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### Introduction and key context
- Saudi Arabia’s economy grew strongly in recent years driven by high oil prices and output, strong private sector activity, increased government spending, and domestic reform initiatives.
- Oil dependence:
  - Over 90 percent of fiscal revenues and 80 percent of export revenues come from the sale of oil.
- Recent shock:
  - Substantial drop in oil prices since the summer of 2014 is an important risk to the outlook and will immediately affect fiscal and external balances and likely lead to slower growth over time.
- Two key policy challenges:
  - Manage heavy dependence on oil revenues and insulate the domestic economy from global oil market volatility.
  - Diversify the economy to reduce reliance on oil revenues over time.
- Context: chapters served as background for the Article IV consultation with Saudi Arabia during May 2014.

### Chapter 1 — Outlook for the global oil market and implications for Saudi Arabia
Findings and projections
- Global drivers:
  - Subdued global growth, rapid increase in U.S. oil production, and security issues in several oil-exporting countries shape the outlook.
- Recent demand and supply changes:
  - Global oil demand increased by 2.5 million barrels a day (mbd) over the past three years (driven by non-OECD demand).
  - Substantial production outages in Libya and Iran reduced output by more than 2 mbd in several quarters relative to end-2010 levels.
  - U.S. oil production increased by more than 2 mbd since end-2010; Saudi Arabia, Iraq, Kuwait, and the United Arab Emirates also increased output.
  - Between 2011 and August 2014, oil prices hovered within the $100–$120 a barrel range.
  - Prices dropped by more than 25 percent since the beginning of September 2014 and, as of November 14, 2014, stood at about $75 a barrel.
Medium-term supply drivers (selected estimates)
- U.S. unconventional/tight oil:
  - IEA: increase in total U.S. oil production (including NGLs) by 2.8 mbd by 2019.
  - EIA projects light tight oil output to peak around 2018 (smaller increases relative to IEA).
  - BP: tight oil production to grow by 1.5 mbd between 2012 and 2015 and reach 4.5 mbd by 2030.
- Other non-OPEC supply:
  - Canadian oil sands increase non-OPEC supply by 1.2 mbd by 2019.
  - Argentina and Brazil expected to add another 1 mbd.
Implications and scenarios
- Potential for supply to grow more quickly than demand, creating downward pressure on prices.
- Saudi Arabia’s production response has important implications for the global oil market and for its fiscal and external balances.
- Whether prices or output adjust downward, the fiscal (and external) balance will deteriorate.

### Medium-term supply outlook, market balance, and quantitative projections
- Non-OPEC oil supply could increase by 6.3 mbd (including NGLs) by 2019.
- OPEC production capacity estimated to increase by 2.1 mbd by 2019 (largely due to Angola, Iraq, and UAE).
- Uncertainties: Iraq and Iran production trajectories under political and sanctions scenarios.
- IMF staff projection for Saudi production: 9.7 mbd in 2013, increasing modestly by 0.5 mbd over the next five years; Saudi oil exports assumed broadly unchanged.
- Demand-side outlook:
  - Projected increase in global oil demand of 7.7 mbd by 2019 driven mainly by non-OECD demand.
  - Non-OECD demand projected to increase by 19 percent or 8.6 mbd by 2019.
- Baseline market balance (selected figures from Table 1.1):
  - Call on OPEC crude (2013–2019 under baseline): 30.5 (2013); 30.4 (2014); 30.3 (2015); 30.3 (2016); 30.5 (2017); 30.8 (2018); 31.2 (2019).
  - Excess supply for crude (2013–2019 under baseline): -0.1 (2013); 0.1 (2014); 0.6 (2015); 1.0 (2016); 1.3 (2017); 1.4 (2018); 1.4 (2019).
  - Global demand (2013–2019 under baseline): 91.4 (2013); 92.8 (2014); 94.2 (2015); 95.5 (2016); 96.8 (2017); 98.0 (2018); 99.1 (2019).
  - Global supply (2013–2019 under baseline): 91.5 (2013); 93.0 (2014); 94.4 (2015); 95.7 (2016); 97.0 (2017); 98.2 (2018); 99.3 (2019).
  - Non-OPEC (includes NGLs) (2013–2019): 54.7 (2013); 56.1 (2014); 57.3 (2015); 58.4 (2016); 59.4 (2017); 60.3 (2018); 60.9 (2019).
  - United States production (2013–2019): 10.3 (2013); 11.4 (2014); 12.0 (2015); 12.6 (2016); 12.8 (2017); 13.0 (2018); 13.1 (2019).
  - OPEC total (2013–2019): 36.7 (2013); 37.0 (2014); 37.7 (2015); 38.3 (2016); 38.9 (2017); 39.2 (2018); 39.8 (2019).
  - OPEC crude (2013–2019): 31.2 (2013); 30.4 (2014); 30.5 (2015); 31.3 (2016); 31.8 (2017); 32.2 (2018); 32.7 (2019).
  - Saudi Arabia production (2013–2019): 9.6 (2013); 9.7 (2014); 9.7 (2015); 9.8 (2016); 9.9 (2017); 10.0 (2018); 10.1 (2019).
  - Iran production (2013–2019): 2.7 (2013); 2.8 (2014); 2.8 (2015); 2.8 (2016); 2.9 (2017); 2.9 (2018); 2.9 (2019).
  - Iraq production (2013–2019): 3.1 (2013); 3.3 (2014); 3.5 (2015); 3.6 (2016); 3.8 (2017); 3.9 (2018); 4.1 (2019).
  - Libya production (2013–2019): 0.9 (2013); 0.7 (2014); 0.8 (2015); 0.8 (2016); 0.9 (2017); 1.0 (2018); 1.0 (2019).
- Baseline implication: OPEC supply would exceed OPEC demand by 1.4 mbd in 2018 and 2019, sustaining downward price pressure unless production adjusts.
- Saudi spare capacity: about 2.7 mbd (more than half of global spare capacity); Saudi accounts for more than 16 percent of global proven reserves.

### Saudi Arabia’s role and illustrative policy responses
- Historical behavior: Saudi Arabia has increased production to offset supply interruptions and scaled back production during demand weakness.
- Three illustrative Saudi responses considered: no adjustment, adjustment by half, and full adjustment.
- Demand elasticity scenarios considered: −0.2, −0.1, and −0.05.
- Saudi full adjustment assumes Saudi cuts production to absorb all excess supply in 2015.
- Example projections and implications (2015 scenarios, Table 1.3 summary as presented)
  - Under baseline, a 0.6 mbd shortfall relative to baseline was considered; "there is no impact on prices." Fiscal balance would deteriorate by 2 percent of GDP in 2015.
  - "No adjustment" (Saudi does not cut production): price and fiscal impacts depend on price elasticity:
    - If elasticity = −0.2: oil prices fall by 3 percent; fiscal balance falls by 1 percent of GDP.
    - If elasticity = −0.05: oil prices fall by 12 percent; fiscal balance drops by 4 percent of GDP.
  - "Adjustment by half": impacts fall between the no-adjustment and full-adjustment scenarios.
  - "Full adjustment": prices unchanged; fiscal impact smaller or zero depending on scenario entries in Table 1.3.
  - Table 1.3 entries (preserved form): Impact on oil price (percent change) and Impact on oil revenue (percent change) and Impact on fiscal balance (in percent of GDP) are reported across scenarios and elasticities with specific numerical entries as in source text.
- Downside/upside risk examples:
  - Combined downside risk (higher non-OPEC supply and lower global demand): estimated excess supply about 3.9 mbd (versus 1.4 mbd in baseline).
  - Combined upside risk: excess demand over supply of about 2.1 mbd by 2019.
  - If Iraq and Libya production remain unchanged at current levels (3.3 mbd and 0.7 mbd respectively per November 2014 IEA report), excess supply in the baseline would be reduced to around 0.4 mbd (from 1.4 mbd).

### Chapter 2 — Fiscal framework to support growth and manage natural resource dependence
Key fiscal challenges
- Insulate economy and budget from large or sudden fluctuations in oil revenues (avoid procyclical spending).
- Ensure efficient use of oil revenues for development.
- Save enough current oil revenues for future generations because oil is nonrenewable.
Fiscal reform agenda (high-level elements)
- Strengthen the annual budget to make it a better guide to fiscal policy intentions.
- Introduce a medium-term fiscal framework to guide multi-year spending decisions.
- Use a structural budget rule to guide decisions under the medium-term framework (without at this stage introducing a formal fiscal rule).
- Review the public investment management framework.
Fiscal anchor and medium-term framework recommendations (design elements)
- Recommend incorporating elements of a structural budget rule as a policy guide tied to structural revenues and an overall structural balance target.
- Suggested oil price rule: a five-year backward-looking price rule to balance volatility reduction and responsiveness.
- Structural oil output: simple average of past output recommended given lack of established country experience.
- Structural balance target: consider a surplus target to accumulate savings for future generations.

### Public investment management
- Past spending:
  - Capital spending grew by 24 percent on average annually in nominal terms from 2000–08, increasing about 3 percentage points of GDP.
  - Capital expenditure averaged over 11 percent of GDP between 2009 and 2013.
- Efficiency:
  - Saudi Arabia’s infrastructure quality improved (WEF Global Competitiveness ranking from 41 in 2008/09 to 31 in 2013/14) but public capital efficiency below top peers.
- Recommended actions:
  - Review public investment management processes from appraisal to ex-post evaluation.
  - Improve project quality-at-entry and governance (Box 2.1 Norwegian QAS provided as illustrative example).

