To finance Vision 2030, Saudi Arabia's plan to transform and diversify its economy and grow the private sector, authorities aim to deepen their debt and equity markets to increase foreign direct investment. The strategy also entails investments by the government and its related entities as well as the private sector of about Saudi Arabian riyal (SAR) 12 trillion ($3.2 trillion) by 2030. However, one question is, where will the funds come from? While S&P Global Ratings thinks banks will continue to play an important role in financing Vision 2030, we foresee an increased role for the local capital market. What's more, we understand that an increased amount of the funding will be pushed off the central government and onto the balance sheets of government-related entities and broader private sector.

While the U.S. dollar will continue to be the currency of choice for issuance in Saudi Arabia, we expect to see gradually greater use of Saudi Arabian riyal-denominated issuance as the local market develops. The currency peg between the U.S. dollar and the riyal, which we expect will remain, could help attract foreign investors actively hunting for yield in an environment of low interest rates. A gradual deepening of the local capital market would likely increase levels of transparency and could reinforce governance practices in Saudi Arabia in coming years.

The Largest Non-Oil Economy In The GCC Is Transforming

Saudi Arabia is a Group of 20 (G-20) country, given that it is one of the world's largest economies, with GDP of about $700 billion at year-end 2020, and is the world's largest oil exporter. Of the Gulf Cooperation Council members, it has the largest population of about 33 million--60% of which are local nationals--at year-end 2020.

Given the size of the local population and their requirements for goods and services, the country also has a sizable non-oil economy (see chart 1). In addition to its extractive industries, it has a large and growing manufacturing base, transportation sector, construction, as well as a large consumption sector that hosts many different business operators.

Nevertheless, the hydrocarbon sector accounts for about 40% of real GDP. This dependence carries risks in coming years as the world moves toward cleaner energy. With that in mind and to reduce the impact of the volatile oil market on the economy, Saudi authorities embarked on an ambitious plan, Vision 2030, to transform the country and diversify away from oil. The plan targets change in several key sectors including health, education, tourism, infrastructure, renewables, manufacturing, and defense—and development of the financial sector. Indeed, the strategy will require a large amount of financial resources over the next decade, which Saudi Arabia hopes to raise via capital markets, among other sources.

Chart 1

The Capital Markets: Under Construction

Over the past decade, the Capital Markets Authority (CMA), the country's capital markets regulator, has undertaken several measures to develop its equity and debt capital markets and attract foreign investors.

For example, over the past few years, there were several initiatives to improve the infrastructure and trading rules of Tadawul, the country's stock exchange, to increase market access for investors. This paved the way for Saudi Arabian stocks to be included in the MSCI Emerging Markets Index in 2019 and FTSE Russell and S&P Dow Jones indices subsequently, further increasing the visibility of Saudi equities to global investors. Similarly, in 2020, the CMA started allowing nonresident foreigners to invest directly in listed and nonlisted debt instruments. We have also seen a visible increase in listed debt issuances by Saudi corporates, particularly government-related entities, which represented about 90% of the about $26 billion listed corporate bond and sukuk issuance in 2019 and 2020.

Low Oil Prices And High Deficits Pushed The Government To Borrow

When oil prices dropped sharply beginning in the second half of 2014, the Saudi government balance fell into deficit, requiring a broadening of its funding options and a move away from depleting its assets. As a result, the Saudi Debt Management Office was set up in 2015, and between 2015 and 2020 the government issued over $200 billion of bonds and sukuk. As a result, debt outstanding has increased sharply (see chart 2). We forecast that gross debt will rise to about 46% of GDP by 2023, up from 20% in 2019 and close to zero in 2014. In March 2020, the government increased its debt ceiling to 50% of GDP from 30%, to accommodate further borrowing. We expect the sovereign to remain an active issuer over the next few years based on our projections of increasing but moderating fiscal deficits.

Chart 2

Nevertheless, nonsovereign debt capital markets in Saudi Arabia remain underdeveloped relative to other key markets globally. We estimate that the total value of bonds and sukuk outstanding that Saudi banks and corporates have issued as of May 2, 2021, is slightly lower than 10% of the country's GDP at end-2020. In comparison, we estimate this ratio at about 25% for Brazil, Russia, and India, and about 50% for the top 20 largest economies of the world, based on Bloomberg data. Furthermore, when we look only at the local currency portion of the outstanding issuance for Saudi Arabia, this ratio is even lower at about 3%. We expect to see a visible increase in this ratio in line with the country's planned investments and financing needs.

