IMF Highlights Saudi Arabia’s Economic Transformation and Challenges

The IMF mission to Saudi Arabia has mentioned that the country’s unprecedented economic transformation is progressing well. As the careful macroeconomic policies, the transformative changes, including fiscal reforms and regulatory improvements in the business environment, and the strong domestic demand have supported non-oil growth.

The inflation has remained contained, while the work on spending reprioritization and the recalibration of major spending programs still ongoing. Efforts to diversify the economy are beginning to show positive results.

Recent economic developments

Economic activity remains robust. Real non-oil growth decelerated from 5.3% in 2022 to a still robust 3.8% in 2023, driven mostly by private consumption and non-oil investment, with the latter tapering off to 11.5% (down from an exceptional 32% growth in 2022).

Oil GDP contracted by 9% in 2023 due primarily to Saudi Arabia’s Opec+ and voluntary oil production cuts, leading to a 0.8% 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% 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.

Unemployment rate

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% in the last quarter of 2023—inching closer to the 2030 Vision objective of 7%. Labour 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%.

Headline inflation has decelerated rapidly despite some pressure pockets. After peaking at 3.4% in January 2023, year-on-year inflation receded to 1.6% in April 2024, helped by an appreciating nominal effective exchange rate.

However, rents are growing at a brisk rate of about 10% 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% of GDP in 2022 to 3.2% 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% 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% of the IMF’s reserve adequacy metric by end-2023.

Economic outlook and risks

Domestic demand is expected to remain the main driver of economic activity. Non-oil growth is projected at about 3.5% 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% in 2024 but increase by 5.1% 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% in 2025 before stabilizing at 3.5% per year over the medium term.

Inflation would remain stable at 1.9% in 2024, buttressed by a credible peg to the US 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% 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.

Fiscal policy

The overall fiscal deficit is expected to widen further this year. While the 2024 budget projects the overall deficit to stabilize slightly below 2% 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% 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% 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% 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% 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% 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% by 2029.

Financial sector policies

The financial sector is on a strong footing. Banks’ performance indicators are strong, with capital adequacy ratio above 20%, 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% 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 Programme (FSAP) show that banks as well as non-financial corporates are resilient to shocks even under severe adverse scenarios.

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 17th 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 programme, further increases in female labour 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.