Saudi Arabia’s new wealth fund seeks to diversify revenue

Sunday 17/04/2016
A Saudi man looks at the trading board at the Tadawul Saudi Stock Exchange, in Riyadh.

Washington - Saudi Arabia’s plan to cre­ate a $2 trillion sovereign wealth fund as part of a larger project to move the kingdom from an oil reve­nue-based economy poses a funda­mental question: What will replace oil as the country’s main source of revenue?

The proposed fund would eclipse in size any other, including Nor­way’s ($825 billion) and Abu Dha­bi’s ($773 billion). To be called the Public Investment Fund (PIF), it would receive a large cash infusion from sales of shares in state oil gi­ant Saudi Aramco through an ini­tial public offering (IPO) in 2017 or 2018. The government plans to sell no more than 5% of the company. The Council for Economic and De­velopment Affairs, chaired by Dep­uty Crown Prince Mohammed bin Salman bin Abdulaziz, is to oversee the PIF.

The general assumption has been that the Saudi Aramco IPO would focus on downstream assets. That would likely necessitate a merger of Saudi Basic Industries Corpora­tion (SABIC) and the state oil giant to combine petrochemical assets before shares were offered. But Prince Mohammed made it clear that “SABIC and Saudi Aramco are two independent companies but both will have a majority owner­ship by PIF”.

According to the prince: “IPOing Aramco and transferring its shares to PIF will technically make invest­ments the source of Saudi govern­ment revenue, not oil… Within 20 years, we will be an economy or state that doesn’t depend mainly on oil.”

If all goes to plan, the PIF would play a decisive role in the king­dom’s economy, investing both domestically and abroad. Prince Mohammed said the fund would be “very aggressive” in making foreign investments after initially being built on domestic assets, including the contribution from Saudi Aram­co. The PIF holds interests in SABIC and the nation’s largest lender, Na­tional Commercial Bank.

The fund has reportedly made several foreign investments, in­cluding a 38% interest in South Ko­rean Posco Engineering & Construc­tion Company and a $10 billion agreement with the Russian Direct Investment Fund to invest in Rus­sia. The latter move is perceived by some as more politically than finan­cially driven — perhaps an effort by the Saudis to encourage Moscow to soften its Syrian position.

Saudi Arabia has proved to be a savvy investor over the years and the PIF will undoubtedly provide an impressive financial buffer for Riyadh in the coming decades if it does reach the $2 trillion threshold.

However, the Saudis have yet to spell out how the domestic econo­my would transform from oil-rev­enue dependency and what new industries would provide wealth and job creation as the government strives to reduce dependence on the state for employment and ser­vices.

It has been estimated that ap­proximately 250,000 young Saudis enter the job market each year and given that about 70% of the Saudi population is under the age of 30, the Saudi government will be in­creasingly under pressure to create jobs for its growing young work­force in the coming years.

The International Monetary Fund (IMF) warned in October 2015 that lower oil prices underscore the need for Gulf governments to im­prove business environments by “enhancing incentives for nation­als to work in the private sector and making workers’ skills more relevant to the private sector by im­proving the quality of education”. The IMF argued that “lower oil prices will eventually force govern­ments of oil exporters to hire fewer public servants”.

The IMF must be encouraged by the kingdom’s move to curb energy-related subsidies and will likely support proposed plans for complete or partial privatisation of more than two dozen state firms, including the national airline, the state telecoms firm and the state power generator. Prince Moham­med has pointed to the health care sector as another prime candidate for privatisation.

As part of the National Transfor­mation Plan (NTP), which is to be rolled out shortly, the Saudi gov­ernment is expected to introduce a value-added tax (VAT) and “sin” taxes on sugary drinks and ciga­rettes.

While these are commendable fiscal reforms that will raise non-oil income, the real changes that must be made to transform the economy — including bringing women more fully into the workforce, reining in spending within the extended rul­ing family and providing the ap­propriate education to support a ro­bust private sector — will face social and political obstacles.

One can argue that, with Saudi Aramco strengthening a petro­chemical industry dependent on crude and gas feedstock, Saudi Ara­bia would not really be diversify­ing its economy that far away from oil-based revenue. As details are revealed regarding the NTP, there may be specifics about non-oil in­dustries that are being prioritised for development and job creation.

However, it is clear that regard­less of how the Saudi government plans to transform its economy, Saudi Aramco’s premier position as the country’s industrial crown jew­el is not likely to change soon.