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THE ECONOMIC OUTLOOK FOR SAUDI ARABIA

Recent developments

According to the World Bank, Saudi Arabia’s economy contracted moderately at 0.6 percent in 2017, as oil production was restrained in accordance with the OPEC+ agreement, and non-oil sector growth slowed in the wake of reduced public spending. Early data for 2018 suggests that non-oil gross domestic product (GDP) in the first quarter may have fallen further, given the January purchasing managers’ index (PMI) level of 53.0, significantly less than 57.3 in December 2017 and the slowest recorded since August 2009. PMIis an indicator of the economic health of the manufacturing sector based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The fiscal deficit markedly improved to 9.0 percent of GDP in 2017, compared to the 16.9 percent a year earlier. This substantial progress increased space to mitigate the household impacts of fiscal reforms.

Upon the completion of the recent crack-down on corruption, during which purportedly over $100 billion in assets were garnered, the authorities in Saudi Arabia announced new allowances for state employees over 2018 to compensate for the higher costs of living. The authorities have acknowledged that they should slow down the pace of austerity so as not to adversely impact the economic recovery being led by the private sector. Deflation was evident in the economy through October 2017, and the annual inflation average registered by the Saudi Arabian Monetary Authority (SAMA) stood at -0.23 percent over the course of calendar year 2017. Although the deflationary trend has seemingly reversed, it could still spell a weaker demand environment in light of recent reforms and an uncertain political environment.

The kingdom has continued to peg its currency to US$, which given recent depreciation could help rebalance pressures on non-oil exports and rein in imports. On the external side, the pace of contraction in exports, registering at 4.7 percent as the OPEC+ agreement slowed Saudi oil production, was outpaced by the discernible slowdown in imports by 8.3 percent. Together, this translated into a swing of the current account into a surplus of 1.7 percent of GDP.

Regarding labor market issues, the latest available data suggests an improvement. The pace of job creation improved in the second half of 2017 as the unemployment rate decreased to 5.8 percent in the third quarter. The Emirates NBD Saudi Arabia PMI survey revealed that hiring picked up to its strongest level since August 2016. However, the unemployment rate remained broadly unchanged in 2017 at approximately 5.8 percent for the overall population and increased to slightly above 12 percent for Saudi nationals (up from 11.5 percent a year earlier). As in other GCC countries, the bulk of low-income residents are migrant workers, but as the citizen population crosses the 20 million-mark, inadequate access to economic opportunities is also an issue for nationals. With the prospect of low oil prices for longer, the old social contract based on government employment, generous subsidies, and free public services is no longer sustainable. The report notes that the reform agenda contained in the Vision 2030 document envisages deep structural changes that will profoundly impact the population in all aspects of their livelihoods. While the authorities are serious about mitigating the negative impact of reforms, as seen in public pronouncements and actions, targeted support is still a new concept in the country. Identifying the most poor and vulnerable groups has been difficult, and little evidence exists to inform policies about the level of support to be provided to them. In that respect, the authorities are currently building capacity and institutions for welfare measurement and analysis.

Outlook

The report says the Saudi economy is projected to expand again in 2018 mainly due to a moderate recovery in oil production levels compared to last year’s sharp cuts and marginally higher public spending. However, as the negative short-term effects of structural reforms are mitigated and government balances improve, it is projected that growth will rise to over 2 percent in 2019. As reforms and direct government initiatives aimed at the private sector are implemented while capital spending is simultaneously ramped up, further domestic growth opportunities will open up.

Crown prince Mohammed bin Salman, the report notes, continues to enjoy strong popular support, providing a strong signal to investors and the wider public of a longer-term commitment to continue the path of reforms despite the negative perceptions generated by specific initiatives. With improved economic conditions, and an announcement by authorities of fewer fiscal constraints in 2018, the fiscal deficit is expected to narrow only slightly in 2018 to 7.6 percent, as a share of GDP. The fiscal outlook incorporates a continued strong commitment to reform efforts. Recovering oil prices are expected to further strengthen the current account from its estimated surplus of 1.7 per- cent of GDP in 2017. Inflation is projected to be considerably more volatile in the coming years, rising to nearly 5 percent in 2018 and then dropping to below 2 percent in 2019 as the introduction of VAT

Risks and challenges

The report concludes that over the medium-term, the main challenge to the Saudi economy is an ability to translate general strategic directions into specific policies, at which point opposition tends to materialise. In practice this means that reforms with broad “middle class” negative impacts are more prone to reversal, such as subsidy reform and taxation. To stave off such opposition to the social contract, credibility that alternative sources of job creation will emerge is critical. In addition, while the government has tended to downplay fears of capital flight, net foreign assets held by SAMA had fallen steeply in recent years until late 2017. Buffers are still ample, but depleted relative to 2014. The clear intention to engage in more directive investments with foreign assets raises risks that foreign assets could be less liquid, inhibiting the country’s ability to cope with oil price volatility.

The Middle East and North Africa

Another report by the World Bank Group released last month says growth in the Middle East and North Africa (MENA) is expected to rebound to 3.1% in 2018, following a sharp decline to 2% in 2017 from 4.3% in 2016. The increase in growth is broad-based, and almost all countries will experience growth this year. On the back of a good performance by Gulf Cooperation Council (GCC) countries, oil exporters could see growth reach 3% in 2018, double their rate in 2017. Improvement in oil importers is also expected to be driven by a sharp rebound in Egypt. Stabilisation policies, reforms, and a surge in foreign receipts are expected to lower fiscal and external imbalances in 2018 and beyond. In the short term, the outlook for MENA remains positive, and the growth rebound is expected to hold firm over the next two years, reaching 3.3% in 2019 and 3.2% in 2020. However, geopolitical tensions, the challenges posed by the forcible displacement of people, including refugees, and the rising level of debt in the region could cloud the positive outlook.

The report notes that while stabilisation policies have helped economies adjust in recent years, a second phase of reforms is needed that should be transformative if the region is to reach its potential. Indeed, the current growth trajectory is markedly below that potential and insufficient to absorb the hundred million young people who will enter the labor market in coming decades. The reportex-plores the role that public-private partnerships can play, not only in providing an alternative source of financing but in helping change the role of the state from the main provider of employment to an enabler of private sector activity.

Studies have shown that the gap between MENA economies and fast-growing ones is the performance of the services sector. The report suggests that rapid technological change offers new opportunities for boosting private-sector-led growth through enhancement of high-tech jobs in the services sector. For each job created in the high-tech sector, approximately 4.3 jobs are created across all occupation and income groups. The MENA region has a fast-growing pool of university graduates and a heavy penetration of social media and smart phones. Combining them could serve as the foundation of a digital sector that could create much-needed private sector jobs for the youth over the next decade. Several MENA countries have developed strategies to transform their economies and take advantage of disruptive technology, but more is needed to capture the opportunity.

The report also shows how external forces are disrupting various markets, including those for energy, which exposes MENA countries to new risks, including of stranded assets.