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Saudi Arabia's biggest challenge: Saudis themselves

Saudi Arabia's government is due to unveil a long-term economic blueprint for life in a low-oil world, but key structural challenges are set to test the Kingdom's resolve.

Titled "Saudi Vision 2030," the plan, due for release later on Monday, is expected to announce regulatory, budget and policy changes that will be implemented over the next 15 years to make the Kingdom less reliant on crude.

As the world's largest oil exporter, the bulk of Riyadh's state revenues come from energy exports. But with crude prices extending declines—the per-barrel price of global benchmark Brent is down 60 percent since the rout's start in June 2014—the nation logged a record $98 billion budget deficit for 2015.

Officials are already taking action to diversify revenue sources before existing state coffers get depleted. This month, Deputy Crown Prince Mohammed bin Salman said that ownership of the Arabian American Oil Company (Aramco) and some other national assets would be transferred to a public fund that invests cash from the country's oil and gas operations into other sectors.

Analysis from McKinsey suggests the Kingdom could double gross domestic product (GDP) growth from 3.4 percent in 2015 and create as many as six million jobs by 2030 by focusing on eight non-oil sectors, including manufacturing, mining, tourism, healthcare and finance.

But although Riyadh has been pursuing a diversification policy ever since its first Five Year plan in 1970, progress has always been hindered by structural blockages, which are still in place today, warned Steffen Hertog, associate professor at the London School of Economics.

One key obstacle was the fact that almost everything in the Saudi economy was directly or indirectly fed by state spending, he said. With nearly two-thirds of the workforce in the public sector, the majority of household demand comes from Saudis who are paid government salaries. The total size of wages paid to Saudi households from the private sector amounts to just 4 percent of GDP, he said.

"So, in a situation of austerity, i.e. when oil prices go down and state spending has to follow, demand drops domestically and the private sector feels that...It's difficult for private industries to thrive within the existing structure," he explained.

In the private sector—where major industries include construction, real estate, electricity and telecommunications—80 percent of labor comes from overseas, typically developing countries. The low wages paid to these migrant workers deter Saudi citizens from taking jobs in the sector. Moreover, nationals tend to gravitate towards high-paying government roles because they are informally guaranteed employment and job stability.

Saudisation, or the promotion of nationals in high-skilled and semi-skilled jobs in the private sector, has been discussed for years but progress remains slow.

Labor market reforms are essential to the nation's diversification plan, the International Monetary Fund (IMF) warned in a December report.

Tighter control of public sector jobs and wages, refocusing education toward the skills needed in the private sector and increasing the competitiveness of nationals in the private sector were among key measures the IMF recommended.

But Monday's plan won't have a dedicated policy on how to close the gap between the two sectors, according to Hertog.

Another key constraint to economic diversification and liberalization was the political system, experts said.

"It's fine for consultancy firms like McKinsey to come up with brilliant ideas but these ideas need to be implemented in an open political system that doesn't have all the challenges Saudi does," said Madawai Al-Rasheed, visiting professor at National University of Singapore.

A lack of transparency and accountability, combined with high level of corruption, were impediments to greater private sector expansion, she noted.

"We don't know even know what the real issues are," she said. "We don't fully know what the private sector is, we don't know how much oil there is because that's top secret."

In an effort to address such concerns, the national stock exchange, the Tadawul, said this month that it would start disclosing the ownership information of executives at listed companies, including equity ratios.

Despite the challenges to reform, some investors remain bullish on Saudi's prospects.

"We've been investing in Saudi for some years, it's one of those markets that we think are generally underestimated by people," said Richard Titherington, CIO and head of EM & APAC equities at J.P. Morgan Asset Management, who called the "Saudi Vision 2030" encouraging.

People tended to think about Saudi as a country related to oil but domestically, banks and consumer companies were interesting, he explained. "Saudi is a market that we're optimistic about."

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