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Economic diversification in Saudi Arabia, connecting the dots

  • Saudi Arabia historically dependent on oil for economic growth
  • The government is working upon to make the country more diversified backed by ‘Vision 2030’
  • Economic, as well as societal reforms, are required to achieve its full growth potential 

 

Saudi Arabia, the world’s second largest crude oil producer and the largest producer in the OPEC group has continued to be highly dependent on the black liquid for economic growth since its discovery in 1930 in the country. Oil being one of the most traded, consumed and widely used commodity has had its periods of ups and downs based on the overall demand-supply and financial market scenario globally. While the global demand for oil improved persistently over the past few decades, so has been the supply which witnessed a healthy growth mainly from the non-OPEC players. Saudi Arabia’s overdependence on the commodity has taken a toll on its economy, especially during periods of weaker oil prices as it forms the largest share of the revenue pie for the government.

Historically, even during the 1980s and up to 2000s (particularly 1998), fluctuation in the oil prices weighed on the country to increase its focus on other sources of income. The economic diversification activity had been underway in Saudi Arabia for decades. The government has been focusing on infrastructure, education, defense, training, health and social services and allowing more freedom to women for reducing gender inequality amongst others to drift away from oil dependency, but the non-oil sectors could not grow as expected due to political and cultural challenges. 

While looking at plain numbers, the government’s efforts have borne fruits as it was successful in reducing the share of the oil sector in the overall GDP from over 80% (1971-75) to the latest reading around 40%. Nonetheless, there is still a long way to go before one can conclusively say that Saudi Arabia could exist without the support from oil. The government’s revenue continues to be oil-driven with an average revenue contribution standing at ~90% for the period 2005-13. However, amidst the huge decline of oil prices in the international markets for the past few years, the overall share of revenue from oil has reduced drastically. This has negatively impacted the budget balances as government’s expenses have been growing at a moderate pace. The revenues fell by 7.5%, 9.8%, 41.1% and 15.2% during 2013-16 due to falling oil prices globally. These numbers were in line with the trend in the GDP numbers of Saudi Arabia (as shown in the above chart) and clearly reflects the reliance of its economy on the oil sector both locally and globally. It is interesting to note that the GDP growth numbers stood highly correlated to the movement or growth in the oil sector as compared to the non-oil sector, notwithstanding the fact that composite share of oil in the GDP came down during the past 3-4 decades. The correlation of growth in the GDP with the oil sector and non-oil sectors for the period of 1972 to 2017 stands at 0.95 and 0.25 respectively, further cementing the base case. 

In order to transform the economic structure, in April 2016, the country's then Deputy Crown Prince Mohammad bin Salman (now, Crown Prince of Saudi Arabia) came up with an ambitious plan named ‘Vision 2030’ to diversify and globalise the Saudi economy by expanding non-oil sectors. The plan outlines specific goals on economic, political and societal development, including lowering of the unemployment rate and increased emphasis on the private sector to drive the non-oil revenue for the government. Infrastructure, financial sector reforms, changes in the education system and SMEs upgradation forms the key focus under the plan. Further, under the strategy, regulations would be improved to stimulate growth in the private sector and to attract foreign investments, which is expected to strengthen nation’s trade between three continents; Asia, Europe and Africa. 

   

The execution of the above plan seemed to be moving in the right direction under the leadership of Mohammad bin Salman (also known as MbS) with few of the data points indicating towards his and his government’s seriousness towards economic growth. For instance, infrastructure is a critical point of focus in the new plan and is also significant for the country where the population is growing and rapid urbanisation is taking place. In 2017 budget, infrastructure and transport sectors were allocated SAR 52 billion, this was 39% higher of the actual spending in 2016. In ‘Vision 2030’, the government is aiming for digital transformation of the nation in partnership with private organisations. Its goal is to exceed 90% housing cover in the densely populated cities and 66% in other urban zones. Further, in order to fund this ambitious plan, the Saudi government has announced the sale of its 5% stake in the Saudi Aramco, (the national oil company of the country) to the public. This is anticipated to be one of the world's biggest public offering in the history bringing around $100 billion to the government coffers. Though the initial timeline for Aramco’s sale has been delayed from the second half of 2018 to anywhere in 2019 or even later, the public offering continues to be a priority.

