## cr18264-sa ## Source details **Canonical URL:** [cr18264-sa](https://www.imf.org/-/media/files/publications/cr/2018/cr18264-sa.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18264-sa.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18264-sa.pdf.json) --- ### Introduction and context - Fiscal policy objectives in Saudi Arabia: macroeconomic stabilization, development, and intergenerational equity. - Oil revenues averaged 77 percent of total budget revenues and 27 percent of GDP since 1985. - Oil revenue sensitivity: - Fell to near 55 percent of total revenues during low oil price periods and reached over 93 percent during periods of high oil prices. - Government spending growth: - Accelerated to an average yearly growth of 12.3 percent during the oil boom (2003–14). - Averaged -0.7 percent during the low oil price period 1991–2002. - Fiscal balance extremes: - Deficit of 25 percent of GDP in 1987. - Surplus of 30 percent of GDP in 2008. - Government targets: - Balance the budget by 2023. - Not have central government debt exceed 30 percent of GDP. - Recent policy direction (since 2015): boost non-oil revenues, reduce energy subsidies, rationalize spending, and strengthen budget process and expenditure management. ### Empirical patterns and macroeconomic interactions - Fiscal policy is more procyclical relative to non-resource rich peers; higher real GDP growth (2003–17) when real government spending growth was higher. - Volatility medians (Annual growth in percent): - Real Non-oil GDP: Saudi Arabia — 3.1 (1990-2002), 6.0 (2003-2017), 4.7 (1990-2017). - Real GDP: Saudi Arabia — 2.9 (1990-2002), 4.4 (2003-2017), 3.7 (1990-2017). - Real Government Spending: Saudi Arabia — 3.6 (1990-2002), 6.2 (2003-2017), 5.1 (1990-2017). - CPI Inflation: Saudi Arabia — 0.4 (1990-2002), 2.5 (2003-2017), 1.5 (1990-2017). ### Lessons from resource-rich countries on fiscal rules - Desirable properties for fiscal rules: simplicity, flexibility, macroeconomic stability, resilience, robustness, and sustainability. - Implementation prerequisites and lessons: - Successful rules often preceded by fiscal consolidation. - Require strong supporting institutions: budget planning and monitoring, PFM, medium-term fiscal frameworks, risk-based approaches, and fiscal transparency. - Common weaknesses in RRC experiences: - Short-lived rules and prolonged suspensions. - Price-smoothing rules poorly suited to large, persistent commodity price shocks. - Structural balance rules require strong institutions to calibrate buffer accumulation during booms. - Non-resource primary balance rules can be undermined by weak escape clauses or inadequate buffers. - Sovereign Wealth Funds (SWFs): - Effective for stabilization and saving, but ad-hoc withdrawals or rigid rules disconnected from fiscal targets can undermine objectives. - Saudi government deposits at the central bank have functioned as buffers. ### Assessment for Saudi Arabia: recommended focus and rationale - Principal conclusion: prioritize strengthening the fiscal framework rather than introducing a formal fiscal rule at this stage. - Rationale and priorities: - A fiscal rule is only as effective as the institutional framework that supports it. - Priorities: - Strengthen fiscal strategic planning. - Enhance fiscal reporting and monitoring. - Strengthen budget execution and broader public financial management. - These measures help translate long-term objectives into annual budgets and increase accountability, improving credibility of any future rule. ### Implications for rule design and next steps - If a fiscal rule is later considered, design should: - Balance simplicity with flexibility to allow automatic stabilizers. - Address difficulty of estimating the economic cycle in oil-dependent economies. - Include mechanisms to build and manage fiscal buffers during booms and clearly specified escape clauses for large shocks. - Integrate SWF rules and budgetary instruments so accumulation and withdrawal rules do not conflict with fiscal targets. - Preconditions for durable rules: strengthened fiscal institutions and a period of demonstrable fiscal consolidation. ### Strengthening fiscal strategic planning and MTBF credibility - Shift from historical bottom-up budgeting to top-down strategic planning with: - MTFF for 3–5 years with quantitative fiscal objectives. - Fiscal policy strategy document translating MTFF into medium priorities. - MTBF setting multi-year expenditure plans and objectives. - Annual budget consistent with MTFF and MTBF. - Recent reforms: - Vision 2030 shifted toward top-down budgeting. - Fiscal Balance Program (FBP) provided a medium-term anchor. - Bureau of Capital and Operational Spending Rationalization (BSR) set savings targets until 2020. - MFPU provides macro forecasts and reconciles revenue forecasts for MTFF & MTBF. - Medium term fiscal strategy covers 3 years (2018–20); MOF has projections through 2023. - Recommended planning reforms: - Use macro projections to inform aggregate and entity ceilings; for 2019 guidance ceilings provided around late January; final ceilings (plus or minus ten percent of guidance ceilings) should be agreed before July. - Develop forward estimates and costing methodologies. - Introduce preventive mechanisms to ensure MTBF compliance (alternative paths with contingent measures, regular projection updates, contingent reserves, room under entity ceilings, limit carryovers). - Embed systematic risk analysis in MTFF and MTBF; monitor SOE-related risks and contingent liabilities. ### Fiscal reporting, monitoring, and legal framework - Produce and publish: - Strategy update in the first half of the year defining the MTFF and expenditure ceilings. - End-of-year report (EYR) assessing consolidated fiscal accounts and compliance. - Progress: - Internal Pre-Budget Statement (PBS) produced October 2017. - MFPU prepared in-year execution reports since 2017, monthly Fiscal Monitoring Report (FMP), and a published Quarterly Budget Performance Report (QBPR). - Fiscal strategy update 2019–21 will refine Budget 2019 ceilings. - Further reforms: - Strengthen PBS and FSR analyses (alternative fiscal paths, contribution of next year’s objectives to medium-term goals, across-year explanations). - Consider a Fiscal Responsibility Law (FRL) to reinforce credibility through rules on accountability, transparency, and stability. ### Budget execution reforms and broader coverage - Execution best practices require: sufficient appropriations, reliable cash-flow forecasting, commitment controls, frequent in-year reports, and standardized accounting. - Recommended actions: - Strengthen expenditure commitment controls; Etimad portal introduced for project contract management. - Implement a Treasury Single Account (TSA) to pool cash and improve forecasting and appropriation control. - Tighten rules for supplementary appropriations: restrict mid-year increases, forbid adoption of new programs mid-year, cap discretionary spending increases or require offsets. - Expand GFSM 2014 coverage beyond budgetary central government to include PIF, Aramco, pension funds, and specialized credit institutions by 2020 to better capture fiscal risks. ### Long-term fiscal anchors: objectives, options, and buffer sizing - Long-term objective discussion: - Government objective: achieve fiscal balance by 2023. - Limitation: the 2023 objective does not guide policy beyond 2023 and is heavily influenced by oil price developments. - Recommendation: consider longer-term objectives excluding oil revenues if aim is to save exhaustible resources. - Anchor options and quantitative implications: - Bird-in-the-Hand (BIH) / “Norwegian” model: - Spending from return on financial wealth; implies considerable savings upfront. - If rule starts in 2028 after a 5-year adjustment: - Non-oil primary deficit needed around 3 percent of non-oil GDP by 2028. - Afterwards, deficit starts increasing, leveling at an average of about 6 percent of non-oil GDP during 2028–2040. - Permanent Income Hypothesis (PIH) annuity: - More gradual use of oil revenues. - Converging to PIH by 2028 implies: - Non-oil primary fiscal deficit of about 17 percent of non-oil GDP by 2028. - An average of 14 percent of non-oil GDP during 2028–40. - Assumes oil price constant in real terms beyond WEO horizon and rate of return on assets higher than non-oil real GDP growth. - Fiscal buffer sizing (based on 2017 oil revenues and WEO forecast-error simulations): - Forecast errors: about 60 percent of one-year-ahead errors around +/– 5½ percent; remaining errors up to +/– 40 percent. - Fiscal impact: - 5½ percent oil price deviation ≈ shock of about 1¼ percent of non-oil GDP. - 40 percent deviation ≈ shock of about 9.5 percent of non-oil GDP. - Buffer illustrations (three-year shock scenario): - Buffer of about 50 percent of non-oil GDP in 2011 (about 40 percent in 2013) would cover small three-year shocks, two extra years if medium-term buffers fully used, and partial (up to 50 percent) of a large shock. - To cover a large shock fully, double buffers: 100 percent of non-oil GDP in 2011 (about 80 percent in 2013). - Actual GNFA: - End-2011 GNFA: 77 percent of non-oil GDP. - End-2013 GNFA: 96 percent of non-oil GDP. - Conclusion: GNFA end-2011 insufficient to cover simulated large 2011 shock; end-2013 GNFA would have been sufficient to cover end-2013 one. ### Operational fiscal rule types, trade-offs, and historical illustrations - Non-oil primary deficit rule: - Caps annual deficit excluding oil revenues; risks procyclicality and misclassification of structural shocks. - Illustration: a slightly dynamic rule (2004–14) capping increase in non-oil primary deficit at previous year’s deficit plus nominal equivalent of 2 percent of non-oil GDP: - Would have reduced fiscal volatility and generated cumulative savings of about 18 percent of non-oil GDP (1.6 percent annually) over 2004–14. - Expenditure rule: - Caps expenditure growth; aligns with MTBF. - Practical spec: government spending growth limited to nominal non-oil GDP plus ½ percent. - Result: smoother spending path during 2004–14. - Cumulated savings: 17 percent of non-oil GDP (1.5 percent annually). - Implementation note: spending cap could be linked to last year’s GDP or a longer-term average due to non-oil GDP forecasting difficulties. - Structural balance rule: - Uses moving averages of oil prices to calibrate spending; useful to reduce cyclical spending responses but sensitive to moving average specification and does not clearly signal pace of consolidation. - Debt brake / CGNFA