Saudi Arabia: toward a profound diversification of the model (Note)

Usefulness of the article: This article highlights the desire of a country whose economy has been built around hydrocarbons to break free from this dependence by rapidly diversifying its economy.

Summary:

• The Saudi economy is based primarily on the oil industry (35% of GDP).
• The Vision 2030 plan launched by the current Crown Prince aims to diversify the economy and sources of income;
• Renewable energies, tourism, and new technologies are the Kingdom’s main sectors of the future, and three megaprojects embody this transition to a new model (the futuristic city of NEOM, luxury tourism in the Red Sea, and the Qiddiya theme park).
• Saudi Arabia is diversifying its sources of financing through the Public Investment Fund (PIF), debt, and national and international private actors.

Monitoring the price of Brent crude oil makes it easy to gauge Saudi Arabia’s economic situation. The hydrocarbon industry accounted for nearly 75% of public revenues, 80% of exports, and 35% of GDP in 2019. The last three shocks to the price of oil (the 2008 crisis, overproduction from 2015 onwards, and the Covid-19 crisis in 2020) instantly pushed GDP into negative territory. The effects are also being felt on public finances (public deficits of -16% and -17% of GDP in 2015 and 2016 respectively) and on external accounts (current account deficits of -9% of GDP and -4% in the same years).

Source: WEO, BP statistics

It was in response to this problem of dependence on black gold that in 2016 Saudi Arabia, under the impetus of the current Crown Prince Mohammed bin Salman, launched a program to modernize its economy with the presentation of the Vision 2030 Plan. The program is highly ambitious, aiming to double the 2016 GDP and generate public revenues from new sectors that exceed those from the oil industry. The program is based on accelerated economic diversification with massive involvement from the private sector and foreign investors.

The stakes are high for Saudi Arabia, and the implementation of the Vision 2030 Plan is as much economic as it is social. The country’s large youth population (more than 60% of the population is under 30) is the segment of the population that is most affected by unemployment: nearly 29% among young people at the end of the first half of 2021, compared with an average of 12% for Saudi nationals (the overall unemployment rate for all nationalities is 5.7%). It also aims to respond to women’s desire for emancipation and, more broadly, to maintain living standards.

1. The Vision 2030 Plan projects

1. Sectors of the future targeted in the Vision 2030 Plan

An ambitious commitment to renewable energy. As a symbol of its diversification process and reduction of its dependence on hydrocarbons, Saudi Arabia is planning a large-scale investment plan in the renewable energy sector. In early 2017, the Saudi authorities launched the National Renewable Energy Program. Part of the Vision 2030 Plan, it aims to develop a renewable energy capacity of 58.7 gigawatts, or one-third of the country’s electricity mix, compared to production that was still close to zero in 2017. This renewable energy development capacity is expected to replace carbon-based energy sources, particularly oil, which the country aims to reserve for export. The program also provides for the closure of oil-fired power plants, which currently account for 40% of electricity production.

Since its launch, major calls for tenders have been issued: 600 MW in Al-Faisaliah (photovoltaic), 400 MW in Dumat Al Jandal (wind), 300 MW in Sakaka (photovoltaic), etc. In addition, the NEOM mega-project will operate with a 100% renewable energy system. Saudi Arabia has also declared its aim to achieve carbon neutrality by 2060.

The tourism sector is also part of Saudi Arabia’s growth plan. Saudi Arabia, one of the only countries in the world not to issue tourist visas (except for pilgrimages),is seeking to bring about a real change in attitudes. However, since September 2019, Saudi Arabia has authorized the issuance of tourist visas. No fewer than 400,000 visas were issued until the borders were closed in March 2020 due to Covid. In order to boost the sector and ensure regular monitoring, a Ministry of Tourism was specially created in early 2020. The sector’s flagship project is the « Red Sea » project, which aims to develop islands off the coast to accommodate high-end tourism. To carry out this project, The Red Sea Development Company was created in 2018. According to the company, contracts worth nearly $580 million have been awarded since its creation, mainly for road infrastructure (roads, airports, bridges). Ultimately, the sector is expected to account for 10% of GDP by 2030 ($80 billion), compared with 3% currently.