Nevertheless, Saudi Arabia’s problem is not only about how and at what pace the government is able to implement these plans. A much bigger and broader aspect to be watched is the change of the psychology of the public and the country as a whole. Historically, Saudi Arabia’s working structure has been quite different from other nations. The kingdom favoured all revenues from the major sources going to the King, the government and the people around them. With healthy oil revenues over the decades, the government has managed to generate and save billions of USD. Especially during the period between 2002-14 when almost all the major global commodity prices were rising along with equities, oil was a major beneficiary and aided Saudi Arabia to enhance its forex reserves by ~15X from USD ~50 billion to USD ~750 billion. Government revenue and savings were utilised in investments across the nation for construction, infrastructure, defence and for the other needs within the society, both in terms of direct and indirect expenses (subsidies), while these were also used for foreign investments in bonds-equities.

Similarly, a respectable chunk of revenue continued to move towards the sustenance of royal lifestyle of the King and other dignitaries. Additionally, to keep the masses appeased, the expenditure on society has always remained a major spending area for the government such as building free infrastructure or its distribution in terms of subsidies, which range from water to electricity, while indirect allocation also prevails in aspects like free education, cheaper healthcare, unemployment benefits among others.  All of this has not gone well for the economy as freebies have moved into the blood of Saudi Arabian people which have continued to be spendthrift (with savings from subsidies) simultaneously also inflicting the societal psychology. The citizens lack seriousness towards education and a competitive spirit is absent in workspaces. This can be linked to the overall population diversification which has taken place in the nation over the last many decades. In the last 20-year period (1998 to 2017), the proportion of the population of citizens and non-citizens has moved from ~73% (citizens), 27% (non-citizens) to 63% and 37% respectively. Historically, the country has been dependent on foreigners for high-quality, technologically intensive and even small-scale labour-intensive work across the length and breadth of the economy. Non-Saudi’s account for more than 75% of the total employed labour (Source: Labour Market Fourth Quarter 2017 Report, General Authority for Statistics, Saudi Arabia).  

Hence, backed by the 'Vision 2030', the government is gradually working to change the mindset of the people, which is why education is being defined as one of the critical areas to focus. In the last few years, the subsidies have been rolled back in a phased manner. According to an IMF report, the government increased fuel prices (ranging from 10% to 134%) across most major energy and water products to businesses or households. Further, prices rise is planned over the next 5 to 7 years. The below table provides details of indicative reforms being planned on important fuel based and electricity tariffs in the country. One of the other aspects parallelly worked upon is increasing the share of renewable energy source, especially solar in the country in the power mix which historically has been nearly completely dependent on oil. Saudi Arabia is rich in sunlight, wherein to harness the same the government is aiming to generate 10% of its energy by 2023.

Energy price reforms planned by the government

In conclusion, it can be stated that the Saudi government is really trying hard to reform the economy with renewed energy, while focusing on areas like development, education along with reforms in energy and other allied sectors. However, this is going to be a challenging process for the government, public and private institutions and the public in general in the country. It will be an arduous task for the administration to transform the nation’s rigid cultural mindset as most Saudis are conservative, status-oriented, addicted to oil and hence, lack motivation for hard work. In addition, mismatch of skills between Saudi’s and the private job requirements also acts as a major hurdle against governments long-term plan on economic expansion, which would not be possible without higher education, motivation and dedicated workforce. In order to achieve its privatisation goal of 'Vision 2030', the country might have to continue its dependence on foreign labour till its own people take charge of their own work. The reforms initiated in main sectors (especially, water and energy) have to be implemented and monitored very closely for a real change. This should happen in a structured and phased manner as an unexpected heavy burden on the public and institutions could lead to protests, something not witnessed in the country historically. Even small but fundamental change like the recent permission of allowing women to drive is not being accepted by the public very easily. The government also has to check the undertone of the right-wing clerics, which hold significant power in a nearly full Islamic nation. It is walking on a double-edged sword and has to balance between economic and societal transformation as both need to go hand in hand for the achievement of 'Vision 2030'. Whether the government would be able to completely align with the plans for 2030 is a big question, though it can be mentioned that Saudi Arabia appears to be taking all steps in the right direction.

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