floor: - Set a floor on central government net financial assets so automatic adjustment measures trigger when assets fall below threshold. ### Conclusions and policy recommendations on fiscal anchors and rules - Recent policy steps: policies introduced to reduce fiscal deficit, strengthen budget process and fiscal framework, and increase transparency. - Targets reiterated: balance by 2023 and keep central government debt below 30 percent of GDP. - Key recommendations: - Define long-term fiscal objectives beyond 2023 to choose an appropriate fiscal anchor. - Frame fiscal objectives in terms of the primary non-oil balance rather than the overall balance. - Ensure debt-to-GDP target consistent with fiscal balance target and financing mix. - Prefer setting a target level for net financial assets consistent with fiscal balance target rather than relying solely on a debt ceiling. - Prioritize strengthening fiscal processes and institutions before introducing a formal fiscal rule. - Strengthen budget execution: maintain MTFF and MTBF, develop implementation/monitoring tools (commitment controls, TSA, rules on expenditure reallocation, reporting, and audit). ### Labor market key findings and policy implications - Labor market outcomes and challenges: - Unemployment rose from 10 percent in 2008 to 12.8 percent in 2017; driven by higher female and youth unemployment. - 52 percent of the unemployed have a bachelor’s degree; women with tertiary education are the majority of college-educated unemployed. - Long-term unemployment high: about 43 percent of the unemployed had been looking for a job over 10 months as of December 2017. - Employment growth: 5.1 percent in 2010–14, slowed to 2.2 percent in 2015–17; most employment growth from the public sector. - Jobs needed by 2023 to absorb new entrants at current participation rates: 0.5 million jobs; if female participation rises by 1 percentage point every year, jobs needed by 2023 could rise to 1.4 million. - Vision 2030 targets: - Lower unemployment of nationals to 7 percent and increase female labor force participation rate to 30 percent by 2030. - Policy instruments and assessment: - Instruments: Nitaqat quotas, expatriate exclusions in some retail sectors, expatriate fees and levies, wage subsidies, measures to boost female employment, education and training reforms. - Assessment: interventions reduced some distortions (boosting female participation, reducing wage gap) but can induce firm adjustments and growth costs; reforms should be gradual and comprehensive. ### Expatriate levy modeling results (G20MOD) - Levy history and design: - 2012: SAR 200 per month per worker. - January 2018: raised to SAR 300 and SAR 400 per worker and rising to SAR 700–800 by 2020 depending on Saudization share. - Monthly fees of SAR 100 for each dependent introduced July 2017. - Levies projected to amount to about 20 percent of the current average wage gap by 2020 when fully implemented. - Model assumptions: - Two incidence scenarios: (1) expatriates bear the levy; (2) firms bear the levy. - Levy increases over three years and projected to raise roughly 2 percent of GDP in additional revenue by 2020. - Assumed 0.5 percent of GDP used to finance a temporary two-year labor subsidy for Saudis; remainder improves fiscal balance permanently. - Core model findings: - Expat levy increases fiscal revenues but reduces real GDP relative to baseline in both incidence scenarios. - If expatriates bear the levy: - Employment broadly unchanged; expatriate disposable income and consumption permanently decline. - Remittances decline; private consumption and investment fall; long-run capital stock and output lower. - External and fiscal balances improve; net government asset position gradually improves. - If firms bear the levy: - After-tax return on capital falls, investment falls, capital stock declines, and potential output drops. - Firms may reduce real wages; households cut consumption and labor supply; larger GDP and employment costs. - If firms have economic rents, adverse impact smaller. - If expatriate exits occur (assumed 1 percent leave each year), long-run GDP lower relative to baseline. - Policy implications: - The levy yields revenue but not employment gains if wage gap remains large. - To avoid negative growth impacts from Saudization policies, preconditions needed: - High-productivity national workers must replace lower-productivity expatriates. - Sufficient nationals willing to work at productivity-reflective wages. - Recommended reforms: - Reform expatriate labor policies (internal mobility, sponsorship, visa reform). - Change public sector role and wage growth expectations. - Remove barriers to female employment and support firms with reconfiguration costs. - Improve education, vocational training, and public spending efficiency. - Review wage subsidy design and support private sector development (SME finance, regulatory environment). ### Financial sector development, inclusion, and SME support - Financial system structure (end-2017): - Total financial sector assets: about $1.1 trillion (159 percent of GDP). - Composition: Commercial banks 57 percent; Pension funds 31 percent; SCIs 7 percent; Investment funds 3 percent; Other financial institutions 2 percent. - Commercial banks: 24 banks (12 domestic, 12 foreign); four largest banks hold 55 percent of banking assets. - Bank liabilities and assets (2017): Equity 16 percent; Deposits 75 percent; Interbank 4 percent; Debt issuance 2 percent; Cash & reserve 11 percent; Loans 62 percent; Investments 19 percent. - Lending breakdown: corporates 34 percent of total assets; households 20 percent of total assets; mortgage loans about one-fourth of household lending. - Direct government exposure: 6 percent of total assets; credit to government and public enterprises: 10.6 percent of GDP in 2016. - SCIs: total assets 11 percent of GDP (17 percent of non-oil GDP) at end-2017; provide credit equivalent to around 18 percent of banking sector credit. - Financial depth and markets: - Bank private credit and deposits to GDP in line with peers and statistical benchmarks but lower than high-income countries and GCC average. - Stock market capitalization to non-oil GDP declined from around 107 percent in 2008 to 92 percent in 2017; 10 largest companies represent 60 percent of market cap. - Domestic corporate bond market small at less than 1 percent of GDP; lack of benchmark yield curve and liquid secondary market. - Financial access and inclusion: - Account ownership increased to 72 percent in 2017 from 46 percent in 2011. - Borrowing from financial institutions around 11 percent in 2017. - Informal borrowing about 33 percent of adults in 2017. - Gender gaps: 80 percent of male adults had accounts in 2017; 58 percent of female adults had accounts. - Digital banking usage: 25 percent of adults used mobile/internet to access accounts in 2017. - SME finance and constraints: - SME borrowing from banks very low: average of 2 percent of total loans. - SMEs: nearly 1 million firms, 38 percent of jobs (80 percent expatriate), and 20 percent of GDP. - 88 percent of SMEs are micro firms (up to 5 employees). - Institutional constraints: low credit registry coverage, weak legal rights index, poor SME financial statements, high collateral requirements, low financial literacy. - FSDP and policy recommendations: - Financial Sector Development Program adopted May 2018 aims to develop diversified financial sector and improve inclusion. - Policy priorities: - Improve SME access to finance (increase bank lending to SMEs from around 2 percent to 20 percent by 2030 via capital increases to Kafalah, data collection, alternative funding, Fund of Funds). - Promote Fintech and digital banking (regulatory sandboxes, regulatory reforms, consumer protection, data protection). - Raise financial literacy target to 50 percent of adults by 2030 via a financial literacy entity. - Deepen capital and debt markets (primary dealer system, sukuk program, regular issuance, yield curve development). - Improve data on unbanked markets and measure inclusion. - Maintain strong focus on financial stability while pursuing development and inclusion. ### Government support to SMEs (Box 4) - SME role and challenge: - SMEs account for around 20 percent of GDP; Vision 2030 aims to raise SME contribution to 35 percent of GDP by 2030. - Banking sector lending to SMEs about 2 percent of total lending. - Key programs: - Kafalah program (established 2006): partial guarantee up to 80 percent of SME loans; guarantees for 10,583 SMEs; guarantees amount SAR 10.8 billion (0.4 percent of GDP); average coverage 55 percent of SME loans; recent SAR 800 million capital increase approved. - Fund of Funds under PIF with capital SAR 4 billion to invest in private equity/VC. - Social Development Bank and Saudi Industrial Development Fund provide SME financing. - Policy recommendations for SMEs: - Address legal and credit infrastructure, expand alternatives to bank finance (leasing, factoring, private equity, VC). - Improve corporate governance, business environment, and reduce bureaucracy. - Foster financial inclusion via social programs tied to bank accounts, digital banking, and wage protection system uptake. - Develop fintech-friendly regulatory frameworks and promote private equity/VC development. - Enhance data production and measurement for access and usage. - Continue strong supervisory focus to preserve financial stability. _Italic: Source — IMF staff paper as presented in "FISCAL FRAMEWORKS AND FISCAL ANCHORS: THE EXPERIENCES IN COMMODITY EXPORTING COUNTRIES AND IMPLICATIONS FOR SAUDI ARABIA" (June 28, 2018)._ ### 1. Fiscal Strategic Planning________________________________________________________________ 11 ### FISCAL FRAMEWORKS AND FISCAL ANCHORS: THE EXPERIENCES IN COMMODITY EXPORTING COUNTRIES AND IMPLICATIONS FOR SAUDI ARABIA ### Introduction and context - Fiscal policy in Saudi Arabia focuses on three main objectives: macroeconomic stabilization, development, and intergenerational equity. - Oil revenues averaged 77 percent of total budget revenues and 27 percent of GDP since 1985. - Oil revenues fell to near 55 percent of total revenues during low oil price periods and reached over 93 percent during periods of high oil prices. - Government spending growth: - Accelerated to an average yearly growth of 12.3 percent during the oil boom (2003–14). - Averaged -0.7 percent during the low oil price period 1991–2002. - Fiscal balance extremes: - Deficit of 25 percent of GDP in 1987. - Surplus of 30 percent of GDP in 