Significant support for the industrial sector. Riyadh wants to create national champions in industry, a sector that relies almost exclusively on the oil industry with Aramco (^thirdlargest oil producer and^largest oil exporter) and Sabic (Saudi petrochemical giant). In 2019, the Kingdom launched the National Industrial Development and Logistics Program (NPDIL). With diversification as its leitmotif, the NPDIL aims to attract more than $453 billion in investment in sectors such as mining and logistics. In order to ensure an environment conducive to the development of the sector, the overall objective is to create special economic zones across the country, enabling control of the entire supply chain from upstream to downstream. The program thus provides for significant investments in transport infrastructure, with the aim of creating interconnected logistics hubs. It also provides for a restructuring of the mining and petrochemical sectors to ensure local production and enable exports. Other investments are planned, such as in pharmaceuticals to increase the share of local production, and in energy efficiency.

Development of new technologies. Innovation and entrepreneurship would play a key role in Saudi Arabia’s Vision 2030. The Public Investment Fund (PIF) plans to invest heavily in new technologies, both in mega-projects and other national projects. In order to promote and protect local innovation, in March 2017 the Kingdom established the Saudi Intellectual Property Authority (SIPA), which aims to protect and regulate intellectual property rights in the Kingdom. The objective is also to respond to the desire for digital transformation among public and private entities. It was to meet this need that the Saudi Information Technology Company (SITE) was created in 2017. It provides cyber and digital services to national organizations (both public and private). Since its creation, it has contributed to the digital transformation of more than 200 of them (according to the PIF). In terms of financial market modernization, a fintech center was created in 2019 between the Saudi Arabian Monetary Agency and the Capital Markets Authority. It has granted 31 licenses since its creation and focuses on the development of payment technologies and crowdfunding. The Kingdom took advantage of the^5th edition of the Future Investment Initiative to illustrate its desire to become a hub of attractiveness and innovation.

2. The « mega projects » that symbolize the Kingdom’s desire for diversification

Saudi Arabia’s Vision 2030 includes three « mega projects » that embody the Kingdom’s diversification plans:

The futuristic city of NEOM. This is a project to create a futuristic city based on new technologies. Equipped with an ultra-high-speed wireless network, the city will be connected, powered by a 100% renewable energy system, and car-free. Located in the northwest of the country (on the Egyptian and Jordanian borders), the city will cover 26,500 km² and require nearly $500 billion in investment by 2030. The futuristic city is intended to be a living laboratory, conducive to entrepreneurship and innovation. The city has had its own airport since 2019, and the headquarters of the company in charge of the project (wholly owned by the PIF) has moved from the capital to Neom. In July 2020, a $5 billion contract was signed with an American company for the production of green hydrogen-based ammonia. The production plant will itself be powered by renewable energy sources.

Luxury tourism in the Red Sea. The Red Sea project is a project aimed at high-end international tourism. It involves the development of an archipelago of 90 islands and is based on an ecosystem (zero waste, 100% renewable). It hopes to attract one million tourists per year. The project is the most advanced in terms of contract value (US$580 million).

The Qiddiya entertainment city. An exceptional 334 km² amusementpark south of the kingdom’s capital, Riyadh. Unlike the Red Sea project, this entertainment project aims to promote local tourism. The population is predominantly young and the country offers few entertainment and leisure activities. This project is part of the Kingdom’s overall desire to promote culture, leisure, and sports, all of which will be part of Qiddiya. The park will be accessible via a specially designed metro line.

2. The key to success: diversifying sources of funding for the economy

1. The Public Investment Fund

National projects related to the Vision 2030 Plan are mainly financed through the sovereign wealth fund, the Public Investment Fund (PIF). Created in 1971, it had previously financed projects related exclusively to the oil industry. In March 2015, the PIF underwent a revival when it was placed under the supervision of the new Council of Economic Affairs and Development, under the direct authority of the current Crown Prince. It now embodies the financial arm of the Vision 2030 Plan. The PIF holds 100% of the capital in each of the new companies created to implement national projects (primarily « megaprojects »). In its first strategic plan for 2018-2020, it founded more than 30 companies in 10 strategic sectors in line with the Vision 2030 Plan. The PIF’s 2021-2025 strategic plan is no less ambitious, with plans to invest $40 billion annually in national projects.

