157bn ($41.9bn) as it continued its bid to stimulate enterprise across the Kingdom. Over the past two years, mega-projects worth a total of more than SR2trn ($533.2bn) have been tendered by the government, according to data from MEED.

Social Spending

Estimates for government spending in 2014 are once again more generous than the previous year, up 4% on 2013 from SR820bn ($218.7bn) to SR855bn ($228bn), and for the first time since 2005 there is a balanced budget, with anticipated income also totalling SR855bn ($228bn). Health and welfare will together receive 38% of the total, signalling a continued commitment to social welfare. Although budgeted spending is SR70bn ($18.7bn) below actual spending in 2013, economists at Jadwa Investment do not regard this as a sign that the government is backing away from its expansionary stance, and they point out that the last time actual spending was lower than the budget forecast was in 2000. They add that the average overspend over the last 10 years has been 24%, and that budget forecasts are traditionally based on conservative estimates of the price of crude oil in the year ahead. Budgeted current spending has been raised to SR607bn ($161.8bn), with wages and salaries being the largest component.

Spending on education is set to rise by 3% to SR210bn ($56bn), while health and social affairs projects will receive SR108bn ($28.8bn), an 8% increase on 2013. The budget for major engineering projects, including bridges, inter-city roads, drainage systems and designs for public transport projects in Makkah and Riyadh, has risen by 9% to SR39bn ($10.4bn), with a further SR66bn ($17.6bn) earmarked for 3500 km of road works and the expansion of ports and airports. The shape and scale of the budget reflect a continued commitment to investing in improvements to the welfare, health and educational attainment of citizens.

Defence Of The Realm

The annual budget does not include details of defence and security expenditure, but Jadwa Investment reports that it accounted for 31% of the budgeted total in 2013. In February 2014 London’s International Institute for Strategic Studies reported that Saudi Arabia had overtaken the UK to become the world’s fourth-largest defence spender in 2013. In another report published in February 2014, IHS Jane’s reported that Saudi Arabia’s defence budget has tripled in 10 years, with 2013 marking its largest rise since 2007. The same organisation reported that Saudi Arabia was the world’s second-largest importer of arms in 2012, spending $3.7bn, and that the 49% growth in UK arms exports since 2008 has been driven by military aviation sales to Saudi Arabia in the form of Typhoon exports and Tornado support contracts. BAE Systems confirmed in February 2014 that it had successfully negotiated a higher price for its $7.47bn Al Salam deal to supply 72 Typhoons to Saudi Arabia, to cover the additional cost of advanced weaponry and equipment. More than 30 of the aircraft have already been delivered. A report put out by the German government in November 2013 showed that Saudi Arabia was its biggest customer, spending €1.24bn on German defence equipment in 2012, including a €1.1bn contract for a border security facility with defence firm Cassidian.

Meanwhile, defence spending has had a positive impact on Saudi Arabia’s private sector thanks to the Economic Offset Programme (EOP), which applies to high-value military contracts. Contractors are expected to provide offsets equal to 35% of the value of the contract, and this has helped create dozens of firms employing thousands of workers to provide specialist support in a range of areas, including electronics, medicine, education, training and aerospace. It is estimated that Saudi Arabia has spent as much as $100bn on defence deals in recent years, and if all the contracts met the EOP criteria, the total value of offsets in that period could be as much as $35bn.

Debt Declining

Repeated years of surplus have also resulted in a decline in public debt. Preliminary estimates in the 2014 budget suggest public debt fell from SR98.8bn ($26.3bn) at the end of 2012 to SR75.1bn ($20.02bn) at the end of 2013, representing less than 2.7% of projected GDP for 2013. In 2012 this figure was 3.6%, and in an IMF survey from that year Brunei Darussalam was the only economy in the world with a lower ratio of gross debt to GDP at 2.4%.

However, Jadwa Investment reports that over the first 10 months of 2013, commercial bank holdings of government and quasi-government debt securities increased by SR39bn ($10.4bn), and bank holdings of long-term government bonds also rose by SR5bn ($1.3bn) to SR47.7bn ($12.7bn), despite the fall in public debt. It suggests the increase may be due to banks investing in sukuks, or Islamic bonds, such as those issued by the General Authority of Civil Aviation. The two state pension funds, the General Organisation for Social Insurance and the Public Pension Agency, hold the remaining government debt.