2008. - The government has set targets: - Balance the budget by 2023. - Not have central government debt exceed 30 percent of GDP. - Recent policy direction (since 2015): boost non-oil revenues, reduce energy subsidies, and rationalize spending; strengthening budget process and expenditure management. ### Empirical patterns and macroeconomic interactions - Fiscal policy in Saudi Arabia is more procyclical relative to non-resource rich peers; real GDP growth was higher (2003-17) when real government spending growth was higher. - Volatility comparisons (medians across groups, Annual growth in percent): - Real Non-oil GDP: Saudi Arabia — 3.1 (1990-2002), 6.0 (2003-2017), 4.7 (1990-2017). - Real GDP: Saudi Arabia — 2.9 (1990-2002), 4.4 (2003-2017), 3.7 (1990-2017). - Real Government Spending: Saudi Arabia — 3.6 (1990-2002), 6.2 (2003-2017), 5.1 (1990-2017). - CPI Inflation: Saudi Arabia — 0.4 (1990-2002), 2.5 (2003-2017), 1.5 (1990-2017). - Comparative medians (selected groups shown in source): Oil Exporters, G20, Primary Product Exporters (full table values in source). ### Lessons from resource-rich countries (RRCs) on fiscal rules - Desirable properties of fiscal rules: simplicity, flexibility, macroeconomic stability, resilience, robustness, and sustainability. - Key implementation prerequisites and lessons: - Successful rules are often preceded by fiscal consolidation. - Fiscal rules require strong supporting institutions: budget planning and monitoring, public financial management (PFM), medium-term fiscal frameworks, risk-based fiscal policy approaches, and fiscal transparency. - Common weaknesses observed in RRC experiences: - Short-lived rules and prolonged suspensions. - Price-smoothing rules poorly suited to large, persistent commodity price shocks. - Structural balance rules work better for less resource-dependent countries but require strong institutions to calibrate for buffer accumulation during booms. - Non-resource primary balance rules can provide a medium-term framework but have been undermined by weak escape clauses or inadequate buffers. - Sovereign Wealth Funds (SWFs): - Effective for stabilization and saving, but ad-hoc withdrawals or rigid rules disconnected from fiscal targets can undermine both stabilization and intergenerational investment objectives. - In several RRCs, substantial buffers were used post-2014 commodity price collapse without clear fiscal-rule governance, creating tensions between stabilization and long-term investment objectives. - In Saudi Arabia, government deposits at the central bank have functioned as buffers. ### Assessment for Saudi Arabia: recommended focus and rationale - Principal conclusion: at this stage the focus should be on strengthening the fiscal framework rather than introducing a formal fiscal rule. - Rationale: - A fiscal rule is only as effective as the institutional framework that supports it. - Saudi Arabia should prioritize: - Strengthening fiscal strategic planning. - Enhancing fiscal reporting and monitoring. - Strengthening budget execution and broader public financial management. - These measures would help translate long-term objectives into annual budgets and increase accountability, making any future rule more credible and operationally effective. ### Implications for rule design and next steps - If a fiscal rule is considered later, design choices should account for: - The need for simplicity balanced with flexibility to allow automatic stabilizers to operate. - The challenge of estimating the economic cycle in economies highly dependent on oil revenue/prices. - Mechanisms to build and manage fiscal buffers during booms and clearly specified escape clauses for large shocks. - Integration with SWF rules and budgetary instruments so that accumulation and withdrawal rules do not conflict with fiscal targets. - Strengthened fiscal institutions and a period of demonstrable fiscal consolidation are preconditions to improve the chances of durable and effective fiscal rules. _Italic: Source — IMF staff paper as presented in "FISCAL FRAMEWORKS AND FISCAL ANCHORS: THE EXPERIENCES IN COMMODITY EXPORTING COUNTRIES AND IMPLICATIONS FOR SAUDI ARABIA" (June 28, 2018)._ ### 10. International experiences highlight some key lessons that influence considerations of ### 10. International experiences highlight some key lessons that influence considerations of how an effective fiscal rule could be introduced in Saudi Arabia ### International lessons for fiscal rules - A strong institutional environment will be critical: fiscal rules need support from a strong medium-term fiscal framework, a robust public financial management (PFM) system, broad enough coverage of the government sector, and transparency and independent oversight. - Fiscal rules should be designed to guide government savings objectives: primarily to provide buffers against shocks and potentially to achieve a longer-term goal of saving for future generations. - Buffers and escape clauses are crucial for RRCs (resource-rich countries): - Buffers insure against risks (including to some degree large oil price shocks) and help avoid abrupt, unnecessarily disruptive adjustments. - Most escape clauses are about triggers warranting suspension of rules in tail-risk events and the process to return to rule application after a commodity price shock. ### C. Institutional Considerations: what is required versus what is there - A strong institutional framework for fiscal policy is key to successfully implementing a fiscal rule. Saudi Arabia could gain from further deepening reforms underway to strengthen its fiscal framework and PFM practices before adopting a fiscal rule. - Reforms should focus on: having its fiscal strategy within a medium-term fiscal framework; improving the budget process and fiscal institutions; enhancing spending execution; and improving transparency and accountability. These reforms are prerequisites for successful implementation of a fiscal rule (IMF 2009, 2015). ### Strengthening fiscal strategic planning in Saudi Arabia - Historical budgeting process: - The budgetary process traditionally followed a bottom-up approach, starting with an MoF circular referencing the Budget Preparation Manual and an aggregate expenditure target without entity ceilings. - Ministries’ spending proposals included financial costs but not objectives, limiting prioritization at the aggregate level and resulting in incremental decision-making. - Box 1: Fiscal Strategic Planning — key elements and rationale: - Shift to strategic planning: project fiscal variables over the medium-term while combining fiscal policy objectives to produce short- and medium-term fiscal objectives operationalized through a medium-term budget and annual budget. - Components of the broader framework: - A medium term fiscal framework (MTFF) for 3–5 years with quantitative fiscal objectives. - A fiscal policy strategy document translating the MTFF into medium fiscal policy priorities. - A medium-term budget framework (MTBF) setting multi-year expenditure plans and objectives. - An annual budget consistent with the above. - MTFFs commit, report, and set accountability requirements for medium-term aggregate fiscal objectives and serve as the starting point for allocation via MTBFs. - MTBFs translate MTFFs into medium-term revenue projections and disaggregated expenditure limits; conversion requires reconciling top-down and bottom-up approaches through iterative discussions between MoF and budget entities. - Recent reforms and institutional arrangements: - Vision 2030 initiated a shift toward a top-down budget preparation approach. - The Fiscal Balance Program (FBP) provided a medium-term fiscal anchor and aimed to reduce reliance on oil revenues and moderate spending responsiveness to oil prices. - The Bureau of Capital and Operational Spending Rationalization (BSR) set specific savings targets for operational and capital expenditures until 2020. - Ministries set KPIs and a national performance monitoring agency (Adaa) was established. - MoF adopted a Strategic Plan in early 2017 to implement top-down reforms; the Fiscal Balance Program Office (FBPO) prepared the initial medium-term fiscal strategy and worked with the Macro Fiscal Policy Unit (MFPU). - The MFPU provides macroeconomic forecasts, revenue projections linked to its macro forecast, and works with the non-oil revenue department and revenue collection agencies to reconcile a single revenue forecast for the MTFF & MTBF. - The medium term fiscal strategy currently covers 3 years (2018–20), although MOF has revenue and expenditure projections through 2023. - Financing strategy: - A borrowing plan to finance fiscal deficits is designed and managed by the Debt Management Office (DMO) and approved by MoF; historically, past fiscal surpluses explain the previous lack of a financing strategy. - The MTFF should be based on a broader asset-liability management framework consistent with macroeconomic policy objectives under Vision 2030. ### Reforms recommended going forward (planning and MTBF credibility) - Use macroeconomic projections more effectively to inform aggregate and entity expenditure ceilings: - For 2019, the Budget Deputyship used 2018 expenditure ceilings by economic classification; guidance ceilings were provided to entities around late January; final ceilings (plus or minus ten percent of guidance ceilings) should be agreed and a consolidated draft prepared before July. - Develop forward estimates and costing methodologies to enhance MTBF credibility: - Forward estimates are crucial for expenditure forecasts at current policies; costing methodologies assess the cost of new programs and projects and mitigate informational asymmetry. - Introduce preventive mechanisms to ensure compliance with the MTBF, e.g.: - Design alternative paths supported by contingent revenue and expenditure measures to return gradually to medium-term fiscal objectives if deviations occur. - Maintain regular updates of medium-term macroeconomic and fiscal projections. - Build contingent reserves calibrated by historical deviations of expenditure or the volatility of relevant macroeconomic variables. - Leave room under entity-level ceilings to accommodate expected (but not yet included) expenditure commitments. - Limit expenditure carryovers between consecutive years. - Improve MTBF with better risk analysis: - Historically, contingent reserves were used but not sized based on risk analysis or past forecasting errors. - The 2018 Budget Statement included a qualitative risk statement for the first