Saudi Arabia: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.
Publication Date:
13 Oct 2016
eISBN:
9781475544275
Language:
English
Keywords:
ISCR; CR; private sector; debt management; real GDP; GDP; expenditure; liquidity-constrained government; undertaking privatization; government stake; government action; government ownerships in so; Public investment and public-private partnerships (PPP); Public enterprises; Public investment spending; Oil prices; Global
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Saudi Arabia: Selected Issues

Abstract

Saudi Arabia: Selected Issues

Privatization and PPPs in Saudi Arabia: Past Experience and the Way Forward1

“We have great opportunities to create jobs in the private sector” His Royal Highness Deputy Crown Prince Mohammed bin Salman.

Saudi Arabia is considering privatization and Public-Private Partnership (PPP) programs as part of the policy response to the decline in oil prices. These programs have considerable scope to increase efficiency and productivity in the economy as well as unlock greater value of government assets. Implementation should proceed transparently with a clear time-table, and be underpinned by institutional, legal and regulatory frameworks. Lessons from international experiences with privatization and PPPs could usefully be incorporated in designing the policy frameworks. There are important fiscal and macroeconomic considerations that require appropriate policy response.

A. Introduction

1. The sustained decline in oil prices means that the government can no longer be the main driver of growth and employment. Fiscal consolidation already initiated and planned over the next years will have adverse implications on growth in the short-term not only due to the scaling back of public investment, but also the potential crowding out of financing the large deficits on private sector credit. Moreover, the government will not be able to absorb nationals into jobs in the public sector at same rates as previous years. The recently announced Vision 2030 and National Transformation Program (NTP) outlined goals and objectives to diversify and transform the economy. The Vision and NTP envisage a greater role for the private sector, including through privatization and expanding the use of PPPs, with a view to increasing efficiency, productivity, and job opportunities for nationals in the private sector.

2. Privatization and other policies to increase the role of the private sector have been an objective in Saudi Arabia over the past decades, but the government has nonetheless maintained a large role in the economy. This reflects mainly the dominance of the oil sector which has been largely untouched by previous privatization programs. It also reflects the slow and narrow implementation of previous privatization programs, focusing on profitable enterprises in a few sectors. More broadly, diversification policies have achieved limited progress in meaningfully increasing the share of the non-hydrocarbons output in GDP and the share of the private sector in economic activity, which increased by only 10 percentage points over the past 15 years. Research on the diversification experience in Saudi Arabia and other GCC countries point to the role of the presence of a large state-owned enterprises (SOEs) sector and their wide-ranging mandates as a barrier to entry that limits competition and diversification (Callen et al. 2014).

3. Saudi Arabia has already initiated plans to step up its privatization and PPP programs. In 2015, ground services in all the airports were partially privatized and the timetable for the long standing privatization of the grain silos corporation and two airports this year has been released. A privatization committee has recently been formed and a unit established at the Ministry of Economy to prepare the broad guidelines for implementation of new privatization and PPPs programs. The Deputy Crown Prince has announced the possibility of the partial privatization of ARAMCO, and key mega projects are also planned for public private partnerships, including the Mecca and Jeddah metros. A number of elements in the design and implementation of privatization and PPPs need to be addressed to maximize the benefits of these programs. This paper sheds light on Saudi Arabia’s past privatization programs (section B), considers the international experience with privatization and PPPs (section C), and discusses key fiscal and macroeconomic considerations that can arise in the implementation process (section D). The conclusion draws lessons and provides policy recommendations.

B. Past Experience

4. Privatization, broadly defined as the full or partial sale by a government of state-owned enterprises or assets to private economic agents, has been a key element of structural reform in many developing and transition economies. Governments undertaking privatization have pursued a variety of objectives: gains in economic efficiency, given the extensive prevalence of poor economic performance of SOEs in many countries and limited success with SOEs reform; improving the fiscal position, particularly in cases where governments have been unwilling or unable to continue to finance deficits in the SOE sector; and liquidity-constrained governments facing fiscal pressures have sometimes privatized with a view to financing fiscal deficits with the proceeds. Other objectives have included the development of domestic capital markets (Davis et.al, 2000).

5. In Saudi Arabia, privatization programs were part of a broader agenda to enhance the role of the private sector in the economy. As in other GCC countries, the size of the state in the Saudi economy has been historically dominant, reflecting the developmental role the government has assumed to address large physical and institutional infrastructure needs since the early stages of state building. Following the 1998-99 oil price slump, the Saudi authorities reinforced their structural reform effort with a view to enabling the private sector to take a leading role in the economy and help diversify the economy away from the oil sector. Divesture of public assets was part of this broader agenda and was officially adopted in 1997 by the cabinet’s approval of a privatization strategy. However, it wasn’t until 2001 that the objectives and priority sectors were identified and the administrative and implementation procedures enacted. The Supreme Economic Council was charged with the responsibility for supervising the privatization program, while a Privatization Committee was charged with implementation. The privatization process included autonomization of management of some public enterprises to be followed by deregulation (corporatization) and ultimately private ownership. Twenty sectors were identified for privatization, including telecommunications, electricity, industrial parks, postal services, water, railroads, education, and air transportation.

