Saudi Arabia’s Economic Diversification: Challenges Ahead

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Saudi Arabia has been one of the best-performing G20 economies; however, the key to long-term sustainable economic growth lies in its economic diversification.

Oil Refinery
Saudi Arabia has been one of the best-performing G20 economies; however, the key to long-term sustainable economic growth lies in its economic diversification.

Saudi Arabia’s reliance on oil for wealth needs no introduction. It accounts for nearly 80% of budget revenues and 90% of export earnings.

Overexposure and reliance on a particular commodity sector makes a national economy highly vulnerable on the pricing and supply-demand equation of the commodity–this observation cannot be emphasized enough. Diversified economies perform better than mono-sector economies—a paradigm proved by many economists. And a long-term sustainable economic development is possible only when a reasonable degree of diversification exists.

The Middle East countries, with an oil-reliant economy, may account for some of the wealthiest nations of the world. But they are acutely aware that petrodollars cannot pull their economy in the long run. To overcome the oil-driven economies, almost all of them are actively working towards economic diversification.

SEE ALSO:  Six Reasons why Saudi’s Oil Dominance is in Decline
SEE ALSO: UAE government focus on economic diversification by promoting manufacturing sector

Saudi Arabian Economy—a Perspective

Saudi Arabia is an oil-based economy, controlling about 17% of the world’s proven petroleum reserves.  Since 1970s, the government sponsored five-year development plans control the economic policy framework of the country, with fiscal policy taking a central role, and thereby creating a strong link between fiscal spending and economic activity.

The government’s fiscal policy is geared towards development objectives: investment in social and economic infrastructure, economic diversification, and achieving macroeconomic stability.

It follows a countercyclical fiscal policy with regards to the oil-price cycle, which means drawing on international reserves and issuing debts when oil prices are low and utilizing part of the surplus to ease the existing debt or fund the reserves when the oil prices are high.

“We have for many years used a counter-cyclical approach, i.e. paying down our government debt during the upswing of the cycle, and in our case the upswing cycle is higher oil revenues be it through prices or quantities, or both, and running budget deficits during the downswings in order to cushion the economy so it does not go into a tailspin as when oil prices sometimes do…The result was that we were able to shirk the global recession of 2008-2009, and briefly run a budget deficit in 2009.” Said H.E. Dr. Muhammad Al-Jasser, Governor, Saudi Arabian Monetary Agency Maintaining a Stable Global Financial System: Shared Responsibility during a U.S.-Saudi Business Opportunities Forum held at Atlanta, Georgia, on December 6, 2011.

The country’s monetary policy closely follows the US monetary policy through the fixed exchange rate. Budget revenues, thus, are determined by the oil-export proceeds and the US dollar driven exchange rates.

SEE ALSO:  The Hidden Threat in Saudi Economy

Economic Growth in 2013

Between 2010 and 2013, the country’s economic growth rate was more than 6%, which was not attributable to the oil sector alone. The growth of non-oil sector during the same period reached almost 7% — a remarkable feat.

The country witnessed, according to the Central Department of Statistics and Information, a slower economic growth in 2013 compared to 2012. It recorded the economic growth at 3.8% in 2013 against 5.8% in 2012 and the slowdown was mainly due to fall in oil output.

The crude oil production dipped by 2.5% in 2013 and overall hydrocarbons GDP declined by 0.6%. Though it is a very slight decrease, its bearing on the overall GDP is modest because the oil sector contributes to over 20% of the real GDP.

On the non-oil front, as reported by SAMBA’s 2014 forecast, the economy was definitely subdued compared to 2012. The reasons were more than one: difficult external environment, weaker domestic scene, slowdown in government spending on construction projects, crackdown on illegal workers. The average purchasing managers’ index (PMI) was nearly 2.5% below the 2012 PMI.

The actual budget spending rose by a modest 6% in 2013, which was the same as in 2012.

“Saudi Arabia has been one of the best-performing G20 economies. In recent years, the government has smoothed oil price volatility and built significant [fiscal] buffers,” the IMF concluded at the end of its annual Article IV consultations with Saudi authorities in May and June.

Forecast for 2014

Saudi Arabia’s economy is forecast to achieve an economic growth of 4.4% in 2014, which is in line with the IMF forecast, said Fahad al-Mubarak, the central bank governor recently.

The oil prices are predicted to be USD 102 per barrel, which is down from USD 107 per barrel in 2013.

The government’s budget for expenditure in 2014 was set at USD 228 billion (SAR 855 billion), which is equal to the country’s estimated revenues for the year, reports Al Arabiya.

The government plans to focus on three key areas in 2014 budget spending: education USD 56 billion (SAR 210 billion), healthcare USD 29 billion (SAR 108 billion) and infrastructure USD 18 billion (SAR 66.6 billion).

Inflation is forecast at 3% whereas the inflation-adjusted GDP is projected to expand 4.2% in 2014.

Saudi Arabia Economic Forecasts 2013—2015 outlook 

saudi arabia economic outlook forecasts 2013 2015
Saudi Arabia economic outlook forecasts 2013 2015. Image credit- Trading Economics

 Economic Diversification in Saudi Arabia

The government has attempted diversification through power generation, telecommunications, natural gas exploration and petrochemical sectors.

To attract foreign direct investment, the country acceded to WTO in 2005.

Furthermore, the government is undertaking a multi-billion dollar development strategy to build six Greenfield economic cities and industrial zones in the country, a significant step towards its diversification agenda. By 2020, the industrial cities will generate USD 150 billion in GDP and create 1.3 million jobs.

The country’s sincere efforts to shift from an oil-based economy to a knowledge-based economy is substantiated by the record non-oil exports in 2013.

“The Kingdom is driving economic diversification to shift away from a volatile oil-centric economy. This policy has the potential to reduce the impact of any future international financial crises, and is also creating significant investment and financing opportunities,” said Richard Banks, Regional Director at Euromoney Conferences.

According to the Economic and Political Intelligence Centre report published in March 2014, the country’s economic growth appears promising in the coming years.

However, its major concern is over-dependency upon the expatriate workforce for most of its jobs. The government is trying to recruit its citizens through drive called, ‘Saudization,’ besides spending on job training and education, but desirable results seem a distant goal.

Challenges Ahead

The IMF report (annual Article IV consultations with Saudi authorities in May and June, 2013) noted that Saudi policy makers have done a wonderful job in reducing the short-term volatility in expenditure through prudent budgeting. But it still needs higher oil prices to balance its budget.

Shift in oil demand from the West (Europe and America) to the East (Asia) is impacting the kingdom’s economy. The country’s dominant positioning in the world oil supply faces challenges from unconventional oil reserves in North America, domestic fuel consumption and increased oil production by Iraq.

The country needs serious policy deliberation on its domestic energy consumption, which may increase by 250% in 2028. The IEA recorded the energy subsidies in 2011 to be between 40 and 45 billion dollars.

It needs to work out more in diversifying its energy mix. Recent announcements such as increase in the use of unconventional gas supplies, solar energy adoption, introduction of nuclear and renewable energy are welcome, but much depend upon their successful execution

IMF noted that the country will have to balance economic diversification with minimizing the impact of higher energy prices on poorer members of the community.

The government will also have to put strategies in place to distribute the workforce equally between the public and private sectors. The inequality was noted by the IMF as well.

“Within the labour market, Saudis are primarily employed in the public sector, (while) non-Saudis dominate the private sector.”

IMF also concludes that the Saudi government is well placed to continue to build on these advances and achieve success through further reforms in the economy.

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