time. - Embed risk analysis in MTFF and MTBF and systematically monitor macro-fiscal SOE-related risks and other contingent liabilities. ### Fiscal reporting and monitoring - Importance of Fiscal Strategy Reports (FSR) and updates: - Produce and ideally publish a strategy update in the first half of the year that highlights changes and revisions and defines the MTFF, including expenditure ceilings. - Produce an end-of-year report (EYR) assessing final consolidated fiscal accounts and compliance with the fiscal strategy; EYR and SU are usually released to the public in the first half of the year. - Progress to date: - An internal strategy update similar to a Pre-Budget Statement (PBS) was produced in October 2017 and distributed internally; it included the new fiscal strategy and a basic MTBF with GFS 2014 three-digit economic classifications. - MFPU prepared in-year execution reports starting in 2017 and produced a monthly Fiscal Monitoring Report (FMP) and a Quarterly Budget Performance Report (QBPR); the QBPR is published. - The fiscal strategy update 2019–21 will help fine-tune expenditure ceilings for Budget 2019. - Further reforms for reporting and analysis: - Strengthen analysis within PBS and FSR to include: - A discussion of alternative fiscal paths and their characteristics (current practice has only two scenarios: baseline with reforms and alternative of no reforms). - Clear analysis of next year’s fiscal objectives’ contribution to medium-term objectives, emphasizing debt accumulation drivers. - Across-year analysis explaining differences between the previous year’s and the updated strategy. - Consider adopting a Fiscal Responsibility Law (FRL) to reinforce credibility by elaborating rules and procedures related to accountability, transparency, and stability. ### Reforms to strengthen the budget execution framework - Budget execution best practices require actions from planning through ex-post evaluation, including: sufficient budget appropriations for programs; reliable cash-flow forecasting and management; commitment controls; frequent in-year execution analytical reports; and transparent application of standardized accounting practices. - Progress and recommended actions: - Strengthen expenditure commitment controls: weaknesses contributed to arrears when budget execution tightened; MoF introduced an electronic portal, Etimad, for managing project contracts. - Implement a Treasury Single Account (TSA): MoF’s strategic objectives include TSA implementation to quantify and pool cash availabilities, improve cash forecasting, strengthen control over appropriations, and improve execution data quality. - Tighten rules for approving and offsetting supplementary appropriations: - Impose more stringent restrictions on mid-year increases in appropriations, rule out adoption of new programs or expansion of coverage mid-year, and forbid large changes in cost-driving parameters. - Cap increases in discretionary spending or require offsets to keep total deficit unchanged. - Expand GFSM 2014 coverage beyond budgetary central government: - Current coverage excludes important spending units such as the Public Investment Fund, Aramco, pension funds, and specialized credit institutions that carry out fiscal functions and may pose balance-sheet risks. - Subsidized agencies and SOEs can be sources of fiscal risks; transition to broader government coverage is envisaged to be completed in 2020. ### D. Thinking about a fiscal rule in Saudi Arabia - The document outlines that Saudi Arabia should consider the institutional prerequisites described above before adopting a fiscal rule; these include strengthening MTFF/MTBF, budget process reforms, execution controls, transparency, and oversight to ensure the government can deliver on fiscal objectives and implement a credible fiscal rule. *International Monetary Fund — CR18264-SA (section 10).* ### 23. The first and fundamental question before the government when deciding on a fiscal ### 23. The first and fundamental question before the government when deciding on a fiscal anchor is defining the long-term objective this anchor would aim to achieve ### Long-term objective and rationale - Government objective: achieve fiscal balance by 2023. - Limitations of the 2023 objective: - Crucial to reduce fiscal risks and restore long-term sustainability, but does not guide policy beyond 2023. - Will be importantly influenced by oil price developments; could be easily achieved or challenged depending on oil price direction and magnitude. - Recommendation: consider longer term fiscal objectives which exclude oil revenues from the fiscal target if the aim is to save exhaustible oil resources for future generations. ### Options for a long-term fiscal anchor (designs and quantitative implications) - Bird-in-the-Hand (BIH) / “Norwegian” model - Uses spending only from the return on actual financial wealth (implies considerable savings upfront). - If implemented after 2023 with a 5-year adjustment period (rule starts in 2028): - Non-oil primary deficit would need to be reduced to around 3 percent of non-oil GDP by 2028. - After adjustment, the non-oil primary deficit starts to increase as returns increase with accumulation of financial assets, leveling at an average of about 6 percent of non-oil GDP in the following 12 years through 2040. - Permanent Income Hypothesis (PIH) annuity - More gradual use of oil revenues for current spending. - If converging to a PIH-based long-term norm: - Non-oil primary fiscal deficit of about 17 percent of non-oil GDP by 2028. - An average of 14 percent of non-oil GDP during 2028–40. - Assumptions: oil price constant in real terms beyond the WEO forecast horizon and a rate of return on financial assets that is higher than non-oil real GDP growth. ### Fiscal buffers and insurance against oil price shocks - Empirical oil price forecast-error profile (past 20 years, using WEO oil price forecast): - On average, about 60 percent of one-year-ahead forecast errors of oil prices are relatively small (around +/– 5½ percent). - The remaining forecast errors are much higher, with deviations from the initial forecast of +/– 40 percent. - Fiscal impact magnitudes (based on 2017 oil revenues): - A deviation of about 5½ percent in oil prices ≈ a shock of about 1¼ percent of non-oil GDP. - A deviation of 40 percent in oil prices ≈ a shock of about 9.5 percent of non-oil GDP. - Illustration of buffer size using WEO forecast-error simulations (cumulative deviation of oil revenues under a three-year shock scenario): - A buffer of about 50 percent of non-oil GDP in 2011 (about 40 percent of non-oil GDP in 2013) would have been needed to cover: - (i) small shocks that would extend over a three-year period (assumed horizon of the MTFF); - (ii) potential small shocks beyond the medium-term horizon (an extra two years in this example) if medium-term buffers were fully used; and - (iii) a partial cover (up to 50 percent) of a large shock. - To cover the totality of a large shock, double the above buffers would have been needed: - 100 percent of non-oil GDP in 2011 (about 80 percent of non-oil GDP in 2013). - These scenarios assume no adjustment in government spending from its pre-shock level. - Actual net financial position (GNFA) observed: - End-2011 GNFA: 77 percent of non-oil GDP. - End-2013 GNFA: 96 percent of non-oil GDP. - Conclusion: GNFA at end-2011 would not have been sufficient to cover the simulated large 2011 shock; GNFA at end-2013 would have been more than sufficient to cover the end-2013 one. ### Operational fiscal rules — types, advantages, trade-offs, and historical illustrations - Non-oil primary deficit rule - Features: - Sets a cap on the maximum deficit allowed in any given year. - Excludes oil revenues from the fiscal policy target, giving a more accurate measure of fiscal stance. - Helps set fiscal policy on a longer-term horizon and control expansion of government spending not matched by non-oil revenues. - Risks: - Tend to be procyclical. - Risk of not adjusting when shocks treated as temporary when they are structural. - Illustration (2004–14, slightly dynamic rule): increase in the non-oil primary deficit capped at previous year’s deficit plus the nominal equivalent of 2 percent of non-oil GDP. - Result: would have reduced fiscal volatility and generated cumulative savings of about 18 percent of non-oil GDP (1.6 percent annually) over 2004–14. - Expenditure rule - Features: - Sets a cap on expenditure growth (limits procyclicality during oil price booms). - Aligns with budget process and medium-term fiscal planning. - Practical specification illustrated: growth rate of government spending limited to nominal non-oil GDP plus ½ percent. - Result: spending path would have been much smoother during 2004–14. - Cumulated savings: 17 percent of non-oil GDP (1.5 percent annually), virtually the same as with the non-oil deficit rule in the illustrative example. - Implementation note: given forecasting difficulties for non-oil GDP, the spending cap could be linked to last year’s GDP or a longer-term average. - Structural balance rule - Calibrates spending according to the long-term trend in oil prices using moving averages. - Structural spending = structural revenue; structural oil revenue is calculated on a moving average of oil prices over an extended period. - Two variants applied in the 2017 Article IV: - Five-year backward-looking moving average of oil prices. - Backward-forward eight-year moving average (four preceding years, current year, forthcoming three years). - Finding: such rules can be very useful in reducing cyclical government spending responses to short-term oil price swings, but they do not provide a clear assessment of the pace of fiscal consolidation because outcomes depend on the moving average specification. - Debt brake / CGNFA floor - Strengthening a fiscal rule with a debt brake (central government net financial asset floor) could protect sustainability during downturns. - Mechanism: set a floor on CGNFA so that when assets fall below a threshold, automatic adjustment measures trigger to reduce spending and increase GNFA. - This incorporates policy buffer considerations into the fiscal rule. ### Conclusions and policy recommendations - Recent policy steps: - Government introduced policies to reduce the large fiscal deficit, strengthen the budget process and fiscal framework, and increase transparency. - Targets set: balance the budget by 2023 and keep central government debt below 30 percent of GDP. - Key recommendations and observations: - Define long-term fiscal policy objectives beyond 2023 to determine the appropriate fiscal anchor. - Formulate fiscal policy objectives in terms of the primary non-oil balance rather than the overall balance. - Ensure debt-to-GDP target is consistent with the fiscal balance target and an appropriate financing mix. - Prefer setting a target level for net financial assets consistent with the fiscal balance target rather than relying solely on a debt ceiling. - Prioritize strengthening fiscal processes and fiscal institutions before introducing a formal fiscal rule: - International experience shows difficulties in designing rules that are simple, flexible, and robust, especially with large commodity price swings. - A fiscal rule is only as good as the institutions that support it. - Give greater focus to strengthening budget execution: - Maintain and use both a MTFF and MTBF for long-term fiscal planning. - Develop tools for budgetary implementation and monitoring, including commitments control, the TSA, and rules governing expenditure reallocation, reporting, and audit. *Source: IMF staff analysis in the provided chapter content.