Saudi Arabia's Engine of Future Growth Is Running Out of Gas

  • Government has stepped up efforts to tackle oil price fallout
  • Some economists forecasting economic contraction this year

How Saudi Austerity Policy Impacts the Economy

The first year of Saudi Arabia’s drive to reduce its oil dependence may end with the opposite result.

QuickTake Saudi Arabia’s Strains

A flurry of cost-cutting measures will likely push the non-oil economy into recession, analysts say. That means that any overall growth in 2016 will be largely due to record crude output.

Efforts to manage the fallout from cheap oil gathered steam over the past two weeks. Policy makers have suspended bonuses and trimmed allowances for government employees. Ministers’ salaries were cut by 20 percent. The central bank also said it’s injecting about 20 billion riyals ($5.3 billion) into the banking system to ease a cash crunch.

Austerity will help Saudis reduce a budget deficit that reached 16 percent of gross domestic product last year. But it will also likely exacerbate the economic slowdown as consumption falls. A Bloomberg survey shows overall growth at 1.1 percent this year, with Capital Economics and BNP Paribas both predicting the first contraction since 2009.

“The hits to households are getting bigger and bigger,” said Jason Tuvey, Middle East economist at Capital Economics in London.

Pessimism

The growing pessimism about Saudi Arabia’s short-term outlook highlights the challenge facing Deputy Crown Prince Mohammed bin Salman, the architect of economic policy, as he seeks to prepare the kingdom for the post-oil era without provoking a backlash from a population accustomed to state largesse.

Even before announcing his so-called Vision 2030 in April, the government had raised the prices of fuel and utilities. It’s also weighing plans to cancel more than $20 billion of projects, people familiar with the matter have said. The International Monetary Fund expects the budget shortfall to drop below 10 percent of GDP in 2017.

National Commercial Bank, the kingdom’s biggest lender by assets, said in a report on Wednesday that third-quarter corporate earnings “are expected to be on the negative side.” “The weak outlook” has also deterred companies from going public.

Policy makers are trying to soften the blow of austerity. The central bank ordered lenders to restructure loans that Saudis can no longer afford. In an interview with Bloomberg News in April, Prince Mohammed said the government is developing a mechanism to provide cash to low- and middle-income Saudis who rely on subsidies.

Contraction

The likely contraction in the non-oil GDP this year breaks a long streak during which its share of the overall economy increased steadily to more than 55 percent in 2015, according to official data. Growth, however, was fueled by public spending that relied on revenue from hydrocarbon exports to invest in infrastructure projects and create government jobs for Saudi nationals.

That made the spending cuts all the more painful. While non-oil GDP grew 0.4 percent in the second quarter this year after contracting in the previous three months, private-sector activity was flat.

“With cuts to government spending and fiscal reforms, we don’t see growth coming from anywhere in the non-oil sector this year,” said Monica Malik, chief economist at Abu Dhabi Commercial Bank.

Prince Mohammed in April acknowledged the short-term challenges to growth. “We don’t expect it in the early years because they are years of reform, but after the years of reform we will expect very high growth,” he said.

His plan targets increasing the number of nationals seeking private-sector jobs to 50 percent by 2020, compared with a “regional benchmark” of 40 percent. The kingdom also aims to sell stakes in several state-run entities.

‘Tough’

While structural reforms will have long-term benefits, their impact in the near term will be “tough,” said Simon Williams, HSBC Holding Plc’s chief economist for central and eastern Europe, the Middle East and North Africa.

The benchmark Tadawul All Share Index is down 18.5 percent this year, the third-worst performer among more than 90 global indexes tracked by Bloomberg. The MSCI Emerging Markets Index has climbed 15.4 percent.

Mohamed Abu Basha, Cairo-based vice president of research at investment bank EFG Hermes, said he expects non-oil GDP to contract in the third quarter and “probably” in the last three months of the year. “The recent decision to freeze wage raise next year will obviously
impact more 2017 growth –- sentiment wasn’t already that great,” he said by e-mail.

Higher oil prices would help, but “$50 per barrel still isn’t enough,” said Williams of HSBC. “Earnings at that level don’t bring the economy back to life, they only slow the pace of deterioration."

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