Saudi Arabia—Fiscal constraints may frustrate economic diversification

COVID-19 will complicate Saudi Arabia’s Vision 2030 economic diversification program. The world’s largest oil exporter is expected to contract 5.4% in 2020, while the budget deficit is set to hit 12% of GDP as government revenue slumps amid sharply lower oil prices and export volumes. Authorities aim to broadly balance the budget by 2023; an ambitious fiscal adjustment that relies on a strong economic rebound. Government revenue faces significant downside risks should OPEC+ production constraints fail to ease and/or oil prices fall short of budget projections. The tripling of the value-added tax in July to 15% may depress consumer demand and ultimately hinder tax intake. On spending, the large state-sector payroll—which accounted for over half of expenditure and exceeded oil income in the first half of 2020—limits fiscal flexibility. This implies material spending cuts will concentrate on investment, a negative for economic activity.

Achieving a balanced budget could therefore significantly set back the Vision 2030 target of expanding the non-oil sector, which ultimately remains dependent on public oil revenue. During an austerity drive, capital-intensive mega projects—such as the US$500 billion futuristic city on the Red Sea—are likely to prove more difficult to implement. This is particularly so given the government is largely carrying the fiscal burden of the diversification effort; foreign direct investment this year is expected to be less than half the peak in 2018. Nonetheless, ongoing investment in sectors like leisure and entertainment that were fast growing prior to the pandemic will continue. Riyadh may also focus on less-costly initiatives to enhance the business environment; for example, measures to facilitate SME access to credit and improve the relatively weak business legal framework (Chart). Despite the daunting outlook, such reforms could improve exporters’ prospects in Australia’s second largest export market in the Middle East.