With 2019 just around the corner, Saudi Arabia's economic strategists are busy planning the oil giant's budget for the coming year. The outlook for economic growth is good, especially when compared with a year ago. Over the past year, oil prices have been high enough that the desert kingdom has succeeded in narrowing its substantial budget deficit faster than originally planned. Real growth in the gross domestic product hit 1.8 percent in the first half of 2018 — up a full percentage point from the same period of 2017. Non-oil revenue for the first half of 2018 was also up nearly 50 percent year to year from 2017. And spending next year looks like it will be higher than ever. Riyadh plans to boost government spending by as much as 7 percent as part of total budget expenditures, which are expected to total 1.106 trillion Saudi riyals ($295 billion), for the kingdom's biggest budget ever. All told, Saudi authorities project that the country's GDP will grow by 2.9 percent in the coming year.
But while the government is portraying all of this positively, a deeper problem lurks: namely, the economic engine that is responsible for the country's growth. If growth only comes from heavy state spending, rather than private sector activity or higher levels of consumption, Saudi Arabia's ambitious plans to diversify the economy have little chance of success in the near term.
Saudi Arabia is in the midst of an aggressive economic reform program that involves trying to diversify its oil-and-gas-dependent economy. Increasing and improving its attractiveness as a foreign investment destination is part of that push, but political uncertainty in the kingdom isn't helping Riyadh portray itself as an ideal investment destination.
The Original Strategy and the Course-Correcting Reality
The government says it is closely committed to its Vision 2030 goals, which include an attempt to completely restructure the economy to shift the burden of economic growth onto the private sector. This stated priority, however, contradicts the reality of government budgeting, which includes more public spending than ever, in part to make up for the private sector's lackluster performance and the lack of foreign investment to shore up that sector. This poor performance has hurt the kingdom's ability to coax much-needed growth out of the non-oil sector, which would ultimately help contribute to larger goals such as balancing the budget.
For decades, the Saudi economy has been dominated by a model of state-led economic growth that is typical of petrostates. In this, Saudi Arabia is the classic "rentier" state, in which the government and government-linked entities only have one source of income: oil revenue, in the case of Riyadh. This income, or "rent," is then distributed back to the population in carefully controlled outlays, such as subsidies, benefits and job programs.
While oil and gas revenue in Saudi Arabia doesn't contribute an overwhelming portion to the GDP, it does account for the vast majority of the government's budget. What's more, hydrocarbon-related activity is heavily dominated by state-backed companies such as the Saudi Arabian Oil Co. and SABIC. One of the major goals of the ambitious Vision 2030 economic reform plan is to end this imbalance and shift the responsibility for economic growth to the private sector and away from the overburdened the public sector. In so doing, Saudi Arabia hopes to diversify its economy, particularly given that reaching peak oil demand is possible within the medium term.
But this shift is proving to be exceptionally hard to make. Political turmoil, including scandals and diplomatic snafus between Saudi Arabia and other countries and the uncertainty created by shifting oil prices, as well as a spotty record of hitting economic reform targets, is complicating the transition. It is also reducing foreign investors' interest in private sector projects and overall domestic investor confidence in the private sector.
The Tall Order of Attracting Investment
In fact, despite many of Riyadh's efforts to introduce confidence-building measures to bolster the private sector — including easier rules regarding visas and business ownership and the establishment of special economic zones — investors appear to be losing faith in the Saudi market. Indeed, there has been a clear downward trajectory in terms of foreign direct investment (FDI) in Saudi Arabia over the past decade. While some of this decline stems from an overall global lag in FDI after the 2008-09 financial crisis, Saudi Arabia and the Gulf Cooperation Council stand out. In 2017, Saudi Arabia only succeeded in attracting $1.4 billion — a figure that trails a number of poorer countries in the Middle East.
In addition to its efforts on FDI, the country also eased the rules governing domestic investment on its Tadawul stock exchange for big institutional investors and adopted a U.N. industry classification system to help issue foreign investment licenses. Appearing to sweeten the pot was market-index provider MSCI, which recently said it would include Saudi Arabia in its emerging markets index in 2019, and JPMorgan, which stated that the kingdom (as well as the United Arab Emirates, Qatar, Bahrain and Kuwait) could join the bank's emerging market government bond indexes in 2019. But as Riyadh learned in the case of FDI, even if you build it, they won't necessarily come. In the end, investors have displayed overt reluctance about deepening their involvement with the Saudi stock exchange. In fact, Qatar's smaller stock exchange has attracted more investment so far in 2018 than Tadawul — all at a time when domestic capital is continuing to flow out of Saudi Arabia. Taken together, the developments suggest that domestic investors wish to take a breather on the sidelines after last year's disruptive anti-corruption purge.
According to the International Monetary Fund, Saudi Arabia's inconsistent interpretation of the law regarding the business sector has also hurt the country's bottom line for FDI and trade. And because foreigners have to work directly with local partners under the Saudi regulatory system, political uncertainty is a major cause of their hesitation about investing in Saudi Arabia, since outside firms desire assurances that their domestic partners will not suddenly run afoul of the powers that be in Riyadh. Of course, Crown Prince Mohammed bin Salman's ever-shifting reputation is a direct driver of this uncertainty, and questions about the rule of law, security of investments and the stability of the government abound.
Other issues tied to Vision 2030 will also hamper prospects for private sector growth, including efforts to tighten labor market regulations by hiring more Saudis, implementing new taxes and establishing new fees. Although these efforts are designed to bolster the private sector and aid the government in drumming up more non-oil revenue in the long term, they will stoke uncertainty in the private sector in the short term. Moreover, the government's Saudization push has resulted in the departure of many migrant workers who were contributing to the kingdom's economy, thereby reducing overall consumption levels.
State-Led Growth Is the Name of the Game
Of course, the uncertainty pervading the private sector does not preclude the possibility that 2019 will be kind to the Saudi economy. Riyadh has reportedly earmarked 100 billion riyals of public spending for capital-intensive infrastructure and investment projects at home and abroad. State-backed companies such as Saudi Aramco and SABIC are already planning to invest upward of $500 billion in overseas projects, including an Indian refinery featuring Saudi Aramco and the Abu Dhabi National Oil Co. And Saudi Arabia's Public Investment Fund will no doubt make big investment announcements, too. Ultimately, it means Saudi Arabia is still wealthy enough to grow its economy — come what may in terms of falling oil prices and global growth in 2019.
The desert kingdom, however, has a well-established track record of deferring reform efforts. Just last year, it tacked on an additional three years to its deadline of 2020 to balance its budget. And if next year proves to be another year of stagnation and confusion for the private sector — especially in the nascent tourism and entertainment sectors that the crown prince has specifically targeted — Riyadh might have to readjust its targets yet again. But for the moment, Saudi Arabia appears to be in for a tough 2019 in terms of encouraging the private sector to increase its investments at home and abroad — something that will complicate the Saudi crown prince's efforts to portray his landmark Vision 2030 as a rousing success.