This year, too, private sector real GDP growth is set to accelerate only slightly to 4.2 percent while government sector GDP growth holds above 5 percent for the third straight year, tipping the balance in favor of continued state-dominated development. Growth rates of at least 6 percent are necessary in our view for the private sector to be in a position to engage adequately in building a more-diversified economy. Growth must exceed 6.5 percent per year to generate enough jobs.
The emphasis on state funding has in many respects hampered the government's endeavor to stimulate the private sector. The trend toward relying on government cash to push forward crucial infrastructure projects has to some extent stifled the rebound in bank credit and restrained private sector investment.
Fiscally speaking, Saudi Arabia is able to afford for this scenario to continue in the medium term given the rebound in oil prices by almost a third in the past year. With oil prices around $100 a barrel and crude oil output gaining, the Kingdom's public revenues are poised to grow 23 percent this year to SR904 billion, providing it plenty of flexibility to finance new initiatives for Saudi citizens, take the lead in building homes, and raise public sector wages.
Yet with public expenditures this year likely to be triple what they were in 2004, it will become critical in the coming years to transfer a good deal of the financing and expansion burden to the private sector, including both domestic and global players. Since 1990, the private sector's contribution to nonoil real GDP has barely moved. It accounted for 66.7 percent of nonoil GDP in 2010, just 2.3 percentage points more than its contribution 20 years earlier.
While the private sector's share of the non-oil sector forms the majority, investments of the private sector, as measured by its gross fixed capital formation, have in recent years decelerated as government funding swung substantially higher. In addition to the lack of private sector momentum, growth of real incomes of Saudi citizens has lagged many of the country's global peers due to comparatively fast population growth and lower-than-optimal private sector GDP growth.
These challenges highlight the need to ensure government policies avoid having a crowding out effect on the private sector or discouraging enlargement of the small-and medium-sized enterprises sector.
State becomes dominant investor
Involving the private sector in the development plan has been a key government priority for years as part of efforts to strengthen the nonoil economy to reduce reliance on oil exports and create jobs. The most-recent cycle of high oil prices that began in 2003 and ended with the onset of the global financial crisis witnessed a period of private sector and government expansion.
Yet the private sector's investment appetite has grown considerably less quickly than the government's appetite in the past decade. This is understandable given that a surge in oil prices improved the public fiscal position and gave the state a great deal more leverage to be able to invest in building the domestic economy. After years of posting fiscal deficits, the government found itself possessing surplus capital with which to pay off debts, invest in infrastructure and build its foreign assets.
As a result of this shift, the government took on a very important role in domestic investments. The state went from accounting for 14 percent of total gross fixed capital formation (GFCF) in 2001 to 35 percent in 2009. The private sector, meanwhile, saw its share of GFCF fall to 49 percent from 75 percent. GFCF measures the value of fixed asset acquisitions undertaken by businesses, governments and households minus disposals of fixed assets. It provides some indication about how much new value added in the economy is invested as opposed to consumed.
While comprehensible, the private sector's reduced overall role in investments in the Saudi economy does point to some structural drawbacks in the state's approach to expansion. The government's strategy has been one that attempts to generate momentum by pouring
its own funds into key projects, on the assumption that the private sector will reciprocate with a similar level of capital. That has not, however, happened as extensively as policymakers might have hoped hope. Government GFCF surged eight-fold between 2000 and 2010. Private GFCF, by contrast, expanded less than 94 percent over that period. Between 2006 and 2010, private GFCF grew 38.5 percent versus the government's 140.4 percent.
A number of mega-projects in the country have suffered from a lack of investor appetite. When the King Abdullah Economic City mega project was unveiled in 2005, it was considered to be the single-largest private sector investment. One of five economic cities planned to speed up job creation, the city, located along the Red Sea north of Jeddah, includes plans for an industrial zone, a sea port and residential community. The dearth of private sector interest has stalled this project's development compared with its initially stated goals.
State-run Public Investment Fund (PIF) and Saudi Industrial Development Fund (SIDF) have filled a lot of funding gaps for strategic projects since the onset of the financial crisis. But there are limits to how much the government would be able to contribute to such ventures in the medium term.
Private sector’s share
Over the past decade, the government encroached on the private sector's share of investments in some key sectors, including construction, data show. In 2001, some 96 percent of GFCF in residential construction and 63 percent of GFCF in non-residential building encompassed investments by the private sector. In the following eight years, the scenario shifted considerably: The private sector share of residential construction fell to 74 percent and its share of non- residential building dropped to 23.7 percent.
This shift toward state-dominated investing in the real estate market became pronounced between 2007 and 2009, when government GFCF in the residential building space soared 11-fold to SR12.63 billion, compared with a meager 8 percent expansion in private sector GFCF over that stretch to SR36.31 billion.
As recently as 2003, private sector GFCF in non-residential building had exceeded the government share. This shifted with the turn in oil prices and as of 2009, government GFCF in non-residential construction was up more than eightfold from 2001 levels at SR85.54 billion - versus the private sector's SR26.54 billion, up a lower 41.3 percent from 2001.
In our view, the private sector has underperformed despite the period being marked by tremendous optimism in the economy, creating a wealth of investment opportunities. The trend shows the private sector's role is not expanding sufficiently. Rather, the state has acted as the economy's primary engine, stepping in to fill funding gaps as it seeks to address a problem of inadequate housing supply.
Even in the machinery and equipment investment space, the private sector's growth in the last decade has lagged that of the oil sector, CDSI data on capital formation show. Private sector GDP growth fell in the four years to 2009, from 6.1 percent in 2006 to 2.7 percent in 2009 on the heels of the financial crisis. Over the same period, the government sector's GDP has grown from around 3 percent to above 5 percent.
Government shoulders economic burden
These data illustrate that large government-driven investment over the 2000 oil boom years failed to ignite a good deal of private sector momentum. This trend is likely to continue following the king's announcement earlier this year that the government would commit SR250 billion toward the construction of 500,000 new units for citizens in the coming years.
The private sector is not expected to offer enough thrust on its own to fill gaps in real estate supply, in addition to financing numerous major expansion projects. Much of the private sector involvement that does take place happens because private firms are awarded government contracts, not because they are committing their own funds. Private sector growth rates therefore do not reflect a genuine increase in private capital being committed to local ventures. The government became the principle financier behind strategic projects in many core sectors beginning in 2009, and it looks likely to bolster this strategy rather than undercut it.
The private sector has gone through a phase of deleveraging since the onset of the global financial crisis, but this only in part explains the lack of private sector investments. The private sector will need to discover new engines for growth going forward. The sector has become overly dependent on the state for its growth, which has advantages, but over-dependence can also lead to lower productivity.
As the months pass, the private sector is slowly picking up more of the slack nonetheless. Bank credit to the private sector has slowly gained momentum in recent months, reaching 6.5 percent year on year growth in March - compared with rates of less than half that just four months earlier. Banks are very liquid, and many have indicated that, aside from tougher credit extension rules, it is private sector businesses which are not interested in getting financing; companies would rather hold off on expansion until they are better able to assess the economy's future course. In the past two years, without state funds many crucial expansion projects would have been held up or canceled.
While it has not been the state's intention to crowd out the private sector, the tables will need to shift soon for the private sector to be viewed as a serious economic player in its own right. One drawback we have repeatedly cited with the government's stimulatory spending plan is that it has not adequately passed down benefits to small-and medium-sized enterprises (SMEs). Bigger private sector players tend to receive the bulk of state contracts.
As the government works through these challenges, reliance on oil for fiscal and trade accounts remains the standard. In 2010, oil revenues accounted for 87.8 percent of total public revenues, up from 78 percent in 2002 ahead of the oil price rally. Saudi exports have become moderately less reliant on oil, although not exceptionally so - oil exports still account from 85% or more of a year's exports. This has fallen from 91 percent in 2000 and hence signals some improvement in diversifying exports, mostly toward petrochemicals and chemical products.
Real income
Failing to build the private sector more quickly is also taking its toll on improvement of real incomes among Saudi citizens and residents. Looking at nominal GDP figures, which fluctuate widely based on oil prices, per-capita GDP figures have shown a distinct improvement in the last decade. Each Saudi resident earned $16,039 in 2010, a surge of 74 percent since 2000.
Yet these data can be viewed as unrepresentative; per capita income measured at constant prices, to account for inflation, tell a very different story. According to this measure, real per-capita income growth has been stagnant since the mid-1980s. Adjusted for inflation, each Saudi resident was earning $8,550 in 2010, virtually on par with the level in 1991 and below a 1980 peak of $14,773.
The reasons behind this sluggish trend in real income have been rapid population growth occurring without a correspondingly large expansion in the economy, particularly the non-oil economy. Compared with countries such as Nigeria, Malaysia, South Africa or Turkey, Saudi Arabia's population has grown tremendously quickly. Re-based data of the United Nations Population Division show the Saudi population expanded 182.4 percent between 1980 and 2010. Nigeria, which came closest among the eight countries we measured, posted population growth of 112.4 percent over the same period, while Turkey's population grew 64 percent, just above the global average 56 percent.
This apparent discrepancy in Saudi population growth rates translated into much lower growth in GDP per capita vis-à-vis global peers as well. Compared with Korea, Nigeria, Singapore, South Africa and Turkey, the kingdom has the lowest GDP per capita, based on purchasing-power-parity (PPP), which takes into consideration both nominal GDP growth rates and domestic price growth. Between 2000 and 2010, IMF data show per-capita income growth PPP accelerated 44 percent in Saudi Arabia, compared with 99 percent in Korea, 90 percent in Singapore, 66 percent in South Africa, 77 percent in Turkey and 124 percent in Nigeria.
Regionally, too, the Kingdom's GDP per capita PPP is low, according to IMF data, having grown 39.7 percent from 1980 levels. This is versus higher growth of just over 42 percent in Kuwait and the UAE, almost 200% in Bahrain, and more than 300 percent in each of Egypt, Morocco, Oman and Tunisia.
Relatively low real-income data underpin the importance of raising the wage equilibrium in the coming years, a challenge we have discussed previously. Saudi Arabia's labor market needs to shift from one relying on cheap labor to one exhibiting high wage equilibrium to encourage Saudi participation and ease unemployment. This would in turn improve real incomes of citizens and reduce the burden on the state purse.
The government moved a step in this direction by raising the minimum wage this year for civil service employees to SR3,000 per month from SR2,185. However, private sector employers must be compelled to do the same for the proper incentives to be in place to improve real wages in the sector that employs more than 80 percent of the work force. The private sector predominately comprises expatriates, which would shift only once wages become more compelling for citizens.
Private consumption
State-driven development has succeeded in getting the Saudi economy back on track after the financial crisis and subsequent drop in oil prices slowed economic growth to just 0.2 percent in 2009. The state created an environment conductive to boosting consumption by the government and private citizens.
Between 2004 and 2009, Saudi final private consumption expenditure surged 88 percent, exceeding growth in Malaysia, Turkey, Korea and the MENA region average, World Bank data show. Private consumption expenditure includes goods and services used for individual and community needs. Growth in consumption over this period marked a very big rise over figures recorded in 1998-2003; during those six years, Saudi private consumption rose only 7.4 percent, lower than most of the countries measured.
While consumption has climbed among individuals, the overall private consumption ratio against GDP has been trending downward for the past 15 years-from 46.9 percent in 1995 to 34.1 percent in 2010, CDSI data show. Clearly, then, while overall consumption is growing along with the expanding population, individual families have less buying power than they did in the 1990s.
In such an environment, it is logical for the government to enhance its role in social welfare. One measure that provides insight into the government's role in social welfare is government final consumption expenditure, which reflects the state's spending on goods and services for the population's direct needs.
Between 2004 and 2009, Saudi government consumption grew 4.7 percent, compared with declines of 10.7 percent in Egypt and an Arab world drop of 14.6 percent. The Saudi government thus became comparatively more supportive of its citizens, possible due to its strong fiscal position. By comparison, government consumption had dropped 3.1 percent over all from 1999-2009, highlighting a shift in the pattern in the latter part of the past decade. It is likely government consumption grew more rapidly in 2010, and should continue to do so due to the state's focus on bank-rolling citizen benefit schemes.
Final government consumption almost tripled between 1995 and 2010, according to CDSI data. Over that period, nominal nonoil GDP more than doubled, not in a small part thanks to the state playing a bigger role in the economy.
Progress on a state promise in its latest development plan to nurture and organize the SME sector is critical if the tables are to turn in the coming years in favor of the private sector becoming the economic engine. As of 2008, Saudi Arabia had 823,500 private sector enterprises, some 94.2 percent of which were classified as SMEs, according to the government's 2010-2014 development plan. SME's provided 62.5 percent of all job opportunities under the last five-year plan, the government said, highlighting the need to place more emphasis on this sector.
The development plan seeks private sector GDP growth of about 6.6 percent per year on average through 2014, boosting the sector's overall share of GDP. Yet more than a year into the plan, it is the government sector whose share of GDP is advancing. By flexing its financial muscle more and more, the state's share of nonoil GDP has risen since 2008; we estimate the government sector will account for 33.6 percent of nonoil GDP in 2011 compared with 32.3 percent in 2008.
Against this backdrop, the government's announcement in the first quarter of SR485 billion in new spending initiatives for citizens will provide only a short-term fix to a longer-term challenge of achieving genuine diversification for an economy that continues to be steered by the state rather than the private sector.
— John Sfakianakis is chief economist at Banque Saudi Fransi, Riyadh.
