Mission Concluding Statement 

Saudi Arabia: Concluding Statement of the 2024 Article IV Mission

June 14, 2024

Washington, DC: Saudi Arabia’s unprecedented economic transformation is progressing well. Prudent macroeconomic policies, transformative changes—including through fiscal reforms and in the regulatory business environment—and strong domestic demand have helped prop up non-oil growth. Inflation remains contained. Spending reprioritization and recalibration of major spending programs are ongoing. Efforts to diversify the economy have started to bear fruit. Building on these successes, it will be important to sustain the non-oil growth momentum, maintain financial sector stability, continue mitigating risks of overheating, reverse declining total factor productivity and ensure inter-generational equity.

RECENT ECONOMIC DEVELOPMENTS

Economic activity remains robust. Real non-oil growth decelerated from 5.3 percent in 2022 to a still robust 3.8 percent in 2023, driven mostly by private consumption and non-oil investment, with the latter tapering off to 11.5 percent (down from an exceptional 32 percent growth in 2022). Oil GDP contracted by 9 percent in 2023 due primarily to Saudi Arabia’s OPEC+ and voluntary oil production cuts, leading to a 0.8 percent contraction in overall GDP. While non-oil growth for Q1-2024 indicate some moderation in economic activity—staff estimates that the output gap remains in positive territory, close to 2 percent of the non-oil potential GDP. The economy weathered the geopolitical tensions in the Middle East well, thanks to minimal trade and financial exposures to the affected regions and uninterrupted shipments.

The unemployment rate reached historic lows. In 2023, the Saudi economy added over one million jobs, primarily in the private sector. The overall unemployment rate for Saudis dropped to 7.7 percent in the last quarter of 2023—inching closer to the 2030 Vision objective of 7 percent. Labor force participation rates have remained at historically high levels but relatively flat over the past year for both men and women, albeit with the women’s rate still comfortably exceeding the Vision 2030 goal of 30 percent.

Headline inflation has decelerated rapidly despite some pressure pockets. After peaking at 3.4 percent in January 2023, year-on-year inflation receded to 1.6 percent in April 2024, helped by an appreciating nominal effective exchange rate. However, rents are growing at a brisk rate of about 10 percent amid inflows of expatriate workers and large redevelopment plans in Riyadh and Jeddah. Wholesale prices have also edged up recently, reflecting an increase in input costs. So far, some uptick has been observed in the wages of high-skilled workers.  

The current account surplus narrowed significantly. The decline in the current account surplus from 13.7 percent of GDP in 2022 to 3.2 percent of GDP in 2023 mainly reflected lower oil exports and strong growth in investment-related imports. These were partly mitigated by a record surplus in the services balance, including a 38 percent surge in net tourism income. The Saudi Central Bank’s (SAMA) holding of net foreign assets reached $423.7 billion in April 2024, which was slightly above the end-2023 level. Reserves remain ample, representing 15.6 months of imports and 208 percent of the IMF’s reserve adequacy metric by end-2023.  

ECONOMIC OUTLOOK AND RISKS

Staff welcomes the recent recalibration of funding requirements associated with the Vision 2030 Objectives. Its application led to a spending reprioritization through the acceleration of some projects and sectoral strategies and extension of the timeline for others. This exercise will help ensure proper sequencing of spending aimed at reducing overheating risks and maintaining fiscal and external sustainability. Staff is of the view that making public the main implications of this exercise—particularly on spending and sectoral priorities up to 2030—will be important to help provide clarity on government priorities to investors and the public.

Domestic demand is expected to remain the main driver of economic activity. Non-oil growth is projected at about 3.5 percent in 2024 as investment growth moderates before picking up in 2025 onwards, including from the sovereign wealth fund (PIF) and in the lead up to the 2027 Asian Cup, 2029 Asian Winter Games, and 2030 World Expo. Oil output is projected to contract by 4.6 percent in 2024 but increase by 5.1 percent in 2025, reflecting an extension of oil production cuts in 2024 and a gradual recovery to 10 mbpd in 2025. Under those assumptions, overall GDP growth will accelerate to around 4.5 percent in 2025 before stabilizing at 3.5 percent per year over the medium term.

Inflation would remain stable at 1.9 percent in 2024, buttressed by a credible peg to the U.S. dollar, a strong dollar, and supporting domestic policies. Inflationary pressures are expected to be contained by domestic subsidies and an elastic supply of expatriate labor, notwithstanding a projected positive output gap over the medium term.

External buffers remain ample despite a weaker current account. The current account is expected to shift to a deficit in 2024, averaging about 2.3 percent of GDP between 2026 and 2029 due to lower oil export proceeds and increased investment-linked imports. International reserves will remain ample, averaging 13 months import cover over the medium term. Foreign assets held by the PIF and other government-related entities offer strong additional buffers.

Risks to the outlook are broadly balanced amidst high uncertainty. On the upside, accelerated implementation of reforms and investments could yield stronger or earlier-than-expected growth dividends. Conversely, pressures to accelerate investment further could increase overheating risks. On the downside, slippages in the reform agenda, subdued global activity, financial market volatility, geopolitical events, and non-OPEC+ supply growth represent key risks. Over the medium to long term, a quicker shift in the demand away from fossil fuel could hamper growth.

POLICIES

Fiscal Policy

Following its first surplus in nine years in 2022, the fiscal balance swung back into deficit in 2023. The non-oil primary deficit deteriorated to 33 percent of non-oil GDP in 2023 from 32.2 percent in 2022, mainly reflecting a front-loading and acceleration of some capital spending. The overall balance turned to deficit, dragged down by a 12 percent decline in oil revenues despite a new Aramco performance-linked dividend of close to 2 percent of GDP. At 26.2 percent of GDP (as of end-2023), public debt remains low and sustainable.

The overall fiscal deficit is expected to widen further this year. While the 2024 budget projects the overall deficit to stabilize slightly below 2 percent of GDP, estimated lower revenues from extended oil production cuts combined with spending overruns—which manifested themselves through higher broad-based spending in Q1—would push the overall deficit to about 3 percent of GDP in 2024. Revenue projections entail continued support from Aramco, including through performance-linked dividends.

Over the medium term, the overall fiscal deficit would average 2.5-3 percent of GDP. This stance—which assumes no new revenue measures—incorporates the authorities’ latest spending plans, which include sustained investment that remains (on average) 23.7 percent higher than the spending path envisaged in the previous Article IV. That said, under current policies, the non-oil primary deficit would narrow by 8.4 percent of non-oil GDP by 2029. This will be mainly achieved by a reduction in current spending, mostly through wages and use of goods and services. Throughout the forecast horizon, the central government deposits at SAMA are projected to remain above 10 percent of GDP, while foreign borrowing continues to play a pivotal role in financing the deficit—resulting in a public debt-to-GDP ratio of around 35 percent by 2029.

Additional fiscal consolidation measures will be warranted to achieve intergenerational equity and generate buffers to mitigate risks. Stabilizing the Central Government Net Financial Asset (CGNFA) ratio would require further progress on:

• Non-oil revenue mobilization. Building on the efforts made in previous years, a comprehensive medium-term revenue strategy needs to be developed and tax policy measures identified to close the 9 percent tax gap with the G20 average. The mission welcomes the authorities’ efforts to review existing incentive schemes to ensure the coming into effect of the Global Minimum Tax Pillar II does not lead to tax leakages to other jurisdictions. Tax amnesties should be avoided, including through a reconsideration of the extension of the tax penalty waiver. Reforms in the tax policy area should be complemented by further improvements in tax administration, which was enhanced last year through e-invoicing.
• Rationalizing subsidies. At more than 5 percent of GDP in 2023, fuel subsidies—measured as compensatory payments to Aramco—represent a significant burden for the budget despite a slight decrease in 2023. The impact on the most vulnerable of the recent increase in energy prices—such as the 53 percent increase in diesel prices in January 2024— has been alleviated by existing social safety net programs (e.g., the Citizen’s Account). Efforts should be stepped up to remove energy subsidies, including by lifting the existing cap on gasoline prices, with the most vulnerable benefiting from increased recourse to better targeted social programs, such as the Damaan program.
• Rationalizing other spending. Wage bill containment remains the main driver of spending restraint over the medium term. Ongoing spending reviews are helping identify areas for potential savings or efficiency gains. Amid a ramp-up in spending on large-scale projects, ensuring greater efficiency in public investment remains crucial.

The authorities’ welcome efforts to strengthening fiscal institutions will be essential to ensure progress towards Saudi Arabia’s growth and stabilization objectives. Operationalizing a fiscal rule that integrates a dual mechanism comprising a ceiling on expenditure growth and a target for the CGNFA should help decrease the synchronicity of budget spending with the fluctuations in international oil prices. Strengthening the Medium-Term Fiscal Framework remains essential, including through more realistic revenue forecasts that include multi-year revenue initiatives and consistent costing processes.   

Recent progress in developing a sovereign asset-liability management (SALM) framework should be accelerated. A recently formed Oversight Committee, chaired by the Minister of Finance, leads the SALM cross-institutional processes. As of end-2023, a public sector balance sheet has been created for financial assets and liabilities. Next phase, which is expected to be completed by end-2024, should include non-financial assets to be supplemented eventually by off-balance sheet items (e.g., guarantees). As more government-related entities access capital markets and increase leverage to support Vision 2030 objectives, operationalizing this framework would help the authorities monitor sovereign balance sheet exposures and assess future investment commitments in a comprehensive manner.

Monetary and Exchange Rate Policy

Monetary expansion moderated, reflecting tighter policy stance. Thanks to the effective action by the Saudi Central Bank (SAMA), liquidity conditions have stabilized, while higher interest rates drove a notable shift in the composition of money supply towards time and savings deposits. The management of public deposits has been enhanced in 2023 by introducing an auction-based mechanism for placing these deposits with commercial banks, with the central bank acting as a fiscal agent of the government.

The currency peg to the U.S. dollar remains appropriate. The exchange rate regime has provided a credible anchor for monetary policy and is backed by ample external buffers. With an open capital account, it is important that SAMA’s policy rates continue to move in line with the Fed’s policy rate, with the risk premium ensuring an interest rate differential consistent with the peg. Continued use of market-based monetary policy instruments would be essential as well as improved liquidity forecasting and management through strengthening SAMA’s data collection from government entities and enhancing the reserve requirement framework. This will further enhance the effective functioning of interbank money market.

Financial Sector Policies

The financial sector is on a strong footing.  Banks’ performance indicators are strong, with capital adequacy ratio above 20 percent, high profitability and liquidity, and a low level of nonperforming loans. Despite recent moderation, bank credit growth—mainly to the corporate sector—continues to surpass deposit growth and is expected to remain at around 10 percent in 2024. Increased balance sheet interlinkages between financial institutions and the sovereign could amplify systemic shocks, including through fluctuations in oil prices. However, the stress tests performed by the Financial Sector Assessment Program (FSAP) show that banks as well as non-financial corporates are resilient to shocks even under severe adverse scenarios.

The continued efforts by SAMA to modernize the regulatory and supervisory frameworks are key to safeguarding financial stability. The submission of the new Banking Law to the legislative authority remains a priority. The supervisory manuals and procedures should also be revised in line with the best international practices. SAMA has made good progress in developing its financial safety net framework (bank resolution, emergency liquidity assistance arrangements, and deposit protection fund), and the authorities are encouraged to complete the ongoing efforts.

SAMA should continue using macroprudential tools to forestall possible risks stemming from a lending boom. Well-capitalized banks, government subsidies, full recourse mortgages, and existing loan-to-value (LTV) and debt burden ratio limits contain risks from the rapid growth of mortgage lending. To further reduce risks going forward, SAMA should build on its efforts to enhance its macroprudential framework, including by introducing a positive neutral countercyclical capital buffer. However, if elevated credit growth persists or rises further as Vision 2030 project implementation picks up, the authorities should consider reassessing the existing LTV and debt burden limits, tightening the guideline on the loan-to-deposit ratio and/or reducing incentives for reliance on non-deposit types of funding. Better monitoring of risks would also require addressing existing data gaps, including by developing a reliable house price index and monitoring banks’ exposures to large projects.

Structural Policies

Reforms to enhance Saudi Arabia’s business environment and attractiveness for foreign investment are progressing well. Saudi Arabia climbed 15 notches in the IMD’s World Competitiveness ranking in two years, obtaining the 17^th position globally in 2023. The number of foreign investment licenses issued reached a record high, nearly doubling from its 2022 level. A newly enacted law on civil transactions and the forthcoming adoption of the commercial transactions law and investment code will provide regulatory stability and improve market functioning. Ongoing work to boost human capital through the Human Capability Development program, further increases in female labor force participation, significant strides in digital transformation and AI preparedness, streamlining of fees and levies, promotion of access to land and finance, and stronger governance would further enhance private sector growth, help attract more FDI, and contribute to total factor productivity growth.

The authorities’ industrial policies should remain complementary to the structural reform agenda. Saudi Arabia's National Industrial Strategy aims at reducing reliance on hydrocarbons through targeted interventions, incentives, and the establishment of Special Economic Zones (SEZ). Risks associated with these interventions should continue to be minimized by addressing current market failures with a special emphasis on export orientation, while avoiding discriminatory practices. The operations within the SEZs should be regularly assessed to ensure effective linkages with the broader economy, including through technology upgrading and skills training. The authorities’ ongoing efforts to monitor tax incentives, and plans to include strict exit criteria, claw-back mechanisms, sunset clauses, and time-bound incentives are essential to minimize risks.

Saudi Arabia remains committed to achieving net zero emissions by 2060. The authorities continue to invest in renewable energy, energy efficiency, clean hydrogen, and carbon capture technologies. A clear costing and detailing of specific initiatives linked to each target will help assess the progress and adjustment necessary to reduce emissions in line with the Kingdom’s Nationally Determined Contributions. Eliminating energy subsidies would incentivize energy conservation and improve returns on investment in renewable energies. Augmenting the active green finance portfolio—including through the implementation of the Green Finance framework announced in March 2024 and by an inaugural sovereign green bond issuance planned for this year—would be critical for mobilizing private capital.

***********

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