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Can contractors adapt to Saudi’s 2016 budget?

Saudi Arabia’s 2016 budget will steer the country’s transition towards optimised state spending and economic diversification.

Realistic in Riyadh: Saudi Arabia’s 2016 budget has seen the finance ministry boost its efforts to balance state spending and revenues.
Realistic in Riyadh: Saudi Arabia’s 2016 budget has seen the finance ministry boost its efforts to balance state spending and revenues.

The last six months have seen significant changes in Saudi Arabia’s economic and social policies. As global oil prices traverse astounding lows and insufficient highs, the Kingdom, it appears, is effecting tangible changes to evolve beyond its traditional dependence on petrodollars.

Last week, Saudi Arabia’s finance ministry announced a move which looks set to impact large-scale construction and infrastructure projects in the country. The Kingdom’s ministry stated it has amended the advance payment made to construction firms working on government projects.

Companies building government projects will now receive 5% of the contract value as advance payment, instead of the 20% payment made earlier.

Finance minister Ibrahim Alassaf issued a circular stating advance payments should not exceed $13.3m (SAR50m), Reuters reported, citing Al Hayat newspaper.

Construction companies in Saudi are entitled to an advance payment for certain contracts issued by the government.

The move is expected to fund on-site operation, allow for early sub-contractor payments, and the purchase of equipment and materials from suppliers. The amount is amortised and deducted from the contract’s value at a later stage.

Saudi’s latest move is one of the many changes recommended and implemented by the country’s finance ministry.

In October 2015, it was reported that the ministry had stalled state payment and investment for the fourth quarter of the year. According to Arabian Business, two sources reportedly said the ministry “told government departments not to contract any new projects and to freeze appointments and promotions in the fourth quarter”.

The ministry had also banned the “buying of vehicles or furniture, or agreeing any new property rentals and told officials to speed up the collection of revenue”, the report added.

Two months later, the Kingdom announced a 2016 budget unconventional by Saudi standards. The budget features subsidy cuts, taxation, and reduced state investment to help the Kingdom cope with the global oil price slowdown.

At the budgetary announcement, Saudi’s finance ministry said it will review government projects to ensure they are necessary, affordable, and efficient.

Saudi’s government ran a deficit of $97.9bn (SAR367bn) in 2015, according to Arabian Business, citing Reuters.

Consequently, this year’s budget aims to reduce that to $85.9bn (SAR326bn) in a bid to ensure Riyadh does not have to liquidate its foreign assets for funds.

The 2016 budget also suggests the country is not relying on a major recovery in oil prices this year.

State spending for 2016 has been pegged at $223.9bn (SAR840bn), down from the $259.9bn (SAR975bn) actually spent in 2015. Revenues for 2016 are forecasted at $137.1bn (SAR514bn), down from $162.1bn (SAR608bn) in 2015.

Haroon Niazi, vice president and country manager at Hill International Saudi Arabia, tells Construction Week the Kingdom’s 2016 budget is an opportunity for change in the country.

“The prospects of change may be daunting for some, but for others it brings opportunities, particularly for those who are able embrace change and implement alternative operational strategies in order to realise valuable benefits,” he adds.

“The cost cutting measures which have been implemented in the 2016 budget are essential to enable the Kingdom to continue with diversification and assist it in moving away from a commodity based economy. In reality, the price of oil will always underpin and be an important component of the economy in Saudi Arabia,” Niazi continues.

“Looking at the construction industry, it is important to acknowledge the fact that over the last few years the Kingdom has made huge strides in various other sectors, including chemical process plants, construction of mining facilities, and the development of renewable energy facilities.

“The positives [of such diversification activities] can already be seen when analysing the 2015 results, where oil revenue represented approximately 73% of total revenue. In previous years, this figure has ranged between 80%-90%,” Niazi adds.

While this revenue reduction may be attributed to the drop in global oil prices, Saudi Arabia’s King Salman bin Abdulaziz Al Saud assured, during the budgetary announcement, that the Saudi economy “has the potential to meet challenges”, adding the 2016 budget marks a phase during which the Kingdom will diversify its revenues.

In line with King Salman’s statement, the country increased the price of gasoline to 0.90 riyals a litre from 0.60 riyals for 95 Octane fuel on the same day.

Subsidy cuts have typically evoked mixed responses from the Kingdom. In November 2015, Deputy Crown Prince HH Mohammed Bin Salman Al Saud said the Kingdom’s “over-dependence” on oil was a primary challenge he’s keen to tackle. His statements came less than a month after Saudi oil minister, Ali Al Naimi, said the country “assists” its people in their livelihood, “but that’s not a subsidy”.

“You only go back and take away assistance if you are in dire need. And, fortunately, Saudi Arabia is not today in such dire need,” he had said.

Nevertheless, Hill’s Niazi is optimistic about the benefits likely to be offered by Saudi’s subsidy cut. “Some of the measures that are being implemented are proactive and assist with managing the adverse impact of the budget deficit,” he says.

“Historically, the Kingdom has always spent more than its budget forecast. I think the subsidy cuts assist the Kingdom with managing its budget, realising an enhanced benefit of its natural resources, and at the same time, conserving [them].

“As I have said previously in relation to labour reforms [in the country], it is short term pain for long term gain. Everyone seems to be talking about the cost-cutting measures, and appears to ignore some of the other beneficial changes that have been introduced and will have a significant positive impact on the economy,” Niazi adds.

“For example, laws have already been passed allowing foreigners to invest in Tadwaul (Saudi Stock Exchange). Opening the GCC’s biggest economy, which may soon boast the most valuable company in the world as one of its listed entities, brings a wealth of opportunities for direct foreign investment into the Kingdom.”

Saudi Aramco’s January announcement could indeed boost foreign investment in the country. On 16 January, Aramco CEO Amin Nasser, said that “a range of options are being considered” with regard to an initial public offering (IPO) likely to be floated by the state-owned oil giant.

“The government privatisation initiative is designed to capitalise on opportunities that can substantially increase the Kingdom’s economic development and diversification,” Nasser reasoned. “[An IPO] would align with the government’s recently announced broad economic reforms agenda and market deregulations.”

He added the oil giant’s current options include listing “an appropriate percentage of Aramco shares with the government retaining a controlling interest”, or “a bundle of downstream businesses and interests”.

Privatisation may hold the key for a balanced Saudi economy this year, and possibly even until crude price correction stabilises. The Deputy Crown Prince has previously voiced his support for privatisation, and the Saudi 2016 budget stated such schemes will be considered to ease state spending. However, Niazi is quick to point out that privatisation is only part of a larger economic diversification process.

“The implementation of such schemes, which provided that they have the right ingredients, will only assist with ensuring a longer term sustainable economy is created for the Kingdom,” he concludes.

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