### Chapter 3 — Monetary and macroprudential policies under the exchange rate peg
Monetary policy context and liquidity management
- Riyal peg to U.S. dollar provides credibility and stability; pegged for nearly three decades.
- Under the peg, fiscal policy is primary macroeconomic tool; liquidity management operations and macroprudential policy are complementary.
- Large external surpluses and fiscal spending have resulted in a liquidity surplus in the banking system.
SAMA toolkit and operations
- Reserve requirements:
  - Cash reserves: 7 percent of demand deposits.
  - Cash reserves: 4 percent of time and saving deposits.
  - Banks hold 20 percent of their deposits in short-term assets to meet statutory liquidity requirements.
- Repo operations:
  - Repo rate is 2 percent (rate unchanged since early 2009); repos used to inject/absorb overnight liquidity.
- SAMA bills:
  - Issuance ceiling to banks: SAR 9 billion (last revision February 2010).
  - Maturities: 1 to 52 weeks.
  - Interest rate set administratively at 80 percent of SIBID for corresponding maturity.
- Foreign exchange swaps and placement of public funds also used to manage liquidity.
Policy recommendations on liquidity management and macroprudential framework
- Develop more liquidity management tools and establish a liquidity forecasting framework.
- Set up a formal macroprudential framework with SAMA as the designated macroprudential authority.
- Publish early warning indicators and risk assessments.
- Develop a broader array of countercyclical macroprudential instruments.
Empirical findings on transmission
- Interest rate channel:
  - Interest rates not found to have a significant impact on economic activity; U.S. federal funds rate increase has significant negative impact on Saudi prices but small and statistically insignificant impact on non-oil output.
- Credit channel:
  - Strong evidence it is active: one standard deviation shock to credit has positive and statistically significant impact on non-oil output after seven quarters.
  - Elasticity of non-oil output to credit shock ranges between 0.6 and 0.7 after seven quarters.
- Monetary base shocks:
  - Weak evidence of economic impact; statistically significant in only one of two specifications.
- Oil prices and fiscal spending:
  - Increase in global oil prices increases government spending; impact positive and significant after three quarters.
- Policy implication:
  - Normalization of U.S. monetary policy unlikely to have adverse growth impact on Saudi Arabia if driven by stronger U.S. economy; adverse impacts could occur via oil price declines from global financial market volatility.
Macroprudential policy and tools
- SAMA has implemented Basel III capital and liquidity requirements and used capital, liquidity, and sectoral tools (including LTV and DTI).
- Countercyclical provisioning done bilaterally with banks; provisioning levels increased to over 150 percent of gross nonperforming loans by end- (text ends).
- Saudi toolkit comparable to other commodity exporters but used outside a formal macroprudential framework; no explicit caps on currency lending or FX positions.
- Recommendation: formal macroprudential framework, early warning indicators, clear designation of authority, and coordination across regulators.

### Chapter 4 — Economic diversification: past, present, and the way forward
Findings on diversification to date
- Government used oil receipts to raise infrastructure and education spending and improve business climate and SME finance.
- Non-oil output share in GDP has increased steadily, but non-oil exports remain a small share of total exports and concentrated in oil-related products (e.g., petrochemicals).
- No strong evidence of traditional Dutch disease blocking non-oil tradable development, but other crowding-out channels and incentive distortions exist.
- Public sector wages and benefits make public employment more attractive for nationals, especially lower-skilled workers; firms often prefer serving domestic market over risky export markets.
Policy implications to support diversification
- Address incentive issues favoring public employment and domestic-market orientation.
- Complement macro frameworks and fiscal reforms with policies to improve private sector competitiveness, labor market incentives, and export orientation.
- Priority areas:
  - Business climate: strengthen contract enforcement and insolvency resolution.
  - Education: improve quality and alignment with private sector needs.
  - Labor market reforms: increase national employment in private sector, refocus public sector recruitment and wages, active labor market policies.
  - Infrastructure: ensure efficient use of public infrastructure spending.
  - SME development and export promotion: access to finance, export insurance, and targeted measures.
Trade, exports, and services
- Exports dominated by hydrocarbons; crude oil constituted most mineral-sector exports.
- In 2012:
  - Hydrocarbons account for some 85 percent of total exports.
  - Saudi total exports to GCC were 6.6 percent of total exports.
- Non-oil sector comprises half of nominal output but manufactured exports share of total exports is less than 15 percent.
- Services exports: 0.24 percent of world services exports (2012); travel 70 percent of service exports, transportation 21.5 percent.
- Tariffs and trade facilitation:
  - Applied MFN simple average of import duties (2012): 5.1 percent (agriculture 6.2 percent; nonagricultural commodities 5 percent).
  - Documents required to export: five.
  - Costs to export: lower than BRICS; cumulative increase of 18 percent since 2007.
- WTO accession: December 2005.

### Overarching policy messages and conclusions
- Saudi Arabia is currently in a position of strength but scope exists to strengthen macroeconomic and financial policy frameworks to equip policymakers with tools, incentives, and authority to address emerging challenges.
- Given global oil market outlook, Saudi Arabia cannot rely on rising oil prices and increasing government spending to drive future growth; diversification is needed to sustain growth and generate jobs for the young and growing population.
- Key policy recommendations (condensed):
  - Fiscal: introduce a medium-term fiscal framework, adopt structural budget rule elements, strengthen annual budget realism, improve public investment management.
  - Monetary/liquidity: develop liquidity forecasting, expand liquidity management toolkit, deepen short- and long-term securities markets.
  - Macroprudential: establish formal macroprudential framework with SAMA as authority, publish early warning indicators, employ countercyclical instruments as needed.
  - Diversification: improve business climate, labor market incentives, education alignment, SME finance, export promotion, and regional trade integration.

*International Monetary Fund, Middle East and Central Asia Departmental Paper Series (content unit: _1501mcd).*

### 1. Economic development – Saudi Arabia. I. Al-Darwish, Ahmed. II. International Monetary

### 1. Economic development – Saudi Arabia

### Introduction and key context
- Saudi Arabia’s economy has grown very strongly in recent years driven by high oil prices and output, strong private sector activity, increased government spending, and domestic reform initiatives.
- Rising oil prices and oil production have resulted in large external and fiscal surpluses, and government debt has declined to very low levels.
- The Saudi Arabian economy remains very dependent on oil revenues: over 90 percent of fiscal revenues and 80 percent of export revenues come from the sale of oil.
- The substantial drop in oil prices since the summer of 2014 is an important risk to the outlook; lower oil prices will have an immediate negative effect on the fiscal and external balances and over time will likely lead to slower growth.
- Two key policy challenges:
  - Manage the country’s current heavy dependence on oil revenues and insulate the domestic economy from volatility in the global oil market.
  - Help the economy diversify to reduce reliance on oil revenues over time.
- The chapters in this paper were background for the Article IV consultation with Saudi Arabia during May 2014.

### Chapter 1 — Outlook for the global oil market and implications for Saudi Arabia
Findings and projections:
- The global oil market outlook is affected by subdued global growth, the rapid increase in oil production in the United States, and security issues in several oil-exporting countries.
- Global oil demand increased modestly over the past three years by 2.5 million barrels a day (mbd), driven by demand in nonmember countries of the OECD.
- Substantial production outages in Libya and Iran have reduced output by more than 2 mbd in several quarters relative to end-2010 levels.
- U.S. oil production has increased by more than 2 mbd since the end of 2010; Saudi Arabia, Iraq, Kuwait, and the United Arab Emirates have also increased output.
- Between 2011 and August 2014, oil prices hovered within the $100–$120 a barrel range.
- Prices have dropped by more than 25 percent since the beginning of September 2014 and, as of November 14, 2014, stood at about $75 a barrel, their lowest since September 2010.
Medium-term supply drivers noted:
- The ongoing boom in unconventional U.S. oil:
  - IEA estimates: increase in total U.S. oil production (including NGLs) by 2.8 mbd by 2019.
  - U.S. EIA projects smaller increases and light tight oil output to peak around 2018.
  - BP estimates: tight oil production to grow by 1.5 mbd between 2012 and 2015 and then grow much more slowly to reach 4.5 mbd by 2030.
  - OPEC estimates are broadly in line with the EIA baseline in the medium term.
- Other non-OPEC producers:
  - Unconventional oil from Canadian oil sands estimated to increase non-OPEC supply by 1.2 mbd by 2019.
  - Argentina and Brazil expected to add another 1 mbd.

Implications and scenarios:
- There is potential for supply to grow more quickly than demand in coming years, creating downward pressure on oil prices (a scenario occurring in recent months).
- How Saudi Arabia adjusts its production in response will have important implications for the global oil market and for its fiscal and external balances.
- Whether oil prices or output adjust downward, the fiscal (and external) balance will deteriorate.

### Chapter 2 — Fiscal framework to support growth and manage natural resource dependence
Key fiscal challenges identified:
- Need to insulate the economy and the budget from large or sudden fluctuations in oil revenues (avoid procyclical spending).
- Need to ensure oil revenues are used efficiently for development purposes.
- Need to save enough of current oil revenues for future generations because oil is nonrenewable.

Fiscal reform agenda recommended (high-level elements):
- Strengthen the annual budget to make it a better guide to the government’s fiscal policy intentions.
- Introduce a medium-term fiscal framework to guide spending decisions on a multi-year basis.
- Use a structural budget rule to guide decisions under the medium-term fiscal framework (without at this stage introducing a formal fiscal rule).
- Review the public investment management framework.

### Chapter 3 — Monetary and macroprudential policies under the exchange rate peg
Findings:
- The Saudi riyal’s long-standing peg to the U.S. dollar has provided credibility to monetary policy and stability to trade, income flows, and financial assets.
- Under the peg, fiscal policy is the primary macroeconomic management tool; liquidity management operations and macroprudential policy play complementary roles.
- Large external surpluses and fiscal spending supported by oil revenues have resulted in a liquidity surplus in the banking system.

Policy recommendations:
- Develop more liquidity management tools and establish a liquidity forecasting framework to manage banking system liquidity.
- Set up a formal macroprudential framework with SAMA as the designated macroprudential authority to help manage systemic risks.
- Publish early warning indicators and risk assessments.
- Develop a broader array of countercyclical macroprudential policy instruments to identify and manage financial sector risks amid volatile oil revenues.

### Chapter 4 — Economic diversification: past, present, and the way forward
Findings on diversification to date:
- The government has used rising oil receipts to increase spending on infrastructure and education and has taken steps to improve the business climate and access to finance, especially for small and medium enterprises.
- The share of non-oil output in GDP has increased steadily, but export diversification has been more limited: non-oil exports remain a small share of total exports and are largely concentrated in products closely related to oil (such as petrochemicals).
- Saudi Arabia does not appear to suffer from traditional Dutch disease effects blocking non-oil tradable sector development, but oil revenues may crowd out tradable production in other ways.
- Relatively higher wages and benefits in the public sector compared to the private sector make public employment a more attractive option for nationals, particularly lower-skilled workers.
- For firms, serving the domestic market is often a more reliable profit source than targeting riskier export markets.

Policy implications to support diversification:
- Address incentive issues that favor public sector employment and domestic-market-oriented production to remove a missing element in diversification strategy.
- Complement macro frameworks and fiscal reforms with policies that improve private sector competitiveness, labor market incentives, and export orientation.

### Overarching policy messages from the paper
- Although Saudi Arabia is currently in a position of strength, there is scope to strengthen macroeconomic and financial policy frameworks to ensure policymakers have the tools, incentives, and authority to address emerging challenges.
- Given the global oil market outlook, Saudi Arabia cannot rely on rising oil prices and increasing government spending to drive future economic growth; a more diversified economy is needed to sustain growth and generate jobs for the young and growing population.

