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The Fallout from Saudi Arabia’s Economic Downslide

Dec. 1, 2016 The kingdom could face challenges due to economic strains and plunging oil prices.

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  • Last updated: December 1
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Summary

Saudi Arabia, a deeply conservative Muslim country that has been dependent on oil exports for the bulk of its existence, is changing the nature of its polity because of economic woes due to falling oil prices. Changing the way in which it has managed the political economy is always a massive undertaking, but the country’s inability to balance its books makes it significantly more difficult. Compared to overhauling the regime, addressing the nation’s economic woes is a more modest and immediate aim. However, an inability to address these economic problems could lead to social upheaval in a country whose citizens are accustomed to having the government foot the bill for many aspects of daily life. So far this has not happened, but given the scale of the problem and the need to transform the regime, it is only a matter of time before Riyadh’s unique social stability comes apart.

  • Saudi Arabia is short on the one key element that has shaped the country and keeps it going: petrodollars.
  • This is not a temporary crisis that will be overcome by favorable conditions of supply and demand in the international oil markets.
  • The kingdom’s affairs have reached a critical impasse where it has no choice but to radically alter the way in which the monarchy has managed politics and economics.
  • The scale of the change that is required could very well lead to the unraveling of the only remaining Arab power in the Middle East.

Introduction

On Nov. 30, OPEC member states agreed to operationalize a September agreement to cut oil production in an effort to increase the price of crude oil. After long resisting reductions to its output, Saudi Arabia has finally agreed to assume responsibility for the largest production cut (486,000 bpd). The change of heart was brought about by the fear that if it did not move to reduce global oil supply, Saudi Arabia risked depleting its foreign exchange reserves to plug budget deficits. (It was a little over a year ago that the International Monetary Fund warned that if oil prices did not rebound, the kingdom could fully exhaust its reserves by 2020.) This reversal comes as the kingdom goes through a significant leadership transition, as is evident with the replacement of both the oil and finance ministers earlier this year.

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The Kingdom’s Financial Woes

Riyadh has blown through 27 percent of its foreign exchange reserves, which stood at $737 billion in late 2014. In October 2016, they stood at $535.9 billion – a drop of $10 billion from the previous month. The kingdom posted a budget deficit of $98 billion in 2015, and this year it hopes the deficit will not exceed $87 billion. The kingdom has engaged in a number of measures towards this end, including an austerity drive, issuing a bond to sell government debt, privatization of public sector entities that deal with a variety of services, and taxation.

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Much has been made of Saudi Arabia’s success in its first entry into the global capital markets. The bond issuance, which fetched $17.5 billion in mid-October, drew four times as many buyers as were needed. Buyers were enthusiastic because the kingdom leads the world in crude oil production and has very low debt to begin with. However, the figure of $17.5 billion pales when placed in the context of Riyadh’s fiscal woes. That the kingdom resorted to issuing a bond reveals the extent of its economic pressures.

The degree to which the Saudis need to overhaul their political economic structure can be inferred from the recent replacement of the two top officials responsible for ensuring the kingdom’s economic well-being. Finance Minister Ibrahim bin Abdulaziz al-Assaf, who held the post for 20 years, was fired on Nov. 1, weeks after the much-touted bond issuance. In May, the kingdom replaced Ali al-Naimi, who had served as oil minister since 1995. If anything, appointing new ministers to the two most important Cabinet portfolios shows that the Saudis realize they are facing a historic economic crisis that will be resolved only through transforming the system. While both of the new ministers bring with them considerable job experience, they face the same set of constraints as their predecessors. Furthermore, they have the herculean task of steering their bureaucracies into uncharted waters.

According to Moody’s, Riyadh’s debt-to-GDP ratio was at 2.2 percent four years ago; in 2017, this ratio is expected to balloon to 22 percent, and it is expected to reach 30 percent by the end of the current decade. By 2020, GDP growth will slow to 1.9 percent, down from the 5 percent mark that it averaged during the period of 2010-2015. Saudi Arabia’s mounting financial woes have forced the kingdom to transform its spending by engaging in a major austerity drive, which includes slashing payrolls and cutting subsidies. For instance, 70 percent of capital expenditures have been cut in the past few months.

The situation is so dire that the Saudis have been forced to institute measures that are typical in most countries but have been previously unheard of in the kingdom. While denying that it will impose an income tax, the Saudis have not been completely spared from modern forms of taxation given that a value-added tax is expected to go into effect in January 2018. Furthermore, serious consideration has been given to an income tax on the expatriate community. These are major transitions for a kingdom that has not previously experienced this type of taxation.

Additional measures have also been taken to address the economic woes. September saw a $17 billion cut to benefits enjoyed by 3 million public sector employees, and the Saudi government has also delayed payments owed to a number of private sector firms such as the renowned Saudi Binladin Group and Saudi Oger. However, the government earmarked $27 billion in November in an effort to offset that debt. Moreover, the Saudi Press Agency reported on Nov. 7 that development projects worth as much as $266 billion have been canceled.

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The economic malaise has reached such an extent that it has begun to affect the Muslim world’s perception of the kingdom. For decades, the kingdom has promoted itself as the “Custodian of the Two Holy Mosques” given that both the Prophet Muhammad’s mosque and the Kaaba, Islam’s most sacred site, are housed within its borders. As a result, the monarchy and its allied ultraconservative Salafist religious establishment have been the chief organizers of the annual pilgrimage (hajj) and the lesser pilgrimage (the umrah). Although they have overseen these events for decades, the Saudis did not charge fellow Muslims from across the world for rendering this service until this past summer. Now, with the exception of first-time pilgrims, the kingdom has imposed a $533 visa fee on each of the millions who enter the country annually to attend the ritual.

Although this is a major shift, the Saudis believe they have little to lose and much to gain by imposing fees on non-citizens since the number of pilgrims visiting the kingdom is likely to remain stable. Muslims from around the world were already spending several thousand dollars each to fulfill the religious requirement of pilgrimage, and an additional fee is unlikely to deter the faithful.

The Potential for Unrest

For decades, the Saudi regime has been firmly based on two main pillars: oil and Islam. The regime was established as an Islamic state during the inter-war period, and this status was solidified by the discovery of massive oil reserves and the billions of dollars that the Saudis subsequently earned from exporting crude oil.

To get a sense of just how crucial oil has been, one needs to take into account that the kingdom has faced challenges to its legitimacy as an Islamic state since the monarchy’s earliest days. For instance, various groups over the decades have accused the Saudis of betraying the faith to remain in power. Many of the challenges arise from elements within the Salafist ideological space that the Saudis themselves have cultivated, and al-Qaida and the Islamic State represent the most recent and the most serious of such forces. Oil revenues, however, have allowed the Saudi monarchy to fend off such challenges and remain in power. Money has helped sustain the tribes’ loyalty and the tribes, in turn, control the masses as well as the large community of religious scholars. This has served as a bulwark against citizens who may have wanted to rebel against the regime.

More importantly, the kingdom’s financial prowess has been critical in preventing the Saudis’ opponents, both violent and non-violent, from penetrating the wider population. In the wake of the Arab Spring, a series of democratic uprisings that spread across the Arab world in 2011, Saudi Arabia not only increased social spending but also made skillful use of the chaos in other Arab countries to ensure that the masses steered clear of dissent. The privileges that Saudi citizens have enjoyed, courtesy of the kingdom’s petroleum wealth, have served as a key deterrent against any form of opposition. However, spending that was designed to maintain stability has now created a situation that could lead to chaos because low oil prices have forced the kingdom to cut back on these privileges. The public is unlikely to remain compliant.

The kingdom’s legitimacy as an Islamic state is built on the idea that the Saudi royal family is a defender of the faith. However, religious arguments for maintaining the existing governmental structure are unlikely to hold sway under the current economic stress. In fact, many of those providing religious justification could themselves become susceptible to the more radical impulses that they have thus far shunned. While they do not publicly admit it, many within the religious establishment share jihadist groups’ criticisms of the regime. However, they disagree with the jihadist approach of armed struggle and fear that rebelling against the regime would create a far worse situation. Nevertheless, if the regime was seen as unable to manage the affairs of a society, then these members of the religious establishment would likely entertain radical ideas for change.

In general, Saudi citizens are used to the privileged lifestyle that the government has funded for decades. Not only does the government have to scale back because of a plunge in oil prices, but the regime is also being forced to completely revise its economic approach. The regime understands that reducing spending will not fully address the economic situation. In the past, the kingdom has operated on the belief that demand for its oil will always remain high, but this approach is no longer viable given the rise of other producers, particularly in North America with the onset of shale oil. The structure of the political economy has to be changed and people must be expected to work, as is the case in most other countries. However, the public is not ready for such an enormous shift. Additionally, the liberalization of the economy will also require that the regime allow for social liberalization – a difficult concept for a majority of Saudis, who follow the extremely conservative and austere Salafist school of thought.

Saudi Arabia is not simply experiencing short-term financial pain that the masses have to temporarily endure. On the contrary, the evolving situation is creating long-term uncertainty regarding the regime’s inability to manage the state’s affairs. This is where the impending transition of power from the founder’s sons to his grandsons may become problematic. The public’s confidence in the next generation’s ability to steer the country out of the current morass could decline. The media is full of stories about the public worrying about the situation, so there are ample signs that public confidence is waning.

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A picture taken on April 26, 2016 shows workers at a construction site of a new street in the Saudi capital Riyadh. Deputy Crown Prince Mohammed bin Salman announced a long-term reform program, dubbed Vision 2030, marking the beginning of a hugely ambitious attempt to move Saudi Arabia beyond oil, the backbone of its economy for decades. FAYEZ NURELDINE/AFP/Getty Images

This potential for decline has direct implications for the monarch’s 30-year-old son, Deputy Crown Prince Mohammed bin Salman, who is essentially controlling the government. As both defense minister and the architect of the economic reform projects dubbed Vision 2030 and the National Transformation Plan, Prince Mohammed has more power than his cousin, Crown Prince Mohammed bin Nayef. In addition to making domestic economic decisions, the king’s son has also been tasked with making significant foreign policy decisions. For instance, he was behind the decision to pursue the costly war in Yemen that has gone astray for the Saudis and is a major strain on the exchequer. The cost of the war is higher than just the $5 billion that the Saudis have reportedly spent on the fighting; Riyadh also has to spend a significant amount to keep Yemen’s pro-Saudi government afloat, and it will also have to bear the costs of reconstruction.

In addition to Yemen, the Saudis are involved in many other countries since the kingdom is the only remaining power in the Arab world. To prevent the region from spiraling further out of control, the kingdom has to spend tens of billions of dollars on managing conflicts. It has to simultaneously deal with threats from groups like IS, which shares the same basic Salafist ideology as the Saudis, and threats from groups and nations that are ethnic and religious opponents, such as Iran.

Considering that there is no culture of dissent, such bleak conditions are more likely to create a crisis of confidence within the political elite than force the citizenry into the streets. Many within the royal family are already frustrated that the king’s inexperienced son has amassed a disproportionate amount of power. There is precedent for disagreement within the royal family, such as when the founder’s first successor (the first son to assume the throne), King Saud bin Abdulaziz Al Saud, was forced to abdicate by Crown Prince Faisal bin Abdulaziz Al Saud in 1964 after being monarch for a little over a decade. The power struggle between the two half-brothers created a major crisis very early on in the developing years of the state. But the royal family (which was small at the time), in conjunction with the religious establishment, managed this infighting before it could damage the regime. However, that was a very different time when the kingdom did not face multiple pressures (domestically and internationally), as it does now. This greatly increases the chances that the Saudi system could be overwhelmed to the point where its writ begins to erode.

Conclusion

Given the current economic stress, any disagreement within the royal family has the potential to lead to a combination of street agitation and militancy. At present, there are no overt signs that the austerity drive is adversely impacting the kingdom’s political stability. However, since it is likely to be a long while before oil prices return to $90 per barrel (the price at which the Saudis could balance their books), it is reasonable to expect future instability. Ironically, the economic reforms that the Saudis have been forced to adopt to avoid turmoil are likely to exacerbate matters.