FORECAST SUNNY

Saudi Arabia 2014 | ECONOMY | REVIEW: ECONOMY

Saudi Arabia tinkered under the hood throughout 2014, setting the stage for a strong, diversified economic future.

The largest economy in the Gulf and the second largest economy in the region had a strong year in 2014. It was not, however, a year easily summarized by figures or description. This complexity is due to the success of government policies and the resulting structural changes moving throughout the economy, as well as regulatory developments and reform.

For decades, Saudi Arabia has been the world's largest exporter of crude oil, a distinction it maintained in 2014, although the US became the world's largest hydrocarbon producer due to a massive shale gas boom. The Saudi Arabian government has, for many years, attempted to decrease the nation's dependence on oil revenues through a variety of programs directed at economic diversification. While the price of a barrel of crude oil was forecast to average $110 in 2014 and oil revenues exceed the $1.017 trillion earned in 2013, non-oil revenue growth is expected to vigorously outpace growth from crude sales.

In 2013, oil revenues fell by 11% while non-oil revenues grew by 14%, making up 10% of government income for the first time. Although oil revenues are expected to rise in 2014 because of high prices, the trend of high non-oil sector growth relative to oil sector growth is expected to continue. For example, in 2013, Saudi Arabia's GDP reached $745 billion, making it the 19th largest economy in the world, ahead of every other Gulf economy and many European nations, including Switzerland, Sweden, and Norway. Of that record figure, oil GDP declined 4% relative to 2012, while non-oil related activities contributed 9% more to the total.

This clear evidence of diversification is motivated in part by government spending on infrastructure, education, and housing. The IMF projects GDP growth of 4.6% in 2014, up from 4% in 2013, and supported by a record government budget of $228 billion. This funding is being directed at a number of government programs and accompanied by other measures to spur the private sector, but its effects are most clearly visible in the vast number of projects being undertaken to improve roads, rail, airports, ports, and industry.

Over the last five years, some $101 billion in contracts in the construction sector and $73 billion in transportation contracts have been awarded in Saudi Arabia, as well as $54 billion in power projects. This year was also marked by major new rounds of tendering. The government recently began major expansions of the nation's transportation infrastructure, including airports in Riyadh and Jeddah, as well as the renovation and construction of many regional airports. Other major transport-related projects include a high-speed rail line near Jeddah and the Riyadh Metro. Megaprojects such as the King Abdullah Financial District, King Abdullah Economic City, King Abdullah Port, King Faisal University, Mecca's redevelopment, and Kingdom Tower also made contributions to the total, as did power, water, and industrial projects across the country.

Policy and regulatory reforms are either rumored or in process across the Saudi Arabian economy, and labor reforms have had a far-reaching impact on many sectors. In late 2013, Saudi Arabia ended an amnesty period for illegal workers and began auditing organizations and inspecting workplaces. Since November 2013, the government claims to have deported over 1 million foreign workers, a process that will continue into 2015. These measures aim to create jobs for Saudi nationals and fix Saudi Arabia's labor market, which has leaned on poorly documented expatriates for many years. Although the Minister of Labor announced increased hiring of Saudis in 1Q2014, the unemployment rate has hovered around 12%, and is significantly higher among young people and women.

Strong government spending coupled with labor reforms have created a bottleneck in Saudi Arabia's administrative and technical labor market. For example, there are $461 billion worth of ongoing construction projects in Saudi Arabia, with billions more expected in 2014 alone. The scale of these undertakings has stressed the organizational capacity of companies and institutions, resulting in delays to hundreds of projects. Increasingly strict standards of Saudization pressure companies to hire Saudi nationals, who are not always as qualified as and typically command higher salaries than the expatriates they replace. The net effect is to increase demand for highly qualified Saudis, which has raised costs overall, but will eventually result in a more stable and better regulated labor market.

In response to this demand for professionals, the government has invested heavily in human resource development. In its most recent five-year plan, half of the $385 billion will go to schools, universities, vocational institutes, grants, and other measures intended to train and educate Saudis for the workforce. Reducing unemployment among Saudi nationals while maintaining strong economic growth is one of Saudi Arabia's key challenges over the short, medium, and long term.

For the finance sector, 2014 is set to be an important year. Not only has it seen strong earnings for banks, to the tune of an 8.5% increase in profits in 1H2014 in addition to the 9.2% rise in total assets over 2013, but also new opportunities are emerging from an advancing regulatory structure. The nascent mortgage market has begun to yield profits amid a housing boom motivated by government spending, and monetary policy has eased inflation and kept key rates stable while increasing the country's public reserve, now hovering around $700 billion. This built in fiscal stability has proved a profitable environment for banks.

The most significant regulatory development came in July, when the Capital Markets Authority (CMA) announced that the Tadawul, or Saudi Stock Exchange, would open up to foreign institutional investors in early 2015. Saudi Arabia's stock exchange is the largest and most liquid in the region, and in the first half of 2014 it gained 26.9% to reach a market capitalization of around $530 billion. During the same period the exchange led the region in IPO activity with four new listings, and several large listings are expected later in the year, including the country's biggest bank, NCB. Indirect access to the Tadawul by foreign investors has been available for some time through funds and other instruments, but actual ownership and influence has not. The change will promote good business practices, transparency, and give Saudi Arabian companies better access to capital.

The extremely strong growth rates seen in 2011 and 2012 will not re-appear in 2014, but it is likely to be a year of strong if relatively unchanged growth relative to 2013. Projected government spending rose by 4.3% in 2014, compared to 17% in 2013 and 19% in 2012. While this decrease may cool the economy somewhat, it will also reduce dependence on government cash, the vast majority of which comes from oil revenues. This year is an important test for an economy that is more diversified and less dependent on hydrocarbon profits than ever before.

Despite the distinct progress in diversification, the economy still depends on volatile oil revenues, and that dependence remains a key challenge. However, there are many strengths that suggest Saudi Arabia will continue to be one of the region's, and the world's, best performing economies. Government debt is low and spending has been well directed on infrastructure improvements that take advantage of the nation's geographical advantages and its political relationships. The business environment is robust and set to improve with more foreign participation, and regulatory regimes across all sectors of the country are evolving steadily if not rapidly.