An overview of business forecast for Saudi Arabia; Prospects & Challenges

AN OVERVIEW OF BUSINESS FORECAST FOR SAUDI ARABIA: PROSPECTS & CHALLENGES

TABLE OF CONTENTS Executive Summary Introduction Measures for balancing fiscal deficit Introduction of VAT & withdrawal of subsidies Prospective Areas of Investment Defense Education & Vocational Training Healthcare Infrastructure & Transport Renewable Energy Mining

Challenges Low oil prices & its impact on financing projects Restriction on female participation in the labor force Potential for civil unrest as a result of austerity measures Military engagement in Yemen Threat of militancy Repatriation of expats

Conclusion

AN OVERVIEW OF BUSINESS FORECAST FOR SAUDI ARABIA: PROSPECTS & CHALLENGES

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EXECUTIVE SUMMARY With the slump in the oil prices over the past two years and the Kingdom’s excessive dependence on oil exports as a chief source of revenue, the Saudi government introduced its ‘Vision 2030’ project in April 2016 aimed at diversifying the economy and thus significantly reducing its reliance on oil exports. Furthermore, the latest fluctuations in global oil prices had an adverse impact on the economy, with the budget deficit being around 79 billion USD and a dip in foreign reserves was also recorded. In this regard, as a preliminary measure towards achieving the larger goals set under the Vision 2030, the Kingdom introduced ‘Fiscal balance program 2020’ initiative with effect from April 2016 aimed at tackling the fiscal deficit and embarking on the objective of diversification the economy alongside, under the aegis of its Vision 2030 initiative. The measure involves the adoption of multiple austerity measures by providing intense scrutiny of government finances and acting as a spur to increased efficiency. To achieve this, apart from seeking foreign direct investments (FDI) in a host of sectors along with hydrocarbons, Riyadh’s primary focus has been increasing the share of non-oil Private sector contribution to the GDP from the current 39.27% to around 65% by 2030. And Improving the ratio between the expat workers and local workforce in favor of the latter, thus improving upon the employment levels in the Kingdom among the local population. Given the sizable budget allocation and efforts by the government to incentivize foreign investments, areas like defense production and development, education and training, transport and infrastructure, renewable energy, technology sector, mining, logistics, and finance are some of the more lucrative sectors which are expected to draw sizable investments. Despite the proposed returns, the ambitious venture faces certain operational and business challenges and also certain socio-political challenges are likely to have a bearing on these initiatives- US energy policy and its impact on global oil prices, sociopolitical impact of austerity measures, impact of military operations in Yemen and the latent threat of militancy to name a few. The current report thus factors in some of the aforementioned variables and also briefly touches upon the broader measures taken by the Saudi government in this regard to provide an overview of challenges and opportunities for doing business in the kingdom.

AN OVERVIEW OF BUSINESS FORECAST FOR SAUDI ARABIA: PROSPECTS & CHALLENGES

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SAUDI VISION 2030 & FISCAL BALANCE PROGRAM 2020 Given the dip in global oil prices and the continued trend despite registering nominal rise following adherence to the pledged cuts by the OPEC countries, the Kingdom has created an ambitious plan to reduce the role of the state, cutting public wages, cancelling some infrastructure projects and planning world’s largest Initial Public Offering (IPO) in Saudi Aramco. Furthermore, the government under the Fiscal Balance Programme 2020 aimed to achieve 1.Rationalization of Government expenditure- This is expected to be achieved by optimization of Operational and capital expenditure including a wider set of ministries and government expenditure. 2.Operational and capital expenditure including a wider set of ministries and government expenditure. 3.Energy Price Reforms- Progressively increase prices of electricity, fuel, and water, thus withdrawing the subsidies previously extended. 4.Additional incentive to increase in non-oil initiatives- This is likely to be achieved by levying taxes including VAT. In addition to the aforementioned measures, the government is also in different stages of development with regards to, 1.Privatization: It is aimed at reducing the government's expenditure on public expenditure and at the same time introduce competition thus enhancing productivity. 2.Public Sector reforms: These measures are likely to work in tandem with Privatization. It also intends to contain the cost of public sector salaries and is implementing an efficiency program. 3.Debt Management Policy: The government is developing a prudent approach to debt management, accessing international markets, to increase capacity for debt without negative impacts on domestic liquidity. In this regard, the Saudi government undertook the sale of Islamic bonds worth 9 billion USD in April. This move was preceded by similar sovereign bond sale worth 17.5 billion USD in October 2016. This move was partly supported by the low global interest rates and funds frustration with the lack of high-yielding assets around the world. Of the 9 million USD, bonds worth 4.5 billion USD are maturing in 2022 and the other half in 2027. In light of the depressed oil prices, the boost in funds is likely to finance the multiple projects scheduled under the Vision 2030.