* ### 35. In thinking about its fiscal policy objectives and a possible fiscal rule, the government ### cr18264-sa - 35. In thinking about its fiscal policy objectives and a possible fiscal rule, the government ### Fiscal policy objectives, trade-offs, and possible fiscal rules - The government must balance short-term macro-management, medium-term development, and longer-term saving goals. - Policy options and their implications: - Intergenerational equity / saving for future generations - If the government wants to increase saving of the revenues from oil resources for future generations, it will want to pursue larger fiscal surpluses in the future. - Insurance against oil price shocks / rebuilding fiscal buffers - If the primary focus is to insure fiscal policy against oil price shocks, the government will want to rebuild sufficient fiscal buffers to smooth fiscal policy adjustment following shocks over the short-to-medium term and mitigate adverse effects on growth and employment. - This objective would imply rebuilding over the medium-term the fiscal buffers used during the past several years, and thus the need to return after 2023 to fiscal surpluses, although these could be smaller than under the intergenerational equity option. - Demand management and volatility reduction - Fiscal policy plays an important demand management role; reducing volatility is an important objective. - A non-oil primary balance or an expenditure growth rule could help reduce the volatility of fiscal policy and strengthen macroeconomic stability as well as long-term fiscal and external sustainability. - Trade-offs - Pursuing these goals will have costs and benefits and there will be trade-offs among the ambition of the target, the longer-term benefits, and the potential short-term costs. ### Annex I — Fiscal anchors and rules in selected resource-rich countries (summarized highlights) - 1. Norway - Fiscal framework established in 2001. - Non-oil fiscal deficit tied to investment income of the sovereign wealth fund (SWF). - Ceiling: non-oil primary deficit not to exceed 4 percent of the accumulated financial wealth (corresponds to expected long-run real rate of return). - In 2017, government reduced estimated real rate of return on SWF assets from 4 to 3 percent, capping annual transfer from SWF to the budget. - Transfer from SWF can be higher during downturns for countercyclical stabilization and expenditure smoothing. - Appropriate for advanced countries with short resource horizon; less appropriate for countries needing investment in physical and human capital. - 2. Chile - Structural balance rule introduced in 2001, revised 2005; Fiscal Responsibility Law in 2006. - Structural revenues and structural balance concept: (i) economy at full potential; (ii) prices of copper and molybdenum at long-term levels. - Evolution of targets: - 2001–07: constant target (surplus of 1 percent of GDP). - 2008: target changed to 0.5 percent of GDP. - 2009: target set at zero; escape clause introduced for countercyclical measures. - Fiscal council operating since 2013; oversees independent committees on potential GDP and long-run copper price. - From 2015 budget, government no longer adjusts revenues based on long-term prices of molybdenum. - 3. Russia - Fiscal rule introduced in 2008; original long-term non-oil deficit target of 4.7 percent of GDP to be achieved by 2011 (suspended in 2009). - Redesigned rule beginning in 2013: ceiling on expenditures = benchmark oil revenue + non-oil revenues + net borrowing limit of 1 percent of GDP. - Benchmark oil revenues: 10-year backward-looking oil price rule (5-year average used in 2013, to be increased to 10 years by 2018). - Excess oil revenues saved in Reserve Fund until it reaches 7 percent of GDP; thereafter at least half to National Wealth Fund, remainder to budget for infrastructure. - Reserve Fund can be used when oil prices are below benchmark; prolonged declines lead to resetting benchmark to three-year backward average. - After 2014 oil shock, rule suspended in 2015 because three-year moving average benchmark oil price (~$85 per barrel) exceeded actual oil price (~$42 per barrel in 2016). - 2018: implementation started of a modified fiscal rule (legislation passed in 2017), initially targeted for 2019: - New rule targets a non-oil primary deficit of 1 percent of GDP in 2018 (and zero for 2019 and beyond) at a fixed benchmark oil price per barrel of $40 (in real 2017-dollar terms) with a proposed annual adjustment by the US CPI inflation. - 4. Mexico - Fiscal Responsibility Law (FRL) introduced in 2006: fiscal zero-balance target on a cash basis with an escape clause for downturns. - Applies to federal public sector including PEMEX and CFE. - Reference oil price set by a formula; system of four stabilization funds including an oil stabilization fund. - Revisions: - 2008–09: exclude PEMEX investment and change target from zero-balance to a deficit of 2 percent of GDP to boost investment in oil projects and include PEMEX investments in the budget. - Escape clause used in 2010, 2011, 2012. - 2013 amendment: cap on structural current spending (SCS) and definition of SCS clarified. - 2014 amendment: includes target for broader public sector borrowing requirement (PSBR) and cap on real growth of SCS (initially set at 2 percent) to equal potential output growth starting from 2017. - 5. Mongolia - Fiscal Stability Law (FSL) introduced in 2010; implementation starting 2013. Combines three rules: - (i) Expenditure rule: expenditure growth cannot exceed non-mineral GDP growth. - (ii) Budget balance rule: structural fiscal deficit cannot exceed 2 percent of GDP. Structural revenues defined using a twenty four-year moving average of mineral prices (20 previous years, current year, and three future years) with forecasts based on IMF and reputable financial institutions. - (iii) Debt ceiling: government debt in NPV terms cannot exceed 60 percent of GDP. - FSL amended 11 times during 2011–17; new Debt Law enacted with temporary and transitional measures: - Structural deficit temporarily raised to 9.5 percent of GDP in 2018 and set to decline gradually to 2 percent of GDP in 2023 and beyond. - Development Bank of Mongolia spending brought onto the budget and included in structural fiscal deficit. - Debt limits temporarily raised to 85 percent of GDP in 2017 and targeted to decline to 60 percent of GDP in 2021 and beyond; definition of debt narrowed from public to (general) government. - Stabilization fund operation: when mineral revenues exceed structural mineral revenues, the difference is placed in the stabilization fund; when mineral revenues fall short, the fund can be used to finance the deficit. - 6. Timor-Leste - Set a floor on the non-oil deficit in line with an estimated sustainable income based on the Permanent Income Hypothesis (PIH), but deviated from it to scale up public investment. - PIH ties fiscal deficit to financial wealth plus the NPV of oil revenues; current wealth and NPV of future oil revenues finance a constant flow of expenditure in real or real per capita terms. The path of the non-oil primary fiscal deficit consistent with PIH is calculated. ### Annex II — Assumptions for computing long-term fiscal anchors (percent, unless otherwise indicated) - Oil sector - Recovery rate 100.0 - Oil production growth until 2030 1.0 - Oil production growth from 2031 -1.0 - Oil prices annual percentage increase beyond 2023 2.0 - Interest rates and inflation - Return on SAMA's NFA 5.5 - GDP deflator (percent change) 2.1 - Real interest rate 3.3 - Real sector - Real GDP growth 2.3 - Real non-oil GDP growth 3.2 - Population growth 0.5 - Increase in domestic consumption of oil 1.0 - Fiscal sector - Share of oil revenues to budget 68.0 - PIH parameters - Time to reach PIH post WEO projections (years) 5 ### Key labor-market findings and policy implications (from accompanying chapter "THE ECONOMIC IMPACT OF POLICIES TO BOOST THE EMPLOYMENT OF SAUDI NATIONALS") - Labor market challenges and statistics - Saudi unemployment rate increased from 10 percent in 2008 to 12.8 percent in 2017. - Increase mainly reflects higher female and youth unemployment. - 52 percent of the unemployed have a bachelor’s degree. - Women with tertiary education constitute the vast majority of the college-educated unemployed. - Long-term unemployment high: about 43 percent of the unemployed had been looking for a job for over 10 months as of December 2017. - Saudi employment growth: 5.1 percent in 2010–14 and slowed to 2.2 percent in 2015–17 following the oil price shock; most employment growth has come from the public sector. - Jobs needed by 2023 to absorb new entrants at current participation rates: 0.5 million jobs. - If female participation rises by 1 percentage point every year, jobs needed by 2023 could rise to 1.4 million. - Policy measures under "Vision 2030" and current interventions - Goals: lower unemployment of nationals to 7 percent and increase female labor force participation rate to 30 percent by 2030. - Authorities' strategies: increase private sector size (focus on SMEs), overhaul education system, and labor market interventions including: - Nitaqat program of employment quotas; - Excluding expatriates from specific retail sectors; - Increasing fees on expatriate workers and their dependents; - Implementing wage subsidies for nationals; - Introducing measures to boost female employment. - Analytical conclusions and policy recommendations - Interventions have helped reduce distortions: boosting female labor force participation and reducing the wage gap between expatriates and nationals in the private sector. - However, impact on the rest of the economy is not always positive as firms adjust to higher labor costs. - Reforms should be gradual to minimize negative impact on growth. - A comprehensive set of policies is needed to foster job creation for nationals, including: - Leveling the playing field between national and expatriate workers to reduce employer preference for expatriates; - Setting clear expectations about the limited prospects for public sector employment; - Boosting female labor force participation; - Strengthening education and training to support increased productivity of nationals. *International Monetary Fund — Saudi Arabia staff analysis content as provided in the source document.