Since 2015 and its reorientation, the fund has multiplied its international investment strategies in diversified sectors, moving away from its focus on the oil sector. The PIF has invested in numerous international groups, such as Uber, in which it acquired a 5% stake (USD 3.5 billion) in July 2015, and the Korean company Posco,^the world’s^{fourth-largest} steel producer, with USD 1.1 billion. In line with its desire to invest in the new technology sector, as part of its 2018-2020 investment program, the PIF acquired 5% of Tesla (USD 2 billion) and contributed nearly USD 45 billion to the creation of a technology fund managed by Japanese telecommunications champion Softbank. Finally, as an example of the Saudis’ desire to move away from oil, the PIF invested $1 billion to become the largest shareholder in the American electric car company Lucid Motors. There are many examples, and the list is not exhaustive.

At the end of 2020, the PIF’s assets under management were estimated at $360 billion, compared to $150 billion in 2015. The PIF is now one of the top 10 sovereign wealth funds in terms of assets. Investments are continuing and diversifying, such as the very recent acquisition of English soccer club Newcastle. The stated goal is to reach USD 2 trillion in assets by 2030. According to the PIF, the return on investment is 8% for the period 2018-2020, compared to 3% between 2014 and 2016.

The fund benefits from revenues generated through the sale of public assets. In 2017, the Saudi authorities established the National Center for Privatization and Public-Private Partnerships. Its main purpose is to draw up a comprehensive list of privatization projects for public companies and to oversee them. Privatization revenues can be very high: the proceeds from the IPO of 1.7% of the national oil company ARAMCO, amounting to €29.4 billion, went directly into the PIF’s coffers. A number of privatizations are planned, mainly in strategic sectors such as energy, water, and electricity, such as the recent privatization of Acwa Power (Saudi electricity group) with a raise of $1.2 billion. The ongoing and upcoming privatization processes should enable the fund to be substantially replenished and the financing of Vision 2030 projects to continue.

However, uncertainties remain as to the regime’s ability to complete all privatization processes. The kingdom recently suspended the privatization of the largest desalination and power plant, officially because the pandemic prevented bidders from submitting their bids. The caution of economic agents regarding the privatization of Saudi companies may also stem from the lack of transparency of some of them. For example, despite the significant revenues generated by the privatization of Aramco, the ambition was to generate much higher revenues. Originally, 5% of the capital was to be opened up in the company, initially valued at $2 trillion, but this eventually fell to $1.7 trillion. More generally, regional instability, the decline in the attractiveness of oil, and the country’s reputation since the Khashoggi affair are factors that could lead to disappointing revenues from the privatization process.

2. An overhaul of public spending and revenues

Restructuring of public finances since the fall in prices in 2015. Faced with a drop in oil revenues, which accounted for 73% of public revenues in 2015, Saudi Arabia has begun restructuring its public finances. Non-oil revenues almost tripled between 2014 and 2020, rising from 4.6% of GDP (131 billion Saudi riyals) to 13.9% of GDP (366 billion Saudi riyals) over the period. At the end of 2015, the government began drastically reducing energy subsidies by raising prices, particularly for gasoline and electricity. Subsidies on these products, which translate into higher energy and electricity prices, have since been cut in half, boosting public revenues. In 2018, a 5% VAT was introduced, and this was tripled in 2020 to 15%. In terms of public spending, the Saudi authorities have sought to preserve their social spending model while rationalizing certain expenditures since 2015. Total public spending fell from 40.2% of GDP to 33.3%. It has since risen again (notably to finance Vision 2030 projects) but has still not reached its pre-2015 level and currently represents less than 30% of GDP. These efforts to consolidate spending have been achieved by reducing « compressible » expenditures, such as the elimination of the Cost of Living Allowance (Cola, an allowance paid to civil servants) in 2020 and the increase in customs duties, for example. This has also made it possible to focus on increasing the efficiency of capital expenditure. The authorities plan to continue reforms on energy prices and aim to balance the budget by 2023.

Saudi Arabia has a low level of debt, which gives the country some leeway to finance its Vision 2030 plan. Saudi Arabia’s public debt stood at 32.5% of GDP in 2020. It is dynamic, having been only 13.1% of GDP in 2016, but remains at very reasonable levels. In addition, the country enjoys investor confidence as interest rates are generally low, even negative, as was the case with the 3-year debt issue at the beginning of the year. Since 2016, the Kingdom has adopted a foreign currency debt issuance program. In total, nearly USD 52 billion was issued between 2017 and 2020.

