A Post-Oil Future for Saudi Arabia – 6/10/16

If any country has taken the pain of the oil price collapse to heart, then it would have to be Saudi Arabia. Only matched by Russia and the United States in raw output and the de facto leader of OPEC, the kingdom has a lot to lose if its chief export, which makes up over 70% of government revenues, can no longer support its generous government programs and involvement in regional conflicts. Few nations have more to lose in a post-oil future than Saudi Arabia.

Leading Saudi Arabia’s movement towards that post-oil future is the Council for Economic and Development Affairs headed by Deputy Crown Prince Mohammed bin Salman, according to a recently released document outlining future plans: the Saudi Vision 2030. The plans call for growth independent of oil and includes plans to sell shares in Saudi Arabian Oil Co. to create a sovereign wealth fund to encourage non-oil economic activity. It would also have the government encourage more of its citizens to look for jobs in the private sector, shrink its civil service size and salaries, cut subsidies, consider new taxes, and greatly increase the amount of electricity derived from renewable energy sources.

Around 70% of Saudis are currently employed in the public sector because it offers life long job security and high salaries for often undemanding work, an arrangement that is fast becoming unsustainable. The government spends 45% of its budget on wages today, but the new plan would have that reduced to 40% by 2020 via slowdown of hiring and early retirements.

Yet, good intentions can only do so much if the private sector broadly can’t provide alternative employment. Saudi Arabia’s private sector currently makes up only 40.5% of the country’s gross domestic product versus over 60% for most countries, according to the IMF.

Citizens have little incentive to go for the jobs that do exist after seeing their parents live comfortably off of public sector payrolls. A recent study published by Riyadh’s King Saud University found that 80% of Saudis polled in the capital said they would rather wait for a government job than work in the private sector. And who could blame them when the public sector promises long vacations, short working days, and a lifetime of job security. The government will have its work cut out for it reaching its goal of having half of Saudis employed in the private sector by 2020.

For decades, the ruling monarchy used oil money to fund a generous welfare state without substantial taxation, but low oil prices and the inevitability of a post-oil world are forcing a change.

“Now, with resources tight because of lower oil prices, what you are seeing is a move away from this model,” said Farouk Soussa, Citigroup’s chief economist for the Middle East. “The expectation that people should earn a living in the market, that their wage should reflect their contribution to the economy, that is a radical shift in thinking.”

Increased public sector accountability, reduced subsidies for water and electricity, value-added taxes, and levies on tobacco and soft drinks are all part of the plan to reduce the budget deficit. And while Saudi officials say an income tax is not officially planned, the Ministry of Finance has been tasked with “the preparation and implementation of the unified income tax.” The government has made it clear that while it wouldn’t introduce an income tax for Saudi citizens, it may still be considering it for expatriates.

The reason for the sudden urgency comes from two years of low oil prices. The kingdom’s finances are suffered from a record budget deficit of about $98 billion in 2015 significantly reducing its reserves. In response, government has made moves to stem losses: taking on billions in debt; making unpopular spending cuts; and raising the domestic cost of fuel, water and electricity. The International Monetary Fund expects Saudi economic growth to slow this year due to cheap oil.

Unfortunately, much of the success of Saudi Arabia’s plans for a post-oil future the thing it’s been designed to ignore: crude prices. If subsidy cuts, value-added taxation and a green card-type program for foreign workers deliver an additional $20 billion of new revenue each year, Saudi Arabia could balance its budget by 2020, according to EFG-Hermes economist Mohamed Abu Basha. But that scenario assumes a rise in Brent crude prices to $65 a barrel by 2020 and a boost of non-oil revenue to 20% of economic output from 6%, both of which may be overly optimistic.

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