*International Monetary Fund, Middle East and Central Asia Departmental Paper Series*

### 0.8 mbd, respectively (IEA, 2014). Altogether, the non-OPEC oil supply could increase by

### _1501mcd - 0.8 mbd, respectively (IEA, 2014). Altogether, the non-OPEC oil supply could increase by

### Medium-term supply outlook
- Non-OPEC oil supply could increase by 6.3 mbd (including NGLs) by 2019.
- OPEC production capacity is estimated to increase by 2.1 mbd by 2019, largely due to increases in Angola, Iraq, and the United Arab Emirates.
- Uncertainties: the situation in Iraq could reduce capacity increases; uncertainties surround Iran’s production because of sanctions and potential speed of ramp-up if sanctions are eased.
- IMF staff projection for Saudi production: 9.7 mbd in 2013, increasing modestly by 0.5 mbd over the next five years, with Saudi oil exports assumed to remain broadly unchanged.
- High breakeven costs for unconventional producers limit downside pressure on prices.

### Demand-side outlook
- Projected increase in global oil demand of 7.7 mbd by 2019 driven mainly by non-OECD demand.
- Non-OECD demand projected to increase by 19 percent or 8.6 mbd by 2019.
- BRICS (Brazil, Russia, India, China and South Africa) drove recent non-OECD demand growth.
- Saudi oil consumption expected to remain strong but decelerate slightly in the medium term (IEA, 2014a).
- OECD demand expected to decline due to changes in energy consumption patterns, improved energy efficiency, and fuel switching to natural gas.
- BP projects further declines in OECD oil demand up to 2035, particularly in the transport sector; global transport-sector oil demand expected to slow after 2025.

### Unconventional (tight) oil—United States and global implications
- U.S. light tight oil production was 2.5 mbd in 2013 and constituted 24 percent of total U.S. production of crude oil and other petroleum liquids.
- U.S. overall oil production increased by 30 percent over the past five years (relative to the text timeframe).
- Breakeven cost: the breakeven cost of light tight oil production for 98 percent of U.S. fields was estimated to be less than $80 a barrel in 2013; percentage of production with breakeven prices higher than $80 a barrel is expected to rise over the medium term (IEA, 2014b).
- IEA medium-term estimate: U.S. tight oil production to increase by another 2.5 mbd to 5 mbd.
- EIA / OPEC projections: light tight oil supply in the United States and Canada expected to peak around 2017–19 at 4.8 mbd, and then decline gradually to 2.7 mbd by 2035 (EIA low resource scenario).
- EIA longer-term: U.S. tight oil likely to plateau around 2018 at 4.8 mbd before declining.
- BP projects U.S. tight oil to continue to grow and exceed 4.5 mbd by 2030 (BP, 2014b).
- Recoverable resources estimate: one EIA estimate suggests recoverable resources in the United States amount to 33 billion barrels (EIA, 2013).
- Canadian oil sands: projected to average 3 mbd by 2019 (IEA, 2014b).
- IEA projects tight oil supply outside the United States could reach 0.7 mbd from Argentina, Canada, and Russia by 2019; Australia and Mexico expected to start producing marginal amounts by 2019.
- If oil prices remain around current levels of $75 a barrel, medium-term outlook for unconventional oil supply may be revised downward.

### Market balance, baseline and risk scenarios
- Baseline: despite a 7.7 mbd increase in global demand by 2019, high non-OPEC oil supply (6.3 mbd by 2019) implies demand for OPEC would remain broadly unchanged and increase only marginally to 31.2 mbd by 2019 (versus 30.5 mbd in 2013).
- Baseline OPEC crude oil supply projection: 32.7 mbd in 2019.
- Baseline implies OPEC supply would exceed OPEC demand by 1.4 mbd in 2018 and 2019.
- Excess supply in baseline would sustain downward pressure on oil prices unless production adjusts.
- Range of uncertainty examples:
  - Combined downside risk (higher non-OPEC supply and lower global demand): estimated excess supply over demand about 3.9 mbd (versus 1.4 mbd in baseline).
  - Combined upside risk: excess demand over supply of about 2.1 mbd by 2019.
- Saudi Arabia’s spare capacity is about 2.7 mbd.
- If production in Iraq and Libya remain unchanged at current production levels (reported at 3.3 mbd and 0.7 mbd, respectively, in the November 2014 IEA monthly oil market report), excess supply in the baseline would be reduced to around 0.4 mbd (from 1.4 mbd).

### Quantitative medium-term projections (selected figures from Table 1.1)
- Call on OPEC crude (2013–2019 under baseline): 30.5 (2013); 30.4 (2014); 30.3 (2015); 30.3 (2016); 30.5 (2017); 30.8 (2018); 31.2 (2019).
- Excess supply for crude (2013–2019 under baseline): -0.1 (2013); 0.1 (2014); 0.6 (2015); 1.0 (2016); 1.3 (2017); 1.4 (2018); 1.4 (2019).
- Global demand (2013–2019 under baseline): 91.4 (2013); 92.8 (2014); 94.2 (2015); 95.5 (2016); 96.8 (2017); 98.0 (2018); 99.1 (2019).
- Global supply (2013–2019 under baseline): 91.5 (2013); 93.0 (2014); 94.4 (2015); 95.7 (2016); 97.0 (2017); 98.2 (2018); 99.3 (2019).
- Non-OPEC (includes NGLs) (2013–2019): 54.7 (2013); 56.1 (2014); 57.3 (2015); 58.4 (2016); 59.4 (2017); 60.3 (2018); 60.9 (2019).
- United States production (2013–2019): 10.3 (2013); 11.4 (2014); 12.0 (2015); 12.6 (2016); 12.8 (2017); 13.0 (2018); 13.1 (2019).
- OPEC total (2013–2019): 36.7 (2013); 37.0 (2014); 37.7 (2015); 38.3 (2016); 38.9 (2017); 39.2 (2018); 39.8 (2019).
- OPEC crude (2013–2019): 31.2 (2013); 30.4 (2014); 30.5 (2015); 31.3 (2016); 31.8 (2017); 32.2 (2018); 32.7 (2019).
- Saudi Arabia production (2013–2019): 9.6 (2013); 9.7 (2014); 9.7 (2015); 9.8 (2016); 9.9 (2017); 10.0 (2018); 10.1 (2019).
- Iran production (2013–2019): 2.7 (2013); 2.8 (2014); 2.8 (2015); 2.8 (2016); 2.9 (2017); 2.9 (2018); 2.9 (2019).
- Iraq production (2013–2019): 3.1 (2013); 3.3 (2014); 3.5 (2015); 3.6 (2016); 3.8 (2017); 3.9 (2018); 4.1 (2019).
- Libya production (2013–2019): 0.9 (2013); 0.7 (2014); 0.8 (2015); 0.8 (2016); 0.9 (2017); 1.0 (2018); 1.0 (2019).

### Saudi Arabia’s role and potential policy responses
- Saudi Arabia accounts for more than 16 percent of global proven reserves.
- Saudi spare capacity: more than 2.7 million barrels a day, representing more than half of global spare capacity.
- Historical behavior: Saudi Arabia has increased production to offset supply interruptions or demand surges, and scaled back production during demand weakness (examples and magnitudes provided in the text).
- Three illustrative Saudi responses considered for market adjustment: no adjustment, adjustment by half, and full adjustment.
- Demand elasticity scenarios considered: −0.2, −0.1, and −0.05.
- Saudi full adjustment response assumes Saudi Arabia would cut its own production to absorb all excess supply in 2015.

*Source: IMF staff calculations and underlying IMF chapter content provided in the source unit.*

### 0.6 mbd under the baseline. Consequently,

### _1501mcd - 0.6 mbd under the baseline. Consequently,

### Impact of different oil market scenarios (2015)
- Under the baseline, a 0.6 mbd shortfall relative to baseline was considered; "there is no impact on prices." As a result, the fiscal balance would deteriorate by 2 percent of GDP in 2015 (Figure 1.5).
- The "no adjustment" response assumes that Saudi Arabia does not adjust its production and continues to produce the amount assumed in the baseline and as a consequence oil prices fall. Since output remains unchanged, the impact on revenues reflects the price effect alone and differs significantly depending on the choice of the estimate of the price elasticity of demand.
- If a higher estimate of demand elasticity of −0.2 is used, then oil prices would need to fall by less to balance demand and supply (by 3 percent) and the fiscal balance would fall by 1 percent of GDP.
- If a smaller estimate of the demand elasticity of −0.05 is assumed, then oil prices would fall more substantially by 12 percent. Consequently, the fiscal balance would drop by 4 percent of GDP from the baseline in 2015.
- The "adjustment by half" response, under which Saudi Arabia cuts back production by half of that needed and prices partially adjust, falls in between the above two scenarios in terms of the impact on fiscal revenues.
- The extent of the fall in oil prices could be limited by the high breakeven cost of shale oil production, which could provide an effective floor for oil prices.

### Quantified scenario impacts and elasticities (as presented)
- Table 1.3 (Impact of Different Oil Market Scenarios on Saudi Arabia in 2015) presents changes by scenario and price elasticity of demand (values preserved as in source):
  - Change in oil production (in mbd): No adjustment / Full adjustment / Adjustment by half (table headings retained).
  - Price Elasticity of Demand: -0.2 -0.1 -0.05 (noting the explanatory footnote: "Assuming no supply reaction, price elasticity of demand of -0.05, -0.1 and -0.2 implies that a 1 percent increase in oil supply would lead to fall in oil prices by 20 percent, 10 percent and 5 percent, respectively.")
  - Impact on oil price (percent change) (entries as shown in source): No adjustment -3 -6 -12 -8 -17 -33 36 12; Full adjustment 0 0 0 0 0 0 0 0 0; Adjustment by half -2 -3 -6 -4 -8 -17 2 3 6
  - Impact on oil revenue (percent change) (entries as shown in source): No adjustment -3 -6 -12 -8 -17 -34 36 12; Full adjustment -7 -7 -7 -19 -19 -19 7 7 7; Adjustment by half -5 -6 -9 -13 -17 -25 5 7 10
  - Impact on fiscal balance (in percent of GDP) (entries as shown in source): No adjustment -1 -2 -4 -3 -6 -11 1 2 4; Full adjustment -2 -2 -2 -6 -6 -6 2 2 2; Adjustment by half -2 -2 -3 -4 -6 -8 2 2 3
  - (Table sources: International Energy Agency; Energy Information Administration; and IMF staff estimates.)

### Downside and upside scenario effects
- The impact on fiscal balances is larger under the downside scenario compared to the baseline, but the fiscal balance could also improve if the upside risks materialize (Table 1.3).
- With a higher excess supply of 1.6 mbd in 2015, the impact on the fiscal balances under the downside scenario would be much larger for each of the three sets of price elasticities.
- The upside scenario suggests an excess demand of 0.6 mbd, which if met fully by Saudi Arabia, would improve its fiscal balance by 2 percent of GDP.
- Thus, the wide range of uncertainties in the global oil market would impact Saudi’s oil revenue through changes in both the level of oil production and prices.

