Saudi Crown Prince’s Transformation Straining Economy, Boosting Oil Wealth

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(Bloomberg) — Saudi Arabia is facing the most precarious moment in its economic reinvention.

Eight years after Crown Prince Mohammed bin Salman unveiled Vision 2030, his plan for life after oil, delays and cutbacks in the multi-billion dollar transformation are exposing the strain on the kingdom’s finances.

With a budget deficit for six consecutive quarters, Saudi Arabia has become the largest issuer of international debt in emerging markets. And its decision to cut oil production along with other OPEC+ members in 2023 has failed to substantially increase its export revenues.

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Here’s an overview of the main stress points.

Petrodollar Dependence

The Gulf country’s oil revenues have fallen by about a third from 2022 levels, when Brent crude averaged around $100 a barrel, due to Russia’s invasion of Ukraine. That’s weighing on the kingdom’s overall economic stability as it continues to spend on Prince Mohammed’s massive projects, which include everything from the new city of Neom to resorts, soccer leagues and investments in artificial intelligence.

“The vision is facing a reality check and adjustments are being made,” said Jean-Michel Saliba, Middle East and North Africa economist at Bank of America Corp. “This is a sign of maturity. I don’t think it means the vision is being derailed.”

Goldman Sachs Group Inc. found that Saudi Arabia’s sovereign risk score, a measure that takes into account financial and governance parameters, deteriorated the most among emerging markets after Israel in the first half of the year. A ranking by Morgan Stanley in June reached a similar conclusion, with the kingdom among the “top laggards.”

High expenses

“My biggest concern is that increased spending will lead to substantial deficits that are structural, rather than temporary or cyclical,” said Justin Alexander, principal at Khalij Economics and an analyst at consultancy GlobalSource Partners.

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The debt increase reflects the evolution of Saudi finances over the past decade. While still low by international standards, the share of public debt in economic output rose from 1.5% in 2014 to more than 31% by the end of the decade, according to the International Monetary Fund.

Saudi Arabia could face increased scrutiny in the bond market and from credit rating agencies if the ratio « rises faster than expected, » Alexander said.

Record debt

The Saudi government and other entities, including banks, the sovereign wealth fund and oil giant Aramco, have raised more than $46 billion in dollar and euro bonds since the start of the year. That means Saudi Arabia has overtaken China as the most prolific developing country issuer in international bond markets, according to data compiled by Bloomberg.

« Budget deficits will have to continue to be financed both by external Eurobond issuance and by domestic issuance, » said Carla Slim, economist at Standard Chartered Plc.

However, the government has the flexibility — as it is already showing — to reduce or delay investment in its so-called gigaprojects, according to Jim Krane, a research fellow at Rice University’s Baker Institute for Public Policy in Houston.

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« Since there is no organized political opposition, there is no harm in reducing or even making a radical U-turn in your 10-year development plan, » Krane said.

Liabilities on the rise

The country’s external financial position is under pressure due to rising imports. The current account balance, the broadest measure of trade and investment, will fall to near zero in 2024 and turn into a deficit from next year, the IMF forecasts, after running a surplus of 13% of GDP in 2022.

One result is « an unprecedented increase » in foreign commitments by Saudi lenders, according to Barclays Plc, given their growing role as a provider of hard currency to help meet domestic financing needs.

Saudi banks are still struggling to raise funds locally, as evidenced by the interest rates they charge each other for loans. The three-month Saudi interbank rate has averaged a record high of more than 6% this year.

According to the IMF, the Saudi government needs the price of Brent crude to be around $100 a barrel to balance its budget, about $15 higher than current levels. Bloomberg Economics estimates that the equilibrium price is $109 a barrel, once domestic spending by the Public Investment Fund (the sovereign wealth fund) is taken into account.

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Foreign investment

Foreign direct investment has been slow to materialize outside the oil and gas sector, making it more difficult for the crown prince to realize his ambitions.

The government wants to attract $100 billion in FDI a year by 2030, about three times what it has already achieved. Inflows reached about $2.5 billion in the first quarter, according to government data, a fraction of this year’s target.

FDI was just $12.3 billion in 2023, 60% less than that of neighboring United Arab Emirates, a much smaller economy, according to the United Nations Conference on Trade and Development.

That’s partly why non-oil growth, a crucial indicator for the government, slowed in the first quarter to its slowest pace since the coronavirus pandemic. It’s one reason the IMF recently downgraded its forecast for Saudi Arabia’s overall economic expansion this year to 2.6%. By the end of 2023, it had been forecasting 4%.

Authorities are forecasting budget spending of about $333 billion this year, down from 2023, underscoring the government’s new caution.

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Even so, the kingdom’s budget will remain in the red for years, meaning that national institutions like the PIF and Armaco will remain responsible for many mega-projects.

What Bloomberg Economics says…

“The biggest obstacle facing Saudi Arabia remains its unwavering dependence on oil. While the kingdom has tried to raise prices through OPEC+, supply from elsewhere has hampered its efforts. The authorities must spend to keep the economy running and the population happy, but they must also maintain enough restraint to contain the budget deficit.”

— Ziad Daoud, Chief Emerging Markets Economist. Read more here.

Despite all the setbacks and pressures, the crown prince is determined to achieve his goals, even if they take a different form.

“The transformation is now institutionalized,” said Karen Young, a senior fellow at Columbia University’s Center for Global Energy Policy. “The process of large-scale diversification is well underway, and I don’t see much chance of going back.”

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