GEMs Paper #26
Saudi Arabia: beyond oil but not so fast
30 June 2016 Corrected
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Transforming Saudi Arabia, but challenges abound
The Saudi National Transformation Plan (NTP) bodes well for comprehensive reform
efforts to diversify the economy in line with Vision 2030. The NTP a) identifies key
sectors with high growth potential; b) starts to articulate supportive public sector
industrial strategies; and c) seeks to foster higher value-added through enhancements to
processes, products and organizations. Still, ambitious targets in a number of sectors are
unlikely to be reached and medium-term macro sustainability is not yet clear.
USD peg holds but NTP inconsistent with stable FX policy
Our view is still that the USD peg holds. However, the NTP provides a mixed message.
On the one hand, it blurs policymaking incentives given the need for a competitive Fx if
diversification progresses. On the other, unrealistic fiscal targets mean consolidation is
likely to fall short of easing imbalances materially without oil price recovery. Energy
policy thus likely needs to become less aggressive to support macro and FX policies.
Eurobond premium required for fiscal slippage risk
We expect large and regular sovereign Eurobond issuance to support FX reserves and
domestic liquidity but to weigh on regional bond spreads if risk appetite does not hold
up or fiscal balance slips. EMBIG index inclusion is unlikely, in our view. Saudi forwards,
CDS and rates are likely to stay under pressure due to issuance and tight liquidity.
Commodities: NTP adds to medium-term oil tightness
The NTP suggestion that production capacity is maintained until 2020 reinforces our
conviction of medium-term oil market tightness. The NTP gas production target that
could displace domestic crude demand and boost export capacity is challenging.
Equity Strategy: six investible themes on the back of NTP
We see a number of investible themes emerging from the NTP which investors can use
to identify potential beneficiaries. These themes include rising availability of affordable
housing, increased access to healthcare, down-trading as the consumer comes under
pressure, a surge in telecom infrastructure and significant opportunities in the
downstream petrochemical arena. Buy-rated names with access to these themes
include: Al Hammadi, Savola, Al Othaim, STC, Zain KSA and SABIC.
Partial NTP success & MSCI inclusion could drive rerating
The Saudi market trades on a 12m fwd P/E of c.13x, an 11% discount to the long-term
average and its lowest premium to GEMs since 2010. We believe that with earnings
momentum gradually reaching an inflection point a relatively negative outlook is already
being priced in. Given our view that oil prices will gain strong momentum in 2017, even
a partial success of the NTP along with CMA market reforms to expedite inclusion in the
MSCI EM index could be sufficient to improve confidence and thus drive a rerating.
Trading ideas and investment strategies discussed herein may give rise to significant risk and are not
suitable for all investors. Investors should have experience in FX markets and the financial resources to
absorb any losses arising from applying these ideas or strategies.
>> Employed by a non-US affiliate of MLPF&S and is not registered/qualified as a research analyst under
the FINRA rules.
Refer to "Other Important Disclosures" for information on certain BofA Merrill Lynch entities that take
responsibility for this report in particular jurisdictions.
BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports. As a
result, investors should be aware that the firm may have a conflict of interest that could affect the
objectivity of this report. Investors should consider this report as only a single factor in making
their investment decision.
Refer to important disclosures on page 82 to 85. Analyst Certification on page 81. Price Objective
Basis/Risk on page 77. 11643724
GEM Fixed Income Strategy & Economics
Global
Jean-Michel Saliba
MENA Economist
MLI (UK)
+44 20 7995 8568
jean-michel.saliba@baml.com
Hootan Yazhari, CFA >>
Research Analyst
Merrill Lynch (DIFC)
+971 4 4258218
hootan.yazhari@baml.com
Francisco Blanch
Commodity & Deriv Strategist
MLPF&S
+1 646 855 6212
francisco.blanch@baml.com
Faisal AlAzmeh, CFA >>
Research Analyst
Merrill Lynch KSA Company
+966 11 299 3741
faisal.alazmeh@baml.com
Abdelrali El Jattari >>
Research Analyst
Merrill Lynch (DIFC)
+971 4 4258231
abdelrali.eljattari@baml.com
Jamie Clark, CFA >>
Research Analyst
MLI (UK)
+44 20 7995 1300
jamie.clark@baml.com
Ali Dhaloomal
Research Analyst
MLI (UK)
+44 20 7996 9107
ali.dhaloomal@baml.com
Celine Fornaro >>
Research Analyst
MLI (UK)
+44 20 7996 5515
celine.fornaro@baml.com
See Team Page for Full List of Contributors
A Transforming World
This report ties into the enterprise-wide Investment
Themes recently introduced in A Transforming World. In
particular, the Saudi National Transformation Plan is
likely to span the themes of Markets (Frontier),
Government (Reform) and Earth (Energy Efficiency)
Contents
Macro: charting the way forward 3
Towards better governance 3
Public Investment Fund to gain prominence 7
Historic energy sector liberalization 10
National Transformation Plan: many promises, few details 13
Lessons in diversification 31
Eurobond premium required for fiscal slippage risk 34
Commodities: NTP adds to medium-term oil market tightness 36
Equity Strategy: more clarity required, but investible themes emerging 39
Six key investible themes from the NTP are emerging 40
Saudi market valuation not testing 42
Taking positive steps to accelerate MSCI inclusion 45
A higher weighting in international indices 45
Telecom: supporting a move to higher connectivity 48
NTP helps increase penetration of higher margin offerings 48
Health: Not Tremendously Prescriptive 51
Vision 2030 a start but Needs Transparent Proposals 51
Healthcare implications of National Transformation Plan 51
Consumer: a necessary pain 58
Prefer staples over discretionary 58
Rationalization of subsidies for water and electricity 60
Saudi Arabia approves 100% foreign ownership rules 61
Real estate: NTP positive but not enough 64
Key strategic objectives and KPIs to watch 64
Land tax - gradual revenue source 65
Metals & Mining: ambitious growth target 67
Government focus on mining to boost jobs and growth 67
Oil & gas/petchems: focus on downstream 69
Focus on downstream expansion is a priority 69
Refining capacity target: almost there 71
Ambitious natural gas expansion 72
Utility sector: sharing the capex burden and achieving cost reflective tariffs 73
Eight strategic objectives aimed at being self-funding 73
Defence: Vision 2030 supports defence spending 75
Saudi Arabia to build out military industrial base 75
Research Analysts 86
2 GEMs Paper #26 | 30 June 2016
Macro: charting the way forward
Jean-Michel Saliba
MLI (UK)
jean-michel.saliba@baml.com
The Saudi Vision 2030 and National Transformation Plan (NTP) present a
comprehensive roadmap for change and augur for committed diversification efforts, in
our view. Announced reforms can help sustain higher potential growth if fully realized as
new sectoral sources of growth are developed. Positively, the NTP borrows elements
from other successful strategic case studies. Still, we find a number of targets
ambitious or unrealistic on the fiscal and diversification fronts, and the sequencing and
details of the fiscal measures are left nebulous.
In terms of the other pillars of the macro view, namely energy and Fx policy, the NTP
presents a mixed picture, in our view. Energy policy is likely to be less aggressive, as the
NTP suggests a constant oil production capacity. To remain consistent with the targeted
government debt accumulation path, we estimate that oil prices have to average at least
US$50/bbl in 2016-20 along with no growth in spending (excluding the additional cost
of NTP initiatives). Partial implementation could require oil prices of cUS$65/bbl.
Fiscal consolidation remains imperative to support the Fx peg, in line with stability and
economic imperatives. However, as diversification progresses, the case for increased Fx
flexibility to support competitiveness could likely gradually take shape. Policy-making
growth-focused plans may conflict with needs to deflate Fx demand in the economy.
Towards better governance
The comprehensive economic blueprint unveiled by the Saudi Vision 2030 and the
National Transformation Plan (NTP) confirms the economic reform credentials of the
current administration. It is likely to improve government culture, accountability and
transparency, in our view. The NTP will be implemented across 24 government bodies
and has been presented through a number of press conferences with high-level
ministerial presentations. The Governance Framework details steps to institutionalize
and coordinate implementation through restructuring the government. It proposes a
number of committees and bodies to report to the Council for Economic and
Development Affairs (CEDA). It also introduces an escalation mechanism to rapidly
resolve bottlenecks, which could see matters escalated to CEDA in 42 days.
A wide-ranging policy-making reshuffle
In line with ongoing Saudi Vision 2030 implementation efforts, a wide-ranging
restructuring of the Saudi Cabinet and government bodies was announced in May to
drive change in the government. King Salman issued 51 Royal Decrees restructuring the
Cabinet, various government bodies and appointing a number of officials into various
government roles. A statement concurrently issued by the Royal Court suggested these
changes are in line with the recently announced Saudi Vision 2030 and aim to support
its implementation. This follows from the January 2015 restructuring of the bodies
affiliated to the Council of Ministers, which saw the creation of CEDA and the Council
for Political and Security Affairs. We list a few major changes below.
New Oil Minister represents technocratic experience and policy continuity
The appointment of Khalid Al-Falih to the Ministry of Energy, Industry and Mineral
Resources is not surprising, given that former Minister of Petroleum and Mineral
Resources Al-Naimi has previously suggested he was approaching retirement due to old
age. Al-Falih’s appointment continues the tradition of non-Royals heading the Ministry,
while simultaneously holding the Chairmanship role of Saudi Aramco. Furthermore,
according to local press, Al-Falih appears close to Deputy Crown Prince Mohamed bin
Salman, and his appointment likely confirms the recently assertive Royal influence over
energy policy, in our view. New Minister of Energy, Industry and Mineral Resources Al-
Falih’s past official pronouncements are consistent with stable Saudi energy policy, in
our view.
GEMs Paper #26 | 30 June 2016 3
Expanded role for the Oil Ministry under Vision 2030
The Ministry of Petroleum and Mineral Resources has been expanded to become the
Ministry of Energy, Industry and Mineral Resources. It will be dedicated for energy, in
addition to expanding to encompass responsibilities relating to electricity and industry.
It will also undertake the management of the National Industrial Cluster Development
Program (NICDP). The new Minister will chair the board of directors of the Royal
Commission for Jubail and Yanbu, the Industrial Development Fund, the Saudi
Organization for Industrial Estates and Technology Zones, the Saudi Geological Survey,
the King Abdulaziz City for Science and Technology, the Saudi Exports Development
Authority and the King Abdullah City for Atomic and Renewable Energy.
Energy sector liberalization drives non-oil diversification
The wider role for the Ministry of Energy, Industry and Mineral Resources is in line with
the expanded industrial responsibilities foreseen for Saudi Aramco in the Vision 2030. It
may also suggest a continued desire to liberalize the energy sector. The National
Industrial Cluster Development Program (NICDP), established in October 2012 by the
Ministry of Petroleum and Mineral Resources and the Ministry of Commerce and
Industry, could likely gain further importance in the industrialization strategy adopted in
the Vision 2030. The NICDP will be managed by the Ministry of Energy. It seeks to
leverage Saudi Arabia’s comparative advantage in energy, petrochemicals and minerals
to create sustainable export oriented industries, initially focused on the automotive,
construction material, appliances, metal processing and flexible packaging sectors.
Restructuring the Cabinet and other government bodies
The Ministry of Commerce and Industry will become the Ministry of Commerce and
Investment and sees the appointment of a new Minister. The new Minister will chair the
board of directors of the General Authority for Investment, the General Authority for
Small and Medium Enterprises and the Saudi Standards, Metrology and Quality
Organization. The Ministry of Labor will be merged with the Ministry of Social Affairs to
form the Ministry of Labor and Social Development, and sees the appointment of a new
Minister. The Ministry of Water and Electricity has been disbanded. The Ministry of
Agriculture was renamed the Ministry of Environment, Water and Agriculture and
expands its responsibilities into these areas. Two new Ministers for Transport and
Health were appointed. The Ministry of Hajj has been renamed the Ministry of Hajj and
Umrah and sees the appointment of a new Minister.
The Saudi Fund for Development will now report to the Council for Economic and
Development Affairs. The General Authority for Entertainment and the General Authority
for Culture have been created. The Department of Zakat and Income Tax was renamed
the General Authority for Zakat and Income, and will report to the Ministry of Finance.
New Central Bank Governor maintains commitment to USD peg
Saudi Arabian Monetary Agency (SAMA) Governor Al-Mubarak has been replaced in his
post by SAMA Deputy Governor for Research and International Affairs Dr. Al-Kholifey. A
number of officials were also appointed into various government and advisory roles.
New SAMA Governor Al-Kholifey’s past policy pronouncements suggest continued
commitment to the USD peg.
Watch the Saudi Fund for Development
The Saudi Fund for Development (SFD) new direct link to the Council for Economic and
Development Affairs likely concentrates further authority in the Deputy Crown, in our
view. Given that the Public Investment Fund (PIF) last saw similar links being established
prior to plans being made for it to be turned into a Sovereign Wealth Fund (SWF), this
could suggest further strategic changes may take place at the SFD.
4 GEMs Paper #26 | 30 June 2016
Exhibit 1: Saudi Vision 2030 Governance Model
Source: Saudi Vision 2030
A web of Strategic Programs
Saudi Vision 2030 incorporates a number of Executive Programs and initiatives, with
implementation carried out by several government entities. The Vision continues to
centralize decision-making into CEDA, chaired by Deputy Crown Prince Mohammed bin
Salman, and reporting to the Council of Ministers. The Ministry of Economy and
Planning also retains an important role, with lower emphasis being put on the Ministry
of Finance. The Project Management Program also suggests emphasis on ongoing
review of capital expenditures, whereby existing review served to examine their approval
process, and control their level. From a macro perspective, the three most important
programs for now are: a) the re-shaping of the Public Investment Fund (PIF) into a
US$2trn Sovereign Wealth Fund (SWF); b) the new corporate strategy for Saudi Aramco
to transform it into an energy and industrial conglomerate; and, c) the National
Transformation Plan (NTP) which encompasses medium-term growth boosting
initiatives and fiscal consolidation measures (alongside the Fiscal Balance and
Privatization Programs). We discuss these three elements in turn below.
Table 1: Strategic Programs introduced by the Saudi Vision 2030
Strategic Program
Comment
Government Restructuring Program
Supreme Councils have already been implemented, and the Council of Political and Security Affairs and the Council of
Economic and Development Affairs (CEDA) have been established
Strategic Directions Program
Strategic directions determined by state agencies and approved by the government
Regulations Review Program
Several laws have been reviewed or enacted already such as the Company Law, the Non-Governmental Organizations Law,
the White Land Law, and the General Authority for Endowments (Awqaf) Law
Performance Measurement Program
Center for Performance Management of Government Agencies has been established
Human Capital Program
Aims to measure, assess, analyze and support the efficiency of civil service
Program for Strengthening Public Sector Governance Strategic Management Office reporting to CEDA as well as a Decision Support Center at the Royal Court are to be established
Strategic Partnerships Program
Aims for stronger ties with economic partners to enhance exports
"Daem" Program
Aims to enhance the quality of cultural activities and entertainment
Private Sector Growth Stimulation Program
Under consideration
Regional Development Program
Under consideration
Fiscal Balance Program Likely target of achieving fiscal balance by 2020
Project Management Program
Expert Project Management Offices (PMOs) and a Central Delivery Unit have been established
Saudi Aramco Strategic Transformation Program
Aims to position Saudi Aramco as a leader in more than one sector
Public Investment Fund (PIF) Restructuring Program
Aims to transform the PIF into the largest Sovereign Wealth Fund (SWF) in the world
Privatization Program
Comprehensive privatization program; targets under study
National Transformation Plan Program Interim Key Performance Indicators (KPI) targets to achieve by 2020
Source: Saudi Vision 2030, BofA Merrill Lynch Global Research
GEMs Paper #26 | 30 June 2016 5
Table 2: Initiatives introduced by the Saudi Vision 2030
Initiative Current Target
Religious tourism
Number of yearly Umrah visitors per year (mn) 8 30
Building the largest Islamic museum in the world - -
Culture
Number of Saudi heritage sites registered with UNESCO 4 8
Number of Saudi cities recognized in the top-ranked 100 cities in the world 0 3
Household spending on cultural and entertainment activities (%) 2.9 6
Social
Average life expectancy (years) 74 80
Unemployment rate (%) 11.6 7
Female labour force participation (%) 22 30
Household savings ratio (% of household income) 6 10
Ranking in the Social Capital Index 26 10
Ratio of individuals exercising at least once a week (%) 13 40
Number of volunteers per year 11,000 1,000,000
Localization
Localization of oil and gas sectors (%) 40 75
Localization of defence industry (%) 2 50
Renewable energy value chain (%) - -
Sovereign Wealth Fund
Public Investment Fund assets (SAR bn) 600 7,000
Economy
Global ranking of the economy in terms of size 19 15
Ranking in the Global Competitiveness Index 25 10
Ranking in the Logistics Performance Index 49 25
Private sector contribution to GDP (%) 40 65
Foreign Direct Investment (% of GDP) 3.8 5.7
Non-oil exports share in non-oil GDP (%) 16 50
SME contribution to GDP (%) 20 35
Non-profit sector contribution to GDP <1 5
Improving the business environment and pursuing public-private partnerships - -
Rehabilitating economic cities and restructure King Abdullah Financial District - -
Establishing special zones such as logistic, tourist, industrial and financial ones - -
Revise energy subsidies and redirect support to eligible citizens and economic sectors - -
Ease restrictions on ownership and foreign investment in the retail sector - -
Fiscal
Non-oil government revenue (SAR bn) 163 1,000
Governance
Ranking in the Government Effectiveness Index 80 20
Ranking in the E-Government Survey Index 36 5
Source: Saudi Vision 2030
6 GEMs Paper #26 | 30 June 2016
Public Investment Fund to gain prominence
The restructuring of the Public Investment Fund (PIF) is likely to allow greater focus on
achieving a diversified foreign asset base which could support in turn the build-up of
non-oil revenues. According to Deputy Crown Prince Mohammed bin Salman,
government ownership of Saudi Aramco would be transferred to the PIF, which will be
transformed into a SWF that will look to increase its overseas assets (from 5% of total
to 50% of total by 2020) following its recapitalization and the proceeds of Aramco IPO.
The PIF would hold on-paper a vast amount of wealth post-IPO (US$2trn, according to
the Deputy Crown Prince, the bulk of which would be Saudi Aramco) as ownership of
Saudi Aramco is transferred to the PIF, but it would only be able to deploy the cash
proceeds of the monetized Aramco stake in the near-term, in our view. We think the
PIF’s transformation is still at a relatively early stage for now.
Room to grow PIF stature and budget contribution
The restructuring of the PIF is likely to allow further diversification of foreign assets,
which will in turn increase the share of investment income in the budget over time. We
estimate that in 2015 investment income transferred to the budget stood at US$9.9bn
(1.5% of GDP), which entails transfers of US$4bn from the PIF and US$5bn from SAMA.
These transfers pale in comparison to the estimated budgetary contributions among
main GCC peers. We estimate that the rate of return (investment income) on foreign
assets of SAMA, government entities and the private sector averaged c2% over the past
8 years, which already suggests some exposure to riskier asset classes, in our view. As
the PIF gains importance, it will become more prominent in the examination of the
breakdown of the Saudi Net International Investment Position .
Transitioning to an Abu Dhabi model
It will be interesting to see how the restructuring of the PIF into an SWF works out in
practice. We hypothesise that it may be that, on top of the monetization of Aramco's
stake sale, PIF could get a portion of the assets of SAMA. In this scenario, we would
effectively transition to the Abu Dhabi and Kuwait model where the central bank holds
little reserves and non-transparent SWFs are what matters both in terms of flow and
stock. Foreign assets purchases of the PIF would also have to be managed within the
overall Balance of Payments (BoP) framework as they could lead to drains on SAMA
reserves in the near term. Over time, Saudi Arabia could decide to emulate the Norway
model, which would entail a more prudent use and conduct of fiscal policy, in our view.
Chart 1: PIF budget contributions small versus GCC SWF contributions
40
35
30
25
20
15
10
5
US$bn % of GDP % of total revenues
0
Qatar Abu Dhabi Kuwait Saudi Arabia Dubai
Source: Haver, IMF, Saudi Ministry of Finance, BofA Merrill Lynch Global Research. 2015 data,
Investment income and transfer of profits of public entities for Kuwait. Investment income from
public enterprises (incudes Qatar Petroleum’s net income) for Qatar.
Chart 2: High rate of return suggests foreign assets well diversified
10
Implied rate of return with respect to IIP assets (%)
Implied rate of return with respect to SAMA reserve assets (%)
3.0
Net income balance (% of GDP, rhs)
2.5
8
2.0
6
4
2
0
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Source: Haver, BofA Merrill Lynch Global Research. Implied rate of return on SAMA reserve assets
simplistically assumes all investment income is earned by SAMA (instead of being earned by SAMA,
government entities and the private sector).
1.5
1.0
0.5
0.0
-0.5
-1.0
GEMs Paper #26 | 30 June 2016 7
PIF largely a domestic inward-looking entity until recently
The IMF reports that the PIF had assets of 11.1% of GDP in 2014 (c.SAR310bn). PIF has
foreign assets of SAR14.1bn as of end-2015. It has outstanding loans of SAR103.9bn as
of 3Q15 (excluding electricity loans of SAR14bn that PIF administers). According to
Bloomberg, PIF had stakes in publicly listed companies on Tadawul worth SAR934bn as
of April 2016. According to the MoF, PIF held equity worth SAR63.3bn in 41 Saudi
companies in total at end-2011, as well as stakes worth SAR14.9bn in a number of pan-
Arab corporations.
In July 2014, the cabinet authorized the PIF to establish companies inside and outside
Saudi Arabia, alone or in partnership with other institutions from the public or private
sectors. It also bought a US$1.1bn stake in a South Korean company and recently
announced in early June it took a US$3.5bn stake in Uber, denying in the process that it
was considering a US$3bn loan to fund the acquisition. PIF has been asked to co-invest
US$10bn in Russia or the Middle East with the RIDF. Note that PIF has established
Sanabil investments with SAR20bn in capital. The PIF has paid dividends to the budget
last year (SAR15bn). It now reports directly to the Council of Economic and
Development Affairs headed by the Deputy Crown Prince, after reporting to the Ministry
of Finance in the past.
JASTA bill not a hurdle for further Saudi investment in the US
We expect that the deep and liquid US financial markets will remain a prominent
destination for Saudi foreign asset holdings. The potential passage of the “9/11” bill
(Justice Against Sponsors of Terrorism Act, JASTA) in US Congress raises the possibility
that Saudi Arabia would choose to liquidate up to US$750bn in assets in the US,
according to Saudi Foreign Minister Adel al-Jubeir. A forced and rapid liquidation of USbased
Saudi foreign assets may expose SAMA and other government entities to markto-market
losses, and require changes to Fx reserve management
The language of the JASTA bill as it currently stands does not suggest an imminent
Saudi sell-off of US assets, in our view. The “Stay of Actions Pending State
Negotiations” section inserted into the bill allows a stay to be granted for an indefinitely
renewable 180-day period. This would be subject to court petition by the Attorney
General and repeated certification by the Secretary of State that the US is “engaged in
good faith discussions with the foreign state defendant concerning the resolution of the
claims against the foreign state”. The certification thus depends on the current and
future US administration foreign policy inclinations, in our view. Separately, we note
that the White House spokesman said US President Obama did not support the
legislation and likely would not sign it. (A potential presidential veto may however still
be overruled if Congress assembles the necessary two–thirds vote of each house). We
continue to expect a close relationship between the US and Saudi Arabia given the
confluence of interests in a broad range of matters.
8 GEMs Paper #26 | 30 June 2016
Table 3: Breakdown of Saudi Arabia Net International Investment Position (US$bn)
2007 2008 2009 2010 2011 2012 2013 2014 2015
Net International Investment Position 380 471 435 479 585 685 763 792 703
% of GDP 91 91 101 91 87 93 103 105 108
Net Foreign assets (excluding SAMA) 74 28 24 34 41 28 37 59 87
% of GDP 18 5 6 6 6 4 5 8 13
Assets 495 631 636 708 824 936 1,028 1,069 993
Non-reserve assets 190 188 226 262 280 279 302 337 376
by holder:
Investment funds 7 4 4 5 5 5 6 8 7
Commercial banks 39 41 56 52 56 57 56 67 84
Public Investment Fund (PIF) foreign investment 1 2 2 4 4 5 4 4 4
Saudi Fund for Development (SFD) cumulative loan disbursements 6 6 6 7 7 7 8 8 -
Public Pension Agency (PPA) and General Organization for Social Insurance (GOSI) net foreign assets - 49 - - - 98 112 - -
of which, managed by SAMA (e) 43 48 51 59 65 69 75 80 78
PPA net foreign assets - 24 - - - 63 72 - -
GOSI net foreign assets - 25 - - - 35 40 - -
Development funds and other government (exc. PPA/GOSI) entities’ foreign assets managed by SAMA (e) 15 17 18 20 22 23 25 27 26
Other - 69 - - - 85 92 - -
by instrument:
Direct investment abroad 17 20 23 27 30 34 39 45 63
Portfolio investment 105 99 122 146 158 168 178 199 202
Equity securities 53 50 59 79 82 92 99 111 109
Debt securities 52 48 63 68 77 75 79 88 94
Other investment 68 69 82 90 92 77 85 93 111
Loans 3 4 4 3 3 2 2 1 1
Currency and deposits 55 63 73 76 78 69 76 85 105
Other assets 10 3 5 11 11 6 7 6 5
SAMA Reserve assets 306 443 410 445 544 657 726 732 616
Currency and deposits 93 132 111 117 148 197 191 187 204
Foreign securities 211 308 286 315 380 444 519 532 400
Other assets 2 3 13 13 16 16 15 13 12
Liabilities -116 -160 -201 -228 -239 -251 -265 -278 -289
Direct investment in reporting economy -73 -113 -148 -176 -187 -199 -208 -216 -224
Portfolio investment 0 -3 -4 -4 -6 -10 -17 -17 -17
Equity securities 0 0 0 0 0 -9 -15 -15 -15
Debt securities 0 0 0 0 0 -1 -2 -2 -2
Other investment -42 -44 -49 -48 -46 -42 -40 -45 -48
Loans -13 -14 -13 -13 -12 -11 -9 -10 -12
Currency and deposits -28 -28 -25 -25 -23 -20 -19 -25 -26
Other assets -1 -1 -11 -10 -11 -11 -11 -11 -11
memo:
Identified Saudi Arabian and Middle Eastern holdings in the US
Saudi Arabia US Treasury (UST) holdings 51 46 83 69 68 76 80 91 109
Long-term securities 50 45 82 68 67 74 78 88 107
Short-term securities 1 1 1 1 1 2 2 3 2
Saudi Arabia holdings of US equities 45 42 31 36 53 65 68 78 52
Saudi Arabia holdings of US Agency debt securities 8 42 14 7 5 5 7 6 6
Long-term securities 8 41 14 7 5 5 7 6 6
Short-term securities 0 1 0 0 0 0 0 0 0
Saudi Arabia holdings of US corporate debt securities 7 14 17 12 12 9 15 19 15
Long-term securities 5 9 11 9 8 6 10 13 13
Short-term securities 2 5 6 3 4 3 5 5 3
Middle East Foreign Direct Investment (FDI) position in the US (cost basis) 9 9 10 8 10 11 12 11 -
Middle East oil exporters gross claims on US banks 81 122 106 101 136 132 134 129 120
Saudi Arabia deposits in Bank for International Settlements (BIS) reporting banks
Cross-border deposits with BIS reporting banks 163 180 169 167 188 244 224 210 212
of which, implied deposits from banks and others 102 142 128 113 135 180 174 158 170
of which, deposits from nonbanks 60 39 41 54 53 64 50 52 42
Saudi Fund for Development
Cumulative signed loans 7 8 8 9 10 11 11 12 -
Cumulative disbursements 6 6 6 7 7 7 8 8 -
Government entities foreign assets managed by SAMA off-balance sheet 58 66 69 79 87 92 100 107 104
Deposits with banks abroad 4 5 3 2 2 6 13 10 5
Foreign securities 55 61 66 77 85 85 87 97 98
Source: Haver, SAMA, IMF, SFD, BofA Merrill Lynch Global Research. Middle East oil exporters consist of Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.
GEMs Paper #26 | 30 June 2016 9
Historic energy sector liberalization
Partial privatization of energy sector assets could represent one of the cornerstones of
the ambitious medium-term diversification strategy, and, if confirmed, serve as a highly
visible and historic milestone. Such privatizations could ease key macro concerns
regarding unsustainable debt accumulation and Fx reserves drawdown. We believe it
would also confirm the government’s macro reform credentials, its preparedness for a
prolonged period of low oil prices and likely signal no near-term energy policy
capitulation. The NTP suggestion of a flat production capacity through 2020 suggests
less aggressive market share strategy, in our view.
Privatization of energy sector could start by 2018
In a recent interview with Bloomberg, Saudi Deputy Crown Prince Mohammed bin
Salman outlined an array of measures the Saudi government could introduce to help
diversify the economy, reduce its reliance on the hydrocarbon industry and ultimately
support medium-term fiscal consolidation in a low oil price environment. Amongst these
measures, the Deputy Crown Prince included a potential Initial Public Offering (IPO) of
Saudi Aramco (at the parent level, and including various subsidiaries). With close to
250bn bbls of oil reserves, more than 10mn bbls per day of production and the world’s
4th largest gas reserves, Saudi Aramco is the leader in hydrocarbon access among state
owned, private and public Oil & Gas (O&G) companies alike. Saudi Aramco is the world’s
largest Oil & Gas Company by production and arguably the Kingdom’s most important
asset. Specifically, he outlined a plan that would see “less than 5%” of the company
being sold to investors on the Saudi stock exchange no later than 2018 (but potentially
as soon as 2017). Furthermore, he indicated the Kingdom is seeking to transform
Aramco into an “energy-industrial company”. The high profile stake sale would provide a
highly visible anchor to diversification efforts and capitalize its newly restructured SWF.
Energy assets form a major and strategic sector for the economy
It is hard not to understate the central role the energy sector plays in the Saudi
economy. The hydrocarbon sector represented 43.0% of the economy in real terms in
2015. Deputy Crown Prince Mohammed bin Salman suggested a US$2trn price tag for
Saudi Aramco in his Bloomberg interview. Aramco is deeply intertwined with the Saudi
state, and its workforce Saudization has increased over the years to 83%. Furthermore,
it is the foundation of its state’s domestic and international energy policy. As such, a
decision to partially privatize the energy sector will be a momentous one to be carefully
examined by the technocratic and political leadership, in our view.
More questions than answers at this stage
Deputy Crown Prince Mohammed bin Salman’s initial suggestion in an interview with
The Economist that a Saudi Aramco IPO could be considered has raised market
expectations. Ensuing comments from Aramco’s management did not make clear
whether a listing would occur, and if so, in what form (upstream versus downstream),
although the Deputy Crown Prince’s subsequent Bloomberg interview suggested further
impetus being given to studying the matter.
A listing of the entity itself may force much more transparency regarding hydrocarbon
reserves (broadly unchanged for several years), lifting costs (local crude oil sales suggest
cUS$5/bbl if no loss is incurred) and the fiscal regime (estimates in the press have
suggested that Aramco’s profits are taxed at 85%, with royalties set at 20%, but we
also note from fiscal data that the fiscal transfer ratio in oil revenues to the Ministry of
Finance appears to drop in years of low oil prices). It may also conflict with noncommercial
ventures or strategic aspects of Saudi Aramco. This would include the
maintaining of spare capacity and state policy matters (including energy policy). Note
for instance that the US is the second regional destination for Saudi crude oil exports
(17.5% of total Saudi crude oil exports) behind Asia. This was due to a strategic
geopolitical decision to remain an important crude oil supplier to the US and was
achieved through the buying of stakes in refineries in 1988.
10 GEMs Paper #26 | 30 June 2016
Chart 3: Saudi Arabia proven crude oil reserves
bn bbl
Saudi Aramco Others
300
250
200
150
100
50
Chart 4: Saudi Arabia proven gas reserves
trn cf
300
Saudi Aramco Others
250
200
150
100
50
0
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
0
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Source: SAMA, Bank of America Merrill Lynch Global Research
Source: SAMA, Bank of America Merrill Lynch Global Research
Oil sector privatization could slow debt build-up and support Fx reserves
Potential energy sector asset partial privatization could raise a substantial amount for
the Saudi government, in our view. A share sale would be a non-debt creating financing
flow for the budget, which would lessen the need to borrow domestically or externally. A
share sale could also increase Saudi Arabia’s ability to project soft power and influence
regionally and internationally. However, it would only support the build-up of Fx reserves
in the case of foreign investor participation. Assuming a US$2trn valuation suggested
by the Deputy Crown Prince as the value for the SWF, the vast majority of which would
be Aramco through a possible 5% listing, such a listing could raise up cUS$100bn, which
would represent the current annual government borrowing requirements and associated
Fx reserves drawdown. We expect further administered energy price adjustments over
the next five years, which should increase state revenues, in our view.
A share sale may also facilitate international borrowing on the back of Saudi Aramco’s
balance sheet. Saudi Aramco also announced it would look to set up a corporate debt
program to fund its NTP initiatives, although issuance does not appear to be an
immediate prospect. A corporate debt program, alongside a sovereign one, could allow
the government to simultaneously tap a new pool of liquidity through corporate bond
investors, upstream proceeds if needed and support Fx reserves. This could be achieved
without impacting central government debt ratios and without saturating the
government debt issuance room with sovereign debt investors. Saudi Aramco raised a
US$10bn syndicated loan in late March 2015 in part to fund acquisitions. The loan
replaced US$4bn in existing facilities agreed to in 2010, and includes a US$6bn fiveyear
tranche with two 1-year extension options, a US$1bn 1-year renewable facility, a
non-interest bearing SAR7.5bn (US$2bn) five-year tranche with two 1-year extension
options and a SAR3.75bn (US$1bn) 1-year tranche renewable yearly.
Very roughly, taking the US$2trn Deputy Crown Prince potential valuation for Aramco,
and assuming an optimal 10% net-debt-to-equity medium-term target, it would suggest
that Aramco could manage leverage of up to US$200bn (c30% of GDP) in domestic and
external debt on its balance sheet. Within a corporate setting, possible higher gearing
needs to be justified to shareholders and could reflect financing of acquisitions or NTP
costs. From a macro angle, international issuance would support Fx reserves.
Three aspects of energy policy to consider going forward
Energy sector privatization is likely to raise questions on the future path of energy
policy, though we believe the latter will stay the course for now. We believe that are
three aspects that are central to energy policy in Saudi Arabia: a) competition for global
market share in upstream operations; b) future investment decisions and maintaining of
spare capacity buffer; and c) integration and expansion of downstream ventures to
create domestic jobs, secure captive crude demand and make operations less volatile.
GEMs Paper #26 | 30 June 2016 11
Targeting a stable oil price
As a matter of Saudi policy, we would expect a preference for oil market stability over
volatility, in line with recent official pronouncements. Although volatility makes it more
difficult for high cost unconventional producers to operate, volatility is also damaging
for Saudi Arabia and long-term planning domestically. For instance, no budget was
announced for 1986 due to uncertainties in the world oil market, with monthly current
appropriations set at one-twelfth of estimated actual expenditures for the prior year.
We think Saudi authorities view possible eventual sharp upward price spikes in the oil
price as damaging to both oil-consuming and oil-producing countries.
Future investment decisions will be critical for oil prices
Spare capacity is an important policy parameter for Saudi Arabia. In addition to its
influence on prices through its ability to adjust production, Saudi can decide on the pace
of its reserves development which would potentially affect future supply. There are
distinct trade-offs in this decision. If Saudi Arabia is producing at close to its maximum
capacity, it will have little control over sharp upside movements in oil prices. If excess
capacity is large, oil prices are likely to be under downward pressure.
In the near-term, given the uncertainty in the market, in our view, there is likely little
incentive for Saudi Arabia to embark on a program to invest and increase capacity from
the current level. New investments may still be made to offset declines in existing
fields. Over time however, our commodities research medium-term oil balances suggest
that Saudi’s spare capacity would be eroded over time unless further increases in spare
capacity take place. Our BofAML commodities research medium-term supply-demand
balances suggest an increased call on OPEC and need to increase production capacity. In
2004-09, Aramco invested cUS$100bn into its largest-ever capacity expansion program,
which increased total capacity from 10mn bpd to 12.5mn bpd. For now, Aramco has
suggested it will not slow down its hydrocarbon capex program for the next three years
as cuts were achieving through savings in drilling costs and supplier discounts.
Energy policy is likely to be less aggressive going forward
We expect a less aggressive energy policy going forward, particularly as the NTP
suggests a constant oil production capacity and an increase in gas production
domestically. This is in line with Saudi Minister of Energy, Industry and Mineral
Resources Al-Falih’s pronouncements during the June Ordinary OPEC meeting. While his
comments served to project increased OPEC institutional credibility and increased
rapprochement with fellow OPEC members, he suggested that Saudi Arabia will remain
responsive to customer needs but dismissed fears that increasing Saudi market share
would take place in an aggressive manner (that could drive prices lower again).
Downstream operations - increased focus
Saudi Aramco’s downstream integration drive is likely being pursued for two core
reasons: (1) to support demand for Saudi crude (placing own crude in own refining
capacity) and (2) a risk reduction mechanism in a highly volatile oil environment (having
an integrated value chain allows capture of margins from well to the forecourt,
promoting stability). In reflection, Saudi Aramco is building highly sophisticated
refineries domestically, in addition to already completed joint-ventures and stakes in
refineries abroad (China, US, Japan, South Korea, Indonesia). Domestic joint-venture (JV)
refineries Satorp and Yasref added 400k bpd each of capacity in 2H14. With the
completion of the fully-owned Jazan 400k bpd refinery in 2018/19, overall total refinery
capacity would stand at 5.7mn bpd, of which Saudi Aramco’s share would be 3.3mn bpd.
This would allow Saudi Arabia to guarantee security of demand for its heavy crude,
increase domestic job creation and diversification, build an export base of refined
products (likely middle distillates to the EU) and lower imports of refined products.
12 GEMs Paper #26 | 30 June 2016
National Transformation Plan: many promises, few details
The National Transformation Plan (NTP) released by the Saudi government is a further
step towards execution of Saudi Vision 2030 through a set of ambitious interim targets
to achieve by 2020 by 24 government bodies. The NTP is a comprehensive program
encompassing medium-term growth boosting initiatives and fiscal consolidation
measures. The sequencing and details of the fiscal measures are however still left
nebulous. Implementation of growth-boosting initiatives will require a challenging
crowding in of private sector investment, particularly from domestic sources.
The NTP is likely to introduce a number of one-off supply-side shocks to inflation
through its fiscal or labor measures, which could negatively impact Real Effective
Exchange Rate (REER) competitiveness. Discretionary consumption growth and real
incomes are likely to remain under pressure. We find the diversification measures
encouraging, although they appear too ambitious to be met within the time frame
envisaged in the NTP, in our view. The focus on diversification could introduce mediumterm
incentives to adopt a more competitive exchange rate, while also detracting from
the binding fiscal constraint under which the government has to operate. Energy policy
is likely to be less aggressive and support oil prices. Fiscal targets are difficult to reach,
but medium-term oil prices of at least US$50-65/bbl could support NTP progress.
Table 4: Selected macro Key Performance Indicators (KPIs) under the National Transformation Plan
Regional
b’mark
Government entity Key Performance Indicator (KPI) Unit Baseline 2020 target
Ministry of Finance
Total non-oil revenues SARbn 163.5 530 10.9 691.0
Budgeted salaries and wages SARbn 480 456 N/A N/A
Salaries and wages as a percentage of the budget % 45 40 30 12
Approved projects according to criteria and timeline (% of total) % 0 40 30 78
Credit rating - A1 Aa2 Aa2 Aaa
Government debt as percentage of gross domestic product (%) % 7.7 30 35 54
Total recorded non-oil assets SARtrn 3 5 N/A N/A
Ministry of Economy & Planning
Total revenue resulting from privatization projects Under Study Under Study Under Study N/A N/A
Value of water and electricity subsidy decrease SARbn 0 200 N/A N/A
Percentage decrease in non-oil subsidy % 0 20 N/A N/A
Value of private sector contribution to GDP SARbn 993.3 Under Study 122.6 14,133.8
Ministry of Energy, Industry and Mineral Resources
Value of exports of non-oil commodities SARbn 185 330 Under Study Under Study
Value of the mining sector's contribution to GDP SARbn 64 97 13 262
Local content in expenditure of public and private sectors % 36 50 Under study 57
Petroleum production capacity mn bpd 12.5 12.5 3.8 11
Dry gas production capacity bn cf pd 12 17.8 5.7 16
Refining capacity mn bpd 2.9 3.3 1.1 1.9
Ministry of Labor and Social Development
Unemployment rate for Saudis % 11.6 9 Under Study 5.8
Cost of employment of Saudis compared to expatriates % 400 280 N/A N/A
Proportion of female labor force % 23 28 Under Study Under Study
Ministry of Hajj and Umrah
Number of formal Hajj pilgrims (domestic and foreign) mn 1.5 2.5 N/A N/A
Number of Umrah Pilgrims from abroad mn 6 15 N/A N/A
Number of Umrah pilgrims (domestic and GCC nationals) mn Under Study Under Study N/A N/A
Commission for Tourism and National Heritage
% contribution of tourism sector to GDP % 2.9 3.1 4.9 5.4
Ministry of Civil Service
% decrease in the payroll and benefits expenditure % Under Study 20 Under Study 22
% of workers reduction in the civil service sector % Under Study 20 Under Study 18
Saudi Arabian General Investment Authority
Foreign Direct Investment (FDI) SARbn 30 70 45 481
Time needed to issue work visas for new expat employees Day 30 10 10 3
Time needed to issue new business permits Day 19 1 8 0.5
Source: National Transformation Plan
Global
b’mark
GEMs Paper #26 | 30 June 2016 13
Ambitious diversification agenda is not without risks
Diversification initiatives will require material participation from the private sector.
Vested interests and the large bureaucracy could act as a dampener on timely reform
implementation going forward. The large size of the NTP program may mean some of
its outcomes are internally inconsistent, in our view. Cultural and entertainment changes
could be opposed by conservative or clerical factions. Slippage could occur due to
execution risk or reform fatigue, particularly due to the socio-economic impact of fiscal
consolidation. Any material changes to subsidies or wages could be difficult to
implement in the absence of a social safety net. While fiscal consolidation measures are
unprecedented in scope, they appear too ambitious or difficult to reach and may leave a
financing gap. As such, the measures may still fall short if oil prices do not stabilize,
which suggests a need for a less aggressive energy policy going forward, in our view.
Government leaders continue to show focus on delivery
The US visit of Deputy Crown Prince Mohammed bin Salman and finalization of various
Memoranda of Understanding (MoUs) with prominent US corporates helps provide a
highly visible anchor for foreign investment and instil business confidence in regards to
government focus. It also helps boost the profile of the Deputy Crown Prince both
domestically and internationally. This is in line with our view that the government is
likely to target rapid implementation of several ‘low-hanging’ reforms to spearhead the
program and boost confidence. Energy sector liberalization could also serve as another
highly visible anchor to the reform program, in our view.
Table 5: Announced US corporates plans during the US visit of the Saudi Deputy Crown Prince
Company Sector Outcome
Six Flags Entertainment Company has been allowed to operate in Saudi Arabia
Pfizer Pharmaceuticals Company has been awarded a direct investment license
3M Manufacturing Company has been awarded a direct investment license
Dow Chemical Chemicals Company has been awarded a direct investment license
Microsoft IT Memorandum of Understanding signed
Cisco IT Memorandum of Understanding signed
Apple IT Discussions on entry to Saudi market possibly under way
Source: Press reports, Saudi Press Agency, BofA Merrill Lynch Global Research
Diversification drive is a step in the right direction
The comprehensive medium-term diversification drive introduced by the NTP follows
the typical macro template, in our view. We discuss in a later section diversification
lessons from Malaysia and Norway and conclude that the NTP contains elements from
these successful case studies. In particular, it a) identifies key sectors with relatively
high growth potential (mining, petrochemicals, manufacturing, retail and wholesale
trade, religious and other forms of tourism, healthcare, real estate and finance); b), it
starts to articulate supportive public sector industrial strategies, including through
localization policies; and, c) it seeks to foster higher-value added in the economy
through enhancements to processes, products and organizations.
14 GEMs Paper #26 | 30 June 2016
Chart 5: More sustained private non-oil sector growth needed in Saudi
25
20
15
10
5
0
-5
Oil Sector
Private Non-Oil Sector
Government Non-Oil Sector
Real GDP growth (%yoy)
Chart 6: Oil sector large; government controls 60% of real economy
16.9%
43.0%
39.3%
-10
-15
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Oil Sector Private Non-Oil Sector Government Non-Oil Sector
Source: Haver, BofA Merrill Lynch Global Research. Series uses contributions to growth from real GDP
data with 1999 base year prior to 2010.
Source: Haver, BofA Merrill Lynch Global Research. Data as of 2015.
Human capital is critical and takes time to build
In our view, improvements to human capital, rather than business climate supply-side
reforms, are the critical barriers to overcome. While building the appropriately qualified
workforce takes time, Saudi Arabia has been making progress in this area. c25% of
Saudi tertiary graduates complete humanities and arts programs, but this is down from
39.4% in 1999. Graduates from social sciences, business and law represented the
largest share of graduates at 27.2% of total in 2014, up from 15.5% in 1999. Still, as we
discuss in later sections, diversification prospects are mixed across sectors and will
likely depend in part on providing the appropriate incentives to the private sector.
Chart 7: Distribution of Saudi tertiary graduates by field of study (%)
40
35
1999 2014
30
25
20
15
10
5
0
Humanities and arts
Education
Social sciences,
business, law
Science
Engineering,
manufacturing
Health and welfare
Agriculture
Others
Services
Source: UNESCO, BofA Merrill Lynch Global Research
Mobilizing domestic resources is key
The NTP makes clear that part of the NTP costs (40%) will need to be shouldered by the
private sector. Out of a total estimated NTP cost of SAR447bn (US$119bn; 18.4% of
GDP), the NTP implies that the private sector will need to contribute about SAR179bn
over the coming five years (US$47.6bn; 7.4% of GDP). Implementation of growthboosting
initiatives will require a challenging crowding in of private sector investment.
The NTP expects only a SAR40bn increase in the level of Foreign Direct Investment
(FDI), meaning that the bulk of private sector investment could have to come from
domestic sources. While the government investment is generally in retrenchment mode,
the NTP may be suggesting that selective and strategic projects are likely to go ahead.
Authorities have also suggested a number of projects could be structured as Public-
Private Partnerships (PPP).
GEMs Paper #26 | 30 June 2016 15
Chart 8: Saudi government non-hydrocarbon and private sector
investment growth are relatively correlated
110
90
70
50
30
10
-10
Government non-oil GFCF (3yma, %yoy)
Private sector GFCF (3yma, %yoy)
Chart 9: Crowding in domestic private sector investment when the
government sector retrenches can be challenging
20
Government non-oil nominal GFCF (% of GDP)
Private sector nominal GFCF (% of GDP)
Oil prices (US$/bbl, rhs)
15
10
5
120
100
80
60
40
20
-30
0
0
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
Source: Haver, BofA Merrill Lynch Global Research. GFCF refers to Gross Fixed Capital Formation.
Source: Haver, BofA Merrill Lynch Global Research. GFCF refers to Gross Fixed Capital Formation.
Ambitious non-oil export and tourism targets, but little details
The NTP targets increasing non-oil exports by SAR145bn (US$38bn, 6.0% of GDP) to
SAR330bn (US$88bn, 11.4% of 2020f GDP) over the next five years. Although
implementation details are lacking, we anticipate that part of the increase could be
linked to the higher mining output targeted. These would nevertheless be dependent on
the global economic cycle. Higher exports of refined oil products, if all of the additional
capacity to be installed by 2020 is exported, could add cUS$7.3bn to exports at current
price levels (but not qualify towards non-oil exports targets under the NTP as they are
classified as hydrocarbon exports). Currently, 61% of Saudi non-oil exports represents
chemicals and plastics, and maintains a correlation with oil prices, and re-exports
account for another 17% of total non-oil exports and have little added-value.
Chart 10: Chemicals, plastics, re-exports form bulk of non-oil exports
SARbn other
200
food
machinery
100
metals
150
re-exports
80
plastics
100
chemicals
Brent (US$/bbl, rhs)
60
non-oil exports (% of total, rhs)
40
50
20
Chart 11: Non-oil exports are diversified in terms of destination
19%
26%
12%
14%
29%
0
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
0
Asia GCC MENA EU Other
Source: Haver, BofA Merrill Lynch Global Research.
Source: Haver, BofA Merrill Lynch Global Research.
Likewise, the focus on religious tourism is appropriate given its importance in Saudi
Arabia but NTP targets appear ambitious to us with a targeted 20%yoy CAGR increase
in Umrah pilgrims. Religious tourism accounted for c40% of total tourist expenditure in
Saudi Arabia in 2015, bringing in proceeds of SAR33.4bn (US$8.9bn; 1.4% of GDP). Note
that, for balance of payment purposes, total tourism revenues stood instead at
SAR37.9bn (US$10.1bn; 1.6% of GDP). The NTP targets would thus imply religious
tourism external revenues/expenditures to increase to US$10-US$20bn (1.3-2.6% of
2020f GDP). This would be helpful on the external front but not a game changer on its
own, in our view.
16 GEMs Paper #26 | 30 June 2016
Chart 12: Breakdown of expenditure on inbound tourist trips
SARbn
80
60
40
20
Other
Religious
Business
Family visits
Holidays
religious tourism (% of total, rhs)
80
70
60
50
Chart 13: Inbound tourist trips to Saudi Arabia by country of origin
1%
7% 5%
45%
25%
17%
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: SAMA, BofA Merrill Lynch Global Research.
40
GCC Middle East Asia Europe Africa America
Source: SAMA, BofA Merrill Lynch Global Research. Data as of 2015.
Mixed prospects for fiscal consolidation
The apparent redistribution of part of the proceeds of the flagship fiscal measures
towards funding the NTP initiatives suggests that the fiscal consolidation efforts could
fall short of the necessary requirement to narrow imbalances materially in the absence
of a sustained oil price recovery. We calculate that the NTP targets a total net
cumulative fiscal consolidation effort of SAR648bn (US$172.8bn) or c1% of GDP
annually, assuming progressive and full implementation of the non-oil revenue targets.
Energy policy needs to support economic transformation
Energy policy is likely to be less aggressive going forward, particularly as the NTP
suggests a constant oil production capacity as well as an increase in gas production
domestically which could free up domestic crude for exports. To remain consistent with
the targeted government debt accumulation path, we estimate that oil prices have to
average at least US$50/bbl in 2016-20 along with no growth in spending from 2016
levels (excluding the additional cost of NTP initiatives but including implementation of
the NTP non-oil revenue measures). Oil prices of at least cUS$65/bbl would be required
if spending is not disciplined or revenue targets are missed by c50%, in our view.
Blueprint for fiscal measures lacks details
The approved NTP initiatives will have a total fiscal cost of SAR268bn (US$71.5bn;
11.6% of GDP) spread over five years (annually, SAR54bn equivalent to US$14.3bn or
2.3% of GDP). Government financing could represent 60% of total funding needs for the
NTP initiatives, with total NTP costs of SAR447bn (US$119bn; 18.4% of GDP). Against
that, the NTP envisages raising SAR366bn in non-oil revenues and cut the wage bill by
5% or SAR24bn (US$6.4bn or 1% of GDP). Non-oil revenue is seen rising to SAR530bn
(US$141bn, 23% of 2016f GDP) by 2020 from SAR163.5bn (7% of GDP).
Wage bill measure unclear but may carry profound social implications
In an unprecedented austerity measure, the share of the wage bill in total spending
would fall by 5ppt to 40% (SAR456bn, from SAR480bn) by 2020. It is yet unclear how
this could be achieved in practice. Furthermore, note that the MoF budget
announcement estimated the wage bill in 2015 to stand at SAR450bn, blurring the
target. Privatizations of government entities are likely to lead to a natural drop in the
public sector number of employees and wage bill. Yet we note that the Ministry of Civil
Service has two Key Performance Indicators (KPIs) directly linked to a decrease in the
payroll and benefits expenditure, and to a reduction in workers in the civil service sector.
This would likely be a contentious and unpopular measure to implement, and its
implementation and success appear challenging to us.
GEMs Paper #26 | 30 June 2016 17
Spending path is unclear and is flattish (excluding NTP costs) in the best case
The spending path targeted or assumed by the NTP is unclear and does not appear to
match realized outturns. It may suggest that spending is likely to remain flattish,
excluding NTP costs. However, the indicative level spending would settle at is around
peak 2014 expenditures levels and well above the 2015 realized spending and 2016
budgeted levels. While 2015 spending could have been understated and may be revised
higher, at least SAR88bn from the 2015 spending is non-recurrent as it relates to the
one-off Saudi Royal edicts decreed upon King Salman’s accession.
Going by the indicated 2020 target for the share of the wage bill in total spending, this
would suggest that government spending is targeted at SAR1,140bn in 2020. This
represents a 2.7% increase over peak 2014 spending levels and 16.5% increase over
2015 actual spending levels. Excluding the NTP annual costs, this suggests that
government spending should still increase by 11% over 2015 levels and drop by 2% over
2014 spending in nominal terms.
In our view, given the lack of precise spending targets, one way of remaining consistent
is to use the two NTP figures for wages and infer the NTP fiscal spending from the
stated share of wages in total expenditures. This would suggest that fiscal expenditures
would reach SAR1,140bn in 2020, from SAR1,067bn in the base year (unstated in the
NTP). This is a 6.8% increase, but excluding the NTP costs, is just 1.8% higher. As such,
in the best case scenario, we think the NTP suggests flattish spending, excluding NTP
costs. If we instead take the NTP level of spending inferred to be the correct amount,
this would materially widen the fiscal deficit by SAR190bn (8.0% of GDP) and would be
deeply negative for the sustainability of the fiscal and Fx stance, in our view.
Fiscal adjustment burden shifts to raising revenue, oil prices and exports
The possible flattish spending implication of the NTP would tend to indicate that the
bulk of the spending cuts are now beyond us. Government projects are likely to continue
to be prioritized, likely according to their economic benefits and relevance to the NTP.
Flattish spending will thus shift the burden of forthcoming fiscal adjustment on raising
non-oil revenues, raising hydrocarbon exports and a sustained recovery in oil prices.
Table 6: National Transformation Plan-related spending across government entities (2016-2020)
Cost (SARbn) Cost (US$bn) % of total
Ministry of Housing 59.2 15.8 22.0
Royal Commission for Jubail and Yanbu 41.6 11.1 15.5
Ministry of Education 24.4 6.5 9.1
Ministry of Health 23.1 6.1 8.6
Ministry of communications and IT 14.9 4.0 5.6
Ministry of Agriculture 13.9 3.7 5.2
Ministry of Water and Electricity 12.9 3.4 4.8
Saudi Commission for Tourism & National Heritage 10.5 2.8 3.9
King Abdulaziz City for Science and Technology 8.3 2.2 3.1
Ministry of Labor 7.9 2.1 3.0
General Presidency of Youth Welfare 7.8 2.1 2.9
Ministry of Transport 5.6 1.5 2.1
Ministry of Social Affairs 5.4 1.4 2.0
King Abdullah City for Atomic and Renewable Energy 5.2 1.4 1.9
Ministry of Commerce and Industry 4.3 1.1 1.6
Ministry of Municipality and Rural Affairs 4.2 1.1 1.6
Ministry of Finance 3.4 0.9 1.3
Ministry of Culture and Information 3.3 0.9 1.2
Ministry of Economy and Planning 3.3 0.9 1.2
Ministry of Justice 3.2 0.9 1.2
Ministry of Petroleum and Mineral Resources 2.7 0.7 1.0
Saudi Arabian General Investment Authority 1.1 0.3 0.4
Others 2.3 0.6 0.9
Total 268.4 71.6 100.0
Source: National Transformation Plan
18 GEMs Paper #26 | 30 June 2016
Focus on increasing non-hydrocarbon fiscal revenue could fall short of target
The breakdown of measures to raise non-oil revenues is not given. However, the tally is
close to the US$100bn targeted in the Vision 2030 and is thus likely to include
measures discussed then: hikes to administered energy prices, review of current levels
of fees and fines, introduction of new fees, land tax (we estimate annual revenues of
1.5-2% of GDP in its first phase when fully implemented). In this regard, the NTP
suggests forthcoming privatizations, imposition of taxes on harmful products (likely
tobacco and soft drinks), introduction of a Value-Added Tax (VAT) for which we estimate
annual revenues of up to 2% of GDP, implementation of a unified income tax and of an
income tax on residents (although official comments later clarified there were no plans
to tax nationals but stayed equivocal regarding expatriates).
Although there is no direct budgetary impact, water and electricity subsidies are
targeted to decrease by SAR200bn. Non-oil subsidies are targeted to decrease by 20%
by 2020. The latter, we believe, consists largely of subsidies for social and sports clubs,
private education, private hospitals, and other agricultural subsidies. They were
budgeted at SAR3.9bn (US$1.0bn; 0.2% of GDP) in 2016, down from SAR15.0bn
(US$4.0bn; 0.6% of GDP) in 2015. A 20% cut to these on-budget non-oil subsidies would
thus generate minimal savings of US$0.2-US$0.8bn (0.1-0.5% of GDP) depending if the
reference base year was 2015 or 2016.
According to the Deputy Crown Prince pronouncements early in the year, medium-term
plans are also likely to target the introduction of US$400bn of unutilized state assets
(land, etc) to state-owned funds, with the latter in turn in charge of developing them
into projects and companies than can be IPOed to the public. In our view, this may be
linked to the Ministry of Finance assigned KPI of increasing total recorded non-oil
assets (real estate, etc) from SAR3trn to SAR5trn.
The Deputy Crown Prince provided a breakdown of the government target of raising
US$100bn in additional non-oil revenue annually by 2020. The bulk of this increase in
non-oil revenue would come from the restructuring of subsidies which could generate
US$30bn per year (4.9% of GDP), according to the Deputy Crown Prince. VAT
implementation, a Green Card-like program and a plan to allow corporates to hire
foreign workers in excess of their official quotas could bring in US$10bn (1.6% of GDP)
a year by 2020, according to the Deputy Crown Prince.
Chart 14: US$100bn in additional non-oil revenue targeted by 2020
Source: Bloomberg
US$10bn
US$10bn
US$40bn
US$10bn
US$30bn
Other measures
Subsidy reform
Fees to excees foreign worker quotas
Green Card-like program
Value-Added Tax
Chart 15: Government to focus on raising non-hydrocarbon revenue
SARbn
1,500
1,000
500
-
Source: Haver, BofA Merrill Lynch Global Research
Non-oil revenue
Oil revenue
Oil revenue (% of total, rhs)
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
100
90
80
70
60
50
GEMs Paper #26 | 30 June 2016 19
Chart 16: Breakdown of non-hydrocarbon fiscal revenues
40
35
30
25
20
15
10
5
0
Investments
Other revenues
Customs duties
Petroleum products tax
Documents fees
Zakat
Other income taxes
Source: MoF, BofA Merrill Lynch Global Research. Data as of 2015.
Non-oil revenues (SARbn)
% of total non-oil revenues
Telecom revenues
Fees of port services
Visa fees
General service fees
Rents and sales
Mining fees
Chart 17: Budgeted non-oil subsidies form a small portion of spending
SARbn
50
45
40
35
30
25
20
15
10
5
0
Budgeted subsidies
% of total budgeted spending (rhs)
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Source: SAMA, MoF, Bank of America Merrill Lynch Global Research.
7
6
5
4
3
2
1
0
Further energy subsidy reform is likely
The figures announced by the Deputy Crown Prince regarding proceeds of subsidy
reform suggests material changes over the next 3-4 years, with annual savings close to
the landmark first round of administered price changes in late 2015. However, his
suggestion that the changes could be accompanied by partially offsetting cash transfers
to poor households suggests policy-making caution. We do not think such a
redistributive system could be technically put in place in a short time span.
Recall that concurrently with the 2016 budget, a first round of energy subsidy reform
saw sweeping energy, water and electricity administered price changes being instituted
in late December. We estimated the natural gas price hike on petrochemical firms,
domestic crude oil price hike as well as the combined gasoline and diesel price hike
introduced could add US$2.2bn, US$2.0bn and US$3.8bn to central government
revenues if fully passed to the budget (a combined 1.2% of GDP). Impact of continued
similar policies on domestic prices would be a further 1.5-2ppt annual increase in
headline inflation, and a gradual squeeze to household incomes (where gasoline, water
and electricity likely represented c.1.5%, c0.4% and 1.6% respectively of consumer
spending basket prior to the late December 2015 administered price adjustments).
Table 7: Administered energy price adjustments carried out in December 2015
Product Price prior to Dec 2015 Current price % change
Methane (US$/mn BTU) 0.75 1.25 66.7
Ethane (US$/mn BTU) 0.75 1.75 133.3
Arab light (US$/bbl) 4.24 6.35 49.8
Arab Heavy (US$/bbl) 2.67 4.4 64.8
Diesel (US$/bbl) 9.8 14 - 19.1 68.5
Heavy Fuel Oil (HFO) 380cst 2.08 3.8 82.7
Heavy Fuel Oil (HFO) 180cst 2.08 4.25 104.3
Propane (USD/metric ton) - - -
Naphtha (USD/metric ton) - - -
Butane (USD/metric ton) - - -
Natural gasoline (USD/metric ton) - - -
Kerosene (US$/bbl) 25.7
95 octane gasoline (SAR/ltr) 0.6 0.9 50.0
91 octane gasoline (SAR/ltr) 0.45 0.75 66.7
Source: SPA, BofA Merrill Lynch Global Research. Propane, naphtha, butane and natural gasoline used to be: price using the following
formula: Japanese Naphtha price less transportation from Saudi multiplied by 0.72. The formula now is differentiated by product and is as
follows: Japanese price of the underlying product less transportation from Saudi multiplied by 0.8.
Fiscal consolidation plan looks challenging to fully achieve
The US$100bn target in additional non-oil revenue through 2020 appears difficult to
reach and is likely to leave a sizeable financing gap based on the current proposals, in
20 GEMs Paper #26 | 30 June 2016
our view. This would thus imply that fiscal consolidation is likely to fall short of
narrowing imbalances materially without a sustained oil price recovery.
The fees on excess foreign worker quotas and the green-card like program targeted
proceeds are difficult to reach, in our view. We calculate that to raise US$10bn from a
green-card like program, authorities will need to set the program fees at US$1,500 (in
line with upper bound of similar programs elsewhere) and have all expatriate workers
applying to enrol in the program. This appears an unrealistic target to meet, particularly
as it is not clear how these proceeds would be recurrent yearly. As for the foreign
worker quotas proceeds, we calculate that, based on private sector expatriate figures
and the stated 85% overall compliance with Nitaqat sector quotas, that the fees would
need to be set at a large cUS$10,500 per non-compliant worker to be consistent with
the NTP target. The large fee amount would likely be a material disincentive to private
sector corporates and a squeeze on their profits.
One of the obstacles to meeting the subsidy reform target is likely to be political in
nature given the impact on inflation and household incomes. We calculate nevertheless
that the target could be reached through a combination of a administered prices
changes. We do not think there is major room to increase natural gas feedstock prices
to petrochemical firms, given the NTP focus on the petrochemical sector as a source of
future growth. We estimate raising natural gas prices to US spot levels in an oil price
environment of US$50/bbl would bring in revenues to the central government of just
US$2.5bn (0.4% of GDP) if fully passed to the budget. This is likely to suggest that the
bulk of the future adjustments are likely to center on hikes to administered price
adjustments for domestic crude oil sales, diesel and gasoline. Selling domestic crude at
US$25/bbl rather than an average of US$5.4/bbl would bring in US$20.8bn in revenues.
Gasoline and diesel prices could rise by the same percentage as in December 2015 to
bring in additional revenues for a minimum inflation pick-up cost of 0.5ppt.
The most difficult part would be meeting the US$40bn in other non-oil revenues target,
in our view. Given that the latter’s breakdown was not provided, we have attempted to
group several measures being studied (according to local press) to provide a tentative
decomposition. Still, our analysis suggests the need for a further US$16.8-US$20.7bn in
financing to meet the US$40bn target. Land tax proceeds of US$11bn in the first phase
of implementation are the largest item, in our view. We calculate that a 20% sin tax on
tobacco and sugary drinks would raise US$2.1bn (0.3% of GDP) at a 0.5ppt cost to
inflation. A remittance tax being studied, according to local press, and could impose a
tax of 6% gradually decline to 2% over a number of years. At the upper bound of the tax
rate (6%), we calculate that the remittance tax would raise US$2.3bn (0.4% of GDP). We
calculate that a 10% income tax on expatriates would raise at least between US$3.9-
US$7.8bn (0.6-1.2% of GDP), depending on the assumed annual overall expatriate
earnings. That being said, measures to tax expatriates could be detrimental to
diversification and labor force prospects and were opposed to politically in the past.
GEMs Paper #26 | 30 June 2016 21
Table 8: Fiscal consolidation measures through 2020 leave undisclosed financing gap
Fiscal measure Annual revenue raised (US$bn) Annual revenue raised (% of GDP) Impact on inflation (ppt) Remark
Non-oil revenue measures 100 15.8 - NTP target
Fees on excess foreign worker quotas 10 1.6 - NTP target
Green-card like program 10 1.6 - NTP target
VAT 10 1.6 5 NTP target
Subsidy reform 30 4.7 NTP target
Natural gas feedstock for petrochemicals 2.5 0.4 - BofA ML assumption
Domestic crude 20.8 3.3 - BofA ML assumption
Gasoline 1.4 0.2 0.5 BofA ML assumption
Diesel 1.9 0.3 - BofA ML assumption
Other measures 40 6.3 - NTP target
Land tax 11 1.7 - BofA ML assumption
Remittance tax 2.3 0.4 - BofA ML assumption
Income tax on expatriates 3.9-7.8 0.6-1.2 - BofA ML assumption
Sin tax on tobacco 0.7 0.1 0.1 BofA ML assumption
Sin tax on sugary drinks 1.4 0.2 0.4 BofA ML assumption
Memo:
Undisclosed revenue financing gap 16.8-20.7 2.7-3.3 - BofA ML assumption
Cost savings Annual savings (US$bn) Annual savings (% of GDP)
20% cut to on-budget non-oil subsidies 0.2-0.8 0.1-0.5 - BofA ML assumption
5% cut to the wage bill 6.4 1.0 - NTP target
Cost increases Annual cost increase (US$bn) Annual cost increase (% of GDP)
NTP costs (US$71.5bn) 14.3 2.2 NTP target
Source: National Transformation Plan, BofA Merrill Lynch Global Research
Chart 18: Breakdown of electricity consumption by sector
Chart 19: Water consumption by sector
4%
2%
11%
16%
50%
Municipal,
9%
Industry, 3%
17%
Residential Commercial Industry
Government Other Agriculture
Source: SAMA, BofA Merrill Lynch Global Research. Data as of 2015.
Agriculture,
88%
Source: UN, BofA Merrill Lynch Global Research. Data as of 2010.
Budgeted defence spending – up or down
Localization policies in the defence industry could help cut imports (total defence
imports of US$9.8bn equivalent to US$1.5bn or 6% of total imports in 2015, according
to consultancy IHS) and conserve Fx reserves, but we expect this to be a slow and
gradual process. We think that large defense imports are typically amortized over a
number of years. Defence spending is an important part of fiscal spending in Saudi
Arabia, accounting for c30% of total budgeted spending. Defence spending in 2016 was
budgeted at SAR213bn (US$56.9bn; 9.0% of GDP), down from SAR307bn (US$81.8bn;
12.7% of GDP) in 2015. Increased military and security projects in 2015 saw an
additional overspend of SAR20bn last year. It is unclear to us if all of the regional
military costs have been recognised on-balance sheet. A negotiated settlement to the
Yemen conflict through the ongoing political negotiations in Kuwait could help contain
security spending near-term.
22 GEMs Paper #26 | 30 June 2016
Chart 20: Budgeted spending – up or down?
SARbn
Budgeted Defense & Security spending
% of total budgeted spending (rhs)
350
300
250
200
150
100
50
0
45
40
35
30
25
20
15
10
5
0
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Source: SAMA, Ministry of Finance, Bank of America Merrill Lynch Global Research.
Privatization comes back to the government’s agenda
The consideration of a privatization program is not surprising at the current juncture, in
our view. Recall that the Saudi privatization program was initially started in 1999 with
the creation of the now-dissolved Supreme Economic Council, following the drop in oil
prices in 1998. Small-scale privatizations took place in the early 2000s, and 2002 saw
large privatization in the telecommunication sector and postal services.
Selling public sector stakes is one of the non-debt creating financing options for the
government that would help minimize the direct drain on Fx reserves, encourage private
sector development and improve services delivery. That being said, given the lack of
non-oil taxation, this would only contribute to one-off financing flows alongside savings
from a drop in budgetary allocations to the privatized entities, in our view.
The 2015 budgetary appropriations for public institutions totalled SAR163.7bn
(US$43.7bn; 19.0% of total budgeted spending and 6.8% of GDP). We calculate that the
public institutions related to the entities that appear to have been slated for
privatization according to press reports account for budgetary appropriations of
SAR124.8bn (US$33.3bn; 5.2% of GDP. This is likely to be the upper bound of fiscal
savings possible under the privatization program. In our view, this is unlikely to be
realized fully as it includes a large number of universities and because most timelines
appear to center around 2020.
Table 9: Privatization / Public Private Partnerships (PPPs) planned
Entity Date Comment (press reports and Saudi Vision 2030/NTP, unless stated otherwise)
Airports 2016-2020 Targeted sale of 11 airport units by 2020
Saudi General Grains Organisation 1Q17 A financial advisor has been appointed
Saudi Aramco by 2018 A stake of less than 5% could be sold
Stock exchange (Tadawul) by 2018 A financial advisor has been appointed
Saudia Medical Services -
Saudi Arabian Airlines appointed a financial adviser for the privatization of its unit Saudia Medical Services and had its
Board of Directors restructured in June
Saudi Electricity (SEC) by 2020
SEC’s generation assets are likely to be split into four separate regional companies where minority stakes would be sold to
major global utilities or sold in the public market
Saline Water Conversion Corporation (SWCC) - Investment partners are likely to be sought to buy a stake in production assets, with the holding company to be listed later
General Port Authority by 2020 Commercialization program to be completed by 2020
Saudi Post by 2020
Saudi Post to be turned into a holding company with six subsidiaries. The NTP aims to transform it to a commercially viable
company with government subsidies (SAR2bn) to be phased out by 2020.
Education / schools - Official pronouncements have suggested this could be considered, but there does not appear to be concrete plans for now
Healthcare / hospitals -
The 2030 vision suggests no privatisations in the near-term, in our view. Authorities are likely to look to improve
management and quality of service before considering privatisation, in our view.
Road, railway and port projects - NTP suggests PPPs are planned with percentage in private sector contribution to development and operation to increase
Source: Press reports, Saudi Vision 2030, National Transformation Plan
GEMs Paper #26 | 30 June 2016 23
Table 10: Public institutions budget appropriations
SARbn US$bn % of GDP
Universities 55.7 14.8 2.3
Saudi Arabian Airlines 28.5 7.6 1.2
Saline Water Conversion Corporation 15.6 4.2 0.6
General Authority of Civil Aviation (GACA) 15.5 4.1 0.6
Saudi Post Organization 3.2 0.8 0.1
Grain Silos and Flour Mills Organization 2.9 0.8 0.1
Saudi Ports Authority 1.8 0.5 0.1
Saudi Railways Organization 1.7 0.4 0.1
Other 38.9 10.4 1.6
Total 163.7 43.7 6.8
of which, public institutions in sectors that could be privatized 124.8 33.3 5.2
Source: SAMA, Ministry of Finance, Bank of America Merrill Lynch Global Research. Data as of 2015 budget.
Sales of PIF assets could help replenish fiscal reserves but not Fx reserves
Secondary sales of domestic assets could be a faster way than Initial Public Offerings
(IPOs) and privatizations for the Ministry of Finance (MoF) to raise its fiscal reserves at
SAMA, in our view. We look at this possibility to assess the potential for the MoF to use
it as an option to support its fiscal reserves at SAMA and prevent a debt build-up in
response to ongoing fiscal deficits.
If this were to take place, this could occur through holdings of the PIF rather than the
pension funds who are large institutional investors in the domestic equity market, in our
view. We calculate that the PIF could sell stakes worth around SAR200bn (US$53.6bn)
domestically through liquidating existing minority stakes and selling down majority
holdings while retaining control. If the PIF holdings are above 50%, we assume
arbitrarily that the holding is strategic, and thus calculate the current value of the stake
that the PIF (using the current stock price in the market) can sell down so it retains a
controlling 51% ownership share. If the PIF holdings are below 50%, we arbitrarily
assume that the holding is not strategic, and thus calculate the current value of the
stake that the PIF holds (using the current stock price in the market) as we assume it
could be fully liquidated.
The proceeds of sales domestically (without foreign participation) would increase
central government deposits at SAMA, decrease other domestic liabilities of SAMA but
keep Fx reserves unchanged. Because of the latter, because such large coordinated sales
could weigh on the market and as the PIF is targeted to become the largest SWF by
Saudi authorities, we doubt this is going to be a course policy-makers are likely to be
considering in the near term.
24 GEMs Paper #26 | 30 June 2016
Table 11: Public Investment Fund listed domestic assets and their monetization potential in regards to replenishing fiscal reserves at SAMA
Potential value of
secondary offering if a
government stake is sold,
but with the government
still retaining 51% control
Potential value of
secondary offering if
government’s
existing minority
stake is liquidated
Entity Sector Current government stake (%) Free-float (%) (US$bn)
(US$bn)
Saudi Basic Industries Corporation (SABIC) Chemicals PIF: 70.0%; GOSI: 5.7% 24.3% 12.3 0.0
Saudi Telecom (STC) Telecom PIF: 70.0%; GOSI: 7.0%; PPA: 6.77% 16.2% 6.5 0.0
Saudi Electricity (SEC) Power Government: 74.3%; Aramco: 6.9% 18.8% 5.1 0.0
Saudi Ground Services Travel Saudi Arabian Airline: 52.5%; National Aviation: 14.7% 30.0% 0.4 0.0
Saudi Real Estate Company Real estate PIF: 64.57% 35.5% 0.1 0.0
National Commercial Bank (NCB) Banks PIF: 44.3%; GOSI: 10%; PPA: 10.04% 35.7% 0.0 9.5
Maaden Mining PIF: 49.99%; GOSI: 7.98%; PPA: 7.45% 34.6% 0.0 5.9
Samba Banks PIF: 22.91%; GOSI: 11.76%; PPA: 15.04% 73.2% 0.0 2.4
Yanbu National Petrochemical Co (Yansab) Chemicals SABIC: 51%; GOSI: 11.92% 37.1% 0.0 2.2
Saudi Arabian Fertilizer Company (SAFCO) Chemicals SABIC: 42.99%; GOSI: 12.2% 44.8% 0.0 2.0
Riyadh Bank Banks PIF: 21.75%; GOSI: 16.72%; PPA: 9.18% 46.6% 0.0 1.9
Southern Province Cement Cement PIF: 37.43%; GOSI: 15.82% 46.8% 0.0 1.1
National shipping company Transport PIF: 22.55% 80.0% 0.0 0.9
Saudi Catering Transport General Airline Services KSA: 35.7% 39.8% 0.0 0.8
Kayan Chemicals SABIC: 35% 65.0% 0.0 0.6
Alinma Bank Banks PIF: 10%; GOSI: 5.10%; PPA: 10.71% 74.1% 0.0 0.5
Qassim cement Cement PIF: 23.35%; GOSI: 15.09%; PPA: 5.67% 79.2% 0.0 0.4
Yanbu cement Cement PIF: 10%; GOSI: 12.37% 68.5% 0.0 0.2
National Agriculture Development Agriculture PIF: 20% 85.1% 0.0 0.1
Saudi Fisheries Agriculture PIF: 39.99% 38.5% 0.0 0.1
Saudi Public Transport Transport PIF: 15.72% 100.0% 0.0 0.1
Eastern Province Cement Cement PIF: 10%; GOSI: 10.65% 89.4% 0.0 0.1
National Gas and Industrialization Chemicals PIF: 10.91% 88.0% 0.0 0.1
Saudi Ceramic Consumer PIF: 5.94%; GOSI: 16.19% 83.8% 0.0 0.0
Petro Rabigh Chemicals Aramco: 37.5%; Sumitomo: 37.5% 25.0% 0.0 0.0
Total 24.3 28.6
Source: Bloomberg, Bank of America Merrill Lynch Global Research. PIF = Public Investment Fund. GOSI = General Organization for Social Insurance. PPA = Public Pension Agency. Based on stock prices as of 28 June 2016.
Material fiscal consolidation would be necessary to narrow macro imbalances
There is no substitute for fiscal consolidation to maintain Fx policy unchanged. We map
out below paths for several macro variables depending on fiscal policy and oil prices,
with higher oil prices easing the adjustment requirement.
In a worst case scenario where US$25/bbl oil prices would persist for the next five
years, sustainability of the Saudi Fx policy rests on material fiscal consolidation, which
we believe is achievable based on the mix of revenue-raising and spending restraint
plans likely or announced to date. This would require a total 5-year cumulative
adjustment of SAR500bn (US$133bn; 20% of 2015 GDP or 4ppt of GDP annually) from
2016 onwards, which is close to what the NTP appears to be targeting in non-oil
revenue measures (US$100bn, excluding NTP costs). We think 75% of the adjustment
can take place through revenue-raising measures. The remainder of the adjustment
would need to take place through capex cuts and is similar in size to the capex
retrenchment of the 1980-90s. However, note that if one assumes that the 2015 budget
deficit will be revised higher to 18.9% of GDP, this adds a need for a further 4ppt of
GDP cumulative fiscal adjustment to maintain the same trajectory of Fx reserves.
An overhaul of fiscal policy will likely be required
In line with the 2016 budget announcement, we would expect tight budgets to be
passed. We expect a VAT with 5% yield to be implemented in 2018, alongside further
administered price adjustments for energy, water and electricity. Implementation of the
land tax is likely, but it is unclear whether the proceeds will be ring-fenced to be used
solely for housing projects. Using solely the recurring existing proceeds of the
December administered price adjustments and a VAT introduction, we still see a need
for further fiscal restraint in the order of 1ppt of non-oil GDP annually. The latter would
GEMs Paper #26 | 30 June 2016 25
be equivalent to a SAR100bn cumulative spending cut, which we believe can be
accommodated from capex retrenchment. On the basis of the above, fiscal consolidation
would likely drive real GDP growth lower to an average of just around 1% of GDP. This
estimate is based on a ST GCC fiscal multiplier of 0.2 for real spending to real non-oil
GDP, in line with academic literature.
Fx policy stays the course; NTP blurs medium-term incentives
We do not believe Deputy Crown Prince Mohammed bin Salman is considering Fx reform
in the near-term. We have expressed here our view that the Fx peg would hold as fiscal
policy undergoes a sizeable multi-year adjustment. In a bearish scenario for oil prices,
the NTP is unlikely to be implemented as deep budget cuts are likely to be required to
sustain the Fx policy. We believe an oil price of at least US$50/bbl is broadly consistent
with full and timely NTP implementation, but fiscal policy still needs to be disciplined. If
fiscal non-oil revenue targets are missed, a higher oil price is likely to be needed.
However, if the NTP is successful in diversifying the economy, it will make the costs of
running an overvalued exchange rate more prohibitive, particularly as the external
accounts are likely to become more responsive to an Fx shock. It also introduces a progrowth
bias for policy-makers in charge of diversifying the economy, which may conflict
with the implementation of unpopular fiscal reforms or the depth of fiscal consolidation
needed at weak levels of oil prices. The NTP diversification initiatives may suffer from a
timing mismatch when it comes to net external receipts generated. This is because the
sectors that would generate Fx receipts (non-oil exports, religious tourism) or
localization policies are likely to be slow to ramp-up, while Fx demand in the economy is
likely to be supported (rather than deflated) by government diversification policies. Last,
the desire to build a large SWF may suggest a desire to conserve Fx reserves.
Chart 21: Illustrative paths of Saudi government deposits at SAMA
% of GDP
60
10
-40
US$50/bbl oil - nominal spending flat
US$50/bbl oil - modest fiscal adjustment
US$50/bbl oil - ambitious fiscal adjustment
US$25/bbl oil - modest fiscal adjustment
US$25/bbl oil - ambitious fiscal adjustment
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
Source: , Haver, BofA Merrill Lynch Global Research estimates
Chart 22: Illustrative paths of SAMA foreign assets
100 % of GDP
90
80
70
60
50
40
30
20
10
US$50/bbl oil - nominal spending flat
0
US$50/bbl oil - modest fiscal adjustment
US$50/bbl oil - ambitious fiscal adjustment
-10
US$25/bbl oil - modest fiscal adjustment
-20
US$25/bbl oil - ambitious fiscal adjustment
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
Source: Haver, BofA Merrill Lynch Global Research estimates
26 GEMs Paper #26 | 30 June 2016
Chart 23: Illustrative paths of Saudi fiscal balance
Chart 24: Illustrative paths of Saudi government debt
% of GDP
30
% of GDP
100
20
10
0
-10
75
50
25
-20
0
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
US$50/bbl oil - nominal spending flat
US$50/bbl oil - modest fiscal adjustment
US$50/bbl oil - ambitious fiscal adjustment
US$25/bbl oil - modest fiscal adjustment
US$25/bbl oil - ambitious fiscal adjustment
Source: Haver, BofA Merrill Lynch Global Research estimates
2018
2020
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
US$50/bbl oil - nominal spending flat
US$50/bbl oil - modest fiscal adjustment
US$50/bbl oil - ambitious fiscal adjustment
US$25/bbl oil - modest fiscal adjustment
US$25/bbl oil - ambitious fiscal adjustment
Source: Haver, BofA Merrill Lynch Global Research estimates
2018
2020
Consumer to face mixed trends
Labour policies are likely to remain a major focus for the Saudi government. Low oil
prices have dented the government’s direct ability to support the consumer compared
to the boom years. Furthermore, negative to flat public sector wage growth is likely to
dampen income and consumption trends, although Specialized Credit Institutions (SCIs)
could alleviate tightening banking sector household lending standards.
The NPT suggests a focus on boosting female employment as well as increasing the
cost of foreign labor relative to national labor. The latter implies a negative impact on
corporate margins and profits, in the event higher labor costs are not reflected in higher
consumer prices and inflation). The negative near-term cost and efficiency implications
of continued labour market reforms are mitigated by the fact that eventual increase in
private sector employment of higher-paid Saudi labour should prove supportive for
consumption trends once the dust settles.
The NTP targets increasing the cost of employment of Saudis compared to expatriates
from 400 to 280. We calculate that the ratio of private sector wages of Saudis
compared to non-Saudis stood at 3.64 and 1.29 for males and females respectively in
2015. The NTP target is thus akin to increasing non-Saudi private sector wages by 43%
over the period to 2020, a CAGR increase of 7.4%. This would squeeze corporate profits,
lead to inflationary pressures in the economy, and lead to annual additional Fx outflows
through remittances of US$2.8bn (0.4% of GDP). As such, it is more likely that the
employment cost of non-Saudis is likely to be increased through measures such as fees
for government services, taxes and levies. It is unclear that the NTP target can be met
solely through this route, but it would avoid additional Fx outflows despite still having a
negative impact on corporate margins and inflation, in our view.
The Nitaqat Saudization program is likely to be extended in the near-future through the
forthcoming launch of the “balanced Nitaqat” initiative. While employment quotas are
likely to be tightened, they will also take into account wage levels, job quality and
women employment ratios, according to local press. A likely target is likely to be
increased job creation for Saudis in the retail sector through higher quotas, in our view.
GEMs Paper #26 | 30 June 2016 27
Table 12: Selected drivers of Saudi consumer
Direction
Comment
Oil prices Volatile Indirect impact through economic activity and confidence
Population growth Decreasing Direct impact through lower number of expatriates and national birth rate
Public sector wage growth Flat to contracting Freeze in government wage bill
Private sector wage growth Flat to minor increase Some sectors to contract (construction), others resilient (retail, staples)
Saudi private sector male employment Mixed Saudization helps, but economic slowdown and supply-side factors impact negatively
Saudi private sector female employment Increasing NTP aims to increase it through several measures
Consumer leverage Decreasing Banking sector liquidity and lending standards are tightening
Real estate finance Increasing NTP measures are supportive in this area
Specialized Credit Institutions (SCIs) Flat SCIs can continue to support the economy
Saudization Increasing Negative impact short-term, positive impact medium-term
Subsidies Decreasing Timing and breadth unclear as of yet
Other fiscal consolidation measures (VAT, etc) Likely forthcoming Direct and indirect negative impact on consumer
Source: BofA Merrill Lynch Global Research
Chart 25: Private sector average monthly wages are increasing
SAR/month
2004 2005 2006 2007 2008 2009
3,500
2010 2011 2012 2013 2014 2015
3,000
2,500
2,000
1,500
1,000
500
0
Male Female Total
Source: SAMA, BofA ML Global Research. SAMA wage data coverage appears incomplete.
Chart 26: Wedge between Saudi and non-Saudi private sector salaries
SAR/month
7,000
2014 2015
6,000
5,000
4,000
3,000
2,000
1,000
0
Male Female Male Female
Saudis
Non-Saudis
Source: General Organization for Social Insurance (GOSI), BofA ML Global Research.
Banks and contractors will require supportive policies to realize NTP benefits
The banking sector is targeted to benefit from the NTP initiatives through greater
disintermediation (SMEs, real estate financing, non-oil export financing) and greater
household savings. However, domestic liquidity is likely to remain structurally tight, in
our view. The NTP targeted increase in non-oil fiscal revenue is likely to tighten
domestic liquidity, all else being equal, as it would have the effect of extracting
resources from the non-hydrocarbon private sector (as opposed to government
domestic spending that injects liquidity).
Linked to liquidity trends and banking sector asset quality, the issue of government
arrears to contractors is likely to take centre stage, in our view. Resolving this is likely to
be required if the capex projects under the NTP are to be executed on a timely fashion,
in our view. We think the government’s proposal to issue "I Owe You' notes (IOUs) could
be a step in this direction.
Government looks to issue IOUs
According to the press, the Saudi government has paid contractors some cash on its
arrears, and is considering to issue "I Owe You' notes (IOUs) to them. Contractors would
receive these notes to cover their outstanding dues, which they could hold until maturity
or sell on to banks. The government has been highlighting it wanted to settle the
contractor sector dues, and recently a high-profile domestic contractor has made mass
redundancies. In the previous downturn in the 1980s, arrears to domestic contractors
were also likely to have been accumulated. We highlighted that the fiscal deficit was
likely under-reported last year. Also, construction was one of the fastest growing sector
last year both in terms of domestic activity and of domestic credit.
28 GEMs Paper #26 | 30 June 2016
Government arrears to contractors could be significant
We estimate the range of unpaid capex for 2015 to be SAR23bn-SAR100bn (US$6bn-
US$27bn or 1-4.3% of 2015 GDP). At the very minimum, unpaid capex could be around
SAR23bn. This is the amount of additional loans taken out by construction contractors
over 2015 compared to 2014. Total construction loans were SAR106bn in 2015 versus
SAR83bn in 2014. Contractors likely did not go to obtain alternative bank funding for
the same amount as the delayed payments from the government, suggesting delayed
payments should be larger than SAR23bn, in our view.
By the same token, the 2015 budget outturns imply capex was down by 45% to
SAR205bn versus 2014 levels of SAR370bn. This is of course unlikely as construction
grew by 5% in real terms in 2015. Correcting the 2015 budget by the likely
underreporting (an additional SAR100bn in spending, assuming it was all capex-related),
then capex spending was likely down by SAR65bn (17%) in 2015. This would be in line
with the c15%yoy drop in construction awards as reported by MEED.
In comparison, government overdues in the healthcare sector are much smaller. Based
on the disclosures of two listed healthcare groups, we estimate the growth of
government receivables owed to them alone is SAR0.4bn. We estimate the total sector
government overdues to private healthcare operators could be 2-3 times this level.
IOUs to serve multiple purposes
IOUs could support simultaneously the multiple needs of the government, domestic
banks and contractors, in our view. The government will be able to conserve fiscal
reserves and restructure the maturity of its outstanding dues. Domestic banks would
substitute corporate credit risk with sovereign risk and improve asset quality, while
contractors could improve their liquidity and working capital position by cashing in early
on the IOUs. We believe most of the contractors impacted could be domestic ones, and
we presume these IOCs would be issued in domestic currency. Furthermore, to the
extent these IOUs are structured as tradable instruments, this could better distribute
risk in the financial sector to those agents more capable or willing to hold it.
Domestic liquidity could be eased, but Fx outflows may not subside
The impact of IOUs on domestic liquidity will likely depend on the issuance mechanism,
of which we have little visibility for now, though this could likely ease domestic liquidity.
We would however expect subsequent Fx reserves losses due to an increase in demand
for Fx consequent to the liquidity injections (a 50% leakage would for instance lead to
US$13.5bn loss in Fx reserves at the high-end of the estimated arrears range).
One possibility for the mechanism would be for banks to extend more secured credit to
contractors using the IOUs as collateral. In this case, domestic liquidity is likely to
remain tight as the banking sector balance sheet would stay stretched. Another, perhaps
more likely, option would be for banks to accept IOUs as deposits. Contractors would
then be able to transfer IOUs to their trade creditors and withdraw cash regularly, with
the total amount being likely a portion of the face value of the IOUs. Banks would hold
new government instruments on the asset side of their balance sheet. This mechanism
could also be structured as a simple sale of the IOUs to domestic banks (with a haircut),
which domestic banks would accommodate through equivalent changes on the asset
side of their balance sheet, without the creation of additional liabilities.
In the latter option, to avoid straining the banking sector liquidity, the deposits
withdrawal or in effect the increased money in circulation would likely require monetary
accommodation from SAMA, in our view. We believe this could take the form of liquidity
injection, possibly through repo operations for the IOUs. Although unconventional, this
GEMs Paper #26 | 30 June 2016 29
possible source of easing of domestic liquidity would still be consistent with Article 6
Saudi Arabia’s Currency Law which imposes a 100% currency backing by Fx reserves,
such that that currency issued cannot exceed foreign reserve assets. The full cover
requirement would still be in force as reserve money currently represents just 14% of
foreign reserve assets, down from c100% throughout the period 1996-2000.
30 GEMs Paper #26 | 30 June 2016
Lessons in diversification
There are only few examples of countries that successfully managed diversification
away from primary dependence. The examples of Malaysia and Norway suggest that a