Inflation

The growing affluence of Saudi consumers, driven by public sector wage rises and further stimulated by Saudiisation measures, has fed into inflation. Inflation is measured by the cost of living index for the 2007 base year, and SAMA estimated it rose by 3.35% in 2013, against 2.9% in 2012. These increases are modest compared to 2008, however, when a surge in oil prices saw inflation peak at just below 11%. In March 2011 the government raised the minimum monthly wage for Saudi public sector workers to SR3000 ($800) and increased unemployment benefit for nationals to SR2000 ($533) a month. According to the human resources firm Aon Hewitt, a survey of 91 organisations in Saudi Arabia found workers were anticipating a 6% pay rise in 2014, which follows a prediction of 5.8% in the previous year’s survey by the same company. At the same time, incentives to employ Saudis under the Nitaqat system have increased pressure on employers to hire more nationals and in so doing boost their spending power.

According to Jadwa Investment, core inflation, excluding food, housing and related services, slowed to 2.6% in the first 11 months of 2013 compared to 2.9% for the same period in 2012. The firm found that food inflation had risen over the same period to 5.9% from 4.4% in the first 11 months of 2012. SAMA also reported that the increase in the non-oil GDP deflator, which measures consumption of all non-oil goods in the economy, declined from 3.8% in 2012 to 1.85%.

According to the Central Department of Statistics and Information, the inflation rate was 2.7% year-onyear as of June 2014, unchanged for three consecutive months, while food prices fell by 0.2% from May.

Swing Producer

According to JODI, Saudi Arabia pumped more than 10m bpd in July, August and September 2013, but with nearly a fifth of the world’s proven oil, the Saudi Arabian Oil Company (Saudi Aramco) maintains the capacity to produce 2m bpd more. According to the IMF, Saudi Arabia controls more than 50% of the world’s spare capacity and can bring that oil to market in just 30 days. It uses this spare capacity to act as the world’s swing producer, with the aim of maintaining stability in global oil markets. However, with oil accounting for 85-95% of export revenues, fluctuations in global prices could translate into significant changes in fiscal balances.

According to Jadwa Investment, actual government spending is 78% higher than it was five years ago, which means the breakeven price of a barrel of oil has risen significantly from $37.60 in 2008 to $81 based on Jadwa Investment’s predictions of expenditure in 2014. It forecasts that Saudi export crude will average $100 per barrel in 2014, which will result in a healthy surplus even though it expects Saudi output to fall to an average of 9.4m bpd as production from Iran and Libya is likely to rise. From 2006 to 2010 Saudi oil was worth less than the 2014 breakeven price of $81 per barrel, with the exception of 2008, when its average price was $94 per barrel. The government could respond to a sudden fall in oil prices by reducing its expenditure during the year, but with some of that spending committed to ongoing capital projects and wages, the flexibility of its response has limits. Any unexpected deficit in this balanced budget could also be remedied by drawing from SAMA’s stock of foreign assets, which Jadwa Investment estimated were worth $712bn in October 2013.

Foreign direct investment (FDI) figures for 2012 released by the UN Conference on Trade and Developments show a trend of annual declines in inward investment, but annual increases in outward investment. In 2012 there was a 25% fall from $16.3bn to $12.18bn in inward investments compared to a 28% increase in outward FDI by Saudi Arabia from $3.43bn in 2011 to $4.4bn in 2012.

Eastern Promise

While Saudi Arabia maintains its place as a pivotal player in the world oil market, the shape of that market is changing rapidly. An IMF report on the history of Saudi Arabia’s oil production published in 2013 stated that during the 1970s Europe accounted for about 44% of Saudi oil exports and Asia took just 30%. However, by the 2000s Asia accounted for over 55% of its oil exports, while Europe’s share dropped to just 15%. Jadwa Investment estimates that demand for oil in Middle Eastern countries accounts for 19% of Saudi exports. The scale of this shift in energy consumption is highlighted in BP’s 2013 “Statistical Review of World Energy”, which reports that in 2012 90% of the net increase in global energy consumption took place in China and India.

While the pace of growth in China may have dropped from double-digit territory, the IMF’s “World Economic Outlook” for 2014 predicts healthy growth of 7.5%, down slightly from 7.7% in 2013. Although China has concerns about air pollution in its major cities, and recognises that traffic and vehicle emissions contribute up to 20% of the particulate matter associated with respiratory problems, vehicle sales continue to grow. The state-backed China Association of Automobile Manufacturers reported in January 2014 that the country had become the first to sell 20m units a year in its domestic market in 2013. It expects deliveries to rise by 10% in 2014, following 14% growth in 2013. Japan is the world’s third-largest net oil importer after the US and China, and Saudi Arabia accounts for the lion’s share of its imports, providing 33% of its oil, or 1.2m bpd, according to EIA figures. After the tsunami and Fukushima incident, Japan increased imports of oil for direct burn in power plants.

