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08 August 2018

Saudi Arabia bolsters its economy

A market report by Ehsan Khoman, Head of MENA Research and Strategy at MUFG, deliberates on Saudi Arabia’s economic transformation agenda

bloomberg/Luke MacGregor

Economic Developments

 Emerging from technical recession, real GDP in Q1 2018 grew by 1.2 per cent year-on-year compared with -1.2 per cent year-on-year in Q4 2017 (and a decline in GDP of 0.7 per cent for 2017 as a whole). The breakdown suggests that the rebound was primarily driven by the oil sector (0.6 per cent yearon- year in Q1 2018 against -4.3 per cent year-on-year in Q4 2017). Meanwhile, there was also positive momentum from the non-oil sector (1.6 per cent year-on-year in Q1 2018 against 1.3 per cent year-on-year in Q4 2017) buttressed by strong growth in the manufacturing industry. Looking ahead, four years after oil prices began to precipitously fall, we continue to witness signs that Saudi Arabia has begun to structurally adjust to the lower energy earnings environment and we expect growth to gather further pace in the near-term.

The Kingdom’s new bankruptcy law will act as a conduit to investment growth. Saudi Arabia introduces its first comprehensive bankruptcy law on 18 August. This is the latest development of a string of reforms under Vision 2030 to further encourage foreign direct investment (FDI) into the Kingdom by structuring the business legal framework. Specifically, the law details provisions related to the liquidation, settlement and financial reorganisation since the current applied legislations are not sufficiently governing the procedural and judicial aspects of these essential matters. In addition, the law will protect creditors’ rights, reduce the costs and timeframe of the bankruptcy procedures and encourage SMEs to invest in the commercial market.

Politics and diplomacy

Saudi Arabia is expected to switch Bahraini support to from unconditional/ implicit to conditional/explicit. Saudi Arabia, Kuwait and the UAE have announced a financial support package for Bahrain after an acute sell-off of the country’s bonds and currency. However, we view that Saudi support which was historically unconditional/implicit in nature will shift to being conditional/ explicit with the Bahraini authorities expected to front-load the delivery of fiscal consolidation (spending cuts and non-oil revenue expansion) pledges. Indeed, Crown Prince, Mohammed bin Salman (MbS) is more pragmatic, less committed to old norms of solidarity and more importantly, cannot be viewed as providing assistance to an ally (Bahrain) that fails on reform implementation whilst its own population in Saudi Arabia is adhering to austerity measures.

This could be the game changer that markets have been waiting for, with investors taking more comfort in the forward guidance type structure of reform execution in Bahrain given the conditionality of Saudi led support owing to the delivery of reform promises. Heightened animosities amongst OPEC+ energy ministers could affect diplomatic ties. There continues to remain a disagreement on the precise magnitude of the increase in oil production amongst OPEC+ members—OPEC+ reached a consensus on 23 June to strive to adhere to the overall conformity level of the agreement for 100 per cent compliance with the overall production ceiling agreed back in January 2017 (1.72 million barrels per day of production cuts). Saudi Arabia and Russia declared that the total increase in output needed would be up to one million barrels per day.

Meanwhile, Iran saw no more than 500,000 barrels per day of additional output. Ultimately, it is the opinion of countries that have the spare capacity to produce more that matters, primarily Saudi Arabia and Russia. Last month, Iran warned Saudi Arabia that any breach of OPEC+ oil production ceiling will hamper the effectiveness of the organisation and a violation of the agreement to revive output. Overall, whilst the consensus agreement by OPEC+ was meant to offer clarity on oil market supply-demand balances, we view that considerable risks remain in relation to the oil price trajectory given the deviations in interpretations of the production increases by OPEC+ members. Compliance adherence will remain central to the determination of the front-end of the oil price curve.

National Transformation Programme (NTP) 2020 and Vision 2030 developments

Saudi Arabia’s new private sector participation (PPP) law will likely strengthen efficiency gains. In line with Vision 2030 objectives to increase the participation of the private sector to GDP from 40 per cent to 65 per cent, the National Centre for Privatisation (NCP) has announced a draft law aiming to organise partnerships between the government and the private sector in preparation to launch a multifaceted set of projects. In April, the government announced plans to generate between $9-11 billion in revenue by 2020 through a privatisation programme that will create as many as 12,000 jobs.

Moreover, the government said that the initiative would target 14 separate public-private investments worth between $6.4-7.4 billion, and will lead to the corporatisation of the Kingdom’s ports, the production portion of the Saline Water Conversion Corporation (SWCC), as well as the Ras Al Khair desalination and power plant. Overall, we view that this new PPP framework will unlock large-scale investment across a broad spectrum of sectors by offering significant credible assurances to private investors to operate under PPP contracts. Saudi Arabia is expected to be added to the JP Morgan emerging market (EM) bond index. In line with Vision 2030 targets to expand the financial sector and following on from the inclusions in both the MSCI EM and FTSE EM indices, Saudi Arabia is on the verge for a third major success, with the likely inclusion the JP Morgan EM bond index. We view that this will represent a further fillip to the country’s Vision 2030 plans to make its financial market more internationally tradeable, and in turn lower the sovereigns cost of funding, supporting their debt issuances and clearly deepen the breadth of the financial sector, and in-turn raise the share of non-oil GDP. 




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