The Kingdom is Transforming. Saudi at a. Crossroad

The Kingdom is Transforming Saudi at a Crossroad May 2017

Saudi at a Crossroad Table of Contents 1. Executive Summary 3 2. Country Fact Sheet 4 3. Historical Background 4 4. The Need for Change 6 A. Fall in Oil Prices 6 B. Geopolitical Turbulence 8 C. Changing Internal Affairs 9 5. Transformation Plan 11 A. Vision 2030 11 B. National Transformation Program 2020 13 6. Conclusion 18 2

1. Executive Summary From being a latent desert region, home to Bedouin tribes to becoming a G20 nation home to bustling cities such as Riyadh and Jeddah in less than 100 years, the rise of Saudi Arabia to become the strongest economical force in the Middle East has been an intriguing one. However, the kingdom stands at a crucial point in its history. picture of a dramatically transformed Saudi Arabia as a progressive modern nation with a diversified market-driven economy. A National Transformation Program 2020 was launched as a stepping stone to achieving this vision. All things considered, the kingdom has a challenging road ahead and a few defining Facing an economic crisis where the country s budget deficit reached 15% for the first time in its history, it is evident that the country is in a turbulent time. For a country where the petroleum industry accounts for almost 87% of budget revenues and 42% of GDP, the huge drop in oil prices hit the Saudi economy very hard. A festering geopolitical situation has cast its shadows with questionable Saudi involvement in Yemen and Syria. The instability persists internally with rising unemployment and growing social discontent. To address these challenges, Saudi Arabia now looks at making serious changes in its core in the form of the 2030 vision championed by Prince Mohamed bin Salman Al Saud. The vision paints an ambitious years, not just for the future of the country, but for the region altogether. In this series of reports, Quick-Wins sheds light on the Saudi transformation journey. We analyze the challenges, opportunities and transition imperatives facing Saudi Arabia, and the potential social and economic repercussions. This report provides a broad picture of where Saudi stands today, recounting the factors that built the case for change, and introducing the Saudi s leadership plan for transformation. Upcoming reports discuss at greater length issues that require adequate focus such as empowering Saudi human capital, government performance, and sectors expected to witness great growth in the near future. 3

2. Country Fact Sheet Saudi at a Crossroad National Facts: King: Salman bin Abdul-Aziz (2015 - Present) Head Of Government: Crown Prince Mohamed bin Nayef Surface Area: 2,149,690 km2 Bordering States: Yemen, Oman, UAE, Iraq, Qatar, Kuwait. Demographics: Population: 33,000,000 Unemployment Rate: 12% Female to Male Unemployment Ratio: 6.9-1 Female Labor Force Participation: 20.1% Social and Government Indicators: Ease Of Doing Business Index (rank): 94 Human Development Index(rank): 38 Corruption Perception Index (rank): 62 Global Competitiveness Index( rank): 29 Freedom Of Press Index (rank): 165 3. Historical Background Saudi Arabia was established in September, 1932 by King Aziz Ibn Abdul Rahman Ibn Al- Saud after he managed to unite the lands of the Hejaz and Najd. Shortly afterwards huge amounts of oil were discovered near Riyadh by the Arabian American Oil Company (Aramco). This discovery led to a huge influx of wealth to flow into the kingdom transforming its mud houses into soaring towers. Slowly but surely the country started to become more Westernized as a result of its alliance with the USA while at the same time trying 60000 50000 40000 30000 20000 10000 0 Saudi GDP Per Capita PPP 2007 2008 2009 2010 2011 2012 2013 2014 2015 Standards Of Living: Nominal GDP Per Head: 21,312.81$ Nominal GDP Per Head at PPP:50,283.93$ Real GDP Per Head: $18,410.95 Gender Inequality Index (rank): 50 to stay in root with its conservative Islamic tradition. These two factors will remain at constant struggle throughout the years. 4