6. Importantly, the privatization program was accompanied by reforms aimed at building the institutional and legal infrastructure. This not only helped with divesting government stakes in state-owned enterprises, but it broadened the scope of private sector investment (including FDI) into areas that were previously limited to the public sector. These reforms included: enactment of new investment laws and establishing the associated investment authority (SAGIA) to facilitate foreign direct investment processing, including the establishment of a one-stop shop for investors; liberalization of restrictions on foreign capital inflows and foreign ownership so that capital and associated technologies are available to support privatization and private sector development (allowing a 100 percent foreign ownership of businesses in most sectors, including gas, power generation, water desalination, and petrochemicals); establishing a new capital markets law and strengthening regulations (the Capital Market Authority (CMA) was created in 2003); accession to the WTO in 2005; and cutting the highest corporate income tax on foreign companies from 45 percent to 20 percent. The opening up of sectors such as health, telecommunication, electricity, and other utilities has also contributed to increased competition and improved governance and reduced the role of the government in these sectors.

7. The implementation of the privatization strategy has moved slowly and achieved mixed results. The strategy tried to achieve a number of objectives including increasing efficiency and productivity in the economy and reducing the fiscal burden of supporting inefficient enterprises. The development of the capital market was a key consideration as well. Implementation, however, was sporadic and focused on divesting stakes in a few sectors mainly telecom, financial, and petrochemicals, although this reflects the narrow economic base given the oil dominance in the economy (Table 1 and Box 1). The government kept majority stakes in many of the enterprises, while asset divestures were mostly executed through IPOs and targeted to citizens. These operations have helped deepen and increase liquidity in the stock market, which witnessed a strong growth during the active period of privatization (Figure 1). Indeed, the IPOs of public enterprises represented more than 50 percent of total IPOs since 2003, while the market value of privatized enterprises accounts now for over 40 percent of total market capitalization. Privatization and the opening of sectors for foreign investors also correlated with a substantial increase in FDI inflows during the 2000s. At the firm level, some empirical work has shown that the performance of the Saudi Telecom Company and the Company for Cooperative Insurance improved after their IPOs as compared to the pre-IPO financial performance (see Alanazi, Liu, and Forster, 2011). However, the analysis does not account for the impact of other potential factors that may have affected these companies’ performance.

Table 1.

Saudi Arabia, Some Major Privatization Operations

(US$ million)

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Sources: Bloomberg; and SAMA annual reports.
Figure 1.
Figure 1.

Saudi Arabia: Stock Market and Foreign Investment

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A002

Saudi Arabia: Key Restructuring/Corporatization of State-Enterprises and PPPs

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Source: SAMA annual reports.

8. Compared to other countries in the region, Saudi Arabia’s privatization program was limited. Unlike other countries in the region where privatization has typically targeted loss making enterprises, the Saudi program mostly focused on commercially run and profitable enterprises (such as SABIC, the petrochemicals company). Several key enterprises that were slated for privatization such as the airlines and airports and utility companies have been under or awaiting restructuring for many years. The water authority and electricity companies remain largely government owned and dependent on budget support despite their corporatization and some restructuring in preparation for privatization (the government has provided soft loans to the electricity company of around $50 billion since corporatization of SEC in 2000). In terms of the institutional and legal frameworks, the Saudi Arabian privatization program lacked an adequate legal base—there were no privatization laws per se and supervision and execution were charged to committees rather than special agencies, lacked clear timetables, and focused on mostly commercially oriented and efficiently run activities. A number of factors have contributed to the slower progress in Saudi Arabia including the lack of adequate legislations and institutional set-ups, long lead-time needed to restructure enterprises, the restrictive regulations on foreign investment—many of which have been recently removed—conditions imposed to protect workers, and other concerns about social implications of potential higher prices and unemployment.

9. The Saudi divesture programs, however, generated significant receipts from a handful of high value operations. Proceeds amounted to over $21 billion, equivalent to 1.1 percent of GDP annually during the main years of privatization (2003-08). In nominal terms, this is larger than what countries like Egypt, Jordan, Morocco, and Tunisia generated from over 300 operations since the beginning of the 1990s (Table 2). There have been an additional $6.8 billion of proceeds from privatization since 2008. While proceeds were used to finance spending and reduce public debt in many oil importers, most of the proceeds in Saudi Arabia accrued to the Public Investment Fund which may have allocated them to other assets portfolios, including investment abroad.