### Conclusions and policy-relevant observations
- There are considerable uncertainties surrounding the outlook for the oil market.
- Demand for oil is set to increase, driven by strong growth in emerging markets, but supply increases from the United States and other countries have also surprised on the upside.
- The economic viability of unconventional oil production will depend on the future trend in oil prices. If oil prices remain at current levels, this could result in downward revisions in the medium-term outlook for unconventional oil supply.
- This creates further uncertainty regarding the outlook for U.S. production, which will depend on oil prices and technological and policy developments.
- Other uncertainties are also considerable, including from the global growth outlook, and the political situations in a number of key oil-producing countries.
- On balance, however, it appears that oil supply will continue to exceed demand in the coming years, sustaining the downward pressure on oil prices.
- Saudi Arabia has adjusted production several times in the past to balance the market. How Saudi Arabia responds in the future will have important implications for the global oil market and for Saudi Arabia’s own fiscal and external balances.

*Source: IMF staff calculations and IMF staff estimates (as presented in the source text).*

### References

### _1501mcd - References

### References
- BP. 2014a. Statistical Review of World Energy. London: BP.
- ———. 2014b. “BP Energy Outlook 2035” (January). BP, London.
- Energy Information Administration (EIA). 2014. Annual Energy Outlook. Washington, DC: U.S. Energy Information Administration.
- Energy Information Administration (EIA). 2013. Annual Energy Outlook. Washington, DC: U.S. Energy Information Administration.
- International Energy Agency (IEA). 2014a. Oil Market Report (June). Paris: IEA.
- ———. 2014b. Oil Medium-Term Market Report. Paris: IEA.
- International Monetary Fund (IMF). 2013a. “Special Feature: Unconventional Oil and Gas in North America: What Are the Implications?” In Economic Prospects and Policy Challenges for the GCC Countries, report prepared for the Gulf Cooperation Council Annual Meeting of Finance Ministers and Central Bank Governors. Washington, DC: IMF. http://www.imf.org/external/np/pp/eng/2013/100513b.pdf.
- ———. 2013b. “Assessing Saudi Arabia’s Systemic Role in the Oil Market and Global Economy.” Selected Issues Paper, in Saudi Arabia: Staff Report for the 2013 Article IV Consultation. Washington, DC: IMF.
- Organization of the Petroleum Exporting Countries (OPEC). 2013. World Oil Outlook 2013. Vienna: OPEC.
- International Energy Forum (IEF). 2014. “A comparison of recent IEA and OPEC outlooks,” (January).
- International Monetary Fund (IMF), 2014, World Economic Outlook, Special Feature on Commodity Prices and Forecasts, April 2014.
- Kilian and Murphy (2012), "Why Agnostic Sign Restrictions Are Not Enough: Understanding The Dynamics Of Oil Market Var Models," Journal of the European Economic Association, European Economic Association, vol. 10(5), pages 1166-1188, October.

---

### Overview of Key Fiscal Policy Challenges in Saudi Arabia
- Saudi Arabia derives more than 90 percent of its fiscal revenue from oil.
- Fiscal policy has three distinct goals:
  - Developmental: make expenditure decisions with a view to long-term economic growth; invest in physical and human capital.
  - Stabilization: smooth the impact of oil price swings or other shocks on the domestic non-oil economy; fiscal policy is first line of defense given fixed exchange rate.
  - Intergenerational equity: account for the nonrenewable nature of oil and dependency on oil revenue.
- Historical observations:
  - Oil and mineral producers see higher volatility in government revenues and expenditures than nonresource-rich countries (Figure 2.1).
  - Saudi Arabia has improved fiscal management over the past decade and experienced a decline in the volatility of government spending, but managing volatility remains a key challenge.

### Fiscal Rules and Medium-Term Budget Frameworks
- Global context:
  - In 2013, 81 countries had adopted some type of fiscal rule; medium-term budget frameworks introduced in 61 countries (Figure 2.2).
  - Fiscal rules commonly: budget balance and debt rules.
- Advantages of fiscal rules:
  - Provide sustainable, predictable, and stable fiscal policy.
  - Correct collective decision-making incentives, strengthen Ministry of Finance, and signal intentions to citizens and markets.
  - Countries with fiscal rules tend to run larger primary balances.
- Disadvantages of fiscal rules:
  - Lack of flexibility in face of large shocks; risk of loss of credibility if rules are jettisoned.
  - May focus on aggregate spending over composition; can induce cuts in public investment to meet targets.
  - Risk of circumvention via off-budget spending, creative accounting, reduced transparency if political commitment weak.
- Advantages of medium-term budget frameworks:
  - Help plan, manage, and prioritize revenue and expenditure over a three- to five-year horizon.
  - Reduce incremental annual decision-making, identify fiscal risks earlier, and link budget to expenditure performance.
- Interaction:
  - Fiscal anchor and medium-term budget framework reinforce each other: anchor gives top-down objective; medium-term framework translates objective into allocations and controls.

### Experiences in Commodity-Exporting Countries (Case Studies)
- General point: medium-term horizon is critical to prevent volatile annual revenues translating into destabilizing expenditure fluctuations.
- Countries considered: Chile, Mexico, Mongolia, Norway, Russia.

- Chile:
  - Copper Stabilization Fund (late 1980s); structural balance rule introduced 2001, revised 2005; Fiscal Responsibility Law 2006.
  - Committees set reference 10-year-ahead copper price and potential GDP for structural budget.
  - Draft budget must contain medium-term (four-year) projections.
  - New administration must present structural balance target within 90 days of taking office.
  - Two funds: stabilization fund (ESSF) and pension reserve fund (PRF, earmarked from 2016).
  - Rule evolution: targets shifted (surplus of 1 percent of GDP in 2008; 0.5 percent of GDP earlier; 2009 target zero with escape clause).
  - Outcome: rule well understood; sheltered economy from copper price swings; expenditure volatility low; reference price revisions during boom allowed strong expenditure growth.

- Mexico:
  - Fiscal Responsibility Law (FRL) 2006, modified 2008; balanced budget on cash basis with escape clause used 2010–12.
  - Rule applies to federal public sector including PEMEX and CFE; 2009 revision excluded PEMEX investment and moved target to 2 percent of GDP deficit.
  - Drawbacks: expenditures rose rapidly during good years; rule did not limit broader public sector borrowing.
  - Reforms: expenditure growth rule for “structural current spending” growth capped at potential growth; target for broader public sector borrowing requirement introduced.

- Mongolia:
  - Fiscal stability law implemented 2013 and a fiscal stability fund; three fiscal rules:
    - Ceiling on structural fiscal deficit of 2 percent of GDP as of 2013.
    - Cap on expenditure growth based on nonmineral GDP growth as of 2013.
    - Debt ceiling.
  - Structural revenues calculated as moving average of major mineral prices over a 16-year period (12 previous years, current year, three future years using IMF and other forecasts).
  - Stabilization fund: surplus mineral revenues placed into fund; deficits can be financed from fund.

- Norway:
  - New fiscal framework 2001 with four goals: macro stability, fiscal sustainability, intergenerational equity, efficiency of resource use.
  - Three pillars: structural fiscal rule, sovereign wealth fund (Global Government Pension Fund), integration of the fund into government budget.
  - Fiscal rule ties non-oil fiscal deficit to imputed 4 percent real return on investments; flexibility allows countercyclical transfers.
  - Large build-up of assets; challenge: pension fund growing faster than economy implying steady fiscal stimulus; when oil and gas revenues decline, inflows to finance future commitments will fall.

- Russia:
  - Previous framework (from 2007) with long-term non-oil deficit target of 4.7 percent of GDP suspended April 2009 and abolished 2012.
  - New framework approved December 2012, implemented 2013:
    - Federal expenditures capped at benchmark oil revenues + federal non-oil revenues + net borrowing limit of 1 percent of GDP.
    - Benchmark oil revenues use 10-year backward-looking oil price rule (transition from 5-year average in 2013 to 10-year by 2018).
    - When oil price > benchmark, excess saved in Oil Reserve Fund; when Oil Reserve Fund reaches 7 percent of GDP, allocations split 50/50 between National Wealth Fund and infrastructure projects.
    - When oil price < benchmark, Oil Reserve Fund tapped to maintain expenditures.
    - If actual oil price below benchmark for previous three years, benchmark reset to three-year backward-looking average.
    - Expenditures cannot be lower than previous budget (acts as floor).

### Summary: Commodity-Exporting Countries
- Common characteristics:
  - Move toward medium-term expenditure frameworks to improve planning and spending efficiency.
  - Experimentation with fiscal anchors (structural fiscal balance rules, expenditure ceilings, or combinations) to decouple expenditures from revenue volatility; rigid rules have not worked uniformly.
  - Establishment of stabilization and sovereign wealth funds to smooth expenditures and save for future generations.
- Design issues for fiscal anchors:
  - Choice of price information for calculating structural revenues: short backward-looking horizon tracks prices and picks turning points well but generates more volatility; longer backward horizon smooths expenditures but can systematically undershoot/overshoot; forward prices are poor predictors in practice.
  - Examples: Mongolia and Russia use long horizons; Chile uses expert committee.
  - Structural balance target choice matters: a structural surplus implies intention to accumulate resources for future generations.
- Empirical note:
  - Figure 2.3 shows standard deviation of oil prices 2000–10 under 3-year, 5-year, 10-year, 20-year averages versus actual.

### Public Investment Management in Oil-Exporting Countries
- Context for Saudi Arabia:
  - High oil prices facilitated higher public spending including investment.
  - Capital spending grew by 24 percent on average annually in nominal terms from 2000–08, increasing by about 3 percentage points of GDP.
  - Capital expenditure averaged over 11 percent of GDP between 2009 and 2013.
  - Non-oil output growth averaged over 7 percent annually during 2000–13.
- Infrastructure quality:
  - WEF Global Competitiveness Report ranking improved from 41 in 2008/09 to 31 in 2013/14 (Figure 2.5).
  - Strengths: roads and telecommunications. Weaknesses: railroads, ports, airports (many projects in progress).
- Public capital stock vs. infrastructure quality:
  - Figure 2.6 compares real public capital stock per capita and infrastructure quality index; Saudi Arabia compares favorably but appears less efficient than Canada, Norway, Singapore.
- Efficiency measurement methods:
  - Two approaches: Data Envelopment Analysis (DEA) and Partial Free Disposal Hull (PFDH).
  - Outputs: (i) infrastructure quality (WEF subcomponent); (ii) infrastructural quantity index (telephone lines, electricity, roads per World Development Indicators).
  - Inputs: public capital stock, GDP per capita as control (two inputs-one output).
  - Final scores are averages of the two output measures across methods.
  - Results: Saudi Arabia’s score is near global average but lower than advanced economies with strong institutions (Figure 2.7).