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INTRODUCTION OF VALUE ADDED TAX & WITHDRAWAL OF SUBSIDIES According to the Ministry of Finance, the mandate of the Committee on Financial and Economic Cooperation Council of the GCC agreed to introduce 5% VAT with effect from the fiscal year 2018. Additionally, the GCC countries have agreed to implement selective taxes on tobacco, and soft and energy drinks during the current fiscal year 2017. Moreover, according to the Fiscal Balance Programme 2020, the companies which employ foreign nationals incur levy of SAR 200 per month per expat employee, for expat employees that exceed the number of Saudi employees. This levy on all expats is expected to be further revised upwards–aimed at directing employers to hire more Saudi nationals. A fee on dependents of expatriate workers will also be levied with effect from July of 2017.

Furthermore, as per the Ministry of Finance, a review and evaluation of the government subsidies, especially in fuel, water and electricity and introduction of direct cash support for eligible low and mid income groups to tackle the impact of the enforced austerity measures, the government has proposed the household allowance scheme. Its aims to improve targeting of government benefits by developing mechanisms that will direct the benefits to eligible segments only and also promotes sensible consumption of energy and water.

AN OVERVIEW OF BUSINESS FORECAST FOR SAUDI ARABIA: PROSPECTS & CHALLENGES

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PROSPECTIVE AREAS OF INVESTMENT

DEFENSE As per SIPRI, despite the overall drop in imports, Saudi Arabia continues to be one of the leading importers of defense equipment with military spending reaching roughly 61 billion USD in 2016. This comprised roughly 26.7% of the government spending and 10.4% of the GDP. Moreover, Saudi Arabia was the world’s second largest arms importer in 2012-16, with an increase of 212 percent compared with 2007–11.

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Furthermore, under the Vision 2030 program, the kingdom aims to draw investments, joint ventures, technology transfers, consulting and training in an attempt to increase the share of indigenous production in the overall inventory. Currently, only 2% of the spending is indigenous with national defense industry being limited to only seven companies and two research centers. Under Vision 2030, the Saudi government intends to increase the share of the to at least 50% till 2030. Given the strategic significance of the industry, it remains highly likely that the government is likely to incentivize partnership between local industry and foreign partners or engage in the public-private partnership aimed at drawing investments and technology transfers of sensitive technologies.

MINING Although the share of mining in the GDP has been significant given the previous improvements and revisions, Riyadh aims to boost the share of mining to roughly 25 billion USD and create 90,000 jobs. It thus provides an interesting area for foreign investment and partnership with local industries.

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EDUCATION & VOCATIONAL TRAINING One of the crucial elements towards attaining the ‘Saudization’ of the workforce and which may ultimately pave the way for a reduction in dependence on expat workforce is training the local population in skills sets required by the industry. Independent market survey reports indicate that there exists a gap between the market requirement and the vocational training and skill sets of the existing workforce. According to Saudi ministry of Finance, the government has invested roughly 53 billion USD in education and training, aimed at attracting significant private sector participation in the sector.

HEALTHCARE According to the Saudi Arabian General Investment Authority (SAGIA) report, the Kingdom spent 20 billion USD in 2016 from 13 billion USD in 2005 with the Ministry of Health (MoH) comprising a major share of the expenditure. By drawing investments in the healthcare sector the government aims to reduce the burden on the state expenditure and also introduce competition in the market to enhance productivity.