Table 2.

MENA Region: Privatization Proceeds in the 1990s and 2000s

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Sources: World Bank Privatization Database (latest available data to 2008); and IMF staff estimates.Source for the GCC counties is Zeya data on IPOs in the GCC stock markets, and staff calculations.

Annual average in years of active privatization.

C. The Size of the SOE Sector and Potential Future Privatization

10. Despite the progress made in divesting assets in public enterprises, government ownership in the economy remains substantial, especially in the hydrocarbon sector. The national oil company, ARAMCO, has been state-owned and run since its full nationalization in 1980. Little information is available on the performance and size of ARAMCO which is believed to be well run and enjoy a high degree of operational independence. Activities of ARAMCO are extended to the downstream—refineries, petrochemical industries, and oil and gas services, including international operations—and to activities that go beyond its core commercial mandate such as building stadiums and universities. With the exception of some joint ventures in upstream gas production, recent privatization efforts in the hydrocarbon sector were limited to the petrochemical industries and downstream operations, notably the 2008 privatization of Petro Rabigh, a refinery and petrochemical joint venture between ARAMCO and Sumitomo Chemical. The oil reserves, to which ARAMCO is a de facto custodian, are vast–over $3 trillion in net present value terms, equivalent to over 460 percent of GDP (Table 3). This estimate, which is sensitive to the oil price and other assumptions used, is not an estimate of the value of ARAMCO because this will also depend on other factors such as the tax regime, but it does indicate that privatization revenues from the hydrocarbon sector could be substantial.

Table 3.

GCC: Net Present Value of Future Oil Proceeds as of End 2015 1/

(US$ Billions)

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Sources: BP statistical review, country authorities and staff calculations.

Staff calculations based on current levels of oil production, proven oil reserves, and future oil prices using WEO projections, and assuming a growth of 2 percent in oil prices annually after 2021.

11. Outside the hydrocarbon sector, Saudi Arabia has a number of key enterprises that might gain from privatization. Compared to some countries in the region where the state has a stake in hundreds of low-productivity firms, potential privatization candidates in Saudi Arabia are concentrated in a few sectors which have been largely untouched by past privatization efforts. Even in the sectors that were partially privatized, the government has retained a large stake. Data on listed companies shows that government ownership is still large in a variety of sectors, notably utilities, communication, and petrochemicals (Figure 2). However, these numbers underestimate the government ownership stake in the non-oil sector given that many large public enterprises and entities are not listed on the stock market including Saudi Airlines, the airports, Railroads Saudi, Gulf International Bank, and SALIC (Saudi Agricultural and Livestock Investment Company). The government also still dominates the provision of services in education, health, and utilities despite the opening up of these sectors to private investment. For example, the government provides over 80 percent of total hospital beds and public universities account for close to 95 percent of total enrolled students.

Figure 2.
Figure 2.

Government Stakes in Listed SOEs, 2015

(Percent)

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A002

Sources: Bloomberg; and IMF staff calculations.

12. Many SOEs have been corporatized and partially privatized in recent years and put on the same footing with private firms. Several SOEs are amongst the most successful and profitable enterprises that are recognized globally (for instance SABIC and MAADEN). The benefits from divesting stakes in such profitable enterprises are not straight forward compared to loss-making enterprises. These enterprises pay dividends which accrue to the Public Investment Fund (PIF) and are usually retained by the PIF, but the government has recently tapped into these funds for additional revenue of more than 10 percent of non-oil revenue in 2015.

13. Depending on the purpose of the privatization programs and the asset/liability management considerations, profitable enterprises represent a more readily available option for financing. Data collected from the stock exchange on government shares in listed companies shows that the value of these assets (based on market capitalization), and excluding shares held by the pension funds, are significant, amounting to close to $130 billion or 20 percent of GDP at end-2015 (Table 4). Again, these figures do not include several large and fully government-owned corporations, on which information is not available, and therefore considerably underestimate the total value of proceeds that the governments can generate from assets sale. Selling stakes in such enterprises could be an alternative to debt financing or part of the financing mix— in some countries using privatization proceeds to relax fiscal constraints could be a preferred option from a political economy perspective if assets sale is subject to less political opposition compared to other options.

Table 4.

GCC: Government Ownership in Listed SOEs

(US$ millions)

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Sources: Bloomberg; and IMF staff calculations.

