What could be worse than a pandemic that triggers a financial crisis? If your economy is based on oil, then a pandemic that drastically reduces worldwide demand for energy is a major blow. That’s the case with Saudi Arabia, the theocratic monarchy bordering the Red Sea and the Persian Gulf, the Middle East’s senior oil giant.
On Sunday, Prime Minister Benjamin Netanyahu and Mossad head Yossi Cohen reportedly visited Saudi Arabia, meeting with Saudi Crown Prince Mohammed Bin Salman and U.S. Secretary of State Mike Pompeo. This historic step comes after Israel, through U.S. mediation, reached agreements with Saudi Arabia’s neighbors, the United Arab Emirates and Bahrain. But Saudi Arabia is in another league.
“The dramatic change in Saudi policy toward Israel stems from a variety of reasons,” Dr. Michal Yaari, an expert on the Gulf states at Ben-Gurion University and the Open University, told TheMarker. “The growing power of the Iranian enemy; the tension between Saudi leaders and the Obama administration, which led to the understanding that the Saudis couldn’t rely only on the Americans to defend them against Iran; the decreased importance of the Palestinian issue; and the disgust with the Palestinian leadership’s conduct.”
The last reason, she notes, is generational – the crown prince hasn’t lived through a period in which the dominant narrative is burning hate toward Israel. “He understands that the loyalty to the Palestinians endangers the kingdom’s security, and recognizes the incredible importance of ties with Israel. He’s part of a young generation that looks at Israel much more pragmatically,” says Yaari.
Israel and Saudi Arabia do not have official or legal economic ties. “Officially, Saudi Arabia bans economic ties between Israeli companies and workers and Saudi companies,” she says. But that doesn’t mean that there aren’t indirect economic ties via third-party companies or countries, she notes.
“There’s no question that a peace treaty would bring Israel massive economic gain, because it would enable broad economic activity between Israel and Saudi companies. There’s a broad range of potential field for economic cooperation,” she says, citing cybercapabilities, water, agriculture and tourism.
What do the Saudi and Israeli economies have to offer each other? Saudi Arabia’s GDP grew by 1.2% in the third quarter of the year, versus the second quarter, based on data the Saudi government released this month. This is a 4.2% drop in GDP from the parallel quarter of 2019, however. This isn’t much different than other major economies, like that of Germany, whose GDP also contracted by 4.2% for the past year, or France, which shrunk by 4.3% – and it’s better than the GDP stats for Spain, Italy and Japan, which all shrunk by 4.7% – 8.7% over the past year.
Saudi Arabia’s economy took a double hit from the coronavirus. First, it was affected locally, like every other country in the world. Afterwards, the pandemic hit Saudi Arabia’s main source of income – oil. During the second quarter this year, the oil market went through one of its worst upheavals ever, as its price dropped below zero for the first time in history.
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The global demand for oil is declining, and Saudi Arabia made several moves that shook up the market when it started ending voluntary cuts to its OPEC+ output quota. Since then, the major oil producers have come to their senses, and are planning to reach an agreement on further cutting quotas during a meeting next week.
In early November, credit rating firm Fitch lowered its credit forecast for Saudi Arabia to negative with a stable outlook, and left its credit rating at A. “The revision of the outlook on Saudi Arabia’s IDRs reflects the continued weakening of its fiscal and external balance sheets, which has been accelerated by the coronavirus pandemic and lower oil prices, despite the government’s strong commitment to fiscal consolidation,” Fitch stated in explaining the decision.
Fitch forecast Saudi Arabia’s budget deficit to increase to 12.8% of GDP for 2020 – or $90 million – up from 4.5% last year. “This reflects a 33% drop in oil revenue, a 5% drop in non-oil revenue and 1% higher spending compared with last year,” Fitch stated in its report.
However, the rating company noted that exceptional profits from government investments will help buoy Saudi Arabia’s fiscal balance. By 2021 it forecasts the Saudi budget deficit will be 8% of GDP, and then down to 5% of GDP by 2022 — this presuming that Brent oil prices recover to a price of $50 per barrel by then, and oil production reaches 9.7 million barrels a day (if OPEC+ scales back its quota cuts).
Kicking the oil habit
Due to the state of the oil market, you might expect that Saudi Arabia would be even worse off. As an economy critically dependent on oil, Saudi Arabia launched a long-term economic plan in 2016 called Saudi Vision 2030 aimed at helping the Saudi economy branch out and decrease its dependence on oil. Despite these efforts, Saudi Arabia has struggled to actually implement the plan. To date its efforts have mainly come as a massive government investment in technology, some of which drew questionable results, such as its partnership in Japanese entrepreneur Masayoshi Son’s Vision Fund.
Saudi Arabia has no choice but to keep trying to diversify its economy. “The coronavirus definitely delayed this transition, and badly impacted oil revenues,” says Yaari. “Thus, Saudi Arabia is working intensely to develop other sources of income, such as tourism. The government is aiming not just for religious tourists but also for Western tourists. On this front it has launched culture events over the last few years, such as the music festival in January. In addition, Saudi Arabia is working to draw foreign investments that would enable advancing various projects as part of the Saudi Vision 2030 project. There’s no question that Saudi Arabia’s economy is still too dependent on oil.”
Do the Saudis have a reason to invest in Israel?
“I’m doubtful that it would be Israel investing in Saudi Arabia. I believe it’s more likely that the Saudis would be investing in Israel companies.
“You need to remember that Israel and Saudi Arabia share challenges not just on the defense front, but also on matters that are no less important: a water shortage, climate change, agriculture in a desert climate, and more. Israel has had unusual successes in these fields, and thus the Saudis are very interested in Israeli technology, knowledge and science. Furthermore, Israel’s cybercapabilities are raising a lot of interest within the kingdom.”
Hit with VAT
After many years during which petrodollars – foreign-currency denominated income from oil sales – funded a comfortable, ostentatious life for the Gulf kingdom’s residents, Saudi Arabia was forced to take harsh steps to compensate for the fall in revenues due to dropping oil prices and demand. This has included taxes that Saudis have never had to pay before, including VAT and income tax.
In July, Saudi Arabia tripled its VAT, to 15%, in an attempt to increase government revenues. Economists in the region believe that pent-up demand will reawaken after a coronavirus vaccine arrives and the virus stops weighing on the global economy. Under such a scenario, Saudi Arabia will enjoy a boost, but in the meantime, the increase in VAT offset part of the third-quarter recovery.
On Monday, Saudi Finance Minister Mohammed al-Jadaan announced that the VAT increase would not be canceled in the short or medium term, despite its high price to the Saudi economy. Jadaan, speaking during a virtual meeting of G-20 representatives, stated that the decision was difficult but necessary for the economy.
Saudi Arabia is slated to reveal over the next year special economic zones in several fields in an effort to pull capital-heavy investments and investments in quality growth, as Saudi Energy Minister Khalid al-Falih put it. These fields include cloud computing, renewable energy, tourism, culture, entertainment and logistics. According to Saudi Energy Ministry data, foreign direct investment in Saudi Arabia increased 12% in the first half of the year versus the parallel period in 2019.