### A Fiscal Reform Agenda for Saudi Arabia
- Starting position:
  - Fiscal position is very strong; government debt virtually eliminated and substantial assets accumulated.
- Key risks and objectives:
  - Although stability improved, macroeconomic volatility remains above advanced economies.
  - Recent expansions in fiscal spending risk overcommitting future budgets and could be unsustainable under persistent negative oil price shocks.
  - Need to safeguard intergenerational equity and avoid abrupt expenditure cuts that undermine development and increase procyclicality.
  - Public investment efficiency is reasonable but below many countries; scope for improvement.
- Current budget process:
  - Budget oil price decided by a committee (Ministry of Oil, Ministry of Economy and Planning, Ministry of Finance).
  - Annual budget: top-down (Supreme Economic Council sets assumptions, policies, expenditure ceilings) and bottom-up (line ministries submit plans; MoF negotiates).
  - Three-year rolling ceiling on government investment program limits future capital commitments.
  - Carry-over limited to certain projects/categories; contingency reserve included; transfers from reserve set in annual decree.
  - Budget announced in late December with broad revenue/expenditure parameters but without previous year’s budget outcome estimate.
  - Common chart of accounts and budget classification being developed per IMF GFS Manual 2001; new GFMIS implementation in progress.
- Historical budget performance:
  - Revenue and expenditure estimates conservative; out-turns have exceeded budgeted amounts by substantial margins (Figure 2.8).
  - Conservative oil price/revenue assumptions led to additional in-year spending; published budget has been a limited guide to fiscal stance.
  - Any in-year budget changes must be approved by Council of Ministers; supplementary budgets not required.

### Reform Recommendations (Three Areas)
- Consider three possible areas of reform:
  1. Introduction of a formal medium-term fiscal framework.
  2. Establishment of a fiscal anchor.
  3. Evaluation of the public investment management process.

### A Medium-Term Fiscal Framework (Recommended Elements)
- Framework components:
  - A medium-term fiscal framework setting overall quantitative fiscal objectives in terms of balance and net worth for three to five years; demonstrates consistency given projected macro variables, oil prices, demographics.
  - A fiscal policy strategy document translating the medium-term framework into medium-term fiscal policy priorities; include fiscal risk analysis and sensitivity to assumptions, contingent liabilities, uncertain events.
  - A medium-term budget framework outlining multi-year expenditure plans in line with available fiscal space and linking five-year development plan to annual budget.
  - Annual budget remains legal appropriation basis but must be consistent with the above.
- Implementation prerequisites and actions:
  - Annual budget must be a reliable point of departure: MoF should include best possible estimates.
  - To reduce budget uncertainty, authorities should:
    - Strengthen capacity to cost existing and new policies to reflect expected costs.
    - Adhere more closely to adopted budget even if oil prices differ from budgeted assumptions.
    - Enhance fiscal reporting on in-year budget out-turns (frequency, timeliness, analysis).
  - Using realistic oil price assumptions would enhance policy planning and budget transparency.
  - Regular updates of the five-year development plan linked to annual budgets on a rolling basis.
  - Enhancing macroeconomic forecasting capacity is essential; establishment of a macro-fiscal unit in MoF would help if appropriately staffed.

### A Fiscal Anchor (Design Considerations and Recommendation)
- Trade-offs:
  - Saudi fiscal track record has been good without explicit rule; fixed exchange rate means fiscal discretion is important.
  - A well-designed anchor can improve fiscal performance and constrain expenditure pressures but may reduce flexibility.
- Recommendation:
  - Incorporate elements of a structural budget rule as a policy guide to support the medium-term budget framework.
  - Anchor expenditures to an estimate of structural revenues with an overall target for the structural balance to delink expenditures from revenue volatility.
- Design issues and suggested approaches:
  - Oil price determination:
    - A five-year backward-looking price rule would balance lower volatility and reasonable adjustment speed to new market trends (Figure 2.9).
    - Longer backward-looking rules (as in Mongolia and Russia) could be overly conservative given Saudi Arabia’s fiscal buffers.
  - Structural oil output:
    - No established country experience for determining structural oil output; a simple average of past output is likely the best option (Figure 2.10).
  - Structural balance target:
    - Given need to save for intergenerational equity, a surplus target could be set to generate sufficient savings to finance future deficits when oil reserves are exhausted.

### Strengthening the Framework for Public Investment
- Rationale:
  - Improved public investment management would enhance efficiency, better resource allocation, and boost growth/diversification objectives.
- Suggested first steps:
  - Review the public investment management process from appraisal and selection to implementation and ex-post evaluation to ensure alignment with government objectives.
- Empirical illustration:
  - Norway example (Box 2.1 referenced) shows strengthened public investment management can yield cost savings on projects.

*Source: _1501mcd - References, IMF PDF chapter content provided.*

### Box 2.1. Norwegian Governance Framework for Public Investment Projects

### Box 2.1. Norwegian Governance Framework for Public Investment Projects

### Background and purpose
- The Ministry of Finance in Norway initiated the development of an obligatory Quality Assurance Scheme (QAS) as a governance framework in 2000.
- Motivation: following a series of unsuccessful major projects and repeated project overspending during the 1980 and 1990s.
- The Ministry of Finance introduced a mandatory external assessment for all state-financed projects over US$500 million.
- The QAS was stipulated in the national budget law.
- The goal was to ensure improved quality-at-entry by establishing a system in which politics and administration is well divided, with the interplay between these two sides well understood.

### Quality Assurance Scheme: two-stage gateway process
- Two stages ensure comprehensive analysis before approval:
  - Measures are taken to ensure the quality of documentation (i) prior to the cabinet’s decision regarding conceptual solution and (ii) prior to the Parliament’s approval of the project’s cost frame.
- First “gateway” (pre-study / choice of concept / early decision to initiate pre-planning):
  - Analyze socioeconomic cost-benefit
  - Assess relevance, efficiency and sustainability
  - Put rankings of alternatives
  - Prepare management strategy
- Second “gateway” (pre-planning completion / before formal submission to Parliament):
  - Analyze management strategy
  - Make a recommendations on cost estimates and strategic framework
- The second gateway is documented in a report containing the consultant’s advice on a cost frame for the project.

### Results, evidence, and key statistics
- As of 2013, the scheme had been used for 160 projects.
- One study shows that 32 of the 40 projects submitted to QAS in the period 2000–09 and implemented during 2000–12, were completed within or below the cost frame (Samset and Volden 2003).
- The total net saving for the projects was estimated at about 7 percent of the total investment.
- Norway: Deviation between Final Project Cost and Project Budget (40 projects in total, percent) — Average cost saving: -7 percent.
- Timeline elements explicitly cited: 2000; 1980 and 1990s; 2000–09; 2000–12; 2013.

### Governance, coordination, and control
- The two-stage process provides a tool for control from the top: Parliament–government–ministry–agency.
- In between the two stages, there are several coordination forums where the Ministry of Finance brings together key interested parties for discussions, often resulting in common understanding and definition of terms and professional standards.

*Source: Box 2.1. Norwegian Governance Framework for Public Investment Projects (IMF).*

### References

### References

### Overview
- The content unit includes a reference citation: Samset, Knut, and Gro Holst Volden. 2003. “Investing for Impact— Lessons with the Norwegian State Project Model and the First Investment Projects That Have Been Subjected to External Quality Assurance.” Norwegian University of Science and Technology.
- The unit presents substantive analysis under the heading "Monetary and Macroprudential Policies in Saudi Arabia" (Naif Alghaith, Ahmed Al-Darwish, Pragyan Deb, and Padamja Khandelwal), covering monetary policy context, international comparisons, SAMA’s toolkit, empirical analysis of transmission, and macroprudential tools.

### Monetary policy context and key messages
- Monetary policy is anchored by the Saudi riyal’s peg to the U.S. dollar, limiting independent short-term interest rate policy.
- Fiscal policy is the primary macroeconomic management tool; liquidity management operations and macroprudential policy play complementary roles.
- Recommendations and scope for improvement:
  - Implement a formal liquidity forecasting framework to reduce volatility of the monetary base.
  - Strengthen the monetary policy transmission mechanism.
  - Establish a formal macroprudential framework with SAMA as the designated authority, and publish early warning indicators and risk assessments.

### Commodity-price exposure and macroeconomic implications
- Commodity price volatility transmits to the noncommodity sector via strengthened external balances and increased government spending when prices rise, and reverses when prices fall, increasing risks to borrowers and financial institutions.
- Saudi Arabia is highly dependent on oil exports. Key elements of the policy framework:
  - The peg to the U.S. dollar has been in place for nearly three decades.
  - Short-term policy interest rates closely follow U.S. Federal Reserve interest rates.
  - Fiscal policy has played a countercyclical role (e.g., during the global financial crisis) but may not always prevent credit booms and systemic risk buildup.
- Trends increasing relevance of monetary and macroprudential policies:
  - Tapering of unconventional U.S. monetary policy.
  - Financial deepening and increased trade synchronization with developing Asia.
  - Authorities’ plans to diversify the economy.

### International comparison of monetary policy frameworks (summary points drawn from Tables 3.1 and 3.2)
- All GCC countries (including Saudi Arabia) have conventional exchange rate pegs (all to the U.S. dollar, except Kuwait) and lack an independent interest rate policy.
- Among 13 comparator countries, only six (Algeria, Azerbaijan, Brunei, Indonesia, Kazakhstan, and Trinidad and Tobago) employ the exchange rate as the nominal anchor; three of these (Azerbaijan, Brunei, and Trinidad and Tobago) have limited exchange rate flexibility (currency board or stabilized exchange rate).
- Other arrangements among comparators:
  - Crawl-like or managed exchange rate arrangements: Algeria, Indonesia, Kazakhstan.
  - Floating exchange rates and inflation targeting: five countries.
- On average, countries with more diversified exports have more flexible exchange rate regimes.
- No single policy framework dominated in delivering better macroeconomic outcomes among commodity exporters over the past decade.
- Selected macroeconomic statistics (as presented):
  - Hydrocarbon exports (in percent of total, 2013): Bahrain 58.7; Kuwait 58.2; Oman 45.2; Qatar 54.5; Saudi Arabia 44.4; United Arab Emirates 30.0; Algeria 31.7; Azerbaijan 36.6; Brunei Darussalam 71.1; Canada 5.9; Indonesia 2 2.0; Kazakhstan 25.7; Malaysia 8.8; Mexico 3.7; Norway 9.7; Russia 3 13.3; Trinidad and Tobago 15.7.
  - GDP Growth, Volatility of GDP Growth (standard deviation), Inflation, Real Government Expenditure Growth, Current Account Balance (selected examples from Table 3.2):
    - Saudi Arabia: GDP Growth 5.2; Volatility of GDP Growth 2.8; Inflation 2.2; Real Gov't Expenditure Growth 10.1; Current Account Balance 16.9.
    - GCC average: GDP Growth 6.1; Volatility 4.1; Inflation 3.1; Real Gov't Expenditure Growth 10.5; Current Account Balance 16.4.
    - Non-GCC average: GDP Growth 4.5; Volatility 3.1; Inflation 5.1; Real Gov't Expenditure Growth 7.9; Current Account Balance 8.4.
  - Notes:
    - Volatility computed as the standard deviation of growth.
    - Real government expenditure growth is deflated by Consumer Price Index; data limitations noted for Mexico and Trinidad and Tobago.

