Saudi Arabia Crown Prince’s Transformation Stress-tests Economy and Stretches Petrowealth

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(Bloomberg) — Saudi Arabia is facing its most critical moment yet in the process of reinventing its economy.

Eight years after Crown Prince Mohammed bin Salman unveiled Vision 2030, his blueprint for life after oil, delays and cuts to the trillion-dollar changes are putting pressure on the kingdom’s finances.

With budget deficits for six straight quarters, Saudi Arabia has become the largest issuer of international debt in emerging markets, and its decision to cut oil production with other OPEC+ members in 2023 has failed to significantly boost export revenues.

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Here’s a look at the main tension points.

Reliance on petrodollars

The Gulf state’s oil revenues have fallen by about a third from 2022 levels, when Brent crude averaged about $100 a barrel, thanks 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 mega-projects, which include everything from a new city called Neom to tourist resorts, a soccer league and investments in artificial intelligence.

“The vision is being tested by reality and there are adjustments being made,” said Jean-Michel Saliba, Bank of America Corp.’s Middle East and North Africa economist. “It’s a sign of maturity. I don’t think it’s a sign that the vision is going off track.”

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

high spending

“My biggest concern is that higher spending will lead to a large structural deficit, not a temporary or cyclical one,” said Justin Alexander, Gulf economics director and analyst at consultancy Global Source Partners.

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The rise in debt reflects changes in Saudi finances over the past decade. While the share of government debt as a percentage of economic output remains low by international standards, it has risen from 1.5% in 2014 and is on track to exceed 31% by the end of the decade, according to the International Monetary Fund.

Saudi Arabia could come under increased scrutiny in the bond market and by credit rating agencies if the rate rises “more quickly than expected,” Alexander said.

Debt record

The government and other Saudi entities, including banks, the sovereign wealth fund and oil giant Saudi Aramco, have raised more than $46 billion in dollar and euro-denominated bonds so far this year, meaning Saudi Arabia has replaced China as the most prolific issuer in international bond markets from developing nations, according to data compiled by Bloomberg.

“The fiscal deficit will continue to be financed through external issuances, both in terms of Eurobonds and domestic issuances,” said Carla Slim, an economist at Standard Chartered Bank.

However, the government has the flexibility—as it already shows—to scale back or delay investments in its so-called megaprojects, according to Jim Krane, a fellow at the Baker Institute for Public Policy at Rice University in Houston.

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“Given the lack of organized political opposition, there is no harm in scaling back or even radically reversing your 10-year development plan,” Crane said.

High liabilities

The country’s external position is under pressure as imports rise. The International Monetary Fund expects the current account balance — the broadest measure of trade and investment — to fall to near zero in 2024 and shift into deficit as of next year, after running a surplus of about 13% of GDP in 2022.

Among the results is an “unprecedented increase” in Saudi lenders’ foreign liabilities, according to Barclays, given their growing role in providing hard currency to help meet domestic financing needs.

Domestic liquidity at Saudi banks remains strained, as measured by the interest rates they charge each other on loans. The three-month Saudi interbank offered rate has hit a record high of more than 6% this year.

The International Monetary Fund says the Saudi government needs Brent crude to be close to $100 a barrel to balance its budget, about $15 above current levels. Bloomberg Economics estimates the breakeven price at $109 a barrel, once domestic spending by the Public Investment Fund, the sovereign wealth fund, is factored in.

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Foreign investment

Foreign direct investment has been slow to emerge outside the oil and gas sector, making it difficult for the crown prince to turn his ambitions into reality.

The government wants to attract $100 billion in foreign direct investment annually by 2030, nearly three times the amount it has ever achieved. Inflows were about $2.5 billion in the first quarter, according to government data, a fraction of this year’s target.

Foreign direct investment is expected to reach only about $12.3 billion in 2023, 60% less than the much smaller economy of the neighboring United Arab Emirates, according to the United Nations Conference on Trade and Development.

Partly because of that, non-oil sector growth — a key metric for the government — slowed to its slowest pace since the coronavirus pandemic in the first quarter. That was one reason the International Monetary Fund recently cut its forecast for Saudi Arabia’s overall economic expansion this year to 2.6%. In late 2023, it had expected 4%.

Officials expect fiscal spending to be about $333 billion this year. That would be down from 2023, underscoring the government’s newfound caution.

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However, the kingdom’s budget will remain in the red for years to come, meaning local entities such as the Public Investment Fund and Armaco will remain responsible for many mega-projects.

What does the Bloomberg Economics report say?

“The biggest hurdle facing Saudi Arabia remains its continued dependence on oil. Although the kingdom has tried to boost prices through OPEC+, supply from elsewhere has hampered those efforts. The authorities need to spend to maintain the economy and the welfare of the population, while maintaining enough restraint to contain the budget deficit.”

— Ziad Daoud, Chief Economist, Emerging Markets. 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 shift is now institutionalized,” says Karen Young, a senior fellow at Columbia University’s Center on Global Energy Policy. “The broader diversification process has come a long way, and I don’t see much chance of a U-turn.”

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