Mission Concluding Statement 

Saudi Arabia: Staff Concluding Statement of the 2019 Article IV Mission

May 15, 2019

Economic reforms have started to yield positive results. Non-oil growth has picked-up, female labor force participation and employment have increased, the successful introduction of the value-added tax has underpinned an increase in non-oil fiscal revenues, energy price reforms have helped reduce per capita consumption of gasoline and electricity, measures have been introduced to compensate low and middle-income households for the higher costs resulting from reforms, and fiscal transparency has increased. Reforms to the capital markets, legal framework, and business environment are progressing well. Challenges, however, remain. Government spending has risen, supporting growth but raising medium-term fiscal vulnerabilities to lower oil prices. Fiscal consolidation is needed to reduce these vulnerabilities. More generally the economic footprint of the public sector is still large. The unemployment rate of nationals remains high. Job creation is a key challenge identified under the government’s reform program. To deliver a diversified, productive and competitive economy, reforms need to make Saudi nationals more competitive for private sector jobs, raise foreign direct investment, and increase the availability of finance for young and growing companies.

Recovery in the non-oil economy

1. Economic outcomes improved in 2018. Real GDP growth rebounded to 2.2 percent after contracting in 2017. Real oil GDP increased by 2.8 percent (3.1 percent decline in 2017), while non-oil GDP growth rose to 2.1 percent (1.3 percent in 2017). Government spending increased, but the exit of expatriate workers and dependents appears to have held back growth. CPI inflation rose with the introduction of the value-added tax (VAT) and increase in energy prices in January 2018 but has eased since as housing rents have fallen. Consumer prices declined by 2.1 percent (y/y) in March 2019.

2. Real non-oil growth is expected to further strengthen to 2.9 percent in 2019. Recent monthly indicators have been positive and the increase in oil prices since the turn of the year is boosting confidence. At this time, it is difficult to assess future developments in the oil market given uncertainties about production in some key exporting countries. On the assumption that Saudi Arabia produces at its agreed level under the current OPEC+ agreement in 2019H2, real oil GDP growth is projected at 0.7 percent in 2019 and overall real GDP growth at 1.9 percent.[1] If Saudi Arabia increases oil production, then oil GDP growth would be higher (as would export and fiscal revenues). Over the medium-term, the team expects a strengthening in non-oil growth to around 3-3¼ percent as the ongoing reforms yield dividends and overall real GDP growth to settle around 2½ percent.

   Higher government spending has supported growth and the implementation of reforms, but has increased medium-term fiscal vulnerabilities

3. The fiscal deficit narrowed in 2018 to 5.9 percent of GDP. The non-exported oil primary deficit (NEOPD)—the team’s preferred measure of the fiscal stance because it focuses on what is directly under the control of the government and is not affected by the volatility of oil revenues—increased to 39.5 percent of non-oil GDP in 2018 from 38.5 percent in 2017. Oil and non-oil revenues increased substantially in 2018 as did government spending. Despite the budget surplus in the first quarter, the team projects that the fiscal deficit will rise to 7 percent of GDP in 2019. No decline in the overall fiscal deficit from this year’s projected level is expected over the medium-term based on current policies and the oil price path currently embedded in financial markets ($57 a barrel in 2024). The NEOPD is expected to decline to 29.4 percent of non-oil GDP in 2024 as announced fiscal measures are implemented.

4. The fiscal deficits in recent years have resulted in a decline in the government’s fiscal buffers. At end-2018, the central government debt-to-GDP ratio was 19.1 percent and the central government net financial asset-to-GDP ratio (defined as government deposits at the central bank less gross debt) was 0.1 percent. While enviable in a global context, these ratios were below 2 percent and around 50 percent of GDP, respectively, at end-2014.

5. Fiscal consolidation is needed to reduce these medium-term vulnerabilities. The team understands the authorities’ desire to support growth and the Vision 2030 reform program through higher spending but believes that fiscal policy should strike the right balance between fiscal sustainability, social spending, and development. If oil prices are lower than assumed in the government’s budget plan, the country would face large fiscal deficits unless spending was reduced, but from a starting position of weaker fiscal buffers than in 2014.

6. Achieving planned fiscal targets will require implementing the reforms set out in the Fiscal Balance Program and identifying additional fiscal measures. Planned energy and water price reforms, supported by compensation for low and middle-income households through the Citizens Account program, and increases in expatriate labor fees should proceed, although the latter can be implemented more gradually to give businesses time to adjust. The cost-of-living allowances introduced in the January 2018 Royal Decree should be allowed to expire as planned at end-2019. In addition, a reduction in the government wage bill, a more measured increase in capital spending, and the better targeting of social benefits will all yield fiscal savings. The introduction of the VAT has been very successful, and consideration should be given to raising the rate from 5 percent, which is low by global standards, in consultation with other GCC countries.

7. Improvements in expenditure management and fiscal transparency need to continue. Important reforms have been implemented to strengthen the budget process, develop a medium-term fiscal framework, introduce an online expenditure management system (Etimad), strengthen fiscal analysis, and increase publicly available information on the budget. The new public procurement law, which needs to cover all procurements from budget resources, should improve spending efficiency and help reduce potential risks of corruption in procurement. Nevertheless, spending has increased with oil prices over the past two years. The fiscal framework and expenditure management processes need to be able to maintain spending at a level that is sustainable across different oil price environments. Otherwise large adjustments in spending will be needed during times of low oil prices which causes undue volatility in growth.

