Latest push for diversification

This article is part of a three-piece analysis of the political economy of Saudi Arabia that will be delivered through three separate articles. The following blog post will detail the latest drive led by the Saudi government to diversify its economy through a project named Vision 2030. As a result, the article will look at how the Saudi government aims to tackle taxation, deficit cutting and raising debt. The article will also touch upon areas of reform such as military, taxation, energy subsidies, housing sector and the initial public offering of Aramco. In addition the article will look at why Saudi Arabia wishes to reform its economy at the moment. By detailing its aims to reform, the article will attempt to state what the government will need to do to win over its population in regards to accepting the reforms. Overall, the article will argue that the privatisation of Aramco assets will bring in most of the money that Vision 2030 aims to gain. The second analysis will look at the history of the Saudi private sector and its relationship with the state. A strong independent private sector will help an economy diversify. By assessing the private sector’s relationship with the state the reader can critically assess as to whether the private sector has been independent so far. Such analysis will spur questions such as “will Vision 2030 strengthen the private sector much more than previous diversification plans”? “What makes this plan different to the other previous plans”? “How can the government win over its population to such reforms” .Finally, the last part of the analysis will look at civic engagement within Saudi Arabia. Naturally a high-skilled population will lead to the advancement of the economy and higher participation. Nonetheless, a strong private sector would need a workforce which is more entrepreneurial. As a result, the analysis will look at the engagement between Saudi Arabia’s citizens and its government. A more engaged population will yield a stronger private sector. This will help the reader understand the mentality of Saudi Arabia’s highly educated populace. Finally, these social indicators will give an idea of whether Vision 2030 can truly succeed.

Detailing the Saudi need to reform

The Saudi government have issued ten different development/diversification plans since 1970. The next article that focuses on the political economic history of Saudi Arabia will look deeper into this. For the purposes of this article the following paragraph will state the immediate indicators for the need to reform. They are as follows. Currently 70% of Saudis are employed by the state and unemployment is officially at 11.6%. Two-thirds of the population are under thirty, as a result 1.9 million Saudis will enter the workforce over the coming decade.[1] This means that 3 million new jobs would have to be created by 2020. [2] Couple this with the estimated nine million expatriates living in Saudi, a majority who work in the private sector and indicators for social unrest become apparent. [3]In addition financial reserves have been dwindling rapidly. During 2015, central bank reserves fell from $732 billion to $623 billion in less than 12 months. In addition oil prices have decreased and this time the decline in oil prices has led Saudi to compete against aggressive oil production campaigns from Iran and Iraq.[4] Subsidies for oil and gas amount to $61 billion annually. For the above issues to be addressed significant social and economic changes would need to take place in Saudi Arabia. The following paragraphs will aim to touch upon both the social and economic needs for reforms to be implemented appropriately.

Reform Requirements – Social

In addition to detailing which reforms the government hopes to implement, the article will touch upon the social aspect of how the reforms will be accepted. This will give the reader a holistic view that encompasses social, as well as technical aspects of future reforms. The following paragraphs will look at the topic of water and electricity subsidy reform and how the Saudi population would react to new reforms.For the reforms to become successful, a change in mindset amongst the population would need to occur. The citizen-government relationship would also need to change. The feeling of entitlement amongst the population in connection to government subsidies will pose a significant barrier to reforms if left unchallenged. A majority of citizens are still unaware that energy prices are subsidised by the state. Many citizens still believe that it does not make sense for the government to subsidise a national produced resource. As a result, Saudi citizens need to differentiate between the concept of subsidies and social security.

However, there is hope for the government if it manages to push through the idea that subsidies and social security are two different issues. This would need to be pushed through an educational medium as opposed to warning/awareness messages. In regards to water subsidies the population understands that the resource is cheap nonetheless, it does not recognise that water in Saudi Arabia is scarce. The population finds it illogical that the state would subsidise an abundant domestic resource. Such a mindset can only change through behavioural change campaigns, preferably led by a party that is a Saudi equivalent to the “nudge unit” chaired by the Cabinet office in the UK. Educational messages could be sent out using various measures including energy efficiency campaigns that can educate the population on the need for water conservation. If the government can promote that water conservation is a religious duty such subsidy reform would be more acceptable. The above is of vital importance as harshly implemented reforms can be seen as an attack on the population.A prime example of this can be seen through future electricity reform. The heaviest energy spend in Saudi Arabia is electricity. Air conditioning units and systems are a main reason for this large expenditure. It is common for households in Saudi Arabia to spend over 1000 SAR per month. Basic energy conservation behaviours need to be followed such as, turning off AC in vacant rooms and other factors which contribute to high bills. Higher electricity prices will not be tolerated nonetheless, if the state could help facilitate a change of behaviour amongst its citizens energy reform could be implemented easier.