### SAMA’s monetary policy toolkit and liquidity management
- SAMA sets an interest rate corridor using a repo rate (ceiling) and reverse repo rate (floor); short-term rates (SIBOR, SAMA bill rates) fluctuate within this corridor.
- The interest rate corridor closely tracks short-term U.S. rates.
- Banking system liquidity defined narrowly as the monetary base (currency outside banks + bank reserves). Banking system liquidity surplus defined as excess reserves (commercial bank holdings of cash and deposits at SAMA in excess of statutory requirements).
- Key features and instruments:
  - Reserve requirements:
    - Cash reserves: 7 percent of demand deposits.
    - Cash reserves: 4 percent of time and saving deposits.
    - Banks hold 20 percent of their deposits in short-term assets to meet statutory liquidity requirements.
    - Cash reserve requirements changed infrequently; last adjusted during the global financial crisis.
  - Repo transactions:
    - Manage domestic liquidity by injecting or absorbing overnight liquidity.
    - Eligible collateral includes government and SAMA securities.
    - Repo operations increased significantly during the global financial crisis but dropped to normal levels since 2010.
    - Current repo rate is 2 percent (rate unchanged since early 2009).
  - SAMA bills:
    - Issued to banks and nonbanks to absorb excess liquidity.
    - Ceiling on weekly issuance to banks: SAR 9 billion (last revision in February 2010).
    - Maturities range between 1 and 52 weeks.
    - Interest rate on SAMA bills set administratively at 80 percent of the Saudi Inter-Bank Bid (SIBID) rate for corresponding maturity.
    - Issuance to nonbanks on an ad hoc basis and not included in the ceiling.
    - SAMA bill issuances are not consistently oversubscribed at present.
  - Foreign exchange swaps:
    - Used to provide foreign exchange liquidity and absorb shocks from FX market pressures; similar to repos.
    - Employed during riyal selling pressure episodes in 1993 and 1998.
  - Placement of public funds:
    - SAMA may place or withdraw deposits on behalf of autonomous government institutions to address short-term liquidity shortages or surpluses.
- Empirical observations on liquidity:
  - Large external surpluses and fiscal spending fuel a liquidity surplus in the banking system.
  - Government spending and repayment of government debt (proxied by net international reserves less government deposits) have been main contributors to monetary base growth.
  - Banks hold large excess deposits at SAMA in the form of reverse repos, creating room for credit expansion.
  - Stepped up issuance of SAMA bills has helped sterilize a significant part of surplus liquidity since 2009, but the monetary base remains volatile, indicating scope to improve liquidity management.
  - Forecasting liquidity needs can guide size and timing of operations, reduce excess liquidity, smooth credit availability, and strengthen monetary transmission.

### Empirical analysis of monetary policy transmission (methodology and main results)
- Monetary transmission channels considered: interest rate channel, credit channel, exchange rate channel, asset price channel.
  - Exchange rate channel inactive due to fixed exchange rate regime.
  - Asset price channel analysis hampered by lack of real estate price data.
  - Empirical approach focuses on interest rate and credit channels; includes analysis of transmission from monetary base to economic activity through the credit channel.
  - Two model specifications used as robustness check (details in Appendix 3.1).
- Main empirical findings:
  - Interest rates:
    - Interest rates are not found to have a significant impact on economic activity.
    - An increase in the U.S. federal funds rate has a significant negative impact on prices in Saudi Arabia, but the impact on non-oil output is small and statistically insignificant.
    - Similar results when replacing the U.S. federal funds rate with SIBOR.
  - Credit channel:
    - Strong evidence that the credit channel is active.
    - A one standard deviation shock to credit has a positive and statistically significant impact on non-oil output after seven quarters.
    - Point estimates imply an elasticity of non-oil output to credit shock ranging between 0.6 and 0.7 after seven quarters.
  - Monetary base shocks:
    - Weak evidence that shocks to the monetary base have an economic impact; impulse responses of non-oil output and prices to a monetary base shock are statistically significant in only one of the two specifications.
    - Two specifications yield directionally similar and consistent results.
  - Oil prices and fiscal spending:
    - An increase in global oil prices increases government spending in Saudi Arabia; impact positive and significant after three quarters.
  - Imported inflation:
    - An increase in the Consumer Price Index of partner countries increases prices in Saudi Arabia; estimates imply an elasticity of nearly 0.6 after six months.
  - External demand:
    - An increase in U.S. GDP has a positive and statistically significant impact on Saudi non-oil output (likely via global oil demand, oil prices, and government spending).
- Policy implication from empirical results:
  - Normalization of U.S. monetary policy is unlikely to have an adverse growth impact on Saudi Arabia, especially if driven by improving U.S. economic conditions.
  - Adverse impacts could occur via oil price declines stemming from global financial market volatility related to premature U.S. policy normalization; in such a scenario, fiscal buffers and SAMA liquidity provision can respond.

### Role of surplus liquidity and implications for transmission
- Surplus liquidity in the banking system may hamper monetary transmission because bank liquidity has not constrained credit supply.
- With weak monetary transmission and interest rates tracking U.S. rates, SAMA has limited ability to influence aggregate demand via additional reserves.
- If oil prices moderate and surplus liquidity declines, monetary policy transmission may improve and SAMA could more actively influence outcomes via liquidity management operations.

### Macroprudential policy framework and instruments
- SAMA has implemented Basel III capital and liquidity requirements and used a variety of macroprudential instruments:
  - Capital tools: leverage ratio and provision requirements.
  - Liquidity tools: loan-to-deposit ratio, liquid-asset-to-deposit ratio.
  - Sectoral tools: loan-to-value (LTV) ratio, debt-to-income ratio (DTI), and concentration limits.
  - Exposure limits: large exposures.
- Countercyclical provisioning:
  - Banks have been encouraged to provision in a countercyclical way.
  - Provisioning levels increased to over 150 percent of gross nonperforming loans by end- (text ends here in provided content).

*International Monetary Fund*

### 2013. However SAMA’s countercyclical

### _1501mcd - 2013. However SAMA’s countercyclical

### SAMA’s countercyclical approach and recent measures
- SAMA’s countercyclical provisions are part of the supervisory process and are done on a bilateral basis with individual banks, based on microprudential concerns such as operating performance, composition of assets, and riskiness of the loan portfolio.
- Other instruments have been introduced to limit the build-up of risks but have been adjusted infrequently.
  - The DTI ratio was introduced at the end of 2005 to limit consumer credit and contain the buildup of household debt; since its introduction, it has not been adjusted.
  - Basel III capital requirements were implemented in 2012 and played a part in moderating credit growth in 2013, although implementation was not a direct response to developments in the credit market.
- Despite these measures, credit developments have been closely linked to developments in oil prices (Figure 3.5).

### Comparison of Saudi macroprudential toolkit with other commodity exporters (2013)
- Saudi Arabia has used most of the capital, liquidity, and sectoral tools that are popular with other commodity exporters.
- Saudi Arabia does NOT have caps on currency lending or foreign exchange positions, which are common among GCC countries and other commodity-exporting countries.
  - Footnoted practice: Saudi Arabia requires banks to obtain approval before commencing foreign exchange operations.
- Saudi Arabia does not explicitly limit real estate and other sectoral exposures, although:
  - SAMA monitors such exposure of each bank as part of its routine surveillance process.
  - SAMA imposes a loan-to-value ratio of 70 percent for real estate finance companies.
- Table 3.3 (tool inventory) notes tool usage classifications: √ Not used countercyclically; ● Used countercyclically; ○ Tightened over time, but not intended as a countercyclical tool.
- Sectoral tools (concentration limits, LTV and DTI ratios) are the most popular tools among commodity exporters, followed by liquidity and capital measures.

### International evidence on effectiveness of countercyclical macroprudential tools
- Cross-country and individual-country empirical studies summarized in Table 3.4 indicate:
  - LTV and DTI caps, dynamic provisioning, and reserve requirements are effective in curtailing credit growth and, to a lesser extent, asset price inflation (Lim and others, 2011).
  - LTV caps and DTI ratios slow property lending growth and reduce sensitivity of mortgage defaults to property price shocks (Ahuja and Nabar (2011); Almeida, Campello, Liu (2005); Wong and others (2011); Kuttner and Shim (2012)).
  - Dynamic provisioning and provisioning rules can mitigate credit supply cycles and improve firm-level credit availability (Jiménez and others (2012)).
  - Reserve requirement changes are negatively associated with loan growth in some country studies (Wang and Sun (2013)); reserve requirements and house-related policies were effective with respect to house price growth in China.
  - Aggregate findings across multiple studies: macroprudential measures reduce procyclicality of credit growth and can reduce housing price growth and mortgage credit growth.
- Empirical visuals referenced:
  - Figure 3.6: Change in credit growth after the introduction of instruments (percent) — lines denote average of sample countries’ y/y growth in credit (detrended); "t" denotes the time of the introduction of instruments; LTV = loan-to-value ratio; DTI = debt-to-income ratio.
  - Note in figure: <<NO DATA FOR THIS CHART......>>

### Country case: Canada’s experience
- Since 2008, Canadian authorities undertook four rounds of measures to tighten mortgage rules in response to surging house prices and mortgage credit. Measures included:
  - Tightening LTV ratios on refinancing loans and on loans to purchase properties not occupied by the owner.
  - Reducing the maximum amortization periods to 25 years.
  - Introducing a maximum total debt service ratio of 44 percent.
- Empirical observations (Figures 3.7 and 3.8):
  - Residential mortgage credit growth slowed sharply after the first measures in 2008 (Figure 3.7).
  - House price growth has been more volatile but generally lower since the measures were introduced (Figure 3.8).
- Krznar and Morsink (2014) conclude that moderation in house prices and mortgage credit since 2010 has been due in part to policy measures.

