How Saudi Arabia can protect itself from a US recession

Analysts are concerned that the US economy is heading toward a recession. Saudi policymakers should prepare for the fallout by continuing to diversify the economy away from oil, while building links to ensure good relations with the next US administration, regardless of political party.

Although trade between Saudi Arabia and the US is relatively limited, the impact of the US economy on oil prices means that Saudi Arabia will likely be hit economically by a US recession.

Outside oil, trade between Saudi Arabia and the US is relatively limited. In 2017, Saudi exports to the US equaled $17 billion, representing ten percent of total Saudi exports, and around two percent of Saudi GDP. Crude oil makes up the vast majority (94 percent) of these exports.

The limited volume of Saudi-US trade did not prevent the Saudi economy from being adversely affected by the last major US recession during the global financial crisis. Instead, Saudi GDP suffered from the 2008 recession: In 2019, US GDP contracted by 2.5 percent; Saudi GDP fell by 2.1 percent. The weakening Saudi economy saw its current account surplus fall to 4.9 percent of GDP in 2009, from 25 percent the previous year.

This hit to Saudi GDP was driven by the recession’s effect on the global price of oil: when the US economy enters recession, the global economy is adversely affected (sometimes entering recession itself) due to the importance of the US economy to global economic activity. In turn, this causes a decrease in global oil demand and falling oil prices, thereby harming the Saudi economy.

A future US recession could be expected to have a similarly damaging effect on the Saudi economy. What can the Kingdom do to protect its economy?

In the short-term, Saudi Arabia is pursuing effective policies. The government is currently implementing a fiscal stimulus (spending will increase by more than seven percent this year) to boost the economy and facilitate the transition away from oil dependence. The fixed exchange rate against the US dollar (at 3.75 riyals to the dollar) prevents the government from using monetary stimulus; maintaining this peg is the right choice for Saudi Arabia due to the confidence it instills in investors and the price stability it confers upon the economy.

In the long-term, Saudi Arabia must continue to diversify its economy along the lines described in Vision 2030, including the leading goal of increasing the share of non-oil exports in non-oil GDP from 16 percent to 50 percent. If Saudi Arabia successfully diversifies away from oil, it will be far less affected by a recession in the US, with whom trade is limited. Exports to China (17 percent), Japan (15 percent), India (11 percent), and South Korea (10 percent) are collectively much more important to the Saudi economy than the US.

As Saudi Arabia develops its economy and moves up the value chain, it is likely that countries in Africa and Asia will grow in importance to the Saudi economy, at the expense of Europe and the US. For example, developing religious tourism is a central component of Vision 2030, and the majority of the world’s Muslims live in Africa and Asia. This long-term diversification is key to weathering future US recessions.

Aside from the direct economic consequences, a US recession could also impact Saudi-US political relations.

Recession could damage US President Donald Trump’s hopes of securing a second presidential term — undermining his boasts of a strong economy — and therefore make a Democrat president more likely. Saudi relations with the Democratic Party have deteriorated during the last decade in the context of polarized US politics, with Saudi Arabia welcoming the Trump administration’s tough line on Iran and rejection of the Obama administration’s policy of engagement.

Should a new president extend an olive branch to Iran, as the leading nominees in the Democrat race have publicly considered doing, the Middle East may suffer from heightened instability. This would damage investor sentiment and possibly require Saudi Arabia to increase its military and security spending at the expense of projects which benefit the economy, such as infrastructure. This mechanism was evident during the Obama presidency, as Saudi military expenditure rose from 7.4 percent of GDP to 13.3 percent of GDP during the period 2008-2015.

Weakening Saudi-US political relations would in turn further undermine economic relations. Many large US corporations, such as Microsoft and Six Flags, are involved in Saudi Arabia’s Vision 2030 economic reform project. While US corporations are independent from the US government, their willingness to invest in the Saudi economy is inevitably sensitive to local economic conditions and affected by diplomatic relations between the two sides.

To prevent this political fallout, and the broader impact of the US political cycle on the Saudi economy, Saudi Arabia must also work to resurrect its historically strong, bipartisan relations with the US, by building relations with the Democratic Party and stronger ties at the civil society level. These steps would help insulate and fortify the relations at the highest levels of government.

For example, the many thousands of Saudi citizens studying in the US under the King Abdullah Scholarship Program should have volunteering in US non-profit organizations as a funding requirement – such a move would help establish grassroots-level good will toward Saudi Arabia among the American population and encourage cultural understanding. This would also help counter the hyperbolically negative media coverage of Saudi Arabia in the US, which is an impediment to stronger relations.

Finally, one should note that a US recession is not an inevitability. Unemployment remains at its lowest level since the 1960s, GDP is still growing, and asset prices are yet to crash. Nevertheless, continuing to implement Vision 2030 should remain a priority for the Saudi government, which must remain vigilant for all economic and political possibilities.

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Omar Al-Ubaydli (@omareconomics) is a researcher at Derasat, Bahrain.

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Last Update: Friday, 13 September 2019 KSA 06:17 - GMT 03:17
Disclaimer: Views expressed by writers in this section are their own and do not reflect Al Arabiya English's point-of-view.
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