Foreign Policy Blogs

Why We Should Not Abandon Saudi Arabia

A view of the Royal Tower overlooking the town of Riyadh, the capital of Saudi Arabia. (Reuters)

A view of the Royal Tower overlooking the town of Riyadh, the capital of Saudi Arabia. (Reuters)

By François-Aïssa Touazi

Beset by challenges ranging from the collapse in oil prices, to the spreading instability in the region, to criticism from its longtime allies in the United States, Saudi Arabia is facing its most difficult test in decades. But the kingdom has the means to overcome these difficulties, and also has the will to seize a unique opportunity to carry out important reforms.

As 90% of the Saudi government budget is dependent on oil, the collapse—down 60% since mid-2014—in the price of petroleum had an impact on the Kingdom, the largest crude exporter in the world, that is difficult to overstate. For the second consecutive year, Saudi Arabia registered a budget deficit, estimated at nearly $100 billion in 2015 (21% of GDP), forcing it to resort to the bond market and draw on its currency reserves (which decreased from $732 to $644 billion between 2014 and 2015). China, Saudi Arabia’s main trading partner (15% of its market), is also experiencing its own economic slump, which inhibits the ability of a Saudi economic recovery. Many projects are stalled and late payments are affecting business across the country.

In addition to these economic challenges, there is deep regional instability, including the persistence of the conflict in Yemen, the ISIS threat in Iraq and Syria, and the resurgence of Iran—Saudi Arabia’s biggest rival—as a regional power. These crises are costly to the Kingdom: defense and security remain the top priority of the national budget, consuming over $60 billion (1/3 of the budget) each year.

Faced with an economic downturn and regional instability, the Kingdom is at a crossroads. Moreover, many observers seem to be pessimistic, doubting the country’s ability to reform and modernize to keep up with the pace of change. Some analysts go as far as pointing to the end of the House of Saud’s reign. But despite the unprecedented challenges Saudi Arabia faces, these analyses risk overlooking the Kingdom’s many strengths and its resilience.

A strategy that is starting to produce results

First, it should be noted that the decline in oil prices was the result of a deliberate policy choice by the Saudi authorities, which agreed to maintain high supply, along with OPEC, to break the competition with U.S. shale and preserve its market share. Despite significant pressure, Riyadh seems determined to go through with its policy and make the necessary sacrifices. Even if the new fracking techniques in use in America become more powerful and less expensive, this strategy still would produce results: U.S. production has already dropped from 9.6 to 9.2 million barrels per day, triggering a chain reaction of bankruptcies and layoffs throughout the industry. A rebound in oil prices is expected by 2018 as a result of the investment freeze.

Meanwhile, the Saudi government maintains significant financial leeway, thanks to the considerable resources of SAMA, the central bank, and its sovereign wealth funds, which give the Kingdom solvency guarantees for borrowing if necessary. SAMA has demonstrated a willingness to liquidate certain non-strategic or unprofitable assets that it holds (mainly listed shares and government bonds) to meet the Kingdom’s liquidity needs. More than $100 billion have already been sold.

Betting on austerity and the reform of the welfare state

Moreover, King Salman wants to take advantage of the situation to streamline the current welfare state, which has now become too expensive after being funded for years by oil income. It is true that the economic situation is forcing the Kingdom to lower public spending, leading to a withdrawal of the state and an improved return on public investments. Riyadh forecasts that an austerity policy will be better accepted by public opinion in the current context. Therefore, echoing the IMF’s recommendations, an unprecedented austerity program was announced in late 2015.

To spend less, the government is determined to not only make drastic cuts in subsidies for petroleum products (up to 80%), but also to enforce cuts in water and electricity consumption. Its stated goal in this regard is to generate nearly $50 billion in savings per year. The Kingdom is also considering a partial introduction of a value added tax in coordination with other Gulf monarchies to produce additional revenue.

Transparency and privatizations

The austerity methods also apply to the government’s consumption—expenditure rationing will come about through better public finance controls. The government announced the creation of the National Project Management Agency to enhance the effectiveness of public policies. It also introduced a new regulation requiring the Royal Cabinet’s prior approval for any public contract exceeding 25 million euros as a step to increase oversight of profligate spending and graft, as combating corruption is still a major challenge in Saudi Arabia. Companies are also encouraged to increase transparency and initial public offerings (IPOs) in order to boost the Riyadh stock market, which is one of the most influential in the Gulf.

Another potential turning point is privatization: after announcing the privatization of airports, of major state holdings such as the Saudi Telecom Company (STC), the leading mobile and internet operator, or the National Water Company could follow. If the announcement by Deputy Crown Prince Muhammad bin Salman of the Aramco IPO, estimated at $3 trillion, has been received in some quarters as a renewed effort to communicate the Kingdom’s financial power, it should also be interpreted as a new liberal shift in power.

The government is also working to better employ its resources. After the creation of SABIC, the chemical and manufacturing giant that is the largest publicly-traded company, the government is now interested in other mineral resources that are still underutilized in the Arabian peninsula. The country’s substantial precious mineral reserves (phosphate, bauxite and gold) could be strong drivers of growth. Moreover, Riyadh is also attempting its own green transition and aims to become a world leader in renewable energy. By 2040, $110 billion will be invested in solar, wind and geothermal energy to reduce the domestic oil consumption, among the world’s highest.

Finally, authorities are seeking to enhance the area’s attractiveness as an investment destination. Riyadh acknowledges that to succeed in this transformation, there is also a need to attract more foreign capital. To do this, barriers to entry have been lowered. The simplification of visa procedures, the end of the mandatory use of sponsors to enter the market, and the announcement of full ownership rights in certain sectors for non-Saudi contractors are all strong attractants for international investors. Within five years, the country also plans to double the number of tourists—especially religious tourists—coming to Saudi Arabia (from 18 million visitors per year to 35-45 million).

A desire for modernization

Despite these efforts, the country’s path toward modernization and economic revitalization is still perilous and far from assured. In addition to external threats from ISIS and Iran, the society’s inherent conservatism, problems achieving consensus within the royal family, and the fear of social unrest could all, individually or collectively, slow progress toward reform. Unforeseen developments or further economic turmoil could derail the Saudi reform plans.

Aware of such risks, Mohammed bin Salman, who directs the country’s economic strategy, has surrounded himself with experienced technocrats to reform the economy. The initiatives that have been announced in the last six months look likely to pave the way for a modernization of the Saudi system. To achieve this, he must rely on the support and experience of his father, King Salman, and his cousin, Crown Prince Mohammed Bin Nayef, who is recognized for his effectiveness in security and anti-terrorism matters.

With the decline of the welfare state and in order to meet the high expectations of one of the world’s youngest and most restless populations (58% are under 25 years, with an unemployment rate of 30%), Saudi Arabia will also mobilize large private companies to become vital players in the country’s future. If Mohammed bin Salman—whose popularity with the public is palpable—embodies the ambitions of the Saudi youth and middle class for a strong and modernized nation, he will do what he must to succeed. With renewed vigor and reform measures in place, the new generation of Saudi leaders, despite great economic and security challenges, have not abandoned the country. The rest of the world shouldn’t either.

François-Aïssa Touazi is co-founder of the think tank Capmena and author of the book “The sky is the limit – Leaders of the Gulf, their influence, and their strategies” (Current editions, 2015)