Saudi Arabia: Concluding Statement of the 2024 Article IV Mission

IMF News, June 14, 2024

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Saudi Arabia: Concluding Statement of the 2024 Article IV Mission

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• Published: June 14, 2024

Overview

• Saudi Arabia’s unprecedented economic transformation is progressing well.
• Drivers: prudent macroeconomic policies; transformative changes—including fiscal reforms and regulatory improvements to the business environment; and strong domestic demand.
• Non-oil growth has been propped up by these measures; inflation remains contained.
• Ongoing priorities: sustain non-oil growth momentum, maintain financial sector stability, mitigate overheating risks, reverse declining total factor productivity, and ensure inter-generational equity.

Recent Economic Developments

• Real non-oil growth:
  • Decelerated from 5.3 percent in 2022 to 3.8 percent in 2023.
  • Driven mostly by private consumption and non-oil investment; non-oil investment growth tapered to 11.5 percent in 2023 (down from 32 percent in 2022).
• Oil GDP and overall GDP:
  • Oil GDP contracted by 9 percent in 2023 due primarily to OPEC+ and voluntary oil production cuts.
  • Overall GDP contracted by 0.8 percent in 2023.
• Output gap:
  • Staff estimates that the output gap remains in positive territory, close to 2 percent of the non-oil potential GDP.
• Labor market:
  • Over one million jobs added in 2023, primarily in the private sector.
  • Overall unemployment rate for Saudis dropped to 7.7 percent in the last quarter of 2023 (Vision 2030 objective: 7 percent).
  • Women’s labor force participation rate remains comfortably above the Vision 2030 goal of 30 percent.
• Inflation:
  • Peaked at 3.4 percent in January 2023; receded to 1.6 percent in April 2024.
  • Rents growing at about 10 percent; wholesale prices and wages of high-skilled workers have edged up.
• External sector and reserves:
  • Current account surplus fell from 13.7 percent of GDP in 2022 to 3.2 percent of GDP in 2023, reflecting lower oil exports and strong growth in investment-related imports.
  • Services balance record surplus, including a 38 percent surge in net tourism income.
  • SAMA net foreign assets: $423.7 billion in April 2024 (slightly above end-2023 level).
  • Reserves represent 15.6 months of imports and 208 percent of the IMF’s reserve adequacy metric by end-2023.

Economic Outlook and Risks

• Fiscal reprioritization:
  • Recent recalibration of funding requirements for Vision 2030 Objectives led to spending reprioritization: acceleration of some projects, extension of timelines for others.
  • Recommendation: publish main implications (spending and sectoral priorities up to 2030) to provide clarity to investors and the public.
• Growth projections:
  • Non-oil growth projected at about 3.5 percent in 2024.
  • Oil output projected to contract by 4.6 percent in 2024 and increase by 5.1 percent in 2025, reflecting an extension of oil production cuts in 2024 and a gradual recovery to 10 mbpd in 2025.
  • Overall GDP growth projected to accelerate to around 4.5 percent in 2025 and stabilize at 3.5 percent per year over the medium term.
• Inflation projection:
  • Inflation expected to remain stable at 1.9 percent in 2024.
• External balances and buffers:
  • Current account expected to shift to a deficit in 2024; averaging about 2.3 percent of GDP between 2026 and 2029.
  • International reserves expected to average 13 months import cover over the medium term.
  • Foreign assets held by the PIF and other government-related entities provide additional buffers.
• Risks (broadly balanced):
  • Upside: accelerated implementation of reforms and investments.
  • Downside: pressures to accelerate investment increasing overheating risks; slippages in reform agenda; subdued global activity; financial market volatility; geopolitical events; non-OPEC+ supply growth; faster shift in demand away from fossil fuels over medium to long term.

Policies

Fiscal Policy

• Fiscal outcomes:
  • First surplus in nine years in 2022; fiscal balance swung back into deficit in 2023.
  • Non-oil primary deficit: 33 percent of non-oil GDP in 2023 (from 32.2 percent in 2022).
  • Overall balance turned to deficit, driven by a 12 percent decline in oil revenues and an Aramco performance-linked dividend of close to 2 percent of GDP.
  • Public debt: 26.2 percent of GDP (as of end-2023).
• 2024 fiscal outlook:
  • 2024 budget projects overall deficit slightly below 2 percent of GDP; staff estimates overall deficit about 3 percent of GDP in 2024 due to lower revenues from extended oil production cuts and spending overruns in Q1.
  • Revenue projections include continued support from Aramco, including performance-linked dividends.
• Medium-term fiscal stance:
  • Overall fiscal deficit would average 2.5-3 percent of GDP (assumes no new revenue measures).
  • Assumes sustained investment that is on average 23.7 percent higher than spending path in the previous Article IV.
  • Under current policies, the non-oil primary deficit would narrow by 8.4 percent of non-oil GDP by 2029, mainly via reduction in current spending (wages and use of goods and services).
  • Central government deposits at SAMA projected to remain above 10 percent of GDP throughout the forecast horizon.
  • Foreign borrowing continues to finance the deficit, resulting in public debt-to-GDP ratio of around 35 percent by 2029.
• Recommendations to achieve intergenerational equity and buffers:
  • Non-oil revenue mobilization:
  • Develop a comprehensive medium-term revenue strategy; identify tax policy measures to close the 9 percent tax gap with the G20 average.
  • Review incentive schemes to avoid tax leakages from Global Minimum Tax Pillar II.
  • Avoid tax amnesties; reconsider extension of the tax penalty waiver.
  • Complement tax policy reforms with tax administration improvements (e.g., e-invoicing).
  • Rationalizing subsidies:
  • Fuel subsidies more than 5 percent of GDP in 2023 (measured as compensatory payments to Aramco).
  • Recent diesel price increase of 53 percent in January 2024; impacts alleviated by social safety nets (e.g., Citizen’s Account).
  • Recommend removing energy subsidies, including lifting cap on gasoline prices; protect vulnerable via targeted programs such as the Damaan program.
  • Rationalizing other spending:
  • Wage bill containment is main driver of spending restraint over the medium term.
  • Ongoing spending reviews to identify savings and efficiency gains.
  • Ensure greater efficiency in public investment amid ramp-up in large-scale projects.
  • Strengthen fiscal institutions:
  • Operationalize a fiscal rule integrating a ceiling on expenditure growth and a target for the Central Government Net Financial Asset (CGNFA).
  • Strengthen the Medium-Term Fiscal Framework with more realistic revenue forecasts and consistent costing processes.
  • Sovereign asset-liability management (SALM):
  • Recent progress: Oversight Committee chaired by the Minister of Finance; public sector balance sheet for financial assets and liabilities created as of end-2023.
  • Next phase to include non-financial assets and off-balance sheet items by end-2024.
  • Operationalizing SALM is important as government-related entities access capital markets and increase leverage.

