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Country Report Saudi Arabia

Country Report


Flag Saudi Arabia

Weaker oil markets are hurting Saudi Arabia given the high reliance of the economy and government income on the hydrocarbon sector. Fortunately, strong financial buffers provide sufficient mitigation for now.

Strengths (+) and weaknesses (-)

(+) Strong external and fiscal position

Structural current account and budget surpluses, on the back of high oil revenues, have allowed Saudi Arabia to keep public and foreign debt low and build sufficient buffers to weather a period of low oil prices.

(+) “Central bank of oil”

Saudi Arabia’s large spare oil production capacity makes it the world’s only “swing producer” and allows it to influence oil prices. Consequently, Saudi Arabia enjoys significant international clout.

(-) Hierarchical feudal political system limits democratic progress

Progress on reforms towards more democracy promised in 2003, such as holding provincial elections, has been slow. So, real democratic space remains limited.

(-) Narrow economic base

The oil sector accounts for roughly 50% of GDP, 90% of government revenues and 85% of export income, making Saudi Arabia highly reliant on the hydrocarbon sector and, thus, highly susceptible to developments on global oil markets.

Key developments

1. Changing global energy landscape exposes susceptibility to oil prices

In 2013, weaker performance of the oil sector hurt Saudi Arabia’s public finances and this trend is expected to continue in 2014 and 2015. As economic growth is highly reliant on public spending and the performance of the oil sector, economic growth has moderated. Even though public spending increased less than in previous years, lower oil revenues caused a steep decline of the budget surplus in 2013; from 13.6% of GDP in 2012 to 6.4% of GDP. Besides, the oil price needed for the budget to break even increased from USD 78 USD/bbl in 2012 to 89 USD/bbl last year, according to the IMF. From that perspective, recent developments on global oil markets are a matter of concern. A glut of supply driven by the US shale oil revolution and weaker demand due to slower than expected global economic recovery pushed OPEC oil prices to 81 USD/bbl on 16 October, a four-year low and below Saudi Arabia’s government’s budget breakeven price. As a price setter, Saudi Arabia has also played a role in this decline. The Kingdom raised output and lowered its prices in what seems to be an attempt to defend its market share in Asia and to discourage investments in shale production, where the cost-recovery prices are estimated to be higher than in conventional production. Recent developments triggered the International Energy Agency to significantly revise oil supply upwards and oil demand downwards for 2014 and 2015. As a price setter, Saudi Arabia is set to suffer from these trends either through lower oil prices or lower oil output. Consequently, the budget surplus is estimated to fall sharply to 2.5% of GDP in 2014 and move into deficit, at 0.5% of GDP, in 2015. Reforms of the costly public wages and pensions could improve the fiscal position, but could also lead to backlash in the form of social unrest. Fortunately, the Kingdom’s high buffers – public net assets stood at 99% of GDP in 2013 – provide comfort.

Lower oil prices and output also led to a 1% contraction of the hydrocarbon sector, which constrained economic growth to 3.8% in 2013, down from 5.8% in 2012. A deceleration of government consumption growth also played a role. The non-oil private sector, meanwhile, maintained brisk growth. Looking forward, growth will remain modest at an estimated 4% in 2014 and 4.4% in 2015, supported by large public investments in mainly transportation infrastructure and housing programmes, and a continued strong momentum of the non-oil private sector. However, there are both downside and upside risks to this scenario. An exodus of expats caused by the government’s Saudiisation programme and increased fiscal prudence already hurt non-oil sector growth in 14H1, while recent oil market dynamics do not bode well for the oil sector. On the other hand, geopolitical oil supply shocks could boost growth beyond current estimates.

Figure 1: Oil prices fall to 4 year low
Figure 1: Oil prices fall to 4 year lowSource: Macrobond, Bloomberg
Figure 2: Budget surplus shrinks
Figure 2: Budget surplus shrinksSource: EIU

2. Political infighting set to increase, as the King consolidates the clout of his clan

The Saudi Arabian political system resembles feudal structures and political influence is divided amongst the various clans within the al-Saud royal family. The Saudiri faction has been historically the largest and most influential clan, and a rival of the Abdullah faction, to which the current king belongs. But King Abdallah’s astute moves in the past year have consolidated the clout of his clan and other smaller factions. This increases the chance that the moderate policies he supports, such as the adoption of female suffrage in July 2014, will be continued if he would pass away. He has also placed his sons in a better position to become King in the future, especially Miteab. The side-lining of the Saudiri’s might increase tensions within the royal family and, given the close links between business and the extensive royal family, could have negative consequences for the business environment.

3. Foreign relations realigned and ISIS increases security threats

Saudi Arabia’s regional foreign relations changed in the past year, and the expansion of ISIS in Iraq increased security threats. Qatar and Iran are two countries that have been challenging Saudi Arabia’s regional influence in the past decade. Tensions with Qatar escalated in March 2014, when Saudi Arabia, UAE and Bahrain recalled their ambassadors in Doha, because of Qatar’s continuous support of Muslim Brotherhood affiliates in various Arab Spring countries, an Islamist political group the Saudi’s see as a threat to internal security. In the case of Iran, tensions had picked up in recent years as both countries stepped up their regional meddling in order to fill in the vacuum left by a less assertive US in the Middle East. But, in March 2014, Saudi Arabia opened up for talks to Iran for the first time in two years. The tensions with both countries took a back seat since the Islamist group ISIS captured swaths of land in Iraq. The threat of an expanding ISIS pushed Saudi Arabia and Qatar in a joint coalition with the US to counter the advances of ISIS, and led to a first meeting between Saudi and Iranian top diplomats at the UN General Assembly in September 2014. But, while foreign relations have treaded calmer waters for now, ISIS poses a direct threat to Saudi internal security. Indeed, their ideology and approach could appease to the more conservative Saudi Sunni population and increase terrorism back home. The Kingdom’s well developed security intelligence and military provides some comfort in this regard.

Factsheet Saudi Arabia
Factsheet Saudi ArabiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Saudi Arabia has an oil-based economy under strict government control. The country holds a leading role in the OPEC, as it possesses 16% of the world's total proven oil reserves and is the largest oil exporter worldwide. Huge financial buffers built from oil revenues have turned the country into a strong net external creditor. This is reflected in a strong net external asset position, 130% of GDP in 2013, and large net portfolio and other capital outflows on the balance of payments. Saudi Arabia is slowly developing the non-oil private sector in order to diversify its economy and reduce dependence on foreign labour. Expats accounted for almost 30% of the population and 85% of the private sector workforce in 2013, though drastic measures under the Saudiisation programme has reduced their number by 1.4m. As a main source of remittances and financial assistance to other countries, Saudi Arabia is a regional power. This translates into a structurally negative current transfers balance on the current account. Saudi Arabia has no political parties, its monarchy is hereditary and the political decision-making in the country is dominated by the al-Saud royal family. Royal decrees of 2003 and 2006 promised democratic reforms, but progress has been slow. Councillors are appointed by the monarch in what is basically a hierarchical feudal political system. Similarly, the legal system is far from modern and is largely based on Islamist sharia law. In line with the belief in Islamic religious supremacy, the country has not committed itself to accept any jurisdiction of the International Court of Justice. There is some sectarian violence in the oil-rich Eastern Province, where most of the minority Shia Muslims live. Relations with Iran have been tense for decades, due to sectarian differences, as well as fighting for regional hegemony.

Economic indicators of Saudi Arabia
Economic indicators of Saudi ArabiaSource: EIU
Alexandra Dumitru
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 60441

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