   Promoting non-oil growth, diversification, and job creation remain key challenges

8. The government is implementing ambitious reforms to develop the non-oil economy under its Vision Realization Programs (VRPs). These initiatives center around improving the climate for doing business in Saudi Arabia, developing new, or expanding existing, sectors of the economy, attracting foreign direct investment, developing small and medium-sized enterprises (SMEs), broadening and deepening the financial markets, and strengthening the human capital of Saudi nationals. Careful prioritization of the reforms is important to ensure successful implementation.

9. Important reforms have been made to strengthen the legal framework and reduce constraints to business. The bankruptcy and commercial pledge laws fill important gaps in the legal infrastructure, while efforts to streamline procedures for starting a business and clearing containers through ports should support business formation and trade. Looking forward, FDI licensing requirements should be reviewed as planned and the privatization and PPP programs, which are now starting to see transactions, accelerated.

10. Labor market reforms should focus on four areas to encourage Saudi nationals to work in the private sector and companies to hire them:

• Reducing the availability and attractiveness of government work. The authorities should clearly signal that government employment will not increase in the future so that the wage at which workers are willing to accept a private sector job is lowered. Over time, thought will need to be given to how the attractiveness of working in the government sector can be reduced and incentives for working in the private sector increased.

• Strengthening education, training, and career development. Reforms are needed to improve educational outcomes and equip students with the skills in demand in the private sector. The revamping of current vocational training programs and the acceleration of educational reforms will help. Companies need to play their part by ensuring career development is a high priority in their human resource policies.

• Increasing the mobility of expatriate workers through reform of the visa system. Allowing expatriates to move freely between jobs would over time increase their wages, reducing wage differentials with nationals.

• Further increasing female participation and employment. Regulations should be reviewed to ensure there are no impediments to female employment. Creating programs for female entrepreneurs under SME initiatives and expanding as needed existing programs to defer transportation and childcare costs should be considered.

11. Industrial policies such as those in the National Industrial Development and Logistics Program can help overcome the reluctance of private companies to enter new or riskier sectors but need to be carefully implemented. Experiences with industrial policy have been mixed. They have played an important role in development in some countries but have led to large inefficiencies in others. Lessons from successful country experiences suggest these policies work best when government support is made available to priority sectors rather than specific companies, is time-bound, and has strict performance criteria attached. Human capital development is also essential for success.

12.   More broadly, government interventions in the economy need to be carefully handled. The economic footprint of the public sector is large—through higher government spending, the growing role of the Public Investment Fund, and numerous programs of subsidies in housing, mortgage loans, and SME development. Government interventions in the economy should focus on areas where they crowd-in private sector investment.

13.   It is important that the reforms are inclusive and the less well-off are protected from any negative effects. The introduction of the Citizens Account program in December 2017 has appropriately helped shield low and middle-income households from the higher costs associated with the VAT and energy price reforms. The government is also reviewing its social assistance programs to ensure they provide adequate financial support to those in need and are well-targeted. An effective social assistance program should be based on a commonly agreed poverty line and reliable information on the distribution of income.

Financial sector development and inclusion will support growth

14.   Banks are profitable, liquid, and well-capitalized. Mortgage lending is continuing to grow rapidly against the backdrop of the decline in real estate prices in recent years. While mortgages are still a relatively small share of total bank lending, and risks to banks are reduced by salary-assignment and government guarantees on a large share of new lending, SAMA should continue to keep a careful eye on the quality of real estate lending.

15.   Capital market reforms have advanced quickly and have culminated in Saudi Arabia’s inclusion in global equity and bond market indices. This will increase inflows into the equity market and further increase demand for debt. Significant reforms have taken place in the domestic debt market including the introduction of a primary dealer system and the extension of the government yield curve to long-dated maturities. Over time, this will help financial sector development and the deepening of the private debt market.

16. Improving financial access is a key goal of the Financial Sector Development Program. Financial access should be increased for SMEs, women, and youth, although specific sector lending targets should be avoided. The development of agency banking (where transactions take place via an agent such as the post office) and Fintech could help broaden the channels of access to financial services and increase market competition, particularly in areas outside the major cities. As reforms proceed, getting the right balance between innovation and stability will be a key challenge for the financial regulators.

17.   The exchange rate peg continues to serve Saudi Arabia well given the current economic structure. SAMA’s foreign exchange reserves remain at very comfortable levels.

Improved economic data will support policymaking

18.   The availability of economic data has improved considerably, but further efforts are needed. Saudi Arabia does not yet subscribe to the IMF’s Special Data Dissemination Standards (SDDS). The team welcomes the authorities’ commitment and efforts to subscribe as soon as possible. Beyond this, weaknesses in labor market, balance of payments, and national accounts statistics need to continue to be addressed by the authorities.

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“The mission team would like to thank the Saudi Arabian authorities and the people they met outside the government sector for their hospitality, cooperation, and open discussions.”

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[1] The projections assume that oil production will average 10.2 mb/d and oil prices $65.5 a barrel in 2019.