A look at Saudi Arabia as it tries to shift from oil to a diversified economy

 

Crown prince Mohammed bin Salman has opened up the kingdom

The new face of Saudi Arabia

Under the youthful crown prince known as MBS, the country’s de facto ruler, the kingdom has pursued ambitious reforms to transform itself into a thriving 21st-century economy. Simon Wilson reports

Has the country really changed?

Yes, in important ways Saudi Arabia has changed radically in the ten years since King Salman ascended the throne aged 79, and his son Mohammed bin Salman (MBS) became the country’s de facto ruler (as crown prince from 2017 onwards). Ten years ago, women were still shut out of the labour market and public life, prohibited from driving or even leaving the house without a male guardian. Today, they are free to work and travel where they like. Many have ditched the burqa for a simple headscarf. The religious police and “vice squad”, once a ubiquitous presence, have disappeared. Schools have slashed the amount of time devoted to religious instruction. What was once a closed and repressive society has opened up in myriad ways, and become far more akin to other Gulf and Middle Eastern states.

So it’s become a democracy?

Hardly. Saudi Arabia remains an autocracy, where a super-privileged elite hold power and the crown prince does not brook dissent. But the country no longer sponsors and exports jihadist terrorism and is a “force for order” and a “stabilising influence in the Middle East”, says The Economist. It counsels restraint on the conflict in Yemen. It is open to better relations with both Iran and Israel, and has helped Syria’s new government by paying some of its debts. If not exactly an enlightened despot, MBS – still aged just 39, and poised to become king for decades – is at least a sane and increasingly pragmatic one. 

What about the economy?

MBS’s stated mission, under his Vision 2030 rubric, is to transform Saudi Arabia from a petro-state into a diversified 21st-century economy with a flourishing private sector – readying it for the day when the oil runs dry. The hard truth is that while a start has been made, there is much left to do. Oil’s share of the economy remains high, too, although it has fallen from 36% of GDP in 2016 to 26% last year, according to official figures. However, other estimates put the share rather higher than this. And once all economic activity related to oil and gas extraction is factored in, almost half the Saudi economy (48%) is hydrocarbon-dependent, according to the World Economic Forum (WEF). And oil still accounts for between 60% and 75% of government revenues, meaning the House of Saud’s fragile social contract is still underwritten by the nation’s oilfields.

So the oil price is a worry?

According to projections by the International Monetary Fund, Saudi Arabia needs the global oil price to be more than $90 a barrel in order to balance its budget. Prices are currently a little above $60, and are not expected to rise much this year. Goldman Sachs has lowered its year-end 2025 oil price forecast to $60 a barrel for Brent crude, and $56 next year. If prices were to stay around $62 this year, Saudi Arabia’s 2024 budget deficit of $30.8bn would more than double to around $70bn-$75bn, according to the bank’s Middle East economist Farouk Soussa. “That means more borrowing, probably means more cutbacks on expenditure, it probably means more selling of assets, or all of the above, and this is going to have an impact both on domestic financial conditions and potentially even international ones.”

What about debt?

The lower oil price is a worry, but it’s not about to precipitate a debt crisis. At the end of last year, Saudi’s debt-to-GDP ratio was just under 30% – modest compared with the likes of the US (124%) or France (111%). Riyadh still has significant headroom for borrowing. Yet $75bn in debt issuance would be hard for the market to absorb, and the Saudis will need to look at other solutions. In terms of cutting expenditure, many regional economists believe that some of the flashier projects, such as the vast, futuristic “linear city” Neom, will be further scaled back. Other such projects, estimated to cost nearly $900bn by 2030, include 50 luxury hotels strung along the Red Sea, a ski resort in the desert, and the world’s biggest building in Riyadh. There’s also the possibility of selling more domestic assets, including stakes in the state-owned companies Saudi Aramco and Sabic.

What sectors are thriving?

Perhaps more important than such projects are the “government’s efforts to foster new industries, from tourism to carmaking”, says The Economist. Meanwhile, civil servants are rewriting rules on everything from divorce to foreign investment, with more than 600 packages of reforms in the works. A liberalisation of mortgage lending means that construction is booming. Retail and hospitality are growing fast, as is tourism, which has jumped from around 60 million overnight stays in 2016 to more than 100 million in 2023 (the bulk of this being domestic tourism). Yet the Saudi economy remains a textbook case of “crowding out”, where the state’s dominance of key sectors has stifled private investment and enterprise. About half the male labour force work as civil servants and political connections remain vital to doing business.