Debt

As in most cases governments generally wish to reduce spending to help balance their budgets. The case is no different with Saudi Arabia, nonetheless its population has become accustomed to current state spending levels that trickle down through subsidies and tax cuts, among other benefits. Minister of state Mohamed Al-Sheikh has claimed that “if current spending levels are continued then the Kingdom’s federal reserve’s risk running out within the next two years”.[5] As a result, the Saudi government will have to borrow money on the international stage. One of the main aims of Vision 2030 is to become active financially on the international level by setting up an international borrowing profile. This will give Saudi Arabia a more favourable rate when borrowing on the international stage. The government aims to raise its debt to GDP levels to between 30%-35% of gross domestic product.[6] It is hoped that this will increase Saudi’s international borrowing profile. This will also help reduce pressure on local banks which have supported domestic companies and bought domestic bonds.

The above paragraph also runs parallel to the news that Saudi Arabia is issuing an international bond sale. In April 2016, Saudi raised $10 billion from global banks such as Bank of Tokyo-Mitsubishi, HSBC and JPMorgan, in order to embark on its first international debt issuance.[7] The fact that many Asian banks were interested in the loan illustrates how recent agency downgrades did not affect Saudi’s country risk significantly.

Military

Saudi Arabia currently has one of the largest military budgets in the world.[8] Nonetheless, in recent interviews deputy crown prince Mohammed bin Salman emphasised the need for economic reform within the defence industry.[9]According to Vision 2030, Saudi Arabia’s public investment fund is aiming to boost the military. In 2015 the military budget was $46 billion and this year it has increased to $57 billion. Currently only 2% of military spending is spent on Saudi products.[10] The government aims to increase this figure by 50%.[11] By using Saudi products it is hoped that this can help cut reliance on foreign companies such as BAE systems and Lockheed Martin. [12]Nonetheless, this would be an extreme challenge due to limited domestic technology and skills base. This will only develop through long term investment, training and policy making.

There is also the issue of generous social benefits for military servicemen. It is widely understood in Saudi Arabia that social initiatives such as military pension schemes provide strong benefits. Dependants of military servicemen such as wives and daughters also receive benefits. While such benefits may cause deep holes in state budgets the government would need to take into consideration social unrest if it would aim to completely revamp the system of social benefits for military staff. If the government were to either cut military pensions, bereavement allowances for those killed in action or eliminate the current early retirement option for servicemen, it could cause a strong backlash. As described in the chapter above detailing social reforms, the Saudi government would need to implement such reforms slowly and vis-a-vis with a PR campaign that emphasises on the need for a change in attitude towards certain benefits.

Taxation

Taxation is another way to raise non-oil revenue funds and timing the implementation of these taxes in Saudi Arabia is important. Taxation through non oil revenues are outlined in Vision 2030. In May 2016, the supreme GCC council voted that all its members will implement a value added tax from 2018.[13] This decision will not lead to unrest considering the timing of implementing these taxes. Geo-politics in the region has left Saudi Arabia on edge. The wars in Yemen and Syria have given the Saudi population a reason to accept the recent taxation drives.

The government has stated that it wishes to generate $100 billion yearly in non-oil revenue by 2020.[14] $30 billion would be accumulated through subsidy reform.[15] Another $30 billion would be raised by the following measures

• Value added tax
• GreenCard programme for expats
• Foreign worker quota raised

The other $40 billion would be raised through other revenue boosting means. Last year gasoline prices rose to $0.26 a litre. Nonetheless, this rate is still the second cheapest in the world. These new drives are new phenomena for the Saudi population which have generally been exempt from such drives. Conclusively, this new drive is a step in the right direction.

Saudi Government tackles housing crisis and latest push for diversification

The text below will look at taxation drives in Saudi Arabia specifically within the housing sector. Political Risk increases when taxes are implemented in societies which are used to relative welfare benefits. A good analyst who can connect the dots from such case studies will be able to see the larger socio-economical implications of taxation. By looking at the context of the situation (which includes the time and speed of implementation) a good analyst will be able to go further in his analysis. Closer to home Saudi Arabia is facing a housing crisis due to its increasing population.[16] Many landowners have used this opportunity to capitalise on this need by holding large plots of land waiting for the price to increase. Prices of land have increased by 7% in some of these locations. Journalist Kerr of the FT claims that as much as 40% of Riyadh would fall under the category of “white land”.[17] The government’s plans to tackle this issue will be addressed in the next paragraphs.

