Saudi Arabia’s new wealth fund seeks to diversify revenue
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.