Saudi Arabia under Crown Prince Mohammed bin Salman now faces a real political and economic crisis of legitimacy with the killing of Jamal Khashoggi. The Trump administration may choose to put its support behind the crown prince, but Mohammed’s single most important policy objective, Vision 2030, is already derailed.
What happens next in Saudi Arabia will impact the regional economy for years to come. The diversification efforts away from an oil-dependent economy, moving citizens into private-sector employment, and welcoming foreign investment, also known as the “prince’s project,” is at stake. It matters for Saudi Arabia, but also for the broader trends in the region to diminish the heavy hand of state intervention and distortions in domestic economies. If the private sector collapses because of the strangle of the state’s hold on the economy, or from the flight of capital and international partners, the main losers will be young Saudi citizens. There is also a significant cost and lost opportunity to investors in the region and even in the United States.
U.S. interests in economic stability in our own capital and equity markets is an important consideration of self-interest. Political legitimacy will be tested, and markets can be merciless.
Saudi Arabia’s economic future
The direction of the Saudi economy is a bellwether not just for the Middle East, but also of America’s and the world’s. The fate of the Saudi economy is more and more entangled with that of its Gulf neighbors and international investors. In fact, many Americans and Europeans may be surprised to find that they too are invested in Saudi Arabia. Recently, Saudi Arabia and some of its Gulf Cooperation Council, GCC, neighbors have been included in international bond indexes and a prominent equity market index.
These classifications by J.P. Morgan’s Emerging Market Bond Index (EMBI), MSCI and FTSE Russell Global Equity Index Series, mean that passive investors in pension and personal investment funds may now find that their institutional investors have devoted a portion of their “emerging market” allocations to include investment in Saudi debt instruments and companies traded on its local stock exchange, the Tadawul.
In the case of J.P. Morgan’s Emerging Markets Bond Index, the inclusion of GCC sovereign debt (which has ballooned from $25 billion in 2014 to $144 billion in 2018, as governments have used bond issuance to finance their deficit spending) means that global investors will now hold this debt, and it will be distributed and traded more frequently in passive electronic-traded funds (ETFs).
These funds are also likely to become more active investors in the Saudi stock exchange, which has experienced significant volatility over the past two weeks because of the Khashoggi crisis, underlining the “black box” nature of Saudi corporate reporting and vulnerability to political risk. Corporate reporting is lax and local markets are easily spooked by a climate of fear in the domestic economy.
International economic implications
Saudi Arabia is also an important investor in the United States through its central bank and its sovereign wealth fund, separate from substantial holdings of private citizens. SAMA, the central bank, has significant foreign asset holdings of both U.S. equities and U.S. debt in Treasury bonds. The sovereign wealth fund, the Public Investment Fund (PIF), makes large allocations to U.S. debt and equity markets, and in privately held stakes in many U.S. technology firms and investment funds dedicated to infrastructure.
Saudi Arabia had a net international investment position of $557 billion in 2017 (81.5 percent of gross domestic product). According to the IMF, seven countries account for two-thirds of the kingdom’s portfolio investment assets. The United States is largest at (35 percent), followed by Japan (10 percent), the United Kingdom (6 percent), and 4 percent each in France, UAE and Germany. Of Saudi portfolio holdings in the United States, more than 60 percent of these holdings are in U.S. equities, largely shares in companies listed on the New York Stock Exchange. These holdings would be in addition to PIF investments, which are substantial in U.S. tech companies and large alternative investment funds such as Softbank and U.S. infrastructure fund investments, like the $40 billion fund planned by Saudi Arabia with Blackstone. These large alternative investment funds in infrastructure and technology point to the shifting power of global capital to partnerships between governments and their sovereign wealth funds combined with private actors, rather than financial centers such as New York or London.
Saudi Arabia’s state-controlled economy
Inside Saudi Arabia, diversification has been a shell game. The state continues to drive economic activity, now more than ever. And oil revenue accounts for the necessary cushion to continue large fiscal expenditures, mostly on public sector wages and social services. Early indications of the government’s pre-2019 budget statement include a 7.5 percent increase in expenditure. Given the current climate, we should expect the government to use its levers of patronage and benefits to citizens to quiet dissent and political anxiety, as it did last week to reinstate public sector allowances that had been canceled a year before.
The sheer size of Saudi Arabia’s youth population and the human capital at stake for the region makes its economic future uncertain. By the government’s own statistics, there are more than 10 million Saudi citizens under 35. They are at risk to become a lost generation if they cannot find employment opportunities, lose faith in the legitimacy of their political system or are excluded from the consumer culture that surrounds them.
The collective outrage over Khashoggi’s killing will not bring him back, but media attention on Saudi Arabia could help release the many peaceful activists for women’s liberation in detention, and it might help the international community focus its efforts regionally on what is at stake for young people.
Karen Young is a resident scholar at the American Enterprise Institute.