Austerity Arrives in the Kingdom

For the first time in living memory, the Saudi government has embarked on a major austerity drive. In early June, state workers saw their generous cost-of-living allowance abruptly cancelled. Capital expenditure on iconic mega projects has been put on hold as well. In a move illustrative of the sense of urgency felt by Riyadh, the value-added tax rate was tripled to 15 percent. The kingdom introduced VAT just two years ago in a first attempt to address the fiscal deficit that had been on track to reach almost $50 billion (6.5% of GDP) this year – before the Corona pandemic struck.

The recent drop in oil prices has pulled total government revenue down by 22 percent over the first three months of the year, forcing deep cuts in allocations for the Vision 2030 programme. Emergency policy initiatives to fight the spread of the novel coronavirus have also curbed the pace and scale of the economic reforms reforms introduced by Crown Prince Mohammed bin Salman.

According to Finance Minister Mohammed al-Jadaan, the austerity measures are necessary to maintain financial end economic stability over medium to long term and overcome the ‘unprecedented crisis with the least damage possible’. In April, the Saudi Arabia Monetary Authority (SAMA) reported a $24.7 billion drop in its foreign reserve assets – the sharpest decline in over two decades. The kingdom’s central bank tried to limit the damage by shifting $40 billion to the Public Investment Fund (PIF). The one-off transaction enabled the Saudi sovereign wealth fund to snap up shares on the cheap on the world’s major stock exchanges.

SAMA has repeatedly reiterated its commitment to maintaining the Saudi riyal’s peg to the US dollar and has demonstrated the kingdom’s continued financial strength by raising billions in new debt. Based on the domestic money supply, it is estimated that the central bank needs about $300 billion to maintain the currency peg, putting considerable pressure on the kingdom’s $450 billion reserves, mostly held in US Treasury Notes. Al-Jadaan said that he intends to cover the persistent fiscal deficit with a mix of expenditure cutbacks, new borrowing, and dipping into reserves.

Market watchers keep their eyes trained on the size of the $300-billion Public Investment Fund which has been designated as the main conduit for the diversification of the Saudi economy. In the first quarter of the year, the fund acquired $500 million stakes in each of Facebook, Walt Disney, and Marriott International. PIF also invested similarly significant amounts in Cisco Systems, Bank of America, and Citigroup stock. In a sign that they are willing to take on risk, the Saudis bought a $714 million stake in aircraft manufacturer Boeing and a $450 million stake in cruise operator Carnival – two companies hit particularly hard by the corona pandemic.

However, an attempt to acquire UK Premier League club Newcastle United for $365 million has raised considerable objections domestically and is seen as inappropriate given the troubled times. Though supported by most of the club’s fans, the proposed takeover is questioned over a possible conflict of interest. Prince Abdullah bin Mosaad, a prominent member of the royal family, already owns Sheffield United. The Premier League must now decide if Saudi business practices could cause a conflict with its rules on club ownership.

Most of the PIF investments in Q1 2020 were generally well-timed and allowed the fund to maximise its exposure to the recent bull market that saw major indices gaining up to 40 percent in barely 10 weeks. However, the strategy may yet backfire as markets slowly come to grip with the full extent of the pandemic and optimism is replaced by realism.

The Saudi sovereign wealth fund has been an exception in the region. Other public investment funds are mostly sitting tight with a wait-and-see attitude. Much bolder than most, the PIF is seen taking a considered gamble on the kingdom’s pool of capital which is becoming increasingly finite as the world moves away from hydrocarbons. The recent oil spat with Russia over production volumes has added considerably to the financial woes facing Al-Jadaan, depressing oil revenues by well over $24 billion so far this year. To balance the budget, Saudi Arabia needs oil prices to hover around the $70 a barrel mark, a level that seems unattainable for the foreseeable future.

With a relatively young and restless population, recently exposed to the slightly more liberal rule of Crown Prince Bin Salman, the budgetary restraints introduced in the wake of the pandemic may upset an already precarious societal, if not political, balance. The prince’s ambitious and far-reaching reform programme has whetted the appetites of the young and will prove hard to undo. Suddenly, the kingdom’s future looks much less promising than it did just a few short month ago. “I think Vision 2030 is essentially finished,” says Michael Stephens of the London-based Royal United Services Institute for Defence and Security Studies: “Saudi Arabia is facing the hardest time it has ever been through and certainly the most difficult period of Mohammed bin Salman’s tenure.”

The government is aware that the austerity measures unveiled in May, will mostly be felt by those least able to afford them. However, Al-Jadaan emphasised that the government faces a set of difficult choices and can longer postpone changes to the welfare state. This may undermine the social/political covenant that has allowed the kingdom’s rulers to maintain their position largely unopposed in return for lavish benefits bestowed on the population.

The austerity measures have by no means completely disassembled the famed Saudi welfare state. Its largess is still unequalled. At the outbreak of the corona pandemic, the government paid for the repatriation of its subjects and quarantined returnees at luxury hotels with all expenses paid for. It also covered 60 percent of the paycheques of private sector workers, suspended layoffs, offered interest-free loans to households, and slashed utility bills.

Gulf analyst Karen Young of the American Enterprise Institute wonders if the Saudi government has perhaps failed to adjust its operating philosophy – and expenditure – to the leaner times ahead: “At current spending levels, the kingdom will run out of money in three to five years.” Young says that the day of reckoning may be pushed back a few years by aggressive public borrowing. With a current debt-to-GDP ratio of barely 30 percent, there is some room for growth before a hard limit is reached. Meanwhile, the government hopes to foment a new form of ‘fiscal nationalism’, that has Saudis pay – albeit modestly – for the privilege of being part of a generous nation.

A cautious optimism is, however, not misplaced. Middle East sovereign wealth funds boast an estimated $2 trillion in assets – funds essentially put aside up for a rainy day. As it starts pouring, these pools of cash may be deployed to boost economic diversification, offer solace to populations, and experiment with novel business models. The International Monetary Fund (IMF) forecasts Saudi Arabia’s GDP to contract by a relatively modest 6 or 7 percent this year. Other Gulf Cooperation Council (GCC) member states will also see their economies shrink considerably but may expect a strong rebound in 2021. Moreover, most regional banks are well capitalised although reluctant to pass on the emergency support funds released by central banks.

Ultimately, the corona pandemic is likely to accelerate transformations already put in place long before the viral outbreak occurred. The era of limitless spending may have come to an early close, that does not imply that the money has run out. In his statements, Al-Jadaan emphasises that most austerity measures are temporary in nature and will likely be reversed as soon as the pandemic has abated, and oil prices return to their previous level. Business as usual may have been disrupted by the pandemic, new opportunities will arise before long. In short, few regions are actually better poised to seize the post-corona moment then the financial powerhouses and innovators of the Middle East.