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Saudi government spending to stimulate non-oil growth

In the early hours of Wednesday (June 21), Saudi Arabia’s King Salman installed his 31-year-old son Mohammed bin Salman as the kingdom’s new crown prince, ousting his 57-year-old nephew, Mohammed bin Nayef.

Responding to the oil price downturn, the Saudi government has embarked on a radical and ambitious plan to transform the kingdom’s entire economy, restructure its finances and ultimately wean it off its oil dependency. The Saudi Vision 2030 and its associated tactical programs, now provide the basis upon which economic growth and development will be benchmarked. Public expenditures and investment will be redirected towards localising industries, training Saudis and raising economic competitiveness.

Fiscal reform is taking place through expenditure rationalisation, non-oil revenue enhancements and privatisation of state entities, so that by 2020 the kingdom would achieve a balanced budget. Fuel and utility prices have been hiked, taxes are about to be introduced, including a VAT in 2018, while the authorities unveil a private sector stimulus package. That package is to include a housing and household allowance program to mitigate the burden on low income families.

The risks and challenges are immense; the most pressing is the need to stabilize the oil price at a level high enough to kick-start growth in the non-oil economy directly, through government spending and investment in SR 1.4 trillion ($373 billion) worth of outstanding capital projects, and indirectly, through enhanced banking sector liquidity and lending. Consumer activity and confidence should rebound.

Real GDP growth to slow in 2017

Saudi economic growth is projected to slow further from last year’s 1.4 per cent to 0.5 per cent y/y in 2017. Behind the outlook is a contraction in oil sector activity, by -0.3 per cent y/y, in line with Saudi Arabia’s commitment to OPEC’s cuts, and continued weakness in the non-oil private sector. Private sector growth fell to a 26-year low of 0.1 per cent last year, following two years of relative fiscal austerity and low business confidence triggered by the oil price downturn.

This year, however, non-oil activity is expected to rise by 1.1 per cent y/y, thanks to moderately expansive government fiscal policy, including the launch of specific housing and private sector stimulus packages, and a rebound in consumer, manufacturing and construction activity. The consumer sector should get a welcome boost from the recent reinstatement of public sector bonuses and allowances.

The private sector stimulus package, which is worth SR200bn ($53.3bn), aims to boost private sector GDP by 2020 through efficiency enhancements to high energy and labor-intensive industries. The government is also committed to improving the localization of industries such as oil/gas and defence.

Moreover, the non-oil manufacturing sector is expected to benefit from the full operation of major petrochemical projects such as the $20bn Sadara petrochemical complex and the $500m Rabigh expansion project. The direct effects of these and ancillary projects should lead to the creation of thousands of jobs, providing a welcome boost to Saudi employment levels.

Nevertheless, the retail and consumer sector remains a weak spot. The latest metrics, such as point of sale (POS) and ATM transactions, private sector credit growth and the Purchasing Managers’ Index (PMI) show improving but subdued activity.

The roll out of the second round of the government’s subsidy cuts this year, along with the implementation of excise taxes on tobacco and sugary products, and the VAT in 2018, will undoubtedly squeeze consumer finances, although the government has moved to mitigate the adverse effects on lower income families via the introduction of the Household Allowance Program.

Energy price hikes and VAT will push prices up

Inflation has been in negative territory since the start of the year, falling to -0.6 per cent y/y in April. The downward trend is due to a combination of weak consumer demand, still soft international food prices and lingering base effects relating to last year’s subsidy cuts. As a further reflection of anemic demand, real estate prices have also been trending downwards, falling by around ten per cent y/y.

Going forward, however, it is more likely that inflation will pick up once the government’s second round of energy subsidy cuts are instituted and after the authorities roll out their planned excise taxes on tobacco and sugary products by the middle of the year.

The introduction of the VAT in 2018, at a rate of five per cent, will also impact consumer prices, and propel the headline inflation rate towards 2.1 per cent in 2018 from a projected 1.4 per cent in 2017.

Revisions to Saudi economic prospects weigh on market sentiment

Halfway into the year and the main Saudi stock index, the Tadawul All-Share Index (TASI), remains down by more than five per cent year-to-date at around 6,822. The bourse continues to suffer from weak sentiment despite better-than-expected corporate and bank profits in Q1 2017 and despite the king’s reinstatement of state allowances in late April. The retreat in oil prices, the IMF’s downward revision to Saudi growth and Fitch’s debt rating downgrade all appear to have cast a long shadow over the index.

Then there are the preparations for arguably the showpiece event in the realization of the Saudi Vision 2030: the part-privatization of Saudi Aramco. Up to five per cent of the energy giant is expected to be publicly listed either next year or in 2019, generating at least $45bn in proceeds (based on an Aramco valuation of $900bn) for the kingdom’s newly designated SWF, the Public Investment Fund (PIF).

According to Prince Mohammed Bin Salman, 50-70 per cent of the proceeds of the Aramco sale will be invested in local industries such as mining, entertainment and defense; a total of SR500bn ($133bn) will be invested within three years of the Aramco IPO.