### Framework and prerequisites for countercyclical macroprudential policy
- A prerequisite is a system of early warning indicators to signal vulnerabilities and guide use of macroprudential tools.
  - Indicators should identify systemic risks (macroeconomic imbalances, strong credit growth), inter-linkages between financial and real sectors, and fragility in financial system structure.
  - Indicators can be used in a “rules-based” fashion (e.g., Swiss guided discretion approach for countercyclical capital buffer) or in a “discretionary” fashion (e.g., UK Financial Policy Committee core indicators).
  - CGFS (2012) and IMF Staff Guidance Note on Macroprudential Policy (IMF, 2014b, 2014c and 2014d) discuss best practices.
- Formal macroprudential frameworks are becoming more common among commodity-exporting countries to ensure:
  - Designation of macroprudential authority and responsibility.
  - Coordination across authorities.
  - Access to information and requisite powers to act (hard/direct, semi-hard/comply-or-explain, or soft/recommendation).
  - Clear communication and market expectation formation.
- Framework typologies evolving internationally:
  - Central Bank with explicit mandate and powers (example: Czech Republic).
  - Committee within central bank (example: UK Financial Policy Committee).
  - Committee outside central bank (examples: Australia, France, United States).

### Status of macroprudential framework and practices in Saudi Arabia (2013)
- Macroprudential tools in Saudi Arabia are used outside a formal macroprudential framework and coordination among regulators is largely informal.
- Authorities are considering a formal macroprudential framework.
  - SAMA has carried out a detailed study identifying key requirements, international developments in peer and other countries, and tools and instruments for implementation.
  - Structure is yet to be decided; likely that overall responsibility will reside with SAMA, with inputs from other institutions.
- Institutional developments and transparency:
  - A dedicated Financial Stability Division was established in 2013.
  - The Division has developed an internal macroprudential dashboard (Table 3.6) and is improving the stress-testing framework.
  - SAMA is in the process of finalizing the first financial stability report.
- Regional context:
  - All other GCC countries publish financial stability reports (Table 3.5); some started recently.
  - Outside GCC, Norway started reporting in 1997 and Canada in 2002.

### SAMA internal macroprudential dashboard (examples of indicators)
- Overall economy: Oil GDP; Inflation; Oil Prices.
- Credit overview: Credit growth (aggregate and by sector); Credit to GDP; Credit Maturity.
- Banking sector (credit risk, funding and liquidity risk, capital adequacy, market risk, global risk, and interconnectedness): Total assets; Credit; Revenues; Profitability; Expenses; Nonperforming loans; Loan to deposit; Liquidity; Capital adequacy ratio; Investment breakdown.
- Insurance sector (funding, liquidity risk, solvency, market risk): Gross written premium; Net loss ratio; Profitability; Expenses; Liquidity; Solvency; Investment breakdown.
- Capital market: Market capitalization; Turnover; Profitability.

*International Monetary Fund*

### Conclusions and Policy Recommendations

### Conclusions and Policy Recommendations

### Impact of U.S. Monetary Policy Normalization
- The normalization of U.S. monetary policy is expected to have a limited economic impact on Saudi Arabia, especially if it is accompanied by stronger U.S. economic prospects.
- Empirical results indicate an increase in U.S. interest rates may not impact Saudi non-oil output.
- Risk scenario: if a premature normalization of U.S. monetary policy results in a surge in global financial market volatility and has an adverse impact on oil prices, economic activity in Saudi Arabia could slow.
  - In such a scenario:
    - Fiscal policy would have the space to smooth spending.
    - SAMA could provide liquidity to the financial system.

### SAMA liquidity management and monetary policy transmission
- SAMA has been developing its toolkit to influence credit and liquidity conditions.
- Large external surpluses and fiscal spending have fueled a liquidity surplus in the banking system.
- Instruments used to absorb liquidity include:
  - Reserve requirements (used actively during the global financial crisis in 2008).
  - More market-based instruments such as repo operations and issuance of SAMA bills.
- SAMA bills are used to absorb excess banking system liquidity on a more regular basis; SAMA has increased the volume of SAMA bills being issued over time.
- The monetary base is volatile, suggesting:
  - It may be useful to develop a formal liquidity forecasting framework.
  - It may be useful to further refine liquidity management tools.

- Scope to strengthen monetary policy transmission:
  - Fiscal policy is currently the primary macroeconomic management tool.
  - Excess liquidity in the banking system limits SAMA’s ability to contribute toward management of aggregate demand through provision of additional reserves.
  - Going forward, SAMA may find it useful to deploy more active liquidity management operations to reduce excess liquidity and strengthen monetary policy transmission to help manage the impact of future shocks.
  - Steps to strengthen monetary policy transmission may include developing the markets for short- and long-term securities to aid in the transmission of policy signals.

### Macroprudential policy framework
- The macroprudential toolkit in Saudi Arabia is comparable to that of other commodity exporters although it has not generally been used in a countercyclical way.
- Macroprudential policies are increasingly being used in a countercyclical manner in many commodity-exporting countries to influence economic activity and financial sector risk.
- The experience of other countries suggests that these policies have been effective in limiting systemic risk.
- A formal framework for countercyclical macroprudential policy would help to ensure effectiveness:
  - Macroprudential tools in Saudi Arabia are currently used outside of a formal macroprudential framework, and coordination among regulators is largely informal.
  - Establishing a formal framework with SAMA as the designated macroprudential authority would:
    - Bring clarity and credibility to macroprudential policy.
    - Ensure the willingness to act and coordinate with other authorities when necessary.
  - It would also be useful to develop early warning indicators to determine the timing for activation of macroprudential instruments and to signal systemic risks.

### Empirical methodology (Appendix 3.1) — model design and data
- Exogenous variables considered (following Espinoza and Prasad (2012)):
  - oil prices
  - U.S. real GDP
  - a trade-weighted price index from partner countries
  - the U.S. federal funds rate (de facto policy interest rate)
- Endogenous variables for Saudi Arabia:
  - government expenditure (G)
  - non-oil real GDP (Y)
  - private sector credit (Credit)
  - consumer prices (CPI)
  - reserve money (RM) — considered a policy variable
- Data:
  - Quarterly data from 1993:Q1 to 2013:Q4 are used.
  - Annual series for G and Y are interpolated using a quadratic trend.
- Variable transformations and stationarity:
  - All endogenous and exogenous variables except the federal funds rate are expressed in logarithm and found to be stationary in first differences (I(1)) according to the Augmented Dickey-Fuller unit root tests.
- Correlations between innovations in the endogenous variables (from Table A3.1):
  - Correlation matrix (row/column order: G, Y, Credit, CPI, RM)
    - G: 1.0, 0.38, -0.05, -0.06, 0.08
    - Y: 0.38, 1.0, 0.27, 0.20, 0.08
    - Credit: -0.05, 0.27, 1.0, -0.13, 0.17
    - CPI: -0.06, 0.20, -0.13, 1.0, -0.01
    - RM: 0.08, 0.08, 0.17, -0.01, 1.0
  - Correlation between G and Y, and Y and Credit are statistically significant.
  - There is limited evidence of collinearity between the variables.

- Cointegration and model specification:
  - The Johansen cointegration test reveals the presence of one cointegrating vector among the endogenous variables.
  - A vector error correction model is estimated to model the long-run relationship.
  - Cholesky ordering for impulse responses: G, Y, Credit, CPI, RM.
    - Justification: Government expenditure (G) is ordered first under the assumption it does not contemporaneously respond to other variables owing to lags in implementation.
  - Lag selection:
    - Include lags 1, 4, 5, and 8 for endogenous variables.
    - Include lags 1 through 4 for exogenous variables.
  - The model is stable.

### Cointegrating vector and adjustment dynamics
- Estimated cointegrating equation (with t-statistics in parentheses):
  - G + 8.42*Y - 3.24*Credit + 10.36*CPI - 6.54*RM - 82.49 = e_t
    - (3.0) (−3.2) (4.1) (−4.6)
- Interpretation:
  - The cointegrating equation suggests that an increase in G or Y is associated with an increase in credit and reserve money over the long term.
  - Similarly, an increase in Credit or RM may be associated with an increase in G, Y, and the CPI.
- Error-correction dynamics:
  - Estimated coefficients for the error-correction term imply that deviations from long-run equilibrium are corrected primarily through adjustments in Y and CPI.

### Robustness checks
- Alternative specifications:
  - Replacing the trade-weighted price index for partner countries with:
    - the U.S. consumer price index, and
    - the nonfuel commodity price index.
  - These specifications result in two cointegrating vectors.
  - Impulse response functions derived from these models are directionally consistent with those derived above.

*Italic source: Conclusions and Policy Recommendations (content unit: _1501mcd - Conclusions and Policy Recommendations).*

### 0.9 since 2001). Data on the quality ladder of exports by sector—which compares for each

### _1501mcd - 0.9 since 2001). Data on the quality ladder of exports by sector—which compares for each

### Export composition and export quality
- Saudi Arabia’s exports are dominated by hydrocarbons; fuels/crude oil constitute most of exports in the minerals sector.
- Saudi Arabia’s non-oil sector comprises half of nominal output, but exports are dominated by hydrocarbons, which account for some 85 percent of total exports.
- The quality ladder analysis finds:
  - Relatively low export quality in the minerals sector because crude oil constitutes most of its exports in this category.
  - The quality of exports of chemical products compares well to other countries, yet its share in total Saudi exports is still relatively low.

### Trade destinations and regional trade patterns
- The destination of Saudi Arabia’s exports has shifted with global oil demand; over half of exports now go to Asian markets.
- China is now the second most important export market for Saudi Arabia after the United States; Japan is the third largest export market.
- Intra-GCC trade has not taken off despite the customs union:
  - Saudi Arabia’s total exports to the GCC were only 6.6 percent of total exports in 2012.

### Comparative indicators and manufacturing
- Saudi Arabia’s share in total world merchandise exports is slightly above 2 percent; United Arab Emirates has a closest figure of 1.9 percent.
- Manufactured exports as a share of total exports are low, at less than 15 percent (compared to up to 70 percent in a number of MENA countries).
- Oil dominates the export basket, constituting nearly 85 percent of total exports in 2012.

### Employment and wages (Figure 4.3 highlights)
- The chapter reports sectoral breakdowns of employment and average monthly wages by sector for 2008–13 and 2013, respectively, including separate public sector and private sector (Saudi nationals) wage series.
- Employment of Saudi nationals by sector, 2013: the figure highlights a 71% share in one sector grouping shown in the chart (as labeled in the source figure).

### Saudi Arabia and Mexico: compositional differences (Box 4.2)
- Comparison with Mexico underscores Saudi Arabia’s sizable hydrocarbons sector in output and export concentrations.
- Mexico’s production and export structures are more diversified, with capital and transport goods each accounting for one-quarter of total exports.