* ### 5. There are several key features of the labor market in Saudi Arabia: ### 5. There are several key features of the labor market in Saudi Arabia: ### Labor market structure and composition - Saudi employment is concentrated in the public sector while the private sector is heavily dependent on expatriate labor. - Expatriate workers make up 80 percent of the private sector workforce. - A majority of expatriate workers are employed in small and medium sized firms (SMEs) — 26 percent work in firms with less than 6 employees. - Expatriate employment is concentrated in sectors such as construction and trade. - Saudi workers are on average better educated than non-Saudi workers (IMF, 2013) and are primarily employed in the public sector, where they generally receive higher wages, more comprehensive benefits, greater job security, and shorter work week hours than in the private sector. ### Wages, reservation wages, and wage gaps - The de-facto minimum wage for Saudis is SAR 3,000 per month, versus SAR 1,500 per month for a comparably-skilled expatriate worker. - Significant wage gaps skew private sector demand toward expatriates and the supply of Saudi labor toward the public sector. - Saudi entrants to the job market largely seek employment in the public sector and have reservation wages that are well above those of similarly qualified expatriate workers (Hertog, 2013). ### Labor force participation and demographics - Only 40 percent of Saudis participate in the labor force compared to the world average of 62.8 percent. - Female labor force participation is 18 percent. - Women are most likely to participate between 25 and 34 years of age and then drop out of the labor force. - Men drop out of the labor force at 50 years old, reflecting an early retirement age that could affect the long-term sustainability of pension funds. - Women tend to work mainly in the education sector (70 percent) and health and social sectors (13 percent). ### Skills mismatches and education outcomes - There is evidence of skill mismatches: university graduates typically complete degrees in education, humanities and arts, which do not necessarily cater to private sector demand; this is reflected in a large share of unemployed with degrees in education, humanities and arts. - The share of adults without education has been dropping for both men and women and Saudi Arabia is close to attaining universal literacy. - Tertiary education enrollment has increased significantly since 2000, especially for females. - Available data on education outcomes shows Saudi Arabia scores relatively low on standardized cross-country math and sciences and reading tests relative to countries with similar income, with girls tending to outperform boys (TIMSS 2015 and PIRLS 2016). ### Recent labor market policies (objectives and instruments) - Objectives: increase employment of Saudis in the private sector; increase attractiveness of Saudi workers by reducing the cost/wage differential, improve skills, and boost female employment. - Instruments introduced include: - Expatriate levy (introduced 2012; modified 2017–2018). - Wage subsidies and training programs (mostly targeted at women and young job-seekers). - Employment quotas (Saudization / Nitaqat). - Targeted bans on employment of expatriates in some retail sectors (introduced between 2016 and 2018). - Measures to increase female labor participation: subsidized transportation and childcare, expanded childcare facilities, encouragement of teleworking, removal of male-guardian consent to start a business (since February 2018), access to certain military jobs for women. - Education sector reforms and vocational training as part of Vision 2030 and National Transformation Program (curriculum reform, early childhood education, teacher training, strengthening vocational training). ### Details of the expatriate levy and related measures - Levy history and levels: - First came into force in 2012: monthly levy of SAR 200 ($53) per worker on firms with a majority of expatriate workers. - In January 2018 the levy was raised to SAR 300 ($80) and SAR400 ($107) per worker and rising to SAR 700–800 ($213) by 2020, depending on the percentage of Saudis in the workforce. - These levies will amount to about 20 percent of the current average wage gap between Saudis and expatriates by 2020 when fully implemented. - Monthly fees of SAR 100 ($27) for each dependent of expatriate workers were introduced in July 2017. - Other schemes include fees on expatriate labor visas that effectively increase the cost of expatriate workers above their wage. - Regulations strengthening rights of expatriate workers have been tightened, including by increasing fines for violations of workers’ rights. ### Wage subsidies, unemployment assistance, and Nitaqat (Saudization) - Wage subsidies: - Various training and wage-subsidy programs subsidize wages and training for Saudis for up to two years. - Sectoral programs (e.g., Women’s Employment in the Retail Sector, Support Women’s Jobs in Factories) provided wage subsidies for training and hiring Saudi women but required firm restructuring (due to mandated segregation). - Unemployment assistance: - Two main programs are Hafiz and Sanid, providing job seekers with monthly temporary income conditional on participation in training and job search efforts. - Nitaqat: - Revamped in 2011 with sector- and firm-size based employment quotas and penalties/benefits based on compliance. - Amendments in mid-2017 increased the mandatory employment ratio of nationals to expatriates. - Evidence of mixed success: initial increase in national employment but indications of adverse effects on firm profitability, closures, and decreases in overall and Saudi private sector employment over time. - At introduction, Nitaqat covered all firms in the private sector with 10 or more employees and affected approximately 6.3 million national and expatriate workers. ### Assessment approach: model and scenarios - A model-based approach assesses the medium-term impact of labor market reforms: the expat levy, higher female labor-force participation, and Saudization of the retail sector. - Model used: G20MOD module of the IMF’s Flexible System of Global Models (FSGM). - G20MOD is a multi-country structural model with individual blocks for each G20 country and four other blocks for the rest of the world. - Distinguishes “domestic” and “expatriate” labor forces; uses the wage differential as a proxy for relative productivity. - Expatriate workers are assumed liquidity constrained, consuming all after-tax income not remitted; nationals: only a share are liquidity constrained. - Key modeling assumptions for levy analysis: - Two scenarios: (1) levy fully paid by expatriate workers; (2) private firms bear the cost. - Levy gradually increases over three years and is projected to raise roughly 2 percent of GDP in additional revenue by 2020. - It is assumed 0.5 percent of GDP of the revenue is used to finance a temporary labor subsidy for Saudis for two years; the remainder improves the fiscal balance and net government asset position permanently. ### Model results: impact of the expat levy - Overall: - In both scenarios (ex-pat workers bear levy or firms bear levy) the impact on real GDP is negative relative to the baseline (no change in the expat levy). This does not imply growth will be negative. - When expatriates bear the burden: - Employment of nationals and expatriates remain broadly unchanged (assumes expatriates’ new after-levy wage is still higher than their reservation wage). - Net disposable income of expatriate workers declines by the full amount of the levy; their consumption of domestic goods and services permanently declines. - According to the 2013 Household Survey, about 20 percent of consumption is accounted for by expatriate households. - Remittance outflows decline because expatriates remit a constant fraction of their after-tax disposable income. - Permanent decline in domestic private consumption leads to lower private investment and transition to a new, lower long-run level for capital stock and output. - The temporary two-year wage subsidy partially mitigates the decline in output for two years. - With less capital, the marginal product of labor declines leading to a fall in real wages and a marginal decline in the domestic labor force. - External and fiscal balances improve: lower imports and remittances reduce the trade deficit; proceeds of the levy after the first two years are fully saved improving national savings and current account balance; net government asset position gradually improves and, in the long run, income from net government assets further improves the fiscal position. - Sensitivity note: - Should expatriate workers desire to keep the nominal value of their remittances unchanged and thus increase the share of remittances in their lower income, the negative impact on the Saudi economy would be larger. *Source: cr18264-sa - 5. There are several key features of the labor market in Saudi Arabia:* ### 21. When firms bear the burden of the levy, the growth impact is more negative than ### 21. When firms bear the burden of the levy, the growth impact is more negative than ### Levy incidence: firms vs. expatriates — macroeconomic channels and outcomes - When firms bear the levy: - The levy reduces the after-tax return on capital, inducing firms with no economic rents to reduce investment. - With a lower capital stock, the marginal product of labor declines, and firms reduce the real wages of both Saudi and non-Saudi employees. - All households reduce consumption and Saudi households reduce labor supply. - Lower