14. The objective of maximizing the value of the government’s assets should be a priority. Figure 3 shows that the the stock prices of privatized enterprises increased on average by 250 percent on the first day of trading following the IPO, compared to 176 percent for private sector IPOs. Price increases after sale ranged from 10 percent for the National Commerical Bank to 1,430 percent for Bank Al Bilad IPOs.2 The government could have potentially more than doubled its privatization proceeds if it had been able to realize the market price after the IPO. While underpricing is a well documented phenomenon worldwide, empirical evidence suggests that it is more evident in Saudi Arabia and other GCC countries compared to other regions, reflecting perhaps the governments’ desire for privatization to be a channel through which oil wealth is shared with citizens (see Al-Hassan, Delgado, and Omran (2007)). A number of actions prior to and during the privatization process can help increase the price of privatized enterprises (see next section).

Figure 3.
Figure 3.

Saudi Arabia: IPOs Performance of Privatized Enterprises and Private Companies, 2003–15

(Percent)

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A002

Sources: Zawya; and IMF staff calculations.

D. Lessons from International Experience on Privatization and PPPs

15. International evidence generally suggests positive outcomes of privatization. Privatizations are found to be strongly correlated with a lasting improvement in macroeconomic performance. Econometric work by the IMF showed a significant and positive relationship between privatization and growth rates (Davis et. al, 2000), consistent with findings in the literature that growth tended to be more rapid where the share of the private sector in GDP was higher. It is likely that privatization was serving as a proxy in these regressions for a range of structural measures that may be characterized as a change in economic regime. These findings are supported by findings at the micro level where privatized firms in most case studies were found to have become more efficient, more profitable, and financially healthier, and to have increased their capital investment spending—for a comprehensive review of empirical findings, see Megginson and Netter (2001).

16. Job losses could result in the short term, but over the longer term the overall impact of privatization on employment is positive. Layoffs did occur during restructuring and privatization operations in many countries, but as the privatized enterprises expand their operations, employment increased (privatized enterprises employment follow a U shape) (see Gupta, Schiller, and Ma’ (1999) for a review). Moreover, privatization, particularly when accompanied by deregulation, can lead to enough new business formation that the overall level of employment in the sector rises, even if employment and wages in the former state firms falls. In Zambia, for example, the liquidation of the state airline and bus company led to two new airlines and several new bus firms, and in both cases sectoral employment ended up higher (Kikeri (1998)). In Argentina and Mexico—the two countries where employment cutbacks were largest in Latin America—a significant proportion of laid-off workers was eventually reemployed within the same sector (45 to 50 percent within one year in Mexico and 80 to 90 percent within four years in Argentina). Even if employment in the privatized enterprises declined permanently, the number of layoffs was generally small compared to the size of the labor force and therefore didn’t lead to higher unemployment rates. In Latin America, the proportion of the laid off labor force ranged from a low of 0.13 percent in Bolivia to 2 percent in Argentina (see McKenzie and Mookherjee, 2005).

17. However, not all privatization cases have been viewed as having been successful. Some have argued that the observed improvement in performance at the firm level after privatization could be attributed to other supporting reforms such as sector deregulation and competition rather than the change in ownership (Nellis, 2012). In some studies corruption was found to be associated with privatization (sales to well connected individual at low price), especially in countries lacking institutional capacity and well-functioning legal/judicial systems. Evidence suggests that transparency and homogeneity in procedures, speed, and limited restructuring prior to privatization lead to better outcomes and less room for corruption and discretion (see Chong and Lopez-de-Silanes, 2005)).

18. The fiscal effects of privatization have been generally positive. Privatization strengthened the fiscal positions; there were generally positive impacts on revenue from the improvement in efficiency and growth of privatized firms as well as from enhanced compliance and administrative scrutiny; transfers declined markedly following periods of privatization; and broader indicators of consolidated SOE accounts for some countries indicate a large decline in deficits, and probably also in quasi-fiscal operations. Dividends to the budget from public enterprises declined in some countries but these losses were at least partialy offset by increased tax collections. Countries tended to save the proceeds from privatization rather than spend them, i.e. they were used as a substitute for domestic financing and did not lead to a larger deficit. Privatization was also associated with a decline in public debt; some countries (Argentina, Egypt, Hungary, and Mexico for instance) expressed an explicit intention to use privatization proceeds for debt reduction and were able, during the years of active privatization in the 1990s, to sharply reduce their debt which initially ranged between 40 percent and 130 percent of GDP, though this involved many other factors in addition to the use of the privatization proceeds. In addition, this helped shift public spending away from expensive debt-service obligations and the funding of operating losses in SOEs (see Davis et al (2000) and McKenzie and. Mookherjee (2005) for discussion on fiscal implications.)

19. International experience points to a number of good practices in privatization:

  • The privatization process must be carefully designed, sequenced, and have a clear time table for implementation. Privatization is most efficient if preceded by institution-building and the establishment of appropriate regulatory and governance frameworks. Lack of adequate regulation and competition after privatization could lead to market power and exploitation of consumers—the water privatization case in Bolivia (Chong and López-de-Silanes, 2005).