In the early 1970s, the country experienced its first oil boom with major increase in prices. The period from 1970 to 1981 the country s economy started to enhance, economic growth begun to increase and real GDP reached 11%. After this period, the economy took a downturn from 1981 to 1987. The country tried to maintain the high price level by cutting production. The following 15 years the economy was almost stable averaging 3% growth rate annually. The second oil boom was from 2003 to 2013. As the country derived 87% of its government income from oil production, the Kingdom quickly felt the effect of quadrupled oil prices, bringing around an era of prosperity. During this period, the annual average of oil prices reached $110/ $115 per barrel in 2011 to 2013 before falling back in 2014. High oil prices caused an increase in government revenue, which derived the economy to a positive income shock and tripled the real gross domestic income. The real GDP increased by 6% annually and even the nonoil private sector reached a growth of 10% annually. The government attracted inflows for FDIs with almost 1.1 trillion SAR over the decade, mostly in the petrochemicals sector. In addition, the income of households increased significantly by almost 75%. The unemployment rate decreased mainly in the public sector that hires 70% of working Saudis. The government generated 1.7 million jobs, and 1.1 million of them were in the public sector. The government increased investments in infrastructure, health, and education, to reach the world s 19th largest economy after it was the 27th before the boom. GDP 800 700 GDP per Year 600 500 400 300 200 100 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Index Mundi, 2017 Year 5

4. The Need for Change A. Fall in Oil Prices The significant drop in oil prices started from $115 per barrel in the beginning of 2014 to fall under $35 per barrel in 2016. During this period, the oil industry experienced one of the sharpest falls in oil prices in history. This fall was caused, and sustained, by a number of intertwining factors: The expected intense competition in the market with an increasing global oversupply and the anticipated return of Iranian crude oil exports, following the lifting of the sanctions that resulted in multi-year lows. However, prices have started to stabilize after an agreement among OPEC members to combat price drops through production cuts during the first half of 2017. Saudi at a Crossroad US oil producers have apparently taken out a record number of contracts on short positions against the US crude oil benchmark WTI (West Texas Intermediate), thereby protecting themselves against a drop in prices. According to the US Energy Information Agency s short-term energy outlook report, US production is projected to be 630 tbpd higher than its January 2016 forecast, which amounts to roughly half of the proposed OPEN cut of 1.2 mbpd. More significantly, even if OPEC fails to fully implement its own cuts, and oil prices consequently decline, US producers will still be able to expand output since they have locked in current price levels for at least six months through hedges. In an industry that faces a surplus of 2 million barrels per day and with increasing production by the US, Saudi Riyal per barrel/month Saudi Riyal per Barrel 500 450 400 350 300 250 200 150 100 50 0 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Month 6

the oil prices are not likely to rise any time soon. Coincidentally, the US energy sector witnessed another major change in the past few years, namely the shale gas revolution. Advances in oil and natural gas production technology, specifically a new combination of horizontal drilling and hydraulic fracturing, resulted in an immense surge in extraction rates. The shale gas boom, combined with easier access to new and vast natural gas supplies, has led the US shale gas production to increase dramatically over the past decade. This in turn led to a resource surplus and substantially lower prices. However, unlike oil, the boom in shale gas did not stop with the fall in prices, partially due to innovations in drilling techniques which allowed production to remain profitable despite the drop in prices. Shale gas has significantly altered the US gas market and energy mix, reducing the country s dependence on oil imports to 39% as opposed to 60% in 2005. This expected self-sufficiency in oil and gas is bound to reflect on other oil-producing companies as Saudi Arabia. Increasing the demand level could solve the increase in the supply in the oil market. However, this is not happening as several Asian countries like China, India, Indonesia, and Malaysia are decreasing their demand for oil and have begun cutting energy subsidies to strengthen their fiscal position. 7