While there are many criticisms of the Saudi government when it comes to the seriousness of their diversification and taxation policies their new plan seems to tackle some of the outstanding issues. A new law which aims to charge landowners 2.5% for unused land will encourage owners to sell their land or to develop it themselves.[18] Economists have estimated that this could raise $15 billion yearly. This will provide the state with tax revenues but more importantly help ease the housing crisis which the government faces due to the large growing population. Politically, the government allocated the housing ministry $67bn to build 500,000 homes in 2011, which only a fraction of has been delivered. [19]Developers on the other hand want more incentives which include boosting the mortgage market and tackling “red tape” within the development process. Many Saudi’s rely on the rental market and only one-third of the Saudi population own their own homes according to a Jeddah Economic Forum 2013 report. Approval rates for mortgage’s loans are stagnant due to a new 85% loan-to-value requirement among potential home buyers.[20] Commentators claim that Saudi needs to change market approvals, labour regulations and land incentives in order to entice foreign companies. This could intern help Saudi build the required target number of houses needed to address the housing crisis.

Aramco – Privatisation

The main amount of funds that Saudi wishes to accumulate to pursue its diversification aims will come from the world’s largest IPO (initial public offering) where the government will partly privatise (5%) of its national petroleum and natural gas company, Aramco. As a result, Aramco shares will be transferred to the main sovereign wealth fund which would amount to $2 trillion in its deposits.[21] The whole process nonetheless, is an arduous one due to the sheer scale of Aramco. From a governmental perspective the IPO holds various pros and cons. The IPO can help tackle corruption by becoming more transparent according to reformer Prince Mohammed. However, critics claim that inviting multinational companies may actually help foster corruption. [22] In addition, the IPO would mean the government would have to publish financial and reserves data, adding an element of transparency. Critics however have to be aware that only five percent of Aramco will be privatised. As a result, the changes will not challenge the state significantly. The part privatisation of Aramco will be the main cash injection that will help towards funding Vision 2030.

Conclusion

Conclusively, analysts need to give time for economic reform to occur in Saudi Arabia. While the previous diversification plans have not fulfilled their aims, external pressures such as depreciating oil prices may actually give the Saudi leadership the appropriate incentive to follow through with its reforms. In addition strong PR campaigns and the establishment of specific departmental units that deal with the population directly would help cushion the impact the population feel from any potential reform. A strong civic society would need to be established for the reforms to reach their full potential. If serious effort can be put into persuading the population to become accustomed to the reforms, then policy success will be more likely. This coupled with external pressures may mean that Vision 2030 amounts to something.

[1] M. Reed, M. (2016). Saudi Vision 2030: Winners and Losers. Carnegie Endowment for International Peace. Web. Accessed Aug. 2016

[2] ibid

[3] Al-Khatteeb, L. (2016). Saudi Arabia’s economic time bomb. Brookings Institution. Brookings. Web Apr. 2016

[4] ibid

[5] Biggest Ever Saudi Overhaul Targets $100 Billion of Revenue.” Bloomberg.com. April 6, 2016. Accessed Spring 2016

[6] Ibid

[7] Simeon Kerr in Dubai and Elaine Moore in London. “Saudi Arabia Takes out $10bn in Bank Loans – FT.com.” Financial Times. April 19, 2016. Accessed Fall 2016.

[8] PWC. (2016). The Kingdom of Saudi Arabia to implement VAT on 1 January 2018. [online]

[9] Ibid

[10] http://www.ft.com/cms/s/0/80cedc7c-0b05-11e6-9456-444ab5211a2f.html#axzz46xEnWi2D

[11] Ibid

[12] Ibid

[13] PWC. (2016). The Kingdom of Saudi Arabia to implement VAT on 1 January 2018. Web. Spring 2016

[14] Nereim, Vivian. “Saudi Arabia: Four Things We Learned From the Deputy Crown Prince.” Bloomberg.com. Bloomberg, 4 Apr. 2016. Web. Spring 2016.

[15] Ibid

[16] Kerr, Simeon. “Saudi Housing Crisis Proves Taxing.” Financial Times. Financial Times, 18 Apr. 2016. Web. Spring 2016

[17] Ibid

[18] ibid

[19] ibid

[20] Ibid

[21] M. Reed, M. (2016). Saudi Vision 2030: Winners and Losers. Carnegie Endowment for International Peace. Web. Accessed Aug. 2016

[22] Muttitt, G. (2016). Saudi Sell-off: A Step in the Wrong Direction – Oil Change International. Oil Change International. Web. Accessed Apr. 2016