IMF Wraps Up 2023 Article IV Talks with Saudi Arabia

Washington, DC: On July 20, 2023, the Executive Board of the International Monetary Fund (IMF) concluded the 2023 Article IV consultation^[1]with Saudi Arabia.

Saudi Arabia was the fastest growing G20 economy in 2022. Overall growth reached 8.7 percent, reflecting both strong oil production and a 4.8 percent non-oil GDP growth driven by robust private consumption and non-oil private investment, including giga projects. Wholesale, retail trade, construction, and transport were the main drivers of non-oil growth. The output gap is estimated to have closed during 2022, with the non-oil growth momentum continuing in 2023.

The Saudi unemployment rate is at a historical low. Amid an increase in labor force participation, total unemployment dropped to 4.8 percent by end-2022—from 9 percent during Covid—reflecting both an increase in Saudi workers in the private sector and expatriate workers (mostly in the construction and agricultural sectors) rising back above pre-Covid levels. Youth unemployment was halved to 16.8 percent in 2022 over the past two years while female participation in the labor force reached 36 percent in 2022, exceeding the 30 percent target set under the authorities' Vision 2030 reform agenda.

Despite a booming economic activity, inflation remains low and appears to be easing. Average CPI grew by 2.5 percent y-o-y in 2022, in part contained by domestic subsidies/price cap and a strong US dollar. Despite an uptick in early 2023 to 3.4 percent y-o-y, headline inflation is back at 2.8 percent y-o-y in May 2023, as declining contributions from transport and food prices offset the substantial increase in rent.

The banking system remains on a strong footing. The aggregate capital adequacy ratio is strong, profitability—driven by net interest margins—is high and above pre-pandemic levels, and the NPL ratio is low and declining. While growth in mortgages has recently moderated, demand for project-related and consumer loans remains strong, helping offset the impact on profitability from rising funding costs linked to higher interest rates and a greater share of time and saving deposits in banks' liabilities.

Favorable oil market dynamics strengthened the fiscal position, with turned to a 2.5 percent of GDP surplus—the first since 2013. The surplus would have been higher, if not for additional spending that was not initially budgeted for. This mostly reflect increases in goods and services and capital spending. About 2½ percent of GDP of additional expenditures were estimated to be one-off non-recurrent spending (about half in goods and services). At 23 percent of GDP public debt is low and sustainable, with ample fiscal space available to address potential headwinds.

Higher oil prices and stepped-up oil production improved the current account to a 10-year high surplus in 2022. However, the 13.6 percent of GDP surplus did not lead to a corresponding increase in official reserves in view of the large accumulation of assets abroad, albeit these remain at comfortable levels (almost 20-month import cover).

Risks to the outlook are balanced.On the upside, higher oil prices—as expectations of strong oil demand for the rest of the year persist—possible change in OPEC+ oil production cuts and accelerated structural reforms and investment could spur growth. Conversely, too rapid a rise in non-oil investment could further raise domestic demand, thereby adding pressure on prices and external accounts. On the downside, lower oil prices due to subdued global activity represent a key short-term risk while a quicker shift in demand for fossil fuel could hamper growth in the medium to long term.

Executive Board Assessment^[2]

Executive Directors agreed with the thrust of the staff appraisal. They welcomed Saudi Arabia's ongoing economic transformation, supported by commendable reforms under the Vision 2030 agenda and higher oil prices, which has helped create high growth, record low unemployment, contained inflation, and strong external and fiscal buffers, while reducing reliance on oil. Directors noted that risks to the positive outlook are balanced, but that contingency measures, such as tighter fiscal policy, should be considered if demand pressures materialize.

Directors welcomed the impressive non-oil revenue mobilization efforts already initiated which have resulted in doubling non-oil revenues since 2017 and called for additional fiscal adjustment over the medium term which would allow Saudi Arabia to maintain stronger buffers and meet intergenerational needs while mitigating risks from oil price volatility. To support such a strategy, Directors called for additional non-oil revenue efforts, including by maintaining the VAT rate. Most Directors recommended faster increases in energy prices to reduce subsidies, although a few Directors called for continuing the gradual implementation articulated in the Vision 2030 road map. Directors agreed that energy subsidy reforms should be accompanied by scaling up well-targeted social programs to limit the impact on the most vulnerable. They also emphasized the importance of the ongoing rollout of the Medium-Term Fiscal Framework and enhanced disclosure which would support the implementation of a fiscal rule and help delink spending decisions from oil price fluctuations. Directors welcomed the ongoing work on a Sovereign Asset Liability Management Framework and called for its quick completion.

Directors agreed that the exchange rate peg continues to serve the country well. They noted that the monetary policy framework should continue to use market-based instruments to align the interbank rate with the policy rate, which should continue to move in line with the Fed's policy rate.

Directors agreed that the banking sector remains on a strong footing. They welcomed ongoing efforts to modernize the regulatory and supervisory frameworks and recommended maintaining vigilance and considering a gradual tightening in macroprudential guidelines/regulations and phasing out of fiscal incentives in the case of persistently elevated credit growth.

Directors noted the significant progress made in implementing Saudi Arabia's structural reform agenda. In particular, they welcomed the marked improvement in female labor force participation and improvements in regulatory and business environment, which have contributed to higher private sector investment, and encouraged building on this positive progress. They called for careful calibration of investment programs to ensure catalytic effects are in place and avoid private sector crowding out. Directors agreed that the authorities' industrial policy agenda should be supporting these structural reform efforts while minimizing associated risks. They welcomed the progress made to strengthen governance and emphasized the importance of ongoing actions and called for these efforts to be accelerated.

Directors welcomed Saudi Arabia's Green Initiative, whose implementation will be essential to meet the net emissions reduction target with minimal losses. They welcomed staff's assessment that even in a transition scenario where all countries implement their National Determined Contributions (NDC), the impact on the Saudi economy is expected to be limited. Directors looked forward to the elaboration of specific programs and investments related to each goal. Directors commended the enhancements in economic data, which should continue. Directors looked forward to Saudi Arabia's continued leadership in addressing global challenges.

It is expected that the next Article IV Consultation with Saudi Arabia will be held on the standard 12-month cycle.