B. Geopolitical Turbulence When it comes to Saudi Arabia s external affairs, the two issues that dominate the headlines today are Saudi s involvement in Yemen and Syria. Both are only understandable in the bigger context of the longstanding Saudi-Iran conflict. The Saudi-Iran conflict began with Ayatollah Khomeini s rise to power in the late 70 s. Tensions between the two countries grew with Ayatollah Khomeini encouraging Saudis to rise against Al Saud s rule in the 70 s, to Saudi Arabia supporting Iraq in the Iran-Iraq war to the Saudi police opening fire on Iranian pilgrims in the 80 s. The War on Yemen In 2011, protests in Yemen led the then president Ai Abdullah Saleh out of his office and left his deputy, Hadi in power. The instability continued and allowed Islamist groups such as Al Qaeda to conduct violent attacks that ultimately gave them control over Southern Yemen. Another group, the Houthi movement, which represents the Zaidi Shiite minority, took over territory in Northern Yemen. In 2014 the Houthis entered Sana a, the capital of Yemen while Hadi was forced to escape to Aden. As the Sunni dominant Saudi Arabia shares a 1100-mile border with Yemen, Houthi s assimilation to power was regarded as a huge threat in the light of Saudi s decades long conflict with the major Shia power in the Middle East, Iran. In 2015, a Saudi-led coalition started to conduct air strikes on Houthi Yemen in what was known as Operation Decisive Strom. The expectation to quickly get rid of the Iranian backed Houthis was soon proven imprecise as Operation Decisive Storm turned into Operation Restore Hope. Since the beginning of Saudi s Operation, a large number of Yemeni civilians have been killed with a further more injured and a significant percentage of Yemen s population in need of some kind of humanitarian or protection assistance. All this comes with the Saudi forces not much closer to defeating the Houthis than they were at the beginning of the operation. This war has also come at billions of dollars in expense for Saudi Arabia, at a time when it is already facing economic hardships. Involvement in Syria In Syria as well, Saudi s alleged involvement in supporting and supplying rebel groups with arms stems from the fact that President Bashar al-assad is a central ally to Iran in the region. There have been previous speculations over Saudi sending ground troops into Syria, a move which is bound to escalate an already dreadful situation. 8

C. Changing Internal Affairs Volatile Socio-economic Situation Saudi Arabia s estimated population stands at 32,158,000 (2016) of which 50% are under the age of 25. Foreign workers make 33% of the total population. The population growth rate in Saudi Arabia was 1.9% in 2013 and is likely to be higher today. The country has a high unemployment rate of 12%, with the rate for youth unemployment at 28%. Women hold 35% of all unemployment. One of the main concerns in the Kingdom today is the extent to which the government s financials will be able to sustain the growing demographics. In past times, unemployment did not present a threat to the Saudi government as it has been able to offer considerable subsidies and benefits to citizens from the huge profits made from the oil trade. However, with the recent economic troubles facing Saudi Arabia, these subsidies and benefits are being cut and there are speculations to the reactions that cutting subsidies and benefits will have amongst the population. Some of the austerity measures implemented last October have already been reversed. A royal decree in April restored cancelled privileges and financial incentives to civil and military officials. At the moment, the Saudi public sector employs more than two-thirds of all Saudis, and coupled with unemployment benefits and subsidies, the share of Saudi household income coming from the government is on average about 80%. This of course does not apply to the expatriates and their families, the group most likely to be the hardest hit by the hard times facing the country. Saudi Arabia introduced a new levy on foreign workers that will make life in KSA harder for poor Asian expats and more inconvenient for better-off Western expats. An income tax will also be introduced that expats will have to pay. This is done in an organized effort to get rid of some of the expat population as to open jobs for Saudi Arabian nationals. However, even if the government stopped the immigration of expats and replaced the current expats with 800,000 Saudis from now till 2030, there will still be an unemployment that hovers around 20% with a downfall in the average household income. Training and qualifying local workforce to fulfill all positions will also be a challenge. 9

A Change in the Monarchy The kingdom has also faced a momentous change to its system after the death of King Abdullah in 2015. After which, King Salman bin Abdul Aziz assumed power and removed his half-brother and King Abdullah s choice for crown prince (Prince Muqrin) for Prince Mohamed bin Nayef. This is such a huge decision considering that the monarchy system in Saudi has been known for decades to work in horizontal way with the sons of Abdul-Aziz taking power in turns one after the other. With Prince Mohamed bin Nayef crowned as crown prince he is set to be the first prince from the third generation to assume power. King Salman also put his own son, Mohamed bin Salman, as deputy crown prince in what some think is an attempt to change the power structure from a horizontal one into a vertical power structure. Sensing the dire need for change, the Saudi leadership has publicly shared its vision to transform its economy by 2030, through its National Transformation Program (NTP) 2020. The vision 2030 provides a framework to move away from an oil centric economy to an economy which is heavily diversified in the economic, human and social spheres. King Abdullah King Salman bin Abdul Aziz Prince Mohamed bin Salman Prince Mohamed bin Nayef 10