capital stock combined with lower employment leads to a drop in potential output. - Lower real wages of expatriates reduce remittances. - When firms have sufficient economic rents: - The desired level for the capital stock and the marginal product of capital would not change. - Domestic and expatriate workers’ incomes would be essentially unchanged, making the impact less negative. ### Assumption on expatriate exits and additional GDP effects - It is assumed that higher labor costs for expatriate workers lead firms to dismiss expatriate workers. - The reaction of firms depends on expatriate share in employment and the wage/productivity differential; the model assumes the relative wage differential reflects relative productivity, with Saudi workers being more productive than expatriates. - If it is assumed that 1 percent of expatriate workers leave the country each year (either through firm closures or dismissals as cost of employment increases), this further lowers real GDP in the long run relative to the baseline. ### Increased female labor force participation scenario - Assumptions: - Female participation rate increases by 1 percentage point a year for the next five years. - This increases the female labor force by roughly 30 percent. - The increase is exogenous and entering women are prepared to work at the current wage rate of nationals. - Effects (Figure 8 simulation results summarized): - Share of Saudi nationals in the labor market rises; domestic employment increases by more than 6 percent. - Output, consumption, and private investment all increase. - After five years, real output increases by about 2 percent relative to baseline. - Potential output increases marginally faster than actual output, producing a small decline in consumer prices and nominal wage inflation relative to baseline; real wages remain largely unchanged. - Increased potential output leads to a moderate depreciation of the real effective exchange rate and temporary lower domestic inflation (to maintain peg to US dollar); the current account returns to baseline in the long term. - Saudi households increase consumption of domestic and foreign goods; no change assumed in relative price of Saudi tradable goods if increase in female employment is economy wide. ### Saudization in the retail sector — scenarios and outcomes - Baseline employment in retail sector: - 1.2 million expatriate workers and 400,000 Saudi workers. - Scenario assumptions: - Partial ban on expatriate employees in retail results in reduction in expatriate employment of 980,000 by 2023. - Increase in Saudi employment of 326,000 in Scenario 1 and 245,000 in Scenario 2. - Scenario 1 (1 Saudi replaces 3 expatriates): - If wage differential reflects productivity differential, impact on output is slightly positive after five years. - Positive impact driven by higher consumption (Saudis do not remit and consume more domestically), which encourages higher private investment. - Scenario 2 (1 Saudi replaces 4 expatriates): - Real output would decline by 0.8 percent relative to the baseline after five years. - Possible cause: insufficient Saudi workers with the required skills at offered wage rate. - If real wage differential does not reflect productivity differences: - Forcing firms to pay higher wages to nationals when productivity is lower increases unit labor costs. - Depending on market structure: - If firms can pass costs to consumers, inflation will likely increase. - If markets are competitive and costs cannot be passed on, some firms may exit the market. - In either outcome, impact on growth relative to baseline would be more negative. ### Conclusion and policy recommendations (summary) - Current policy shifts are first steps to mitigate major labor market distortions; labor market policies can facilitate more efficient use of labor resources, notably underutilized women. - Model simulations indicate: - The expat levy increases fiscal revenues but leads to output losses regardless of who bears the levy and yields no employment gains if the wage gap remains large. - To avoid negative growth impacts from Saudization policies, two pre-conditions are needed: - (i) High-productivity national workers must replace lower-productivity expatriate workers. - (ii) A sufficient number of nationals must be willing to work to replace expatriates at a wage rate that reflects their productivity. - Otherwise outcomes could be negative, especially if unit labor costs rise and firms exit or prices rise. - Policy guidance emphasizes gradual implementation of labor reforms and a comprehensive, multi-pronged approach led by the Labor Market Policy Committee. - Specific policy measures recommended: - Reform expatriate labor policies: - Allow greater internal mobility of expatriate workers to reduce the wage differential. - Reform sponsorship system and residency rights; consider visa reform to target higher-skilled workers and auction visas to encourage higher-productivity employment. - Change the role of the public sector: - Set clear expectations about limited prospects for future public-sector employment to incentivize nationals toward private sector jobs. - Review structure of, and limit the rate of growth of, public sector wages. - Remove remaining barriers to female employment: - Provide firms with sufficient financial help to defray cost of workplace reconfiguration for regulatory requirements and social norms. - Increase efficiency of public spending on education to reduce skills mismatches: - Continue efforts to improve teacher training, update curriculum, involve private sector in schools, and strengthen vocational training. - Consider a public expenditure review to diagnose cost-benefit of education spending. - Consider a dual-education system combining apprenticeships with vocational schooling and foster public–private partnerships for curriculum design and apprenticeships. - Review effectiveness of wage subsidies: - Wage subsidies can offset bias against first-time job seekers and reduce hiring costs while new employees are trained. - Success depends on design specifics (amount, target group, conditions); further analysis is needed to assess whether subsidies are appropriately designed to support permanent increases in Saudi employment and whether they encouraged lump-sum investments for hiring women. - Support private sector development: - Address constraints to doing business, regulatory and administrative burdens, and lack of access to finance, particularly for SMEs. ### Annex I — G20MOD (model features relevant to results) - G20MOD is an annual, multi-economy, forward-looking module of the IMF’s Flexible System of Global Models (FSGM). - Key features: - Consumption: overlapping-generations households and liquidity-constrained households. - Investment: Tobin’s Q model; firms are net borrowers with countercyclical risk premia. - Trade: reduced-form equations driven by competitiveness indicator and demand; competitiveness improves one-for-one with domestic prices. - Potential output: endogenous via Cobb-Douglas with exogenous trend TFP and endogenous capital and equilibrium employed labor; for Saudi Arabia, potential output moves one-for-one with long-run average oil production. - Inflation: semi-structural forward-looking Phillips’ curves with lags/leads and output gap; consumer price inflation includes weight on real effective exchange rate and second-round effects from food and oil prices; no feed-through from global oil price changes to CPI inflation in Saudi bloc because energy prices do not respond domestically. - Monetary policy: interest rate reaction function; for Saudi Arabia, policy defends fixed nominal exchange rate to U.S. dollar by setting rate equal to U.S. rate under uncovered interest rate parity. - Migration and remittances: bilateral flows captured; population, labor force, and employment distinguish “domestic” and “foreign” households; wage differential proxies relative productivity; expatriates remit a fraction of disposable income and are liquidity constrained. - Commodities: three commodities—oil, metals, and food—allowing distinction between headline and core CPI; in Saudi Arabia, oil is produced and exported, exports respond to Saudi production decisions, and a share of oil revenues accrue to government with remainder to Aramco; oil price fluctuations affect government revenues but have little effect on household wealth or domestic decisions because oil prices are held fixed domestically. *Source: cr18264-sa - 21. When firms bear the burden of the levy, the growth impact is more negative than* ### 10. Countries are largely distinguished from one another in G20MOD by their unique ### HOW DEVELOPED AND INCLUSIVE IS THE FINANCIAL SECTOR IN SAUDI ARABIA? ### Background and objectives - The Financial Sector Development Program (FSDP), adopted in May 2018, aims at developing a diversified and effective financial sector to support development and diversification of the economy, and stimulate savings, finance, and investment. - Financial development and inclusion are linked to long-run economic growth (Levine 2005; Demirgüç-Kunt and Levine 2008). Financial inclusion also helps increase economic growth (Sahay and al, 2016). - Paper objective: assess Saudi Arabia’s level of financial development and inclusion and recommend policies to address identified gaps. ### Structure of the financial system (key metrics) - Total financial sector assets: about $1.1 trillion (159 percent of GDP) at end-2017. - Financial system composition (2017, in percent of total): - Commercial banks: 57 percent - Pension funds: 31 percent - Specialized credit institutions (SCIs): 7 percent - Investment funds: 3 percent - Other financial institutions (insurance and finance companies): 2 percent - Commercial banks: - 24 commercial banks: 12 domestic banks and 12 foreign banks (foreign banks represent 1 percent of total assets). - Four largest banks represent 55 percent of banking system assets. - Bank liabilities and asset composition (2017): - Equity: 16 percent - Deposits: 75 percent - Interbank: 4 percent - Debt issuance: 2 percent - Other liability: 3 percent - Cash & reserve: 11 percent - Fixed assets: 1 percent - Loans: 62 percent - Investments: 19 percent - Others: 7 percent - Deposits and lending structure: - Deposits account for 75 percent of total liabilities (end-2017). - Demand deposits account for 59 percent of total deposits. - Lending constitutes 62 percent of total assets. - Lending breakdown: corporates 34 percent of total assets; households 20 percent of total