3. Massive reliance on the private sector and international investors

Recourse to the private sector is a prerequisite for achieving diversification objectives. The private sector is intended to be the engine of diversification. Its share of GDP is targeted at 65%, up from the current 40%. In March 2021, the Private Sector Participation Law was passed, strengthening the legal framework for privatization and public-private partnerships. It offers protection to foreign investors and exempts privatizations from national worker quotas. Furthermore, the private sector accounted for only 32% of the workforce when the Vision 2030 Plan was launched. The stated objective of the plan is to increase this share to over 60%.

However, the national preference for private employment is likely to be a major obstacle to the development of the private sector. The Kingdom has expressed its desire to « nationalize » private employment in the country (the program is called Nitaqat), three-quarters of which is made up of foreign labor. This desire stems in particular from the fact that unemployment is structurally high among the Saudi population, especially among young people and women (with an unemployment rate of over 30%). The Saudi authorities introduced a tax on foreign workers in 2018 and imposed quotas on Saudi workers in a number of sectors. However, this national preference requires a level of qualification that is not found in the local labor market. In many sectors, particularly industry, this skills shortage is a serious obstacle. In addition, there are significant wage gaps between Saudi and foreign workers, which increases labor costs and affects the competitiveness of businesses. The Saudi authorities must therefore juggle high youth unemployment among Saudis with the desire to develop the private sector in order to achieve the objectives of the Vision 2030 Plan.

The Saudi authorities are developing domestic financial markets to diversify sources of financing. In order to attract international economic players and develop the domestic private sector, the Kingdom has liberalized its financial market. Foreign players can now hold stakes via the Riyadh Stock Exchange, Tadawul. Despite the restrictions that still exist for foreign investors (in terms of amounts, sectors, or locations), the share of foreign holdings has risen to 8% since the opening, and then to 12% in mid-2021. At the end of 2017, with the listing of 1.7% of ARAMCO’s capital on the stock market (the largest IPO ever recorded worldwide), Tadawul became the^ninth largest stock exchange in the world. This has had the effect of stimulating the domestic market. According to the MENA Venture Investment Report 2021, Saudi Arabia raised nearly $170 million in venture capital in the first quarter of 2021 (compared to $180 million for the whole of 2020 and $30 million in 2016).

The business climate is improving but still lacks the flexibility needed to support the desired economic change. The Kingdom has worked on its attractiveness in recent years. This has resulted in a significant improvement in its ranking on certain business environment indicators. On the Ease of Doing Business indicator of the Doing Business ranking (World Bank), Saudi Arabia rose from^92nd place in 2018 to^38th in 2020. According to the World Economic Forum’s competitiveness indicator, Saudi Arabia rose from^66th place in 2010 to^36th in 2020. Saudi Arabia has opened up the possibility in certain sectors (retail and wholesale, for example) for foreigners to own 100% of a company’s capital. In order to achieve its target of foreign direct investment at 5.7% of GDP (compared to less than 2% today), Saudi Arabia plans to create special economic zones in certain key sectors such as tourism. The country also plans to reduce certain taxes for investors, simplify the issuance of business licenses, etc. The Kingdom hosted the^5th edition of the Future Investment Initiative, providing yet another opportunity to show international players its desire to enhance its attractiveness.

There is still significant room for improvement in order to create a business climate that is conducive to attracting foreign investors. Despite the efforts that have been made, the procedures are still numerous and somewhat « vague » for a foreign player who wishes to set up a business or acquire a majority stake in a company. Measures taken to promote local employment risk undermining the country’s attractiveness to international players, while the tax system remains complex, leading to situations of double taxation or unreimbursed overtaxation. In addition, the significant weight of the public sector implies administrative burdens that can lead to particularly long payment delays and accumulating government arrears. Overall, Saudi Arabia is suffering from its war in Yemen, the Khashoggi affair, and its violent anti-corruption campaign. These factors are likely to make investors even more cautious, potentially hindering its ambitions for economic diversification.

Conclusion

The volatility of oil prices has finally convinced the Saudi authorities to commit to changing their economic model. Since the launch of the Vision 2030 plan, numerous obstacles have stood in the way of its implementation: low oil prices, geopolitical tensions (war in Yemen, tensions with Qatar and Iran, the Khashoggi affair), and Covid-19, which is still affecting the Saudi economy today. But these factors have not deterred the Prince, who is determined to see all of his projects through to completion.