5. Transformation Plan A. Vision 2030 In April 2016, Deputy Crown Prince Mohamed bin Salman announced Saudi Vision 2030. The main purpose of this vision is to Nevertheless, the vision is not exclusive to economic development but also includes some social goals that aim to tackle unemployment and gender diversity. Saudi Arabia The heart of the Arab and Islamic worlds, the investment powerhouse, and the hub connecting three continents If this vision is executed as planned the economy would grow by almost two-fold to Saudi at a Crossroad cruise beyond economics of countries like Switzerland, Turkey and Mexico and emerge as the 15th largest economy globally. The plan aims to increase the private sector s contribution to real GDP to around 65% and increase the foreign direct investment to 5.7% of GDP by 2030 from the current 3.8% by facilitating access to investing and trading in the stock markets. This plan also aims to increase home ownership from 47% to around 52% by 2020 while heavily supporting SMEs to receive support through easing regulations and enabling greater access to funding as it is planned to have their contribution from 20% to 35% of the economy. The government plans to increase its non-oil revenues to reach SAR 600 billion from its current SAR 163 billion and this would enable the government to balance its budget if achieved. Government Government Revenue By Source (Billion ( $) Billion $) 120 100 80 60 40 20 0 2003 2013 2030 Oil Non-Oil 11

Furthermore, the government aims to build the world s largest sovereign wealth fund with a value of SAR 7 trillion, through selling a 5% stake in Saudi Aramco (the Saudi Arabian Oil Company) and this would increase investment income to exceed oil revenues by 2030. Aramco is believed to be worth $2 trillion. If this is true, the panned IPO (initial public offering) will be the biggest the world has ever seen. Saudi Arabia has the third highest military spending in the world, trailing only the US and China, which is why another goal of the vision 2030 is localize 50% of all military spending. This includes manufacturing of sophisticated aircrafts inside of the country. It is worth nothing that currently Saudi imports 98% of all its military needs. Another target of the 2030 vision is to create a 10$ billion financial hub to be named King Abdullah Financial District. It is planned to be a special zone that has competitive regulations and procedures, with visa exemptions and directly connected to the King Khaled International Airport. There are also plans for other special zones in logistics, tourism, industry and finance with special commercial regulations put in place to boost and encourage investment. 12

This plan also aims to decrease unemployment to 7% while increasing the female participation in the work force to around 30% by providing 1,000,000 jobs in the retail sector and adding 90,000 jobs to the mining sector. On another note, the vision also aims to improve the education system so that in runs in harmony with the vision while preserving the Islamic values. Beside the social and economic goals there are a couple of goals regarding tourism such as increasing the number of tourists who perform Umrah each year from 8 million to 30 million and creating various touristic areas that offer a cultural and historical tourism along the red sea. Selected Vision 2030 Goals Selected Indicators 2015 2030 Private Sector Share of GDP 40 65 (+25) SME % of GDP 20 35 (+35) Gas production, billion cubic meters 108 216 (+108) % of GDP 6.7 16.8 Non-oil exports/non-oil GDP 16 50 FDI, % of GDP 3.8 5.7 Unemployment rate, % 11.6 7 Local procurement of oil services, % 40 75 Local procurement of defense equipment, % 2 >50 13

B. National Transformation Program 2020 Saudi at a Crossroad The National Transformation Program for enabling and supporting the launch, (NTP) can be considered as a milestone or monitoring, and evaluation of these roadmap towards achieving Saudi Arabia s Vision 2030. This roadmap includes a programs, as well as the release of new programs in the future. number of domains- strategic objectives, targets, outcome-oriented indicators, and commitments that are to be achieved by the public, private and non-profit sectors, with an estimated cost of around SAR 270 billion. The main components of the National Transformation Program are: Increasing the efficiency of capital and operational excellence Increasing non-oil revenues To ensure the success of this vision, the Kingdom has established a number of organizations like the National Center for Performance Measurement, The Delivery Unit, and the Project Management Office of the Council of Economic and Development Improving the efficiency of government support, including directing it to the groups of the society that need it most Promoting and supporting the economic growth and of the private sector Supporting industrial sectors of strategic Affairs. Those bodies are responsible importance and economic potential. 14