Implementation Of Vision 2030 Will Require An Increase In Debt Issuance

Over the next few years, we expect the government to allocate part of spending to a series of large projects under Vision 2030 and away from the oil sector. The Public Investment Fund (PIF) will play a particular role in supporting and funding a certain level of capital expenditure to create direct and indirect jobs through investments in 13 strategic sectors including aerospace and defense, tourism and entertainment, health care, renewables, mining, and transportation.

Reportedly, 24 of the country's largest companies--mostly government-related entities like Saudi Aramco (unrated) and SABIC (A-/Stable/A-2)--plan to invest about SAR5 trillion ($1.3 trillion) in a number of projects, while PIF reportedly will inject SAR3 trillion. The remaining SAR4 trillion will be injected under a new national investment strategy program. This will come on top of the SAR10 trillion in government spending the authorities have already budgeted.

Given the sheer size and the long-term nature of investments under the 2030 program, the banking sector alone will be unable to fill the need. While it remains liquid, well-funded, and strongly capitalized, the banking system is subject to concentration risk regulations and constraints regarding maturity transformation (borrowing money on shorter timeframes than on lending). We therefore expect a significant portion of the funds to come from the capital market, leading to a progressive rebalancing of the country's financial system and development of a broader local capital market.

Investors Have Saudi Arabia On Their Radar

Greater issuance by the Saudi sovereign will attract more attention from investors, particularly given their search for higher-yielding investments in an era of low interest rates. On the corporate debt market, we expect large government-related entities to be the main issuers at first, followed by a few top corporates, rather than a general movement to the capital markets.

In addition, we believe the market will gradually see more issuance denominated in Saudi riyal, though U.S.-dollar denominated issuance will remain prevalent. To that end, Saudi authorities have taken the initiative to create a local currency benchmark rate through sovereign issuance and have increased the volume of riyal-denominated issuance from key government-related entities. In addition, Saudi authorities continue to work on initiatives to further develop the infrastructure for the country's debt capital markets. We believe the peg between the U.S. dollar and the riyal is a comfort factor for foreign investors.

Saudi Arabia's energy transition and transformation of its economy to a more sustainable one should also improve Saudi issuers' standing in terms of environmental, social, and governance (ESG) considerations. We expect to see a higher volume of sustainable funding in the next few years to finance the needs created by Vision 2030. We also think that greater involvement by foreign investors will likely strengthen corporate governance practices in the country.

Corporate And Bank Credit Quality Could Benefit

The underdevelopment of the Saudi capital market limits monetary policy transmission. The government started issuing local currency debt and sukuk in 2015, and we expect this to continue over the next few years. We believe government debt issuance can be instrumental in addressing the absence of a benchmark yield curve and contribute to the development of the debt capital market. Private-sector issuance could follow suit, in a move away from purely benchmark transactions to more systematic use of debt issuance in the funding mix. Like elsewhere in the GCC, nonfinancial corporates in Saudi Arabia fund themselves largely through the country's local banks through instruments that are largely short term in nature. We believe more frequent use of the capital markets will allow Saudi corporates to further diversify their funding sources, access a larger variety of local and international investors, and give them the capacity to extend their funding maturity profiles. We would view all these developments as supportive factors for the credit profiles of Saudi corporates.

The availability of a well-functioning domestic debt capital market can also help the Saudi banking system's funding options. Most funding comes from core customer deposits, a large portion being short term or on demand. As credit continues to grow, the banking system could benefit from longer-term funding sources on the local market, which we view as more stable than cross-border funding. We note that the banking sector still displays an overall net surplus external asset position despite a rapid buildup of external debt on the back of softer monetary policy globally. The presence of a deeper and broader capital local market could be positive for our view of the funding profile of Saudi banking system as a whole.

Editor: Rose Marie Burke.

Related Research

• Research Update: Saudi Arabia ‘A-/A-2’ Ratings Affirmed; Outlook Stable, March 27, 2021
• Corporate Governance Practices In The GCC, March 15, 2021
• SLIDES Published: Saudi Arabia Banking Sector 2021 Outlook: Growth Hinges On Mortgage Lending And Public Spending, Feb. 23, 2021
• Expat Exodus Adds To Gulf Region’s Economic Diversification Challenges, Feb. 15, 2021
• GCC Corporate And Infrastructure Outlook 2021: Proceeding With Caution, Feb. 2, 2021
• Banking Industry Country Risk Assessment: Saudi Arabia, Oct. 13, 2020