INFRASTRUCTURE & TRANSPORT As per reports by KPMG, a leading professional service company and one of the big four auditors, in an attempt to boost the economy, Saudi authorities have undertaken multiple big ticket projects involving investment of 8 billion USD in expansion of rail services across the country along with projects by the Ministry of Transport earmarking 90 billion USD for development and expansion of new metro lines and bus routes in Riyadh, Jeddah, Mecca and Medina. In addition to this development of economic cities are also scheduled across the country and in different stages of development. The King Abdullah Economic city with an earmarked budget of 67 billion USD being one such example. Similarly, according to the Saudi Ministry of Finance, roughly 4 billion USD will be invested in to develop transport and communication infrastructure in Jubail, Yanbu, and Ras al-Khair. Given the capital intensive nature of these development projects coupled with the low oil prices, international investments are expected in these project. However, parallel reports indicate of a slump in public spending on such projects with the real estate prices recording a decline of roughly 8.7% in 2016.

RENEWABLE ENERGY The government aims to seek investment in the field of renewable energy, especially solar, the wind and nuclear energy. In this regard, 1.33 billion USD has been allotted for construction of King Abdullah City for Atomic and Renewable Energy which is expected to generate 3.4 GW of renewable energy and the launch of King Salman Renewable Energy Initiative is expected to be launched as part of the Vision 2030 initiative. However, given the vast oil reserves and the expected relative improvement in the global oil prices, the prospects for development of the renewable energy industry in Saudi Arabia remains limited at this moment.

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CHALLENGES

LOW OIL PRICES & ITS IMPACT ON FINANCING PROJECTS The latest confirmation between Saudi Arabia and Russia to adhere to the pledged cuts till March 2018 has helped stabilize the oil prices at around USD 52.85/bbl. However, IMF reports indicate that the price of oil is expected to remain in more or less the same range till 2021 if the prevailing situation continues. However, uncertainty also lingers on the adherence of the OPEC members to the pledged cuts beyond 2018, as lower production has significantly hampered income and warrants additional measures to balance the budgets.

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Secondly, even if the OPEC decides to adhere to the pledged oil cuts to deal with the oil glut, President Trump’s ‘America First Energy Plan’ which focuses on lifting the regulations on the energy industry implemented during the previous Obama regime is likely to influence the global oil prices. Though a detailed plan elucidating the policy remains to be declared, preliminary reports indicate that production is expected to be jacked up by undertaking exploration and recovery operations in the federally-owned lands in the US. This is expected to propel the US towards energy independence, especially from Middle Eastern oil and also create more jobs, which has been one of the major selling points of President Trump’s election campaign. Moreover, given the glut in energy prices are partially attributed to the addition of US oil in the market, the aforementioned measures are likely to nullify the effects of OPEC cuts. Given that a majority of Saudi revenue continues to be contingent on oil prices, sustainability of the capital intensive projects mentioned above remains in doubt.

RESTRICTION ON FEMALE PARTICIPATION IN LABOR FORCE As per World Bank Data women, participation in the labor workforce comprises roughly 15.21% of the total workforce in the Kingdom as on 2016, which continues to be one of the lowest in the world. Though reforms for women empowerment are hard to come by and restrictions continue to be enforced, the expectation of a significant rise in the share in labor force remains remote.

POTENTIAL FOR CIVIL UNREST AS A RESULT OF AUSTERITY MEASURES Austerity measures involving the withdrawal of subsidies especially in water, electricity, fuel, along with cuts in allowances and bonuses of state employees have resulted in popular discontent among the local population. This led to the government restoring some of the austerity measures. Despite contingency plans like the introduction of household allowance system, given that the population is accustomed to generous state handouts, any attempts by the central government to withdraw them are likely to face resistance. Additionally, the principle of - ‘No taxation-no representation’ is likely to be challenged in the long run, once the government introduced taxes on Saudi nationals, paving the way for demands for reforms as well as more transparency in state affairs. Though the possibility for such an eventuality remains minimum at this time, yet the government’s decision to introduce taxes will certainly figure this variable at the time of formulation.