As mentioned, the NTP includes a large number of targets in a variety of domains. Below are a few highlights: Public Finances Increasing non-oil revenue from SAR 163.5 billion to SAR 530 billion Decreasing public-sector wages from SAR 480 billion riyals to SAR 456 billion Increasing annual non-oil exports from SAR 185 billion to SAR 330 billion Water and electricity subsides to be cut down by SAR 200 billion riyals (the tariff charged on water would cover 100% as opposed to the current 30%) Percentage of new jobs in the civil service to decrease from 5% to 1%. Increasing foreign direct investment (FDI) from SAR 30 billion riyals to SAR 70 billion Economic Development 450,000 new jobs to be created Real estate contribution to total economic output to increase from 5% to 10% with a 7% annual growth rate SAR 300 million to be spent over 5 years to create center of excellence to support the privatization of government owned companies GDP percentage coming from the pharmaceutical industry to rise from 0.98% to 1.97%. GDP percentage coming from information technology to double from 1.12% to 2.24%. The media industry contribution to the economic output will increase from SAR 5.2 billion to SAR 6.64 billion Public and private sector expenditure on local content to increase from 36% to 50% Increasing the volume of private sector investments in high-potential less-developed regions from zero to SAR 28 billion Increasing the size of private sector s new investments from SAR 681 billion to SAR 1.065 trillion Business Environment Improve Saudi Arabia s global ranking in terms of ease of doing business from No. 82 to No. 20 To decrease average resolution time for commercial cases from 575 days to 395 days. To improve Saudi Arabia s rank on World Banks s contract Enforcement Indicator from 85th to 50th 80% of the Justice Ministry s service to delivered electronically To increase female participation in the workforce from 23% to 28% and to increase the number of women in civil services from 39.8% to 42% To reduce average time required to approve new residential projects from 730 days to 60 days To reduce the time needed to issue a new business permits from 19 days to 1 day 15

Energy and Mining To maintain oil output capacity at 12.5 million barrels per day, while increasing refining capacity from 2.9 million to 3.3 million barrels per day To increase output capacity of dry gas from 12 billion cubic feet per day to 17.8 billion To generate 4% of national power from renewable energy To increase the mining sector s contribution to the economic output from SAR 64 billion riyals to SAR 97 billion Enabling atomic energy to contribute to the national energy mix. Health Care To increase the private sector s contribution to health care from 25% to 35%. Plan for reforming and restricting primary health care estimated to cost SAR 4.7 billion 70% of Saudi citizens to have a unified digital medical record. Transport To increase private sector contribution to developing and operating railways projects from 5% to 50%, and ports projects from 30% to 70%. Tourism Increase tourism investment from SAR 145 billion to SAR 171.5 billion Increase total revenues from partnership with the private sector from SAR 80 million to SAR 19 billion. 16

Housing To increase the real estate sector contribution to the GDP from 5% to 10%. To increase percentage of available housing units to subsidy- eligible citizens from 10% to 50%. Education To increase the percentage of students in non-government higher education from 6% to 15%. Technology To increase the number of patents issued by Saudi Arabia from 700 to 500. To increase number of localized and developed technologies in target sectors to 125. Number of technology companies emerging from universities through the Innovative Companies Program to increase to 800. 17

6. Conclusion Saudi at a Crossroad Evidently, Saudi stands at a difficult crossroad. The status quo is no longer possible to maintain. Change, on the other hand, is difficult, costly, and imperative. Armed with a solid transformation program, the country has a clear roadmap to a meticulously designed vision. The journey to realize this potential however, is not expected to be a smooth one. It requires a comprehensive transformation that covers diverse areas as the work force, government institutions and different sectors of the economy.these issues and others will be discussed in upcoming reports. 18

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