  • Pre-privatization restructuring may increase the sales price and help smooth employment adjustment, but it represents a major cost and is better left to the private sector which may be able to restructure the enterprise more efficiently than the government. Evidence from some country experiences even points to a counterproductive role of the restructuring process; restructuring programs lengthen the privatization process considerably and lowered prices for firms sold-in the case of Mexico, for instance, each month of delay is estimated to have reduced the sale price by 2.2 percent (see Chong and Lopez-de-Silanes, 2004).

  • Restrictions on foreign direct investment and other conditions attached to the privatization including those limiting the redundancy of workers led to substantial price discounts for firms sold and negatively affected performance after privatization. Hungary’s very successful privatization program is believed to be partly attributed to the involvement of foreign investors compared to other transition countries.

  • Transparency of the privatization process can have important implications for the number of bidders and for the sale price. It could also help reduce risks of corruption and increase support for reforms.

  • Post-privatization regimes such as the tax and regulatory regime can also affect the price of privatized assets and future fiscal revenue— for instance firms with monopoly power, and which are likely to be regulated only lightly, will likely sell for a better price than those which will be more heavily regulated.

20. On methods of privatization, international experience suggests that auctions and IPOs have served to increase transparency and generate higher returns to the government than trade sales (see review of country cases in Berg and Berg, 1997, and Moginsson and Netter, 2001). Negotiated bilateral deals could allow the government to influence the divestiture to achieve its social objectives or to exclude unwanted buyers. However, constraints on the new owner can lead to a lower sale price, reducing the revenues that the government can use to finance social safety nets (Gupta, Schiller, and Ma’, 1999). Evidence, including from the GCC experience, suggests that countries that have privatized through large scale IPOs have experienced rapid growth in their national stock market capitalization and trading volumes.

E. Some Fiscal and Macroeconomic Considerations

21. Further privatization reforms could have a substantial impact on public finances. The impact will depend on the amount and use of the proceeds and the current financial position of the targeted SOEs. The current focus of the privatization effort on the largely government provided health and education services is expected to generate permanent fiscal gains; currently budget allocations to these sectors represent over 30 percent of total expenditure. Proceeds from assets sale, especially if a stake in ARAMCO is sold, would be substantial. In this regard, particular attention should be given to the following issues:

  • Privatization proceeds are one off, uncertain revenues that need to be carefully used and transparently recorded and subject to oversight. In particular, off-budget placement of privatization proceeds can lead to limited control and lack of transparency in their use. Receipts should be recorded on a gross basis and as a financing item, while the cost of restructuring, recapitalization, or writing off enterprises should be recorded as spending.

  • Additional proceeds should not postpone the needed adjustment or be used to increase spending beyond what is considered appropriate by the overall macroeconomic objectives and fiscal sustainability.

  • In general, the use of proceeds should be assessed in terms of the effect on government net wealth (GNW) and should be determined by asset/liability management considerations. In this context, proceeds can be used as an alternative option of financing the deficit and therefore reduce the need for debt financing or running down more liquid fiscal buffers. They can also be used to repay existing public debt, expand productive capital expenditures, or build financial assets domestically or abroad that will diversify the government’s existing asset holdings (Box 2).

  • Using privatization proceeds to finance the deficit or repay debt would reduce debt service costs, especially when borrowing costs are large. Some countries have earmarked part of the proceeds to cushion social impact of higher prices or workers layoffs arising from privatization.

  • Use of proceeds to finance additional capital expenditure need not reduce GNW if spent efficiently and used to address pressing infrastructure bottlenecks which lead to higher growth—when the expected rate of return on new assets is not less than that on financial assets. Privatization in this case would simply involve a change in the composition of the government’s assets. The implications of additional investment for recurrent government spending would need to be taken into account.

  • To minimize the permanent impact on the budget from the loss of investment income as a result of selling profitable enterprise, improvements in the tax policy to broaden the tax to corporations and strengthen administration would be warranted.

Privatization and Government Net Wealth

The Government Net Wealth (GNW), defined as the difference between total assets and total liabilities, is a useful concept to use in the assessment of the fiscal implications of privatization. Assets include external and domestic financial assets, the government ownerships in SOEs and physical capital stocks, while liabilities could include in addition to domestic and external debts, contingent liabilities such as government guarantees and unfunded pension schemes. GNW, as such, provides a full picture of the fiscal position and makes apparent all sources of fiscal strengths and vulnerabilities that are not captured by the traditional “flow” fiscal variables (expenditure, revenue, deficit, financing) or the stock of public debt.

