Mission Concluding Statement 

Saudi Arabia: Staff Concluding Statement of the 2022 Article IV Mission

June 22, 2022

Washington, DC: An International Monetary Fund (IMF) mission, led by Mr. Amine Mati, conducted discussions for the 2022 Article IV Consultation from May 23‒June 6.

Saudi Arabia managed the COVID-19 pandemic well and is well-positioned to weather the risks posed by the war in Ukraine and monetary policy tightening cycle in advanced economies. Economic activity is picking up strongly, supported by a higher oil price and the reforms unleashed under Vision 2030.The authorities’ commitment to fiscal discipline should help further strengthen fiscal and external sustainability and avoid procyclicality while implementation of the ambitious structural reform agenda will help ensure a durable, inclusive and green recovery.

Saudi Arabia is recovering strongly following a deep pandemic-induced recession. Liquidity and fiscal support, reform momentum, and high oil prices and production have helped the country recover. With a high vaccination rate and a short-lived Omicron-COVID-19 wave, restrictions have been lifted on domestic movement and international travel. Overall growth was robust at 3.2 percent in 2021, in particular driven by a recovering non-oil manufacturing, retail (including e-commerce) and trade sector. With increased labor force participation of nationals offsetting expatriates’ departures, the unemployment rate has fallen further to 11 percent—a 1.6 percentage drop from 2020 mainly owing to higher employment for Saudi nationals, particularly women, in the private sector.

Inflation remains contained, despite some signs of inflationary pressures. Average inflation was 3.1 percent in 2021 and has been low since mid-2021 as the base effect of the mid-2020 VAT hike dissipated, despite some pressures from higher food and gasoline prices, which led to a cap on local gasoline prices in July 2021. Low pass-through of international food and commodity prices, due to some price caps and subsidies, as well as falling rents, which compose over 20 percent of the CPI basket, explain inflation staying low at 2.3 percent (y/y) in April 2022. That said, double-digit wholesale price inflation, increasing commodity prices, and rising shipping/logistics costs suggest rising inflation for the period ahead.

Higher oil prices and stepped-up oil production improved the current account, which registered a 5.3 percent of GDP surplus in 2021, up from deficit of 3.2 percent of GDP in 2020, as strong oil-driven exports surpassed growing imports and large remittance outflows. Net foreign assets declined but remain at very comfortable levels.

Economic Prospects – Positive outlook with balanced risks

Direct spillovers on Saudi Arabia from the war in Ukraine are negligible. With the impact of the war keeping oil prices elevated and considerably above previous forecasts over the medium term, Saudi Arabia’s fiscal and external buffers will be strengthened. Limited direct trade and financial links with Russia and Ukraine, including negligible exposure through Saudi Arabia’s sovereign wealth fund, further limits the impact on the Saudi economy.

The near and medium-term outlook for Saudi Arabia is positive as growth is picking up, inflation will remain contained, and the external position will strengthen further. With oil production increasing in line with the OPEC+ schedule and momentum from the continuation of the ambitious reform agenda under Vision 2030 underway, overall GDP is projected to grow by 7.6 percent in 2022 despite monetary policy tightening expected over the next few months and central government fiscal consolidation going forward. Non-oil growth will increase to 4.2 percent in 2022 before returning to its medium-term potential as the output gap closes and investment projects and reforms continue to yield returns. Headline inflation will accelerate in the second half of 2022 but will remain contained at 2.8 percent on average in 2022 as an appreciating dollar, caps on gasoline prices, subsidies on wheat and continued labor market slack help contain pressure from supply-side shocks. The current account surplus will increase to 17.4 percent of GDP in 2022—a level not seen since 2013—while reserve buffers are expected to stabilize at about 28 months of imports over the medium term.

Risks to the outlook are balanced. On the upside, gains from a successful implementation of the National Investment Strategy and labor market reforms, or further increases in oil production could further improve the outlook. On the downside, key risks stem from pressures to spend oil windfalls and deviate from the reform agenda, inflationary pressures from higher food prices, another COVID surge (domestic or abroad), lower oil prices due to lower global activity if the war in Ukraine has lasting effects, and an abrupt slowdown in China.

