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Low Oil Prices Forcing Saudi Arabia To Modernize Economy

Low Oil Prices Forcing Saudi Arabia To Modernize Economy

The collapse in oil prices is forcing Saudi Arabia to undertake some deep and fundamental changes to its economy, reforms that no amount of browbeating from organizations like the IMF could induce.

A new report from The Atlantic Council finds that the extensive decline in oil revenues is focusing minds in Riyadh. The fiscal pressure is forcing “the kingdom’s leadership to modernize the economy,” the report concludes.

Saudi Arabia ran a fiscal deficit of about $98 billion in 2015, a figure that will decline only slightly to $87 billion this year. That deficit total is also probably closer to $120 billion in reality though, given that the costs from the war in Yemen were not included. Related: China And India Rewrite The Rules Of The Oil And Gas Game

The fiscal squeeze is forcing some changes. First, the Saudi government is looking at new taxes, including a 5 percent value added tax (VAT). That may seem like a run-of-the-mill austerity measure, but for Saudi Arabia it is a novel proposal: it will be the first tax imposed in the country.

More to the point, the VAT is illustrative of where Saudi Arabia is heading. The Atlantic Council argues that the kingdom is starting to reform its economy in fundamentally positive ways. Low oil prices are forcing it to rely more upon taxes and less on oil revenues. That would start to make Saudi Arabia less of a “rentier state,” a country that has no need to build much of an economy because resource extraction is so lucrative. Rentier states often suffer from greater corruption and a deeper lack of responsiveness to the needs of the public, since abundant oil revenues mean that the government does not need revenue from its populace.

Another major shift in Saudi Arabia could be the partial privatization of Saudi Aramco. Prince Mohammed bin Salman made news in early January when he told The Economist that the government was mulling over such a step. There has been a lot of speculation about why an IPO would be staged. Transparency appears to be a top concern. While Aramco routinely publishes operational data, detailing production figures, shipments, and downstream activity, the company reveals very little about its finances. “The most likely explanation for Saudi Aramco’s lack of financial transparency is that it wants to hide how much money is siphoned off to the royal family,” The Atlantic Council report suggests. Related: Why We Could See An Oil Price Shock In 2016

By privatizing some Aramco assets (likely downstream) and cleaning up and publishing data from the company’s books, the Saudi government apparently is showing some recognition that its relationship with the public must change. “Naturally, the royal family is unlikely to find itself cut off from any of the oil benefits to which it is accustomed. However, what is likely to change is that the family will no longer see itself as able to access funds without being held responsible by the Saudi public.”

Obviously, the downturn in oil prices is not exactly something that the Saudi government is happy about. Although it has about $616 billion in cash reserves, enough to finance its large fiscal deficits for years, Saudi Arabia is burning through those reserves at a rapid clip. In 2014, Saudi Arabia had $746 billion in reserves at its highest point.

Also, the government’s perennial top concern is social stability. Having to introduce new austerity measures, reduce subsidies, raise some taxes, and generally acknowledge that the country’s luxurious days could be coming to an end, the fall in oil prices presents some new risks. As The Atlantic Council notes in its report, any instability in a country that accounts for 10 percent of the world’s oil production would be felt across the globe. Related: Brussel’s Terror Attack Drives Europe Further Into Terrorism Rabbit Hole

Still, the reforms underway are long overdue, and in that sense, there is a silver lining in the crude price crash. In recent years, Saudi Arabia has succeeded in starting to build a more diversified industrial economy, with new facilities producing chemicals, fertilizers, aluminum, cement, and other industrial products. Up until now, however, economic diversification has not gone as far as it could. Part of the reason is that Saudi Arabia, as a “rentier state,” does not tax manufacturing, and thus, has had little incentive to promote its growth. For that matter, it has had little incentive to promote the growth of any non-oil sector of its economy.

Now, the reforms underway – new taxes, subsidy cuts, and the partial privatization of Saudi Aramco – are making Saudi Arabia “increasingly resemble most modern economic states.”

However, it is still early days and the reforms are far from assured. “Admittedly, complete change will not come overnight, but it is nonetheless being prodded on by the decline in income,” the report concludes.

By Nick Cunningham of Oilprice.com

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  • sean on March 28 2016 said:
    $616 billion in cash reserves.

    Compare that with the US government debt of $19 trillion.

    Saudi owes not a penny. It can afford to produce at max output for years and years, although most likely there is some realization that the oil fields will not least forever..

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