The Kingdom of Saudi Arabia is currently undergoing a series of significant reforms that will transform the country over the coming years. Vision 2030, which was first unveiled in 2016, has several major goals, including decreasing the country’s reliance on fossil fuels for economic growth and increasing the private sector’s participation in the economy. The kingdom is also in the process of driving foreign direct investment.
Vision 2030 also involves increasing small and medium-sized enterprises’ (SMEs’) contributions to the economy, and privatising government companies in sectors such as utilities, transportation, and religious and archaeological tourism.
Other areas that are currently being focused on include the development of the country’s education, healthcare and infrastructure sectors. This said, the two most important economic reforms at present involve ensuring that public equity markets are aligned with international standards, and enhancing women’s participation in key industries.
Reaching up
With respect to public equity markets, the Capital Market Authority of Saudi Arabia has made several changes to align our local markets with international ones. In particular, these adjustments were focused on the area of settlement activity and on an independent custodian model that allows foreigners to own public equity shares. These changes will help attract foreign capital, which can subsequently lead to a rise in the percentage of public equity shares owned by foreigners. Currently, this stands at two percent, compared with a figure of around 50 percent in other emerging markets of a similar size to Saudi Arabia.
Furthermore, the MSCI’s decision to add Saudi Arabia to its watch list for inclusion in the MSCI Emerging Markets Index reflects the success of governmental efforts to attract foreign capital. With regards to the second target, the Saudi Arabian Government wishes to increase the share of women in the labour force extensively over the coming years; a figure that currently stands at only 22 percent. However, the government’s recent decision to end the ban on women driving will help this increase. According to McKinsey & Company, 25 percent of the US’ current GDP is due to more women entering the workforce since the 1970s – consequently, Saudi Arabia’s economic growth should benefit immensely in the coming decades due to measures adopted today.
Driving change
Economic reforms are benefitting both debt and equity capital markets. In 2017, the government announced its intentions to raise debt in local and international markets to mitigate the impact of budget deficits as a result of falling oil prices. In Q3 2017, Saudi Arabia raised SAR 37bn ($9.87bn) in domestic debt sales and, in April the same year, $9bn from the sales of Islamic bonds. These debt offerings have stimulated demand for local investment banking services.
In equity capital markets, the Capital Market Authority has permitted the listing of real estate investment trusts (REITs). This has stimulated investment banking activity, as many institutions monetise illiquid real estate assets. In addition, the creation of a parallel market – the Nomu-Parallel Market, for the listing of smaller companies with fewer requirements than those listed on the main market – has provided an additional exit option for private equity firms and family offices in the country.
The biggest factor affecting growth at present is the fact that government spending is still driven by energy prices and crude oil production. Oil prices represented approximately 85 percent of government revenue and 70 percent of government spending in 2017. Since January that year, Brent crude prices have remained largely unchanged, though they fell in the first and second quarters before rebounding in the third. Saudi Arabia has also reduced production in compliance with OPEC cuts, which has had a negative effect on growth.
Later that year, the government announced it would be making additional cuts starting in November. This move will undoubtedly have a greater effect on production and market diversity in the months to come; these additional cuts are a major reason why second quarter real GDP growth was minus one percent.
However, in the wider investment landscape, there are many misconceptions that wrongly deter investors from operating in the region. For one, some think the currency is unstable. In reality, Saudi Arabia’s riyal is pegged to the US dollar, and the exchange rate has been fixed at 3.75 riyals to the dollar since 1986. This peg has provided an anchor for local and international investors, while also reducing transaction costs and simplifying macroeconomic policy.
Others question Saudi Arabia’s readiness for investment, when the truth is that the country opened its economy to foreign investment several years ago. Foreigners can now directly own shares in public equity companies, while the ease of owning shares in private companies is increasing. Furthermore, the recent establishment of an official anti-corruption committee has improved fiscal security within the country, providing a more transparent business environment for investors and removing potential hindrances to Saudi Arabia’s economic performance moving forward.
Moving away from oil
Saudi Arabia is keen to diversify its economy away from a dependence on oil, but the speed with which this can happen depends on many factors. For example: its success in attracting foreign investment; its success in encouraging the establishment of SMEs; and the adoption of alternative, renewable energy. It is difficult to predict how quickly this will happen.
I would expect a meaningful reduction in Saudi’s dependence on oil by the Vision 2030 deadline. Oil will remain a significant driver of the economy, but if the kingdom has reduced its reliance by 25 to 50 percent from present-day levels (as a percentage of revenue and expenditure), it would be an astounding success. The government is also expanding its revenue base with measures such as a value-added tax initiative, which is set to take effect in 2018, and new fees for expats. However, a material decline in oil dependence will only come when longer-term initiatives begin to bear fruit.
An example of this is NEOM, a $500bn megacity that the Saudi Government intends to construct on the country’s Red Sea coast. The aim of this project, which was announced in October 2017, is to further diversify the economy away from its reliance on oil. The city will be powered by clean energy, and will provide a high quality of living for Saudi citizens in the post-oil years.
The largest share of economic growth is typically generated from the SME sector. Therefore, the best approach to move away from an oil-based economy is to reduce regulation and make it easier for new businesses to form. In fact, Saudi Arabia could soon lead the Arab and Muslim worlds in technological development – but to do so, an ecosystem must be developed, which requires participation from the government, private sector and education system. I would open several ‘free zones’ in the kingdom, where foreign investors could own 100 percent of a company with little start-up capital required.
Furthermore, the court system in Saudi Arabia is currently undergoing improvements. These changes will lead to more efficient resolutions in disputes in private sector contracts.
Diversification efforts
The private sector in general – and investment firms in particular – have a large role to play in the country’s drive to diversify its revenue base. Banks are financing the government in its efforts to reduce the drawdown of foreign reserves, which currently stand at around $500bn. They’re also key to the National Transformation Plan – the five-year plan ending in 2020 – which calls for the share of residential financing to increase from eight percent of non-oil GDP to 15 percent by 2020.
Investment banks are also participating in the debt and equity capital markets. What’s more, the increased borrowing by the government has translated into more mandates for investment banks’ debt capital market teams. The initiatives set up by the Capital Market Authority, such as permitting the listing of REITs or the development of the Nomu-Parallel Market, have created opportunities for investment banks to list companies and REITs. Additionally, the Capital Market Authority’s development of the independent custodian model has created new demand for custody services that segregate client assets from investment companies’ assets.
It’s remarkable to reflect on the pace of change in the kingdom over the past year; development is happening at a breathtaking speed. Consequently, the Saudi landscape will likely be significantly different in 10 years’ time. With more competition in industries, less reliance on oil, more foreign ownership and additional women in the workplace, the possibilities for Saudi Arabia are endless.