A GNW measure that incorporates under-the-ground resources is particularly useful for Saudi Arabia; it links these nonrenewable resources to long term fiscal sustainability, brings to the fore the related issues of productive and unproductive use of oil revenues, and in view of the possibility of privatization in the oil sector, it incorporates an important and potentially large source of change in the level or composition of GNW. Privatization reduces GNW unless proceeds from assets sales are used to build other assets (financial or nonfinancial) or reduce debt.

Evaluating the impact of privatization in this context does not, however, imply the government should maintain GNW constant or maximize its level. This depends on the fiscal rule that the government follows as well as on the objectives of privatization—for instance using proceeds to smooth large adjustments or compensate groups affected by privatization could result in lower GNW. Still, it is important to keep an eye on the impact of privatization on the GNW and track its changes over time.

In practice, however, application of the GNW concept is not straightforward. The approach is very demanding in terms of data needed to construct the government balance sheet. Even the government sometimes does not know what assets it has acquired over the years, what it owes, and to whom (for instance with contingent or uncertain future liabilities). Moreover, the prices at which assets and liabilities need to be recorded on the balance sheet (market or nominal book values) make an important difference and some are extremely difficult or even impossible to value.

The table below presents an accounting exercise of the Saudi government balance sheet from which the GNW is derived. Assets include (i) government deposits at SAMA, (ii) the value of stakes held by the government in SOEs through the PIF (estimated at SAR 600 as mentioned in Vision 2030), (iii) government capital stock (the initial stock is estimated using the perpetual inventory method and accumulated by capital expenditures, discounted by the rate of depreciation), and (iv) the government share in future oil proceeds (estimated based on a budget share of 82 percent of oil exports representing royalties, taxes, and dividends of proven oil reserves)-the latter is calculated as the Net Present Value of oil exports proceeds using the WEO oil prices). On the liabilities side, only the government public debt is included.

The coverage is not complete and could be further improved if data can be made available on the many other large enterprises owned by the government, investments abroad, and the actuarial position of the pension funds.

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Shares in companies held through PIF. Number for 2015 is from the Saudi Vision 2030. Projections of growth of assets in line with non-oil GDP growth.

Estimated net present value of share of the budget in future oil exports using a share of 82 percent. Export projections are based on current levels of oil production, proven reserves, and future oil prices using WEO projections.

The capital stock is estimated by accumulation of capital expenditure since 1969 using annual depreciation rate of 4 percent.

Sources: Saudi Arabian authorities, Saudi Stock Market, BP statistical review, and staff calculations.

22. Privatization could have other implications that require a policy response. Macroeconomic effects will depend on whether receipts from privatization are saved or spent, from domestic or foreign sources, the degree of capital mobility, and the exchange rate regime. Broadly, the effects of an increase in the deficit financed by privatization receipts would be similar to those resulting from a debt-financed fiscal expansion. The way proceeds are used could also affect domestic liquidity. Selling assets to foreign investors would increase FDI. If large and sustained, capital inflows could contribute to the appreciation of the real effective exchange rate.

23. While there will be important fiscal effects of privatization, in the longer run, the most significant gains should be in terms of improved efficiency and productivity of the privatized enterprises. Productivity has been relatively weak in Saudi Arabia (and other GCC countries) and moving to a more diversified and dynamic economy that is less reliant on oil will require reforms to strengthen productivity growth (see accompanied SIP on “Growth in a Low Oil Price Environment”). A well designed privatization program should over time help with this goal.

24. In the short run, privatization could result in job losses and in some cases where price subsidies are removed, higher prices for consumers. Empirical evidence generally shows that employment contractions were significant within privatized enterprises, but small relative to the overall size of labor force, and in most cases studies, workers tended to reallocate to other sectors, so the impact on employment is smaller over the longer run (McKenzie and Mookherjee, 2005). This, however, may be of particular concern in the GCC given the structure of the labor markets. Concerns about loss of jobs should ideally be addressed in the context of an overall policy to enhance employment in the private sector, a policy that Saudi Arabia has been pursing in recent years. Mitigating impacts on workers can be achieved through smoothing adjustments during the restructuring process, and passive and active labor policies such as severance payments, retraining, and other programs to upgrade skills, and a robust social safety net. Such policies can help reduce workers resistance and increase public support for the privatization process.

