In 2016, in the face of low oil prices and rapidly declining foreign reserves in an unsustainable, oil dependent rentier state, Saudi Arabia was faced with two scenarios: an "Open Road" where social and economic reform would transform the country into a diversified, moderate, and prosperous society; or the "Rocky Road," where the sclerotic government would fail to reform and the country could plunge into a deep recession amid rising internal conflict and a monarchy in peril.

Two years later, under the young Crown Prince Mohammad bin Salman’s leadership, the Kingdom has chosen to pursue a slight variation of the Open Road, called the "Narrow Road." In this scenario, economic diversification and social liberalization reform are achieved, but accompanied by a more authoritarian, nationalistic state where power is concentrated in the hands of one to push through reform while cracking down on dissent. Coinciding with a global economic boom and stable oil prices, these policies could boost economic growth, catalyzing new job creation and entrepreneurial activity.

If Saudi Arabia’s transformation is to be executed successfully and a Narrow Road scenario made a reality, policy makers, businesses, and foreign investors will have to navigate indicators, signals, and challenges to reach milestones along the way.

Commitment to Change

The most salient indicator is the government’s ability to meet Vision 2030 reform targets. Fiscal consolidation brought a reduction in government spending, slashing of public sector wages, subsidy cuts, expatriate levy, the introduction of a Value Added Tax, and excise taxes on soda and tobacco. Yet, sensitivity to popular backlash of rising living costs and subdued growth lead to a rollback of some reforms and introduction of allowances. 

In parallel, social liberalization—including allowing women to drive, the introduction of entertainment, and the defanging of the religious police—was enacted to "revert" the Kingdom to "moderate Islam."

Both segments of reform were enabled by another indicator: increasing authoritarianism wrapped in Machiavellian flair. To push through these changes, King Salman and Crown Prince Salman dismantled the governing system of consensus among various royal fiefdoms and restructured it with the concentration of power to one: the Salman branch.

This autocratic liberalization illustrates zero tolerance for opposition, and included the jailing of dissenters from civil society, the royal family, the government, and clerical establishment, as well as an anti-corruption crackdown that reached the last segment of society, the private sector.

Whether or not these stakeholders choose to accept the new paradigm or attempt to harness potential popular discontent that arises down the line, stakeholders will have to be monitored in anticipation of a bigger milestone: Mohammed bin Salman’s succession to the throne. As of now, the consolidation of power, popular youth support, and newly installed cabinet of a younger generation of princes should ensure a smooth transition.

Economic Indicators

Although abiding by reforms that upend cradle-to-grave welfare has proven a challenging balancing act for the government, they were still able to almost halve the budget deficit in 2017 to 8.9 percent from 15 percent in 2015. However, if the government is to reach its 2.7 percent growth target (IMF forecasts 1.6 percent) in 2018 under an expansionary budget and stimulus package totaling $300 billion, it will have to rely on stronger oil (still 60% of government revenue) and non-oil revenue, while raising more debt.

As a result, oil price volatility and inflation are key indicators. Saudi Arabia has been able to steer OPEC and Russia production cuts to drive oil prices to three-year highs ($70 a barrel). However, Russia and the United States will overtake the Kingdom as the globe’s largest oil producers, with resilient U.S. shale ramping up production and capable of shocking the oil markets again, especially if OPEC projections of increasing global demand fall short. OPEC will hope that its members’ full compliance in 2017 continues throughout 2018, with an eye on the next meeting in June.

Furthermore, after experiencing deflation amidst recession in 2017, the introduction of taxes and allowances is expected to stoke inflation to 5.7 percent. The Saudi riyal-U.S. dollar peg may come under increased pressure, amidst a declining dollar, and the Saudi Arabian Monetary Authority may be compelled to increase interest rates, stifling growth.

Private Sector Job Creation

Small and medium sized enterprises (SMEs) currently make up 21 percent of GDP with a target of reaching 34 percent by 2030. As is the case in developed markets such as the United States and China where SMEs make up 50 percent of their economies, they will lead private sector growth and job creation under the Kingdom’s transformation. The budget and Public Investment Fund (PIF) stimulus are positive milestones that allocate a significant amount to SME development while banks are expected to provide further funding, and a recently established Nomu parallel market at the Tadawul offers further financing avenues.

If Saudi Arabia is to reach the goal of 1.2 million private sector jobs by 2030, cut unemployment to 9 percent from 12.8 percent and increase private sector contribution from 40 percent to 65 percent of GDP, then a key indicator is the number of SMEs established in that time, which will likely have to be about 20 percent of the 1.2 million jobs target.

About 250,000 Saudis enter the job market each year, and the public sector can no longer absorb them as they attempt to reduce their bloated wage bill that amounts to 13 percent of GDP and 60 percent of government expenses. Therefore, the government would do well to avoid crowding out the private sector in emerging industries such as tourism and entertainment, and rather prioritize the completion of enabling infrastructure such as the new Jeddah Airport, Riyadh & Jeddah Metros, and Haramain Train from Makkah to Madinah, while improving the ease of doing business and establishing free zones.

Privatization and Foreign Investment

The Kingdom needs to successfully complete something of the $200 billion privatization of state assets—and/or the $100 billion Aramco IPO—in 2018 if foreign investors are to take it seriously and much needed funds are to be raised. However, early indications of a delayed and unwieldy sale process among various assets have rankled investors.

While it varies by industry, a theme has appeared: the government, by means of the PIF, will likely retain shares in most assets, with the private sector generally relegated to minority shareholder status (unless a sector has been granted 100 percent foreign ownership such as healthcare and retail). This flashes another signal: given the restructuring of power to King Salman and the Crown Prince, buying in to this program is essentially buying in to the Crown Prince.

The way the anti-corruption crackdown has unfolded solidifies the "state as a capitalist," China-esque approach the Kingdom is taking. