Saudi Arabia Faces Economic Contraction as Oil Cuts Highlight Reliance

The decline in oil production and revenue in 2023 could result in Saudi Arabia's first economic shrinkage since 2020, during the COVID-19 pandemic.

Saudi Arabia is at risk of an economic contraction this year due to its decision to extend crude production cuts, revealing its continued heavy reliance on oil amid slow diversification reforms.

Riyadh’s move to extend a voluntary oil output cut of 1 million barrels per day until the end of 2023 led to oil prices surging above $90 this year but falling below last year’s average of around $100 per barrel following Russia’s invasion of Ukraine.

The decline in oil production and revenue in 2023 could result in Saudi Arabia’s first economic shrinkage since 2020, during the COVID-19 pandemic.

However, a substantial dividend from state oil producer Saudi Aramco (2222.SE) is expected to offer some financial stability.

Extending oil output cuts for another three months, in addition to earlier cuts, translates into a 9% production decrease in 2023, marking the largest drop in production for OPEC’s de facto leader in nearly 15 years, as noted by analyst Justin Alexander at Khalij Economics.

Monica Malik, Chief Economist at Abu Dhabi Commercial Bank, now predicts a 0.5% contraction in Saudi GDP this year, revising her previous forecast of 0.2% growth, while Alexander believes non-oil growth must average around 5% this year to sustain overall growth.

However, leading indicators like the PMI (Purchasing Managers’ Index) suggest a modest slowdown, potentially making a small real GDP contraction likely in H2, according to Alexander, who is also a Gulf analyst at GlobalSource Partners.

Last year, the Saudi economy grew by 8.7% and generated a fiscal surplus of 2.5% of GDP, its first surplus in nine years due to high oil prices.

This year, the government has forecast a 0.4% GDP surplus, but some economists consider even that optimistic.

Despite Saudi Aramco’s significant dividend announcement, the government is expected to run a budget deficit of 1.5% of GDP in 2023, well below the budget’s estimate of a 0.4% GDP surplus, as stated by James Swanston of Capital Economics.

The kingdom’s deficit stood at 8.2 billion riyals ($2.19 billion) for the first half of this year, and the International Monetary Fund (IMF) expects the budget to be closer to balance due to the extra Aramco payout.

The IMF also anticipates slight economic growth this year, unlike some economists who project contraction.

Although growth in the non-oil economy remains robust, the share of the non-oil sector’s contribution to GDP only increased by 0.7 percentage points from 2016 to reach 44% of GDP last year.

Neil Quilliam, Associate Fellow at Chatham House in London, suggests that the pace of diversification reforms has been slower than expected, and the economy will remain reliant on hydrocarbons for some time.

The Public Investment Fund (PIF), responsible for Saudi Arabia’s Vision 2030 economic blueprint, has invested heavily in various sectors but reported a loss of $15.6 billion last year, primarily due to investments like SoftBank Vision Fund I and the broader tech market downturn.

Despite these challenges, PIF’s acquisition activity remains strong, with reports suggesting that up to $50 billion worth of fresh Aramco shares could be offered on the Riyadh bourse before year-end, potentially funding major projects.

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