Saudi projects market faces slow 2016

Published in MEED, 2 November 2015

There were fewer contract awards in 2015 and the outlook for next year is little better.

Low oil revenues have forced the Saudi government to scale back its expenditure, and capital spending is bearing the brunt of the cuts. MEED reported in mid-October that 2015 has been the worst year since 2008 for contract awards in the kingdom and the outlook for the near term is bleak.

According to regional projects tracker MEED Projects, some $35bn-worth of deals were awarded in the kingdom between January and early October. In October, the Finance Ministry told government bodies to stop any further contract awards for the rest of the year, which means the figure is unlikely to change much between now and the end of December. That would mean a 28 per cent drop compared with the value of projects awarded last year and puts this year far below the average of $61bn over the previous six years.

Projections for the next few years offer little comfort for those involved in the market. Local bank Samba predicts that capital spending by the government will fall from SR471bn ($126bn) in 2014 to SR425bn this year and SR422bn in 2016. A full recovery seems likely to take several years. Even by 2020, Samba thinks capital spending will only have reached SR463bn, some SR8bn short of the 2014 level.

Such government spending is the main driver for project activity in Saudi Arabia, and underpins growth more widely. That situation helps to explain why many observers are predicting tough times for the Saudi economy.

“The general picture is of one of reduced capital and some elements of current spending this year and the next,” says James Reeve, deputy chief economist at Samba. “That will obviously feed through to the level of economic growth.”

Data from London-based research firm Capital Economics suggests the non-oil sector is already suffering. It says overall economic growth slowed from an annualised rate of 5.5 per cent in July to 4.8 per cent in August. The firm thinks the fiscal squeeze now under way means growth will continue to weaken over the next few quarters.

More importantly, in terms of understanding the projects market, Capital Economics says the main cause of slower growth in August was the non-oil sector. Non-oil imports, which offer an indication of the amount being invested in the country, fell by more than 10 per cent during the month, compared with last year.

“The government is likely to announce that spending is going to be cut in 2016 and that’s likely to remain the case for several years,” says Jason Tuvey, Middle East economist at Capital Economics. “Riyadh has already outlined plans to halt the construction of sports stadiums. New airports may be delayed. New roads may also be culled.”

The slowdown is significant not just for Saudi Arabia itself, but for the region as a whole. There are just over $1 trillion-worth of projects planned or under way across the country, according to MEED Projects. That makes Saudi Arabia easily the largest projects market in the region, accounting for 39 per cent of the GCC total. A deterioration in the Saudi market will drag down the region as a whole.

Of those projects, some $260.6bn-worth are in the execution phase. The rest are either at the design stage or at various points in the contract tendering and bidding process. That leaves plenty of scope for any project owner wanting to rethink their plans, reduce costs or slow down the rate at which they have to pay contractors.

Until recently the signs were that the government would continue with existing schemes, but would be wary of launching any new ones. However, there is now a growing sense that almost any project could be affected and subject to delays.

“The economy is already losing momentum and I’m expecting to see a more marked slowdown in 2016,” says Simon Williams, chief economist for the Middle East at UK bank HSBC. “Some of the project activity will slow, timelines will be extended and you’ll see a sharp slowdown in the pace at which new projects are launched.”

Among the most recent schemes to have fallen victim to the newly parsimonious attitude of the government is the PP9 power plant. MEED reported on 21 October that state-owned Saudi Electricity Company had shelved a $320m plan to convert the facilityto a combined-cycle one. 

The plant was just a small part of the near $170bn-worth of power projects planned or under way around the kingdom, the third-largest sector of activity. Among the other main areas of activity, schemes in the construction sector are valued at $455.3bn, while the transport sector accounts for $229.6bn of the total. Projects in all these areas could be subject to cuts.

In particular, the Finance Ministry’s instructions to freeze new contracts for the rest of the year puts a question mark over schemes such as the $2.6bn first phase of the Mecca metro project, for which an award had been expected before the end of the year. Other transport initiatives are also now the subject of speculation. 

“The Riyadh Metro will go ahead, but there are stories of the timeline for the project being extended,” says one close observer of the Saudi economy. “I think some of the other big transport projects, like [the coast-to-coast rail project] the [Saudi] Landbridge, could be quietly shelved. Some projects in Mecca and Medina might get scaled back.”

It is not simply a case of shelving projects, however. There is also room to improve the efficiency of public sector investment, according to the Washington-based IMF. In its latest annual review of the Saudi economy, published in September, the fund pointed out that the government’s capital spending on transport, health and education projects was running at about 16.75 per cent of GDP in 2014, having more than doubled from 7.5 per cent in 2007.

The IMF suggested that the scale of the activity meant existing schemes should be reviewed to ensure they are actually meeting the kingdom’s development goals.

“While the efficiency of public investment in Saudi Arabia is estimated to be close to the global average, it is below that in advanced commodity exporters such as Australia, Canada, Chile, and Norway,” the IMF noted. “Given the size of the public investment programme, improving its efficiency could yield substantial savings.”

The government has already taken several procedural steps to tighten things up. The Council for Economic & Development Affairs has asked ministries to submit proposals for expenditure reduction, including on capital spending. It has also lowered the threshold for approval of new projects from SR300m to SR100m, and has become far more strict about what it is willing to give a green light to.

“Our understanding is that [the council] has not approved any new capital projects above SR100m so far this year,” says Paul Gamble, director of the sovereign group at UK/US-headquartered Fitch Ratings.

The risk is that too sharp a cut will hamper the long-term growth of the economy as a whole and undermine other economic priorities.

Large transport projects, such as the Riyadh and Jeddah metro schemes, could help to reduce the impact of rising fuel prices on the local population if and when fuel subsidies are cut, for example. In addition, continuing investment in the kingdom’s education facilities ought to be recouped in greater productivity and better employment prospects for young Saudis in the longer term.

The government’s hand is being forced, however, and for as long as oil prices stay low, its ability to pay for projects will remain more limited. The balancing act that Riyadh needs to accomplish is to maintain some economic growth while putting its spending programme on a more sustainable footing.

“The correlation between non-oil economic growth and government spending is very tight and on that basis you could easily assume there will be a recession in the non-oil sector next year,” says Reeve. “However, I think they’ll just about keep growth going, but only by about 0.2 per cent.”

Others agree that the economy as a whole should be able to maintain growth. “I suspect that fears of a recession are overdone,” says Tuvey. “They’ve got a large buffer. So the government is in a position where it can gradually adjust policy to an environment of cheap oil.”