assets. - Within household lending, mortgage loans comprise about one-fourth; remainder is consumer and credit card loans. - Government exposure: - Direct exposure to the government: 6 percent of total assets. - Credit to government and public enterprises: 10.6 percent of GDP in 2016. - Specialized Credit Institutions (SCIs): - SCIs provide medium- to long-term loans to targeted areas (housing, industrial projects, SMEs, agriculture). - SCIs are non-deposit taking, rely on direct budgetary support, and have balance sheets consisting entirely of government equity. - SCIs’ total assets: 11 percent of GDP (17 percent of non-oil GDP) at end-2017 compared to 10 percent of GDP (16 percent of non-oil GDP) in 2009. - SCIs provide credit equivalent to around 18 percent of banking sector credit. - Financial condition and performance of SCIs are not very transparent (FSAP, 2017). ### Benchmarking financial development and inclusion (findings) - Benchmarking approach: - Comparisons to: (i) peer group of oil exporting countries; (ii) other GCC countries; (iii) high income countries; and (iv) statistical benchmarks (expected medians) derived from a regression framework following World Bank’s FinStats 2017. - Statistical benchmarks estimate expected medians based on structural and economic non-policy fundamentals (policy-neutral environment). - Financial depth: - Bank private credit and deposits to GDP are in line with the peer group and the statistical benchmark (expected median), although lower than high-income countries and the average of other GCC countries. - Results are indifferent to use of GDP or non-oil GDP. - Note: Credit to private sector is higher if SCIs credit is added. - Capital markets: - Stock market capitalization to GDP is comparable to peers and the statistical benchmark. - Number of listed companies per 1,000,000 people is very low for Saudi Arabia. - Stock market capitalization (as a percent of non-oil GDP) declined from around 107 percent in 2008 to 92 percent in 2017. - The 10 largest companies represent 60 percent of total market capitalization. - Investor base dominated by Autonomous Government Institutions (AGIs); foreign ownership small though recently increased as restrictions eased. - Debt markets are underdeveloped: lack of a benchmark yield curve, no local rating agency, and a limited secondary market. - Domestic corporate bond market is small at less than 1 percent of GDP. - Profitability and efficiency: - Banking system is profitable relative to peers: lower cost-to-income ratio and higher return on assets compared to peers. - Net interest margins (NIMs) are higher compared to high-income countries and in line with the GCC average and statistical benchmarks. - NIMs have been relatively stable due to large proportions of deposits not receiving interest (for compliance with Islamic principles) and a high share of variable-rate loans. - Financial access and inclusion: - Saudi Arabia’s financial access and inclusion is below that of other peers in the region and high-income countries. - The financial sector appears less inclusive compared to countries of similar income per capita on some measures. - Underserved segments identified include SMEs and women. ### Policy implications and recommendations (from the paper) - Continue policies to promote greater financial development and inclusion, with focus on underserved segments such as women and SMEs, as set out in the authorities’ Financial Sector Development Program (FSDP). - Continue to maintain a strong focus on financial stability while pursuing financial development and inclusion objectives. *Prepared by Abdullah Al-Hassan (WHD), Ali Al-Sadiq (FIN), Anta Ndoye (MCD), Reem alJaber and Walid Alzahrani (SAMA) with inputs from Muhammad Almuzaini (CMA); research and editorial support by Tucker Stone and Diana Kargbo-Sical.* ### Annex 2 for further details). ### Box 4. Government Support to SMEs ### Box 4. Government Support to SMEs ### Role of SMEs and challenges - SMEs play a vital role in the Saudi economy. - Vision 2030 objective: increase the SMEs contribution to the economy from 20 percent of GDP to 35 percent of GDP by 2030. - Key challenges: government bureaucracy and limited access to financing from the banking sector (about 2 percent of total lending from banks). ### Government programs supporting SMEs - Kafalah program - Established in 2006. - Partial guarantee scheme guarantees up to 80 percent of the loans to SMEs by banks in case of default. - Since its inception, Kafalah has provided guarantees for bank loans to 10,583 SMEs, of which 80 percent are in the construction, trade and services sectors. - Since inception, those guarantees have amounted to SAR 10.8 billion (0.4 percent of GDP) and covered on average 55 percent of total loans to SMEs. - A royal decree has recently approved a SAR 800 million increase in the capital of Kafalah Program. - The program is being restructured to improve its focus on specific sectors (e.g. tourism) and regions as well as its operational efficiency. - Kafalah Loans and Guarantees - VC Investment Volumes, 2016 (Percent of total): 2013: 1.3, 2014: 1.7, 2015: 1.8, 2016: 1.8, 2017: 1.8 - Total Guarantees from Kafalah Program (SAR billion): 2,515 3,612 4,007 3,390 1,709 1,173 1,497 1,643 1,711 1,793 - Total Number of Guarantees & entities of Kafalah Program: Number of guarantees / Number of entities (data source: Kafalah data). - Fund of Funds - Established under the PIF with a capital of SAR 4 billion. - Aims to invest in private equity and venture capital funds on a commercial basis to support and incentivize investments, including in SMEs. - Note: There is currently very little venture capital (VC) financing to start-ups in Saudi Arabia compared to the rest of the MENA region. - Social Development Bank - Provides loans for small and emerging businesses and professions as well as low income citizens. - Saudi Industrial Development Fund - Finances SMEs’ industrial projects. ### Observations from regional VC data - VC Investment Volumes, 2016 (Percent of total) by country/region (WAMDA Research Lab, 2016): - U.A.E., 34 - LBN, 21 - EGY, 10 - SAU, 8 - JOR, 4 - MAR, 2 - TUN, 1 - Other MENA, 20 ### Policy recommendations (selected from Section E) - Address institutional constraints to SME lending. - Continue to focus on improving legal credit infrastructures and ensuring that recently or soon to be introduced laws are effectively implemented. - Further development of alternatives to bank finance, particularly expansion in leasing and factoring, private equity, and venture capital. - The SME authority should help companies fully understand the benefits of improved corporate governance practices, particularly in areas of risk management and audit. - Broader efforts to improve the business environment would also help support SME development. - Foster financial inclusion through social programs and digital banking. - Tying social assistance programs to the opening of a bank account (as was done with Hafiz), while reducing administrative and institutional hurdles could help encourage financial inclusion. - Citizen’s accounts (introduced in 2017) provides compensation to Saudi families through the banking system. - Wage protection system (introduced in 2013) requires most firms in the private sector to pay their employees through the banking system. - Digital banking can foster financial inclusion by facilitating access to financial services by unbanked populations such as women and remotely-located population. - Adopt a targeted approach to financial education. - Financial education has a measurable impact if it reaches people during teachable moments (e.g., when starting a job or purchasing a major financial product). - Leveraging social networks tends to enhance the impact of financial education given high mobile and internet penetration in Saudi Arabia (Barajas et al., 2017). - Financial education targeted at Islamic products could be useful as a portion of voluntarily financially excluded people cite religious reasons as a reason for their exclusion. - Broad efforts to promote financial literacy and savings, and assure investor protection through greater transparency and better governance arrangements would help mobilize funds to the capital markets. - Continue to implement policies that will further develop the debt market. - The DMO is in a good position to facilitate the development of local debt markets by continuing to develop the sovereign yield curve. - The existing regulatory framework for corporate bond and sukuk issuance could be improved by streamlining the public offering route. - A clear and consistent treatment of zakat across financial instruments and financial institutions is needed. - Enhance the production of financial services data and measurement. - Improved data on unbanked markets/customers is needed to underpin a sustainable expansion in access to finance. - SAMA could partner with other institutions such as GASTAT and the SME authority to enhance data availability related to access, usage, and quality. - Address policy impediments to Fintech growth. - Supportive regulatory frameworks (legal recognition of electronic signatures, adequate consumer protection) facilitate mobile banking services. - Regulation should not impose restrictions on mobile banking development, such as limits on nonbanks to use e-money. - Develop a comprehensive consumer protection framework and data protection law that apply to financial and non-financial institutions involved in digital finance. - Continued use of regulatory sandboxes would allow fintech companies and traditional financial institutions to test innovations in a live environment. - Developing private equity and venture capital industries would also be useful as these industries have underpinned growth of fintech in advanced economies. - On the demand side, financial literacy and trust constitute major constraints to fintech development (WAMDA 2016; Lukonga ;2018). ### Additional recommendations on competition and stability - Conduct a detailed analysis of the degree of competition in the financial sector to assess whether there are unnecessary barriers that limit banks’ willingness to penetrate higher-risk markets. - Maintain strong focus on financial stability while pursuing financial development and inclusion objectives. - Banks in Saudi Arabia are well regulated and supervised and remain liquid, resilient and sound (FSSA, 2017). *Source: Box 4. Government Support to SMEs — cr18264-sa* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18264-sa.pdf_