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Saudi Arabia Economic Outlook

Saudi Arabia’s economy, where oil income contributes up to 70% of public spending, has recently suffered three economic shocks: a drop in global oil prices, a decline in economic activity due to the coronavirus pandemic, and an increase in “unplanned” government spending, such as health services. This has led to a decline in tax revenue, forcing the Saudi Arabian government to decide to cut crude oil production, has been also forced to seek financial resources by selling serious quantities of gold and foreign currency reserves and in addition also announced unprecedented economic austerity measures.

On 11 May, Saudi Finance Minister Mohammed Al-Jadaan announced an austerity plan to increase taxes and reduce public spending.

From the first of July, value-added tax (VAT) will be tripled from 5 to 15% and the payment of subsidies to public employees will also be suspended.

In Saudi Arabia, the compensation of 1000 rial per month (about $266) for public employees was introduced in 2018 to compensate VAT and gasoline price increases.

Today that same measure is no longer considered sustainable: in just one year, oil rents have contracted by a quarter, reducing overall revenues by 22%. According to many analysts, even with oil prices at 25 dollars, the Kingdom is able to hold out for a decade.

But for a country that has built its fortune on oil revenues, low taxes and cheap foreign labour, the challenge is now to remain competitive on a par with its neighbours.

These countries have much lower VAT and rates and some, like the United Arab Emirates and Qatar, also have better infrastructure and allow expatriate workers more social freedom.

These are certainly unprecedented economic measures, but they are necessary in order to avoid even more drastic measures such as a pay cut in the public sector because at the moment oil does not seem to be showing significant signs of recovery.

In a certain sense, it can be said that the barrel of crude oil is becoming cheaper than water in the “kingdom of the desert”.

Saudi Arabia is the world’s largest exporter of crude oil and has suffered a dramatic impact from the sharp drop in global oil demand, with prices falling by two-thirds since the beginning of the year.

The country’s budget deficit reached $9 billion in the first quarter of 2020, with revenues from oil activities plummeting 24%, according to a report by the Ministry of Finance at the end of April.

According to this report, the Kingdom is preparing to borrow $60 billion in 2020 to meet its budgetary commitments in a health crisis that it calls “unprecedented”.

On the same May 11, the Saudi government announced a further reduction of one million barrels per day in oil production, which will start in June. This is an extra cut compared to the one already decided in April under the agreement with the Opec+ countries.

This decision brings the overall reduction in the Kingdom’s production to around 4.8 million barrels per day.

The lowest level in 20 years.

A painful choice, to which seems to have contributed a threat from the US allies to withdraw their soldiers from the country, if the Saudis had not decided to cut crude oil production.

The “price war” between Saudi Arabia and Russia risked the collapse of the American shale oil industry, which cannot afford to sell crude oil extracted using unconventional techniques at excessively low cost.

Saudi Arabia is by far the country most affected by COVID-19 in the peninsula and has so far recorded 52,000 cases and 302 deaths.

What worries Crown Prince Mohammad bin Salman Al Sa’ud are not health issues, but the project to which the heir to the throne has linked his name: Vision 2030.

Vision 2030 is a pharaonic project that has the ultimate goal of changing the face of the Saudi economy.

The objective is, therefore, to reduce Saudi Arabia’s dependence on oil, diversify its economy and develop public service sectors such as health, education, infrastructure, recreation, tourism but also the private sector.

At the moment, however, the Government has cancelled and suspended some operational expenses and capital investments for some government agencies. In addition, it has cut $26.6 billion of resources that it hoped to invest during the fiscal year 2020 in a series of initiatives and mega-projects (Phase 1) implemented as part of the Vision 2030 program.

Projects like Neom, the futuristic ‘smart city’ on the Red Sea, 33 times larger than New York, costing at least 500 billion dollars, which aims to transform the entire north-western tip of the nation (that completely desert territory between the Red Sea and the Gulf of Aqaba), into a fully wired and technological 4.0 city to boost tourism and business beyond oil, will surely have to be postponed.

In fact, the moment of crisis related to the dynamics of the oil market and the impact of the coronavirus pandemic are undeniably creating difficulties in achieving the “Vision 2030” reform agenda.

We will, therefore, have to wait for a slowdown, especially on the projects considered to be less priority, but I think it is too early to talk about a definitive stop. In fact, with regard to the realization of “Vision 2030” Mohammad bin Salman Al Sa’ud has invested all his political capital, so failure is not allowed.

The Saudi government has a complex choice to make: further increase in public spending, after the first quarter of the year with a budget deficit of $9 billion, or cut welfare?

In one of the last absolute monarchies, where political legitimacy is largely based on the redistribution of oil revenues, drastic economic measures and tax increases can fuel discontent, but could they go so far as to undermine its stability?

We will, of course, have to expect spending cuts, for example, in the search for a way out of the Yemeni conflict.

At the same time, however, there must also be a push for measures, such as those in the field of entertainment, that can increase the reigning prince’s popularity and consolidate his consent at a time when he must demand sacrifices from the population.

What is certain is that the increase in the cost of living could break the social pact with the population and curb all the reforms launched by Mohammad bin Salman Al Sa’ud.

The ultimate goal will be to safeguard the new social pact as it is being reconfigured in this phase of transition towards independence from oil and the income derived from it.

By Michele Brunori

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