Tight Oil

Looking West and to the supply side, the tight oil and shale gas revolution meant production growth in the US was the largest in the world in 2012 and the largest in the country’s history. However, the impact of this technological revolution has not led to a decline in Saudi crude exports to the US. The EIA reported that in 2012 13% of its imported crude oil came from Saudi Arabia. The Kingdom exported an average of 1.4m bpd of total petroleum liquids to the US in the first 10 months of 2012, up from the 1. 2mbpd average for the whole 2011 calendar year, with the US Department of Energy reporting Saudi Arabia exports to the US increased by 14% in 2012. The grade of oil Saudi Arabia is shipping to the US is heavier and darker than the light, tight oil produced by fracking and so is not in direct competition with the new domestic supply. In contrast, producers of light crude from Algeria, Nigeria and Angola saw their exports to the US fall by 41% in 2011-12, with Nigeria’s oil minister citing a 59% fall in exports and describing the shale revolution as a “grave concern”.

Saudi Arabia’s interests in the US are consolidated by its refining operations there. Saudi Aramco and its partner Royal Dutch Shell have three Motiva jointventure refineries in Louisiana and Texas, with a total capacity of around 740,000 bpd.

The long-term impact of the tight oil revolution may be felt more keenly as the technology is exported to other oil-producing countries if this leads to a reduction in crude oil prices. However, in a report published in December 2013 Jadwa Investment concluded that tight oil production would not “materially affect Saudi Arabia’s long-term position in the oil industry”, adding that a greater risk lies in Saudi Arabia’s own high and growing consumption of oil.

Natural Gas

Saudi Aramco is using hydraulic fracture technology to produce shale gas, and the country can also look forward to reaping the benefits of this technology itself. However, in 2010 Khalid Al Falih, Saudi Aramco’s CEO, was the first person to sound the alarm about the potential impact of increasing domestic consumption in Saudi Arabia’s oil economy. He warned that domestic consumption could cost the country 3m bpd by the end of the decade if the pattern of use continued, and the government has since set a target to generate half of Saudi Arabia’s energy from renewables by 2020.

In the meantime, however, oil consumption in Saudi Arabia has continued to grow. According to BP, in 2013 Saudi Arabia consumed 227.7m tonnes of oil equivalent, up 3.5% year-on-year. With no nuclear generation facilities or recorded hydro or renewable energy, Saudi Arabia’s consumption is confined to oil and gas, with the proportion of gas consumed at 40.7% in 2013. In 2013 its total consumption of oil was the sixth highest of any country behind the US, China, Japan, India and Russia. Figures from JODI show average consumption in 2013 was 2.21m bpd.

The consumption of oil is driven in part by its use as a feedstock for both electricity generation and water desalination. According to the EIA, Saudi Arabia plans to increase electricity generation from 55 GW to 120 GW by 2020 to meet the growing demand for electricity. In a country characterised by dry, arid conditions and consumption of desalinated drinking water, Abdullah Al Hussayen, Saudi Arabia’s minister of water and electricity, warned in July 2013 that water consumption by households had reached a new record of 8m cu metres per day, equivalent to 265 litres per person per day. In 2011 the Pacific Institute reported that the average person in the US uses 250-300 litres a day, while the average person in the Netherlands uses just 104 litres per day. A 2010 report by Harvard University stated that Saudi Arabia was using 1.5m bpd of oil to power 30 desalination plants across the country. The construction boom that has resulted from the government’s investment in infrastructure also drives demand for more electricity, running water and air conditioning in new buildings.

Population Growth

Another demand driver for energy is the growth of the population, which has quadrupled in 40 years to 30m, and is expected to reach 40m by 2025. According to the Central Department of Statistics and Information, the population growth rate in 2013 was 2.7%. UN statistics show that foreign workers account for 31% of the population, and 29% of those expatriate residents are female. In 2010 17.2% of the population was aged 15-24, accounting for 26% of the working population. The working age population represented 66% of the total in 2010.

It is 76 years since oil was found in commercially viable quantities in Saudi Arabia, and it is estimated that reserves should sustain oil production based on current technology for another 70 years. As life expectancy in Saudi Arabia is 75, babies born in 2014 may live to see a time when the oil supply has been exhausted. So the challenge for policymakers is to diversify the skill set of the young and increasingly highly educated Saudi workforce, and create a more diverse economy based on knowledge and services as much as on mineral wealth and hydrocarbons.

