SAUDI ARABIA

Saudi Arabia’s economic structure is unbalanced. The country possesses the world’s second-largest proven oil reserves (>15% of global resources) and, at current rates of extraction, its oil will last for over 60 years. In addition, gas reserves will last for a further 70 years or so. Hydrocarbons account for around 33% of GDP and 70% of export earnings (2019). Such a relatively narrow output base, with very slow progress in diversification into other industries and services (other than downstream activities), leaves the economy vulnerable to world oil price cycles. However, in times of high oil prices, large surpluses in the fiscal and current accounts have been accompanied by a build-up in foreign assets and in special sovereign wealth funds (SWF) established to serve future generations. The total reserve assets managed by SAMA (Saudi Arabian Monetary Authority) are officially recorded at around USD450bn (as of end-2020). Another SWF, the Public Investment Fund, currently holds around USD400bn.

The structural business environment in Saudi Arabia is generally adequate, ranking slightly above average in our assessment of 191 economies. The World Bank’s Doing Business 2020 survey ranks Saudi Arabia 63rd out of 190 economies in terms of the overall ease of conducting commercial operations, a considerable improvement from rank 92 a year earlier. Marked advancements in the following sub-components have contributed to the overall improvement: ‘getting credit’, ‘protecting minority investors’, ‘paying taxes’ and ‘trading across borders’. However, ‘resolving insolvency’ remains a weakness in Saudi Arabia despite the introduction of the country’s first Bankruptcy Law in 2018. ‘Enforcement of contracts’ involves less time and procedures than the regional average but the cost is higher. According to the World Bank Institute’s Worldwide Governance Indicators 2020 survey, the legal framework and control of corruption are slightly above the global average while the regulatory framework is below. With regard to our proprietary Environmental Sustainability index, Saudi Arabia ranks only 166th out of 210 economies, reflecting particular weaknesses in renewable electricity output, water stress and the recycling rate.

Exchange rate and price stability

Saudi Arabia has a fixed exchange rate system, with the Saudi riyal (SAR) pegged to the US dollar at SAR3.75:USD1. Despite pressures on the currency during the low oil price period in 2015-2017, the peg held – thanks to the huge foreign exchange reserves held at the SAMA – and we expect this to continue over the next few years. Progress towards a full Gulf monetary union has been limited and we do not envisage the introduction of an effective GCC single currency in the next five years or so.

The peg has ensured relative price stability in the past. Since 2017, Saudi Arabia would have been in principle mired in a deflationary environment amid recession periods, weak domestic demand and falling housing prices, had there not been the introduction of a 5% VAT in 2018, which lifted inflation to an average +2.5% in that year, and the increase of the VAT rate to 15% in mid-2020, which has raised inflation to an average +6% since then. We expect a return to very low inflation or deflation in H2 2021 when the effects from the VAT increase wane.

SWFs provide buffers for fiscal and current accounts

Since mid-2014, sharply lower oil prices led to a substantial drop in fiscal revenues. The fiscal balance swung into a deficit in 2014 and the average annual shortfall accounted for around -10% of GDP in 2014-2020. Initially the fiscal deficits were financed almost entirely by a drawdown of foreign exchange (FX) reserves held at SAMA, which fell from a peak of USD745bn in August 2014 to a temporary low of USD485bn in September 2017 (these reserves include financial assets held by the SAMA Foreign Holdings sovereign wealth fund). Thereafter reserves stabilized and hovered around USD500bn until end-2019 but fell again to USD450bn at end-2020 as the severe crisis required a further drawdown. Current reserves are still sufficient to cover around 30 months of imports, a very comfortable ratio. Since 2016, Saudi Arabia has also successfully turned to the international bond market in order to cover its external financing requirements. As a consequence, public debt has risen from just 2% of GDP in 2014 to about 30% currently. While at this level it is still relatively low compared to peers, the trajectory is somewhat worrisome – we forecast the ratio to increase further in the next few years – and needs to be monitored closely.

However, another SWF, the Public Investment Fund (PIF), currently holds around USD400bn. Assets held in the PIF are meant to support the the economic transformation of Saudi Arabia in the context of the Vision 2030 program; however, they could provide a further cushion if needed. Overall, Saudi Arabia remains a net creditor.

The country’s annual current account balance also shifted to substantial deficits in 2015-2016 in the wake of the oil price slump at the time, after 15 years of very high surpluses. The partial oil price recovery in 2016-2019 and the reduced Saudi import demand against the background of a lower economic growth regime shifted the current account back into surplus, before the double whammy of the global Covid-19 crisis and the renewed oil price slump in 2020 moved the external account back into a moderate deficit of around -3% of GDP. Based on our current oil price forecasts (around 60 USD/bbl on average in 2021-2022), we expect Saudi Arabia’s current account to be close to a balance in the next two years.

Gross external debt in Saudi Arabia has increased from 12% of GDP in 2014 to almost 30% currently but this is still a relatively low level in comparison to peers.