What does the future hold?

One ambition is to establish strength in artificial intelligence (AI) and data centres. Saudi’s new state-owned AI company Humain has signed deals worth $23bn with US tech groups including Nvidia, AMD, Amazon Web Services and Qualcomm, according to its chief executive. And it has launched a $10bn venture-capital fund as it leads the kingdom’s effort to become a global AI hub. It’s currently in talks with US groups including OpenAI, Elon Musk’s xAI and Andreessen Horowitz about its plans. But allied to these lofty ambitions are more prosaic goals – improving the country’s education system; attracting the expertise needed to boost emerging sectors, including carmaking, semiconductors and renewable energy. Social liberalisation may have bought the regime some time in terms of pushing through economic reforms. But those reforms are just getting started.

In light of our HS2 conversation...

Read this quick comentary:

India: the "almost-perfect" emerging-market investment story

Want to ride on a Shinkansen? Of course you do. Everyone wants to ride on a bullet train. But unless you get to Japan at some point in the next few years, you might find that most of India rides on one before you do. This week, Japan’s prime minister Shinzo Abe headed to India to lay the first stone in a Japanese-financed $17bn bullet train project set to cover the 310 miles between Mumbai and the industrial city of Ahmedabad. This is exciting stuff. That’s partly because bullet trains are amazing in themselves – this one will cut the journey time from eight hours to under three. It is partly because the Japanese have offered a fabulous deal on the finance – and are signing various other investment deals along the way. But the really interesting thing is the speed of delivery of the project: India’s prime minister Narendra Modi first decided to bring high-speed trains to India only two years ago. Two years from thought to first stone laying is quite something for a major infrastructure project. For comparison, you might note that the new tram system in Edinburgh, where I live, was first proposed in 2001. It was completed in 2014. It covers 8.7 miles. Very slowly. “My good friend prime minister Narendra Modi is a far-sighted leader”, said Abe this week. Such compliments are a rare thing in politics. Perhaps Modi is far-sighted; it is certainly true that he is prepared to make decisions that bring nasty short term pain – and hit growth – with a view to long-term gain. Late last year, he brought chaos to India’s economy with the abolition of two large-denomination banknotes in an attempt to move towards a clean and taxpaying digital economy. The consumer economy stalled; there were huge lines at the banks; and everyone working in the black economy found themselves having to choose between coming clean or losing their savings. But Modi held firm. He has done the same with this summer’s implementation of a national goods and services tax. It has subdued growth across the board – but should pay huge dividends as it slashes corruption, simplifies the tax system and boosts revenues. This is all good. But it is just the icing on the cake of an almost perfect emerging-markets story. India has fabulous demographics (two-thirds of the population are of working age); a booming middle class keen on consumption; a fast-shrinking current account deficit (under 1& of GDP); a government committed to housing and infrastructure spending (there is a kind-sounding “Housing for All” scheme on the go); and a low fiscal deficit (down to 3.5%). It also has a high level of foreign-exchange reserves (about $400bn) and inflation looks to be properly under control (down to more like 2% nowadays, compared to about 6% a year ago). Some of these things could reverse if the oil price rises again – the current-account deficit would rise again, for example. But for now, while there are some worries around employment and credit growth, the macro environment looks mightily impressive (imagine how thrilled we would all be if the UK’s numbers looked anything as good). India’s stockmarket looks good, too. It is one of the few emerging markets with real depth and breadth: you can get exposure to pretty much any part of the economy you want via a listed company (not all are top quality, of course, but that’s not exactly an emerging-market specific problem). Finally, it is worth noting that India’s stockmarket is supported by local investors rather than just by the fickle international investors who cause so much volatility in emerging markets (they were the ones who sold so energetically when Donald Trump was elected and when the geopolitics around North Korea started to heat up last month, for example). You will all be wanting to rush in... Read the whole of this article on the MoneyWeek website.

Which EME to use as an example in essays:

For those of you still referring to BRICs as potential sources of growth and new markets for the UK, wise-up! This article looks closely at India - which, in reality, is the last BRIC standing (geddit?).