Non-Oil Gowth

In 2013 headway was made on the effort to diversify, with the non-oil private sector growing by 5.5% compared to 4.9% in 2012. Construction, transport and communications, and retail were the fastest-growing sectors in 2013, with expansion of 8.1%, 7.2% and 6.1%, respectively, according to SAMA. In addition, the finance sector grew by 4.9% and non-oil manufacturing by 4.7%. Looking ahead, Jadwa Investment forecasts the non-oil private sector will grow by 5.2% in 2014, with construction, transportation, retail and utilities in particular reaping the benefits of continued government expenditure.

Employment

Translating that success into more employment and opportunities for young Saudis has proven a challenge, as 87% of jobs in the private sector are occupied by expatriates. Conversely, over 65% of Saudi employees work in the public sector, even though wages for Saudis in the private sector are higher than those for non-Saudis with similar education levels. Studies of the expatriate workforce published by the IMF show that only 15% of the 9.3m migrant workers employed in Saudi Arabia are regarded as highly skilled, so the country has relied on almost 8m low-skilled labourers to build, maintain and service its infrastructure. Many Saudis perceive public sector roles with non-wage benefits, better working hours and job security as a more attractive alternative to employment in the private sector. Unemployment among nationals has increased from 10.5% at the end of 2009 to around 12% by 2013, and is concentrated among highly educated women and less well educated men. The public sector wage bill in Saudi Arabia is 10% of GDP.

An IMF report on employment across GCC countries published in 2013 suggests that if real non-oil GDP grows across the member states as predicted until 2018, 600,000 private sector jobs would be created, but that this would only accommodate about one-third to one-half of the young people entering the workforce. The IMF also reports that although 2m jobs were created from 2009 to 2012, three-quarters of them went to non-Saudis. The authorities have responded to the problem by promoting increased participation in tertiary education for young Saudis, using the Nitaqat quota system to reward firms employing Saudis and imposing sanctions of SR200 ($53) per foreign worker on companies relying on cheaper, lowskilled non-Saudis. An unemployment benefit of SR2000 ($533) per month was introduced for Saudi job seekers, but it is coupled with advice and encouragement in looking for work and only lasts for 12 months, after which the payment is reduced and incentives to find work are increased.

According to Prince Abdulaziz bin Ahmed bin Abdulaziz Al Saud, the chairman, president and CEO of Atheeb Group, more needs to be done to align what is taught in schools with the demands of the labour market. “There needs to be a system that better links education outcomes with the demands of the labour market. We must identify what sort of jobs we need to fill and gear education towards that to ensure the success of the government’s Saudiisation efforts,” Prince Abdulaziz told OBG.

Nevertheless, progress in terms of improving educational outcomes has been made, according to Hisham Al Bahkali, president and CEO of General Electric Saudi Arabia and Bahrain. “There is significant year-on-year improvement in the quality of the local workforce as highly educated new graduates who have studied both domestically and internationally are entering the job market,” Al Bahkali told OBG.

Transparent Transactions

Saudi Arabia has also committed itself to tackling corruption and ensuring transparency in transactions by changing processes at home and signing international agreements. In April 2013 the country ratified its signature of the UN Convention against Corruption. In 2011 the Kingdom also vowed to stamp out corruption internally by creating the National Anti-Corruption Commission. In Transparency International Perceptions’ Index, Saudi Arabia’s score improved in 2013 from 44 to 46, giving it a ranking of 63rd out of 177 countries. In November 2013 Mohamed Al Mady, vice-chairman and CEO of Saudi Basic Industries Corporation, expressed his full support for efforts to adopt international anti-corruption policies and said corruption poses a serious threat to sustainable business and economic growth.

This is also part of a broader drive to improve the Kingdom’s business environment, a process which encompasses a wide variety of measures in different areas. Ahmad Almeghames, the secretary-general of the Saudi Organisation of Certified Public Accountants, told OBG, “The switch from our own national accounting and auditing standards to international ones is part of the greater overall push to make the Kingdom more investor friendly. It will promote transparency, reduce paperwork and increase the confidence of those outside the Kingdom who are looking to establish businesses here.”

Outlook

Saudi Arabia’s economy looks set to maintain a strong upward trajectory in 2014, though the pace of growth and expansion in infrastructure are likely to cool somewhat. The IMF predicts that growth will accelerate to 4.4% in 2014, up from 3.6% in 2013. Fiscal policies will maintain focus on investments designed to create sustainable development of infrastructure, while providing enhanced employment and educational opportunities for nationals. Spending plans for the year ahead suggest there will be many more lucrative deals to be done for businesses able to help the Kingdom reach its goals. The country’s economic performance has been among the best of any member of the G20, and when the G20’s finance ministers, meeting in Sydney in February 2014, pledged to collectively boost their GDP by 2% over the next five years, Saudi Arabia must have been more confident than most concerning its ability to achieve this.