Saudi Arabia's near-term economic outlook remains favorable but it still faces major challenges in enhancing the quality of education, appropriate training and development of a more efficient labor market, according to the Institute of International Finance (IIF).
"Low public debt, ample foreign exchange assets, and continued structural reforms would support the pace of non-hydrocarbon real GDP growth even if oil prices were to drop," it said in a report.
The IIF recently released its updated forecast for the Middle East and North Africa (MENA), noting that the divergence in economic prospects between oil exporting and oil importing countries has grown since the beginning of the Arab Spring uprisings.
According to the report, Saudi Arabia's overall growth is expected to moderate to 3. 9 percent in 2013 due to the projected small decline in crude oil production, but pick up again to 4.5 percent in 2014.
Non-hydrocarbon growth, however, will remain robust at 5.2 percent in the Kingdom as continued structural reforms and rapid growth in population underpin private consumption and investment.
Indicators such as cement sales, the value of cash withdrawals from ATMs, point of sale transactions, the PMI (58), and private sector credit growth all point to strong growth in non-hydrocarbon real GDP in the first three quarters of this year.
Monetary policy is expected to remain accommodative given the Saudi riyal peg to the US dollar. The 12-month inflation rate remains modest at 3.2 percent in September 2013.
The banking system as a whole remains well capitalized, highly liquid, and is able to withstand severe temporary shocks.
The IIF said Saudi Arabia has been among the first group of countries to implement the Basel III standards, and is pursuing policies to deepen the financial sector through further development of the mortgage finance and insurance industries.
While banks have adequate capital buffers, they may adopt more conservative lending policies following the strong growth in credit of the past two years.
"We expect total private sector credit growth to moderate from 16.4 percent in 2012 to 13.0 percent in 2013," the report said.
However, lending to middle and lower income segments of the population may accelerate following the enabling legislation of the new mortgage law that was passed last year.
The current account and fiscal surpluses, while narrowing slightly this year, are expected to remain large at $150 billion and 8.7 percent of GDP, respectively.
As a result, foreign assets managed by the Saudi Arabian Monetary Agency (SAMA) are projected to increase further to $760 billion by end-2013, equivalent to 112 percent of GDP.
The breakeven Brent oil price that balances the budget is projected to increase from $78 per barrel in 2012 to $85 per barrel in 2013.
Beyond 2014, the outlook depends on the progress and pace of structural reforms and on global oil market developments.
Total factor productivity (TFP) contributed about 30 percent of the recorded growth in the past decade.
In the current stage of the Kingdom's development, the key challenges are to raise productivity and accelerate the pace of diversification.
This will require continued investment in infrastructure and knowledge-based activities, promoting diversification of the economy, improving the business environment, and enhancing the quality of labor through reforms of the educational system and training programs.
Some of these reforms are already underway in the context of the authorities' Development Plan.
Saudi Arabia scores well in terms of the World Bank's Ease of Doing Business and the Global Competitiveness Report.
The strong position (6th) in terms of macroeconomic stability is largely due to higher oil prices, which kept external and fiscal balances in large surpluses and supported rapid growth. The Kingdom, however, scores relatively low in education and labor market efficiency indicators, according to the report.
While some progress has been made in the past 10 years, the country still faces major challenges in enhancing the quality of education, appropriate training, and development of a more efficient labor market.
Given Saudi Arabia's large population and indigenous labor force (as compared to the small national population of other GCC countries), creating jobs for nationals continues to pose a challenge to the authorities.
Although Saudi Arabia has accumulated large foreign assets to withstand short-run oil price volatility, a sustained drop in oil prices remains a risk to guard against.
While the Kingdom can afford an elevated level of current government spending over the medium term, the high level of wages and implicit subsidies (mostly reflected in the very low retail fuel and energy prices) have created an entitlement mentality, limiting fiscal policy flexibility and possibly eroding fiscal sustainability over the long term.
A gradual alignment of prices of domestic petroleum products with international prices, while ensuring that a social safety net is in place, would in the long run increase overall efficiency and generate more fiscal policy space. Greater diversification of revenues, through the introduction of consumption-based taxes, would also strengthen the structure of public finances.
In addition, Saudi authorities are also pursuing policies to deepen the financial sector through further development of the mortgage finance and insurance industries, both of which are regulated and supervised by SAMA.