Monetary and Exchange Rate Policy

• Monetary conditions:
  • Monetary expansion moderated reflecting tighter policy stance.
  • Liquidity conditions stabilized; higher interest rates shifted money composition toward time and savings deposits.
  • Public deposit management improved in 2023 via auction-based placement mechanism; central bank acts as fiscal agent.
• Exchange rate regime:
  • Currency peg to the U.S. dollar remains appropriate and provides a credible anchor.
  • With an open capital account, SAMA’s policy rates should continue to move in line with the Fed’s policy rate, with the risk premium ensuring an interest rate differential consistent with the peg.
• Recommendations:
  • Continue use of market-based monetary policy instruments.
  • Improve liquidity forecasting and management by strengthening SAMA’s data collection from government entities and enhancing the reserve requirement framework.
  • Enhance effective functioning of the interbank money market.

Financial Sector Policies

• Systemic strength:
  • Banks’ performance indicators: capital adequacy ratio above 20 percent, high profitability and liquidity, low nonperforming loans.
  • Bank credit growth continued to surpass deposit growth; expected to remain around 10 percent in 2024.
  • Increased balance sheet interlinkages between financial institutions and the sovereign could amplify systemic shocks.
  • FSAP stress tests show banks and non-financial corporates are resilient to shocks even under severe adverse scenarios.
• Regulatory and supervisory reform:
  • Continue modernization of regulatory and supervisory frameworks.
  • Submission of the new Banking Law to the legislative authority remains a priority.
  • Revise supervisory manuals and procedures in line with international best practice.
  • Complete development of the financial safety net framework (bank resolution, emergency liquidity assistance arrangements, deposit protection fund).
• Macroprudential policy recommendations:
  • Continue using macroprudential tools to address risks from lending boom.
  • Existing mitigants: well-capitalized banks, government subsidies, full recourse mortgages, and existing LTV and debt burden ratio limits.
  • Consider introducing a positive neutral countercyclical capital buffer.
  • If elevated credit growth persists or rises with Vision 2030 implementation, consider reassessing LTV and debt burden limits, tightening the loan-to-deposit ratio guideline and/or reducing incentives for reliance on non-deposit funding.
  • Improve risk monitoring by addressing data gaps: develop a reliable house price index and monitor banks’ exposures to large projects.

Structural Policies

• Business environment and FDI:
  • Saudi Arabia improved in competitiveness: climbed 15 notches in IMD’s World Competitiveness ranking over two years to 17th position in 2023.
  • Foreign investment licenses nearly doubled from 2022 level.
  • New law on civil transactions enacted; forthcoming commercial transactions law and investment code expected to improve regulatory stability and market functioning.
  • Ongoing human capital development, increases in female labor force participation, digital transformation and AI preparedness, streamlining of fees and levies, improved access to land and finance, and stronger governance will enhance private sector growth, attract FDI, and contribute to total factor productivity growth.
• Industrial policy and SEZs:
  • National Industrial Strategy aims to reduce reliance on hydrocarbons through targeted interventions, incentives, and Special Economic Zones (SEZ).
  • Minimize risks by addressing market failures, emphasizing export orientation, avoiding discriminatory practices.
  • Regular assessment of SEZ operations to ensure linkages with broader economy through technology upgrading and skills training.
  • Monitor tax incentives; include strict exit criteria, claw-back mechanisms, sunset clauses, and time-bound incentives.
• Climate-related policy and green finance:
  • Saudi Arabia committed to net zero emissions by 2060; investing in renewable energy, energy efficiency, clean hydrogen, and carbon capture.
  • Recommendation: provide clear costing and detailing of initiatives linked to each target to assess progress and needed adjustments relative to Nationally Determined Contributions.
  • Eliminating energy subsidies would incentivize energy conservation and improve returns on renewable investments.
  • Augment active green finance portfolio, including implementation of Green Finance framework announced in March 2024 and an inaugural sovereign green bond issuance planned for this year, to mobilize private capital.

Source: Saudi Arabia: Concluding Statement of the 2024 Article IV Mission (June 14, 2024).

References

• Saudi Arabia and the IMF
• IMF Policy Advice -- A Factsheet
• Mission Concluding Statements
• PRESS CENTER
• https://www.imf.org/en/home