F. Public-Private Partnerships: Opportunities and Risks

25. Since the early 1990s, the use of PPPs has increased significantly worldwide. Countries have adopted PPPs in a wide range of social and economic infrastructure projects, but mainly to build and operate hospitals, schools, prisons, roads, bridges and tunnels, light rail networks, air traffic control systems, and water and sanitation plants. PPPs can be attractive to both the government and the private sector. For the government, private financing can support increased infrastructure investment without immediately adding to government borrowing and debt, and can be a source of government revenue. At the same time, better management in the private sector, and its capacity to innovate, can lead to increased efficiency; this in turn should translate into a combination of better quality and lower cost services. For the private sector, PPPs present business opportunities in areas which it may have previously been excluded. Many projects that address clear bottlenecks in roads, railways, ports, power, etc., are likely to have high economic rates of return, and therefore to be attractive to the private sector (IMF, 2004).

26. In Saudi Arabia, the large potential for PPPs could alleviate spending pressures and further engage the private sector. So far, there have been only limited initiatives to encourage private sector involvement in public investment and little progress in the development of a policy framework for PPPs. This is notwithstanding some successful PPPs in the power, water and port services implemented in the early 2000s. There is a strong case for expansion of PPPs given the infrastructure needs and rising fiscal constraints. Partnerships with the private sector could be a viable alternative to traditional public investment to help support growth. It is important, however, that the decision on whether to undertake a project as a PPP should be based on the project’s efficiency and value for money analysis, rather than short-term fiscal gains. Experience shows that using PPPs solely to reduce upfront costs has led governments to take forward low quality and in the longer-term fiscally costly projects that would not otherwise have gone ahead.

27. The government is considering the use of PPPs in strategic mega projects and provision of services. These include the Mecca and Jeddah metros and selected services in five ministries notably Education and Health that were identified based on criteria that measure favorability for private participation including alignment with national priorities, ministry potential for increased private sector participation, level of participation in best practices, the level of autonomy in service delivery, the size and reach of service offering and quality enhancement potential.

28. Establishing the institutional, legal, and regulatory frameworks for PPPs should be given high priority. There are currently no laws in Saudi Arabia that specifically govern PPPs and there is no specific procurement/tender process for a PPP transaction; the PPP tender process operates under the procurement law in the same way that typical procurements do. The institutional set-up is also less developed compared to other countries; the Council of Economic and Development Affairs oversees PPPs, while implementation and coordination with line ministries is usually charged to ad hoc committees. Investment in skills building to manage a PPP program, and in particular to refine project appraisal and prioritization, would also be warranted.

29. When regulated effectively, PPPs allow for flexible risk sharing between the public and private sectors, encourage the private sector to take long term investment decisions, and mitigate potential fiscal risks. Successful programs in many countries have been associated with the existence of special laws for PPPs. For example, the comparative success of Chile’s PPP programs in the 1990s can be attributed to the fact that it is backed by a comprehensive concessions law, while Brazil’s 2004 PPPs law complemented existing legislation in the fiscal area, including the Concessions Law and the Procurement Law. Italy and Spain have also revamped legal frameworks that for many years were an obstacle to PPPs (Akitoby, Hemming and Schwartz, 2007). A number of countries in the MENA region who were active in PPPs programs such as Jordan and Egypt have adopted special legislation for PPPs–the adoption of the PPP law in Egypt has been associated with a significant increase in the number of PPPs. In the GCC region, Kuwait embarked on a number of PPPs in the power and clean fuel projects and enacted a comprehensive PPP law in 2014 and established a technical bureau for implementation. The bureau is in charge of the financial and technical evaluation of PPP projects and is involved in all phases of a project, from inception to financial close.

30. International experience underscores the importance of adequate risk transfer from the government to the private sector (IMF, 2004). This is a key requirement if PPPs are to deliver high-quality and cost-effective services to consumers and the government. Risks could be associated with: (1) construction risk; design problems, and cost and schedule overruns; (2) financial risk—cash flow falling short of the level needed to repay project loans and capital invested; (3) demand risk—demand for the services provided declines; (4) availability risk—lack of continuity and quality of service; (5) political risk—government actions could impair private sector’s earnings potential; and (6) natural disaster risk. Services have to be contractible so that payments to service providers can be linked to their performance and the need for costly contract renegotiation is minimized, and there has to be either competition or incentive-based regulation, which is essential for efficiency. Country experience also shows that a significant amount of PPPs get renegotiated–on average, renegotiations occur every 2 years while incidence of cancellation of contracts is low. Renegotiations tend to favor the private sector; operator increases in tariffs, delays in providing the service, and decreases in investment obligations, increases in cost with automatic pass-through to tariffs and decreases in concession fees paid to the government.

31. PPPs carry important fiscal risks that can be mitigated through adequate contracting, reporting, and disclosure. Risks can arise from moving spending off budget and bypassing expenditure controls and creating contingent liabilities. This could also potentially threaten the integrity of the budget process and undermine efforts to safeguard macroeconomic sustainability, and make it more difficult to achieve fiscal discipline and good governance. When a decision to move ahead with a project has been taken in favor of a PPP rather than procured traditionally, it is important that the process of preparing the project continue to be geared toward achieving value for money and safeguarding fiscal affordability. This is best achieved through a gateway process which is an institutional arrangement to empower the Ministry of Finance to stop or suspend a PPP project during its preparation and negotiation, as well as during the construction and operation if certain conditions are not met (Schwartz, 2007).