### Trade agreements and multilateral accession (Box 4.3)
- WTO accession: Saudi Arabia joined (acceded to) the World Trade Organization (WTO) in December 2005.
- Regional and preferential trade arrangements:
  - Gulf Cooperation Council (GCC) customs union covering goods entered into force in January 2003.
  - Pan-Arab Free Trade Area (PAFTA) entered into force on January 1998.
  - Saudi Arabia participates in or is connected to GCC-related arrangements (EFTA-GCC signed but not ratified; Australia-GCC announced; Japan-GCC announced).
  - Beneficiary of Preferential Trade Arrangements under the generalized system of preferences with Australia, New Zealand, Russia, Switzerland, and Turkey.
- Saudi Arabia’s total trade value per capita is the lowest among GCC economies given its relatively larger population, but is comparably higher than in most MENA countries and comparable to the BRICS (Brazil, Russia, India, China, and South Africa).

*International Monetary Fund*

### Box 4.3. Saudi Arabia, Global Trade, and the World Trade Organization (concluded)

### Box 4.3. Saudi Arabia, Global Trade, and the World Trade Organization (concluded)

### Services Trade and WTO-related Measures
- Saudi Arabia’s share in total world exports of services: 0.24 percent (2012).
  - Travel: 70 percent of total service exports.
  - Transportation: 21.5 percent of total service exports.
- Relative performance:
  - Saudi Arabia’s trade in services fares similarly to MENA countries but is far below BRICS and other advanced economies.
  - World Bank’s Services Trade Restrictions Database: GCC countries have the highest services trade restrictions index worldwide (most restrictive policies in services), particularly in telecommunications and financial services.
  - Saudi Arabia’s overall index score is lowest among the GCC countries.
- Sectoral weaknesses:
  - In transportation and in finance and insurance, Saudi Arabia is weaker than comparator countries in shares in total value added and in generating employment.
- Recent policy changes in financial services (excluding insurance):
  - Capital Markets Authority resolution (March 2010) permitting nonresident foreign investors to trade in Exchange Traded Funds (ETFs) on the Saudi Stock Exchange (Tadawul).
  - Allowed SWAP agreements with nonresident foreigners to transfer economic benefits of shares listed on Tadawul to foreigners.
  - Plans for opening the Tadawul to foreign investors have been announced.
- Trade remedy and export restrictions:
  - According to the WTO’s Trade Monitoring Database, Saudi Arabia has not been part of (subject to) antidumping or countervailing trade measures, export duties, or other export quantitative restrictions over the past six years.

### Tariff Structure and Trade Costs
- Applied Most-Favored Nation (MFN) simple average of import duties (2012): 5.1 percent.
  - Agricultural produce: 6.2 percent.
  - Nonagricultural commodities: 5 percent.
- Export environment indicators:
  - Number of documents required to export: five (low relative to other GCC economies except UAE, BRICS, and several MENA economies).
  - Costs to export (U.S. dollars per container): lower than BRICS; cumulative increase of 18 percent since 2007 (slower rise than in most GCC countries, with the exception of Kuwait).
  - Trade and transport-related infrastructure (Logistics Performance Index, 2012): stronger than most GCC countries (except UAE) and compares well with selected MENA economies and BRICS.

### Business Environment and Regulatory Indicators
- Competitiveness and ease of doing business:
  - Global Competitiveness Index ranking: 18th most competitive economy worldwide among 144 countries in 2013.
  - Ease of Doing Business Index ranking among GCC countries (2013): second to the United Arab Emirates.
- Business startup improvements:
  - Days to start a business: reduced from over 70 days in 2004 to 25 days by 2013; after May 2013 online company application process, procedures reduced to seven and days to 23.
  - Business startup costs (percent of GNI per capita): reduced from 60 percent to 5 percent.
  - Number of procedures to register a business: reduced from 14 to nine over the past 10 years, then to seven after May 2013.
- Investor protection:
  - Strength of investor protection: highest ranked among GCC and selected MENA countries.
- Remaining weaknesses:
  - Global rankings: contract enforcement 127; resolving insolvencies 106.
  - Government actions: planning a new insolvency law; recruiting more judges; establishing commercial courts; improvements to consumer protection; stronger enforcement of competition policy; revisions to company law.

### Labor Market Regulations and Incentives
- Working hours:
  - Workweek can extend to 50 hours per week per worker.
  - Paid annual leave for first year of service: 18 days (lowest among GCC alongside Qatar; up to 30 days in Bahrain and Kuwait).
- Redundancy rules and severance:
  - Severance pay for redundancy dismissal after 10 years of continuous employment: 32.5 salary weeks (higher than most countries in MENA and selected European economies and BRICS, except China).
- Hiring practices:
  - No limit on duration of fixed-term contracts; fixed-term contracts not prohibited for permanent work tasks.
- Incentive distortions:
  - Public sector employment policies and higher public wages inhibit private sector dynamism.
  - National accounts: very high share of GDP goes to capital (gross operating surplus) rather than labor (compensation of employees); ratio for overall economy and for the non-oil private sector is around 75:25.

### Education and Human Capital
- Literacy rates (2011):
  - Adult literacy rate: 87.1 percent.
  - Youth literacy rate (ages 15–24): 98 percent.
- Public spending on education (average, 2004–13 and trend):
  - Public spending on education as a share of national income declined from 6.3 percent in 2004 to 5.1 percent in 2008 (latest available data cited).
  - Government investments include establishment of universities, colleges, academic and technical institutes with a focus on scientific and technological research.
  - Overseas scholarship program size: 185,000 students currently studying overseas.
- Outcome and skills mismatch:
  - Almost half of unemployed Saudi nationals hold bachelors or higher degrees, indicating mismatch between educational outputs and job market needs.
  - TIMSS: academic achievement remains relatively low.
  - Number of years of schooling and enrollment rates in early childhood education are low in relative terms (WEF/EBRD, 2013).

### Experiences of Economic Diversification in Commodity-Exporting Countries (Lessons)
- Diversification is difficult, especially when oil production horizon is long; obstacles include:
  - Economic volatility from oil revenue reliance.
  - Corroding effects of oil revenues on governance and institutions.
  - Risks of overvalued real exchange rates (traditional Dutch disease issues).
- Country experiences and key tools:
  - Malaysia:
    - Active state intervention targeting sectors.
    - Attracted foreign direct investment in export sector.
    - Focus on human and capital development, training, skill upgrading, SME development.
  - Indonesia:
    - Import-substitution plus export promotion, free zones, tax incentives, tariff and nontariff reductions.
    - Large exchange rate devaluation.
    - Use of oil revenues to develop agriculture and aircraft industry.
  - Mexico:
    - Export environment improvements aided by NAFTA accession.
    - Free trade zones, state investment in infrastructure, tax incentives, workforce training abroad; development of aerospace industry.
  - Chile:
    - Use of export subsidies and public-private partnerships; focus on sectors with comparative advantage, SME development, and technology transfers.
- Common elements across successful cases:
  - Provision of strong incentives for doing business.
  - Tapping and strengthening of nontraditional sectors, export promotion, and better trade integration.
  - Attraction of foreign direct investment and reliance on technological transfers.
  - Education, training, and human capital development.
  - Development of SMEs.

### Policies to Support Further Economic Diversification in Saudi Arabia
- Rationale for diversification (four reasons):
  - Reduce exposure to global oil market volatility.
  - Create private sector jobs to absorb young and growing working-age populations.
  - Increase productivity and sustainable growth.
  - Build the non-oil economy needed when oil revenues dwindle.
- Government actions underway:
  - Improving business environment, domestic infrastructure, and education/skills.
  - Developing industrial and economic “cities” clustering industry and services (industrial cities house about one-half of all manufacturing industries).
  - Creating links between universities and industrial cities to enhance research and development.
  - Developing transportation networks to connect cities and move raw materials to processing facilities.
  - SME support initiatives: Kafala Program (initiated 2006) for credit guarantees; Saudi Credit and Saving Bank loans to SMEs; specialized SME units within banks; establishment of SIMAH (Saudi credit bureau).
  - Establishment of the Saudi Export Development Authority to support exports.
- Priority areas for continued efforts:
  - Business climate: strengthen contract enforcement and insolvency resolution; address labor regulations and education constraints.
  - Education: focus on quality and alignment of skills with private sector needs; ensure spending produces improved outcomes.
  - Labor market reforms: increase employment of nationals in private sector; control public sector jobs and wages; refocus education; active labor market policies; ease employment regulations for nationals where appropriate; allow greater mobility of foreign workers to narrow wage differentials.
  - Infrastructure: ensure large public infrastructure spending is efficiently used to improve transportation logistics.
  - SME development: continue facilitating SME access to finance and other supports.
  - Trade policy and integration:
    - Expand participation in free trade agreements (current signatory to only a few).
    - Lead GCC economies in fostering implementation of the Gulf Common Market (launched 2008) for free movement of factors of production, goods, and services.
  - Use targeted measures to encourage firms to export (e.g., export insurance guarantees and financing).
  - Harness foreign direct investment inflows geared toward non-oil activity to strengthen the manufacturing base.

*Source: IMF (Box 4.3. Saudi Arabia, Global Trade, and the World Trade Organization — concluded).*

### References

### _1501mcd - References

### Academic and policy papers
- Alawaji, Saleh (Deputy Minister of Water and Electricity for Electricity Affairs and Chairman of the Saudi Electric Company). 2012. “Saudi Arabia: A Proactive Approach to Energy.” Living Energy No. 7 (November): 76–81.
- Alhouti, Aljowhara. 2013. “Deployment of Solar Energy in Saudi Arabia: A Case Study.” Georgetown University Law School. http://gwujeel.files.wordpress.com/2013/09/johara-alhouti.pdf.
- Cherif, Reda, and Fuad Hasanov. 2014. “Soaring of the Gulf Falcons: Diversification in the GCC Oil Exporters in Seven Propositions.” Paper prepared for the IMF conference on “Economic Development, Diversification, and the Role of the State,” Kuwait City, April 30–May 1.
- World Economic Forum and European Bank for Reconstruction and Development (WEF/EBRD). 2013. The Arab World Competitiveness Report 2013. Geneva: WEF.

### National agencies and reports
- Capital Market Authority (CMA). Annual Report (various issues). Riyadh.
- Central Department of Statistics and Information (CDSI). Annual Statistical Bulletin (various issues). Saudi Arabia Ministry of Economy and Planning.
- ———.Export Statistics Bulletin (various editions). Saudi Arabia Ministry of Economy and Planning.
- General Organization for Social Insurance (GOSI). Annual Statistics Bulletin (various issues). Riyadh: GOSI.

### Databases
- United Nations Commodity Trade Statistics Database (UN Comtrade). http://comtrade.un.org/db/.
- World Bank. World Development Indicators (WDI) Database. http://data.worldbank.org/data-catalog/world-development-indicators.
- ———. Services Trade Restrictions Database. http://data.worldbank.org/data-catalog/services-trade-restrictions.
- World Trade Organization (WTO). Services Profiles. Country tables.
- ———. Trade Profiles. Country tables.
- World Trade Organization (WTO). Trade Monitoring Database.

*International Monetary Fund.*

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