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MILITARY ENGAGEMENT IN YEMEN The prolonged Saudi military intervention in Yemen to roll back the advances made by the Houthi rebels and reinstate the UN-backed pro-Saudi Hadi government has been one of the greatest sources of concern for Riyadh. Amidst major cutbacks and austerity measures, the military intervention is contributing to the fiscal deficit and burdening the government coffers. With limited tactical advances, the overall scenario is more of a stalemate, and with the lack of a concrete withdrawal plan in place, the economic liability is likely to persist. In addition to the operational cost, it is also likely to impinge on the overall Saudi defense procurement bill to replenish the inventory with stocks being used in the ongoing conflict, further adding to the fiscal troubles for the Kingdom. This has thus contributed to the rise in unpopularity of the military engagement. Moreover, the casualties sustained, although are limited keeping in mind the extent of the Kingdom’s involvement, is expected to add to the opposition from the local population.

Image of Saudi fighter jet bombing a location in Yemen

AN OVERVIEW OF BUSINESS FORECAST FOR SAUDI ARABIA: PROSPECTS & CHALLENGES

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THREAT OF MILITANCY Given that the region is a hotbed for multiple militant groups including Islamic State (IS) and al-Qaida in Arabian Peninsula (AQAP) and the ever increasing interest of these groups to target the Kingdom, highlights the persistent threat of militancy in the country. This view is further bolstered by recurrent reports of militant arrest and foiled militant plots. In this context, two suspected militants were killed in Riyadh's Yasmeen district, injuring one security officer in January as well as foiling of an attack on the US consulate in Jeddah in July 2016. Moreover, the country is host to a sizable population sympathetic to the IS and AQAP ideology posing a serious threat of militancy across the Kingdom. Additionally, an uptick in attacks targeting security personnel has been recorded in the restive Eastern province’s Qatif region by Shia militant groups for their alleged sense of marginalization by the government in Riyadh. In this context one soldier was reportedly killed, five wounded in an RPG attack in Qatif in May. Though the recorded attacks have remained localized and the modus operandi unsophisticated, coupled with multiple instances of civil unrest, the issue remains a matter of concern for the Saudi authorities.

Image of medical staff aiding injured civilians in the militant attack on a mosque in Qatif Region

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REPATRIATION OF EXPATS As part of the overall ‘Saudization’ process, a sizable number of layoffs of expats is expected to continue. In this regard, Saudi Binladin Group, a leading construction company laid off around 70,000 foreign nationals in May 2016. Furthermore, reports quoting the Ministry of Civil Services indicates additional layoffs of foreign nationals in the public sector remains likely by 2020. Given the existing discrepancy in the demands of the private industry and the level of the vocationally trained Saudi population, it remains likely that any significant deviation in such a short duration is likely to significantly stall attempts to maintain or enhance the productivity of the industry. Moreover, given that majority of the blue collar jobs have been secured by cheap labor from Asia including India, Pakistan, and the Philippines, replacement of these by Saudi nationals are likely to have a bearing on the overall costs, as the local labor is likely to be more expensive.

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CONCLUSION Given that the ambitious Saudi Vision 2030 plan is in the initial phases of development it provides a host of opportunities for investments and growth, especially the highly lucrative Defence, Energy and the Vocational training and education sector among others. Moreover, most of these ventures being capital intensive, are likely to feature employment of the Public-Private Partnership model with a major emphasis on the effective utilization and employment of local population and resources. This is likely to achieve two main objectives: generate employment among the local population and reduce reliance on expat population and at the same time enable development of indigenous capabilities through technology transfers which in the long run will support the larger goal of diversifying the economy. However, the proposed measures when enforced are likely to result in multiple socio-economic changes which are expected to result in significant opposition from both local entities as well as foreign corporates whose vested interests are likely to be compromised as a result of these measures. Moreover given the heavy investments are likely to significantly influence the global debt market over the coming decade.

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OVERVIEW OF BUSINESS FORECASTS FOR SAUDI ARABIA ...

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