32. Government guarantees are one of the main fiscal risks associated with PPPs and must be well designed and limited in scope and duration. For example, early PPP contracts in Colombia included large demand guarantees from the government that were subsequently triggered and entailed substantial fiscal cost. Partial guarantees may help limit moral hazard and adverse selections. Good disclosure practice is to publish detailed information on guarantees. This should cover the public policy purpose of each guarantee or guarantee program, the total amount of the guarantee classified by sector and duration, the intended beneficiaries, and the likelihood that the guarantee will be called. Information should also be provided on past calls of guarantees. Best practice is to publish quantitative estimates of the potential fiscal impact of guarantees that, based on past experience, are likely to be called (i.e., the expected value of guarantee payments). For example, the United States requires systematic estimates of the potential costs of loan and pension guarantees, deposit and other forms of insurance, and most other contingent liabilities. Where the cost of calls on guarantees is potentially of fiscal policy significance, allowance should be made in the budget to meet the expected cost (IMF, 2004).

G. Conclusions and Policy Recommendations

33. Privatization and PPPs have been part of Saudi Arabia’s broader effort to increase the role of the private sector in the economy. The overall impact of these policies has been positive and the private sector role has been rising gradually since the early 2000s. Nonetheless, the size of the government remains large in terms of its stake in public enterprises and its spending and investment. The hydrocarbon sector remains largely government owned and run, while the government retains large stakes in other sectors such as petrochemicals, telecommunications, financials, and utilities. Capital expenditures are large by international standards, and the role of the private sector in infrastructure investment remains limited.

34. A deepening of the privatization and PPP programs could be an important part of reducing the government’s involvement in the economy and boosting productivity. Increasing efficiency and productivity should be the main objectives of these programs which may need to shift focus to less efficient enterprises and government services. Of concern is the potential negative impact of these programs on short-term employment which can be mitigated through the continuation of ongoing reforms to increase the employment of nationals in the private sector through a re-alignment of incentives and programs to upgrade skills.

35. Privatization and PPPs programs could also help address fiscal pressures. Proceeds from assets sale can be part of the financing of the fiscal deficit or could be used to reallocate and diversify the government’s asset portfolio, while PPPs can be an alternative to public investment which will likely bear the brunt of fiscal adjustment to lower oil prices. Proceeds are a one-off financing source and should not postpone fiscal adjustment. They should be transparently recorded and subject to oversight.

36. A broader tax regime will need to be developed as privatization moves forward. As more of the economy is in the hands of the private sector, an efficient tax regime in the oil and non-oil sectors will be needed. Contractual clauses may make it more difficult to introduce such a tax regime at a later stage. The possibility of selling a stake in ARAMCO raises the issue of taxing profits of a future private investor in the oil sector which will need careful study.

37. A number of good practices from international experience can be usefully adopted in the design and implementation of future privatization and PPPs in Saudi Arabia. Establishing the legal framework and institutional set-ups should be the first step to ensure timely and effective implementation, reduce potential future fiscal risks, and ensure adequate regulation of privatized sectors to foster competition and protect consumers. Restructuring prior to privatization should be carefully considered and in some cases may be better left for the private sector. Finally, limiting upfront restructuring costs, allowing broad participation of bidders, and using transparent sales mechanisms will help maximize sale proceeds.

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1

Prepared by Gazi Shbaikat (MCD), Kusay Al Khunaizy (MEP), and Assem Algursan (SAMA).

2

In 2013, the CMA adopted a fluctuation limit of 10 percent on the first day of trading, so this limited the increase in the NCB share price after the IPO which took place in 2014 (the increase in the share price reached 30 percent after one week of trading).

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Saudi Arabia: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2016: Issue 327
Publisher:
International Monetary Fund
ISBN:
9781475544275
ISSN:
1934-7685
Pages:
73
DOI:
https://doi.org/10.5089/9781475544275.002
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    Saudi Arabia: Stock Market and Foreign Investment

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    Government Stakes in Listed SOEs, 2015

    (Percent)

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    Saudi Arabia: IPOs Performance of Privatized Enterprises and Private Companies, 2003–15

    (Percent)

Saudi Arabia: Stock Market and Foreign Investment

Government Stakes in Listed SOEs, 2015

(Percent)

Saudi Arabia: IPOs Performance of Privatized Enterprises and Private Companies, 2003–15

(Percent)