You won't be able to absorb everything in here, but think in terms of the global context questions - what is India doing that is good for its economy? - (reducing government ownership of assets, reducing regulations), what does it need to do (infrastructure) etc. etc. Think particularly about supply-side polices, which really have been (will be) the key for India, and are probably the key obstacles elsewhere. Skim read and make some notes on key points

India – the coming force

02/05/2015 |

With China’s economy slowing, Brazil rocked by scandal and recession and Russia frozen out of world affairs and now beginning to pay the price, the world is increasingly looking to India to pick up the slack. By Shruti Chaturverdi

With a population of 1.25bn, half of which is under 25 years old, India's potential is vast. It has political stability, it stands to benefit from a demographic dividend that will generate demand, and it is implementing a programme to promote its underdeveloped manufacturing sector. 

Perhaps most importantly, it is taking small but deliberate steps towards removing the bureaucratic hurdles for which it has become notorious.

Hopes are high for what can be achieved by India’s prime minister Narendra Modi, who came to office in May 2014, and finance minister Arun Jaitley. And they are fortunate in their timing: India’s economy is on a much sounder footing than at any time over the last seven years. 

Year on year growth in the fourth quarter of 2014 weighed in at 7.5% (higher than China’s), inflation is falling, low commodity prices are helping a country that imports more than 80% of its energy needs and the current account deficit is declining. 

“Ours is the only economy of larger economies that is growing at 7%-7.5%,” says Venkat Nageswar, chief general manager and regional head of East Asia at State Bank of India. “We are expecting growth at 8%, making India the best of the pack [of major world economies] in terms of overall growth.”

So far, so good. But India doesn’t exactly have a glowing track record when it comes to transparency in business transactions, especially those involving auction of government assets. The nation has long been perceived as one where crony capitalism thrives and kickbacks are par for the course.

This is changing. The new establishment has concluded the reallocation of coal blocks in a smooth and timely manner. The government also raised Rp1.1tr ($17.45bn) from a telecom spectrum auction this year — a process that was widely praised for the speedy and transparent manner in which it was done. All this reassures investors.

Not done yet
India’s prospects, then, look promising. But there is still much to be done for that potential to be achieved. Important areas of reform remain to be tackled, notably recapitalising the banking system, increasing the country’s power capacity and improving infrastructure. 

The Indian budget of 2015 did not contain any big bang reforms, but it certainly set the agenda. The government recognised key areas that need to be overhauled to facilitate foreign investment into India, as well as to stimulate domestic investment.

India has been enjoying a wave of positive sentiment ever since prime minister Modi clinched his sweeping victory. Modi’s corporate and reform-friendly image has been a big factor in fuelling sentiment in the country.
He has been particularly active in trying to woo overseas investors, with high profile visits to several countries, including Brazil, France, Germany and the US.

That can only go so far, however, and market participants believe domestic investor confidence is crucial to attracting foreign investments. “The overseas visits of the PM are bound to help,” says Nilendu Mukherjee, director, local coverage at Royal Bank of Scotland India. “However, we need to see a start and the start should happen from domestic investors.”

Government measures to boost investments on both fronts include unifying rules related to foreign investment and targeted initiatives to boost the infrastructure sector and small and medium enterprises, which would spur consumption as well as attract capital.

Soaring equity markets
India’s equity markets are also receiving unprecedented levels of attention from investors eyeing the large and growing consumer base, with over 62% of the population in the 15-59 year age bracket.

“Indian equity markets have had a combination of high ROEs (averaging 13.5% over the past 20 years) and high earnings growth (averaging 12% in the past 20 years), leading the Sensex Index to post a CAGR of 10% in US dollar terms,” wrote Société Générale analysts in a report published in March.

“Importantly, the markets have historically outperformed peers such as Asia Pacific ex-Japan, EM and Bric markets, barring the initial three years of the current decade.”

Indian stocks have traded at a premium of 39% to global emerging markets and 21% premium to Asia Pacific ex-Japan, according to the report. The higher return on equity of Indian firms is sustainable in the medium term, as these firms have scarce capital at their present stage of development.

India also ranks second highest among 39 emerging economies, with an internal growth rate of 13.34%, behind only Indonesia.

However, there is a need to grow direct investment, believes Mukherjee. “Equity investors are investing [into India] but there is a need for more direct investment as against portfolio investments.”

India has recognised that to realise the potential of its working age population, it needs to generate employment, wealth and demand. The country has announced policies such as the Jan Dhan Yojana scheme to provide universal banking facilities and Mudra Bank to help fund small and medium enterprises.

It has also rolled out the ambitious “Make in India” initiative, which is aimed at spurring companies to set up manufacturing bases in the country, thereby boosting exports, current account and trade balances.

Ease of doing business

With China’s economy slowing, Brazil rocked by scandal and recession and Russia frozen out of world affairs and now beginning to pay the price, the world is increasingly looking to India to pick up the slack. 

Byzantine rules regulating foreign and domestic investment have curbed appetite, but the country is looking to change that through reforms to ease investors’ entry path into the economy. “The government is focused on making it easier for investors to do business in the country and has announced reforms in all areas,” says Nageswar.

He notes the reduction of corporate tax to 25% from 30%, the deferral of the anti-tax avoidance “General anti avoidance rule” (GAAR), and the rollout of a goods and services tax in 2016 as among those reforms that should lead to higher capital flows.

On the flipside, however, difficulties and delays in acquiring land to set up projects throw calculations awry — and have resulted in the country losing out on investment. The government is seeking to address this problem with the “Right to fair compensation and transparency in land acquisition, rehabilitation and resettlement Ordinance”. The land acquisition ordinance seeks to ease the process of securing land assets, while also ensuring rehabilitation, compensation and fair valuation for land owners. 

Getting the ordinance through the upper house will still be far from easy, however. The incumbent government does not have the majority in the upper house that it would need to be sure of enabling it to become an act or law. At present, opposition parties in India are opposing the proposal on the grounds that passing it could be exploited by companies.

Infrastructure and power

India’s underdeveloped infrastructure has proved to be the biggest stumbling block in its growth. Power disruptions, a very low rate of electrification and problems related to power evacuation — the process by which generated power is made available to the distribution network — make it hard to run factory operations consistently.

Key measures to try to tackle this and which were announced during the annual budget include the establishment of a National Investment and Infrastructure Fund (NIIF), with an annual investment of Rph200bn ($3.25bn).

“[The NIIF] would provide long term funding for projects and will eliminate major concerns of asset-liability mismatch faced by companies in the current scenario,” analysts wrote in a note by SBI Caps Securities that was published after the budget.

This initial capital can be leveraged four to five times, allowing the country to cover a portion of the shortfall, adds Nageswar. 

The government has also proposed a tax “pass-through” for Category-I and Category-II Alternative Investment Funds, so that tax is levied on the investors in the funds and not on the funds themselves.

“This will step up the ability of these funds to mobilise higher resources and make higher investments in small and medium enterprises, infrastructure and social projects and provide the much required private equity to new ventures and start-ups,” said Jaitley in his budget speech on February 28.

Investment in infrastructure will rise by Rp700bn in the current fiscal year, with funds coming from the exchequer and the resources of central public sector enterprises, he said. However, this is still small change compared with the $1tr infrastructure spending target that the country plans to meet by 2017.

Nageswar reckons a lot of that money will come not from the government’s coffers but from long term investors such as pension funds, says Nageswar.

“They [the government] have to go out of India for fundraising. These are long term assets that require 10, 15, 30 year investments. A lot of pension funds would like to invest in India for a longer term because of the good yields it offers.”

He contrasted India’s bond yields with those of countries such as Switzerland and Germany, where yields are negative. With quantitative easing under way in Europe, a lot of fund investors will look at increasing allocations towards emerging economies. India, with its stable political environment and promising growth, is a notable bright spot.

It also helps that Moody’s has changed its outlook on the country’s Baa3 rating to positive, particularly as many funds are constrained by ratings when allocating to a certain country, say market observers.

On the power front, the government is planning to set up five new “Ultra Mega Power Projects”, each with a capacity of 4GW. These will be built under a plug-and-play model that will see all clearances and linkages in place before the project is even awarded.

The government reckons these projects will bring in investments of Rp1tr ($16bn). It is also mulling similar plug-and-play projects in roads, ports, rail and airports, which will create attractive opportunities for bank investors.
All the positive sentiment in the world cannot overcome frustrating bureaucracy, however, and the complexity of rules and processes related to obtaining permissions for new projects has often thwarted the hopes of those looking to build infrastructure in the country, said market participants.

“Only one thing is key — make the regulatory environment easier so approvals come in a timely manner and there is no uncertainty in doing business,” says Mukherjee. “If I have to get approvals in five months, it should mean five months. Multiple clearances from various approval authorities need to move into a single window of approvals.” 

The budget has addressed such concerns to an extent. The government said has set up an Ebiz Portal — a platform that allows users to access 11 central government services under one roof.  The move is aimed at helping businesses obtain permissions easily rather than having to knock on one door and then another.

Challenges

The improving macroeconomic picture is evident in the increasing dovishness of the country’s central bank. The Reserve Bank of India has cut rates twice this year, by 25bp each time, with the latest cut coming on March 4.
“Given low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilise available space for monetary accommodation,” said the central bank in a release on the day of the second rate cut.

These are the first rate cuts since Reserve Bank of India governor Raghuram Rajan took over as Reserve Bank of India governor in September 2013. Indian commercial banks have also started reducing base rates for the first time in years. SBI reduced its rate by 15bp and banks like ICICI and HDFC have also cut, so the relaxation is being transmitted to the real economy.

This ought to make the environment conducive for domestic corporates to borrow, but the cuts are also a response to a fall in inflation. India, a net importer, has benefited greatly from the general fall in commodity prices. 

A sustained period of lower inflation is also not desirable, though. “Over the past four years, India’s domestic demand has remained weak while investment demand fell even more sharply,” wrote Société Générale analyst Kunal Kumar Kundu in a report entitled India: entrenched disinflation published on April 15. 

“Not surprisingly, India has experienced one of the longest periods of inventory drawdown. Even the stalled projects are moving at a much slower pace despite being one of the top priorities of the newly elected government. In such a weak environment, every spurt in domestic demand has been met by the drawing down of inventories rather than an increase in production.”

Kundu pointed out that in addition to weak domestic demand, India is also facing weak external demand, as reflected in its export performance. India’s exports in March 2015 stood at $23.95bn, a 21.06% slide year-on-year. 

Kundu attributed the decline to an appreciation of the rupee in real effective exchange rate (REER) terms. The REER, as opposed to the nominal effective exchange rate, takes into account the difference in the purchasing power of two currencies. 

Figures on the domestic manufacturing front are not comforting either. Manufacturing has declined from 18% to 17% of GDP, while manufacturing exports have remained stagnant at about 10% of GDP.  

Despite these systemic and persistent problems, the government seems determined to usher in change. Market participants are confident that India will see a gradual transformation into a global investment hub. But there is a recognition that this will take time. Although the Modi government has completed nearly one year in office, those on the ground say they are yet to see any substantial and demonstrable change in its economic circumstances.
“The investment climate has changed in sentiment terms but it will take some time for it crystallise into on-the-ground capital expenditure,” says one India-based head of debt capital markets. “Even if people have taken decisions to commit, giving orders for capex and funding requirements takes time as most large plants have gestation periods of two to three years. 

“From a capital raising perspective we will continue to see the kind of transactions we saw in 2014, and so far in 2015, which are mostly refinancings and some M&A related.” But he adds that a real pick-up will become visible next year.

http://www.emergingmarkets.org/Article/3450133/Indiathe-coming-force.html?LS=EMS1158867

Short article with quick update on prospects for BRICs

Good for context:

  Broken BRICs: A Shifting Center Of Gravity Among The Emerging Market Giants Mar. 15, 2015 

 BRICs: Strong, solid, steadfast, quite literally the building blocks of growth. 

First coined by Goldman Sachs' Jim O'Neill in 2001, the umbrella term for the major emerging market economies of Brazil, Russia, India, and China made for a compelling story among investors by capturing widespread views over the trajectory of the global economy. BRICs became a household phrase following the onset of financial crises and recessions among advanced economies in 2008. The United States was struggling to escape stagnation, the Eurozone found itself shackled by a common currency, and Japan's decade-long deflationary malady intensified. 

Meanwhile, the BRICs enjoyed near double-digit GDP growth, with no more than a brief interruption in 2009, and a flood of capital from yield-hungry investors looking for an alternative to the low returns on U.S. bonds and equities. Emerging Problems Unfortunately, the BRICs' fortunes have reversed. China's export prowess has faltered and its economy has slowed. 

The "commodities super cycle," which saw Brazil and Russia supply China with the raw inputs it needed to sustain a massive trade surplus, has ground to a halt, contributing to historically low oil prices. Portfolio investment may continue to recede as the United States prepares to raise interest rates, exposing cracks in the BRICs that could be signs of difficult times to come. 

Weaker exports and portfolio investment hamper growth. 

Since the foreign currency used by consumers and investors to purchase exports and portfolio securities eventually winds up with central banks, their access to foreign exchange reserves may come under strain. Dwindling reserves limit central banks' scope to prop up currencies by intervening in foreign exchange markets. This undermines their capacity to guarantee the foreign-denominated debts of their governments and financial systems. 

The fiscal positions of governments reliant on revenue from state-owned oil companies will also deteriorate in the face of low prices. As currencies depreciate, the relative value of revenues denominated in domestic currency and used to service foreign-denominated debts declines, imposing a growing debt burden on borrowers. 

To make matters worse, inflation may take off as the price of imports increases, in effect reducing consumers' real income via higher prices. 

 Misery Loves Company 

 Brazil and Russia share some unhappy similarities. Both economies are reliant on petroleum and commodities exports and are already feeling the pinch from dramatically lower prices. Both have highly indebted corporate sectors, and since much of this debt is denominated in dollars, the weakness in their currencies may yet cause a string of defaults. Where they differ is in their willingness to reform and woo investors. 

Brazil's President, Dilma Rousseff, has taken bold steps to try to improve the country's bloated government finances, though her left-wing congress may still thwart her efforts. 

While Brazil's economy may languish as a result of its leader's inability to reform, Russia's will more than likely continue to suffer, thanks to President Putin's unwillingness to do so. A de-escalation of the war in Ukraine and the lifting of sanctions would help reverse the 50% depreciation in the value of the ruble since August, 2014. Unfortunately, his record of intransigence is less than encouraging. 

It's all downhill from here unless oil makes a comeback, which some industry leaders have suggested. 

 China is beginning to suffer growing pains as it attempts to transition from an export-led economy to a consumer-based one. Rising wages and the appreciation of the renminbi as the government attempts to achieve reserve currency clout have undermined China's export competitiveness. Manufacturers reliant on cheap labor no longer look to China, preferring Vietnam or the Philippines. 

Several trillion dollars of public investment spent trying to counteract the shock of the Great Recession have dried up - much of it was wasted. Consumption and private investment meanwhile haven't grown enough to pick up the slack left by shrinking government expenditures. 

China's opaque and extensive shadow-banking system worries many investors, leaving them to wonder if complex debt liabilities of an unknown scale represent a ticking time bomb. 

 There's a New Sheriff in Town 

India, on the other hand, is a net importer of energy products; falling prices will actually improve its current account. Narendra Modi, India's newly elected Prime Minister, has demonstrated his pragmatism and desire for reform, taking advantage of the fall in energy prices to cut wasteful state fuel subsidies. He now plans to reform complex labor laws and invest in public infrastructure. 

Previous government's failure to do so has prevented India from becoming a manufacturing economy on par with China. India is one of the only countries in the world that requires large industrial employers to get approval from public officials before firing employees. 

Thanks to its import composition and Modi's reputation as the darling of international investors, India looks best positioned to weather the storm of capital flight and falling oil prices. India's currency has outperformed most of its emerging market peers by miles. 

 To be fair, the divergent fundamentals of the BRICs economies have been longstanding. However, unlike the BRICs of the boom years, the BRICs of 2015 are no longer the engines of global growth, but are instead being superseded by advanced economies and their smaller emerging market peers. 

 Ultra-low interest rates in the Eurozone and Japan will hopefully keep yield-hungry investors actively engaged in emerging markets; otherwise, the BRICs can no longer expect to be the joint beneficiaries of easy money. All this calls into question the wisdom of conflating a group of countries with radically divergent profiles. 

 The BRICs are cracking, some more worryingly than others. Their leaders must take bold steps to reinforce the foundations of their economies through structural reforms, lest their houses come crashing down around them.