Policies

Policy priorities will need to manage higher oil revenues while sustaining a strong private sector-led growth and advancing reforms for a greener economy. Policies should continue implementing the Vision 2030 reforms to open and diversify the economy , including by implementing the NIS This—along with continued commitment to fiscal discipline— should help avoid the procyclicality associated with past oil-driven boom and bust cycles and ensure continued reform momentum towards a diversified economy.

Fiscal policy – Managing windfall gains and continuing fiscal consolidation

The fiscal performance in 2022 will outperform the budget . The receding effects of the pandemic, rising oil prices and a strengthening economy are projected to deliver a very strong improvement in the fiscal position in 2022. IMF staff is projecting a surplus of 5.6 percent of GDP this year (relative to 2.5 percent budgeted), even after accounting for staff’s recommendations for additional resources on rising food subsidies and increased provisions for targeted social safety nets that will benefit the most vulnerable. Central government debt-to-GDP ratio would decline to 24.2 percent, while central government net financial asset-to-GDP ratio would improve to –8.7 percent, from –17.7 percent in 2021.

Fiscal policy should focus on managing the higher oil revenue gains sustainably, while continuing fiscal consolidation through the implementation of transformative initiatives already adopted. Staff’s projections assume that most of the non-oil related adjustment will rely on expenditure cuts reflecting the phasing out of pandemic related measures, compressed capital expenditures as some projects have been implemented, identified efficiency gains spurred by the full utilization of the ETIMAD online platform, and the authorities’ plans to rationalize the wage bill.

Over the medium term, consolidation efforts will remain necessary to increase buffers while allowing spending that remains sustainable across different oil price environments. The additional fiscal adjustment would need to build on the reforms already initiated:

• Non-oil revenue mobilization remains critical. Strong efforts have been made over the past four years as non-oil revenues doubled to 12.8 percent of GDP. However, this remains considerably below the G20 average, and further non-oil revenue collection is needed. The mission recommends maintaining the new VAT rate—which was tripled during COVID-19—and broadening potential revenue gains. Implementation of a full-fledged revenue administration strategy fully costing revenue initiatives would be important.
• Energy price reforms . The mission welcomed progress on energy price reforms, which halved subsidies between 2010 and 2020. However, these remain high and with oil prices considerably higher, there is scope for lifting the cap on gasoline prices and considering larger-than-planned step increases for other fuel products. Part of the savings from these increases should allow for scaling up well-targeted social programs—including the Daman program and Citizens’ Account—while the authorities continue pursuing their social security reform aimed at creating a unified social registry and allowing a shift towards a more needs-based social safety net system.

The mission welcomes the Kingdom’s commitment to fiscal sustainability and efforts to avoid procyclicality by setting a spending ceiling that would be delinked from oil price fluctuations. To better support that and the reforms achieved by the Fiscal Sustainability Program, the mission recommends setting an expenditure rule that is based on a long-term fiscal anchor that best help Saudi Arabia serve its growth and stabilization objectives. Such reforms would need to be supported by:

• Stronger efforts to broaden public sector coverage . The increase of the Saudi Arabia sovereign Wealth Fund (PIF), National Development Fund (NDF), and other entities in public investment makes incorporating and regularly monitoring the activities of these entities necessary to assess Saudi Arabia’s true fiscal stance and position. The mission reiterated its longstanding advice to accelerate the authorities’ ongoing work towards developing a sovereign asset-liability management framework, which should be based on a sound understanding of the public sector balance sheet.
• Continued improvements in public financial management . Important steps taken by the authorities towards establishing a robust medium-term fiscal framework, moving towards performance-based budgeting, preparing for a treasury single account, and enhancing budget disclosure requirements should be continued. Careful monitoring and disclosure of guarantees and contingent liabilities is needed, particularly now that PPP projects are expected to increase.

Sound debt management should continue to support fiscal policy and capital market development. Public debt remains sustainable and is expected to remain constant in nominal terms as the Kingdom plans to refinance existing debt instead of using higher oil revenue for repaying debt. The mission supports this strategy, which includes lengthening debt maturities, reducing refinancing costs and building a yield curve in domestic and international markets. Plans for issuing a green bond in 2022 are welcome.

Monetary and financial sector policies – A limited impact from global tightening conditions amidst a well-capitalized banking system

The impact of tighter global monetary policy conditions is expected to be limited in an environment of high oil prices. The current structure of Saudi Arabia’s banking system—which is characterized by low wholesale funding and a high level of non-interest-bearing deposits—implies that additional interest rate hikes in line with the US monetary policy tightening would have a positive effect on banks’ profitability. Staff’s preliminary analysis also finds that the impact on credit growth and non-oil GDP is negligible and positive for the banking sector profitability when oil prices and liquidity are high.

Financial stability risks are well contained . Banks are profitable, liquid and well-capitalized. NPLs remain low despite an end to the deferred loan program put in place during COVID to support SMEs. Macro-prudential requirements —such as loan-to-value ratio, debt service-to-income ratio, and explicit links to salaries— help limit risks to the banking system from the rapid rise in residential mortgages, which continue to require careful monitoring. Further implementation of the new regulatory and legal framework for Islamic banks and of the new resolution framework and stepped-up efforts to move towards Basel IV helps reduce risks further.

The currency peg to the U.S. dollar remains appropriate given the structure of the economy. The policy continued to serve Saudi Arabia well in supporting monetary stability. Saudi Arabia’s external position remains broadly in line with medium-term fundamentals, with adequate buffers to maintain the peg.

Structural reforms – Achieving Strong, Sustained, Inclusive, and Greener Growth

Continued Implementation of the ambitious structural reform agenda under Vision 2030 is essential to diversify Saudi Arabia’s economy and boost growth. The vision is underpinned by economic, structural and institutional reforms based on Vision Realization Plans and robust key performance indicators to monitor progress. The Vision rests on three key pillars of a vibrant society, building a thriving economy and strengthening the government capacity, and is supported by 13 Vision Realization Programs (VRPs). Important steps have been taken to attract foreign investment—including enacting more than 300 initiatives and streamlining regulations since inception. Increased home ownership, female labor participation of 35 percent already surpassing the 30 percent target set for 2030, improved ease of doing business (one-stop shop to register a business in 3 minutes), enhanced digitalization of government operations (procurement, pay, and social services), and increased investment in line with the National Investment Strategy are some of the achievements. However, FDI remains low despite a significant pickup in 2021 and diversification into more sophisticated products is still limited.

Boosting further private sector investment would require a careful calibration of the various elements envisaged under Vision 2030 . Use of public resources—including through the PIF to kickstart new activities—should continue to be subjected to rigorous cost-benefit analysis to ensure PIF returns remain high and generate greater private sector involvement. Labor market reforms—including to increase the mobility of expatriate workers through the reform of the visa system, strengthen education and training programs and close gender gaps—will help increase private sector employment of Saudi nationals and compress wage differentials. Strengthening governance, SME development, and digitalization would further enhance private sector development.

The Kingdom’s efforts on climate policies, both on mitigation and adaptation are encouraging. The Saudi Green Initiative, announced in 2021, aims at reducing carbon emissions, including by meeting 50 percent of the Kingdom’s domestic energy needs from renewables by 2030 (up from 1 percent currently), and at increasing vegetation cover by planting 10 billion trees to serve as a carbon sink, backed by a water strategy that considers Saudi Arabia’s specific vulnerabilities to climate change. The authorities are also ramping up investments in blue and green hydrogen production and are undertaking research and development with a focus on the circular carbon economy. Achieving the Green Initiative’s objectives will, however, require implementation of a detailed roadmap including specifics on the magnitude of the investment necessary and feasibility through viable technology. The overall strategy will also need to be consistent with ongoing energy price reforms, which are essential to reduce emissions, as well as water price reforms.

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The mission team would like to thank the Saudi Arabian authorities and the people they met outside the government sector for their close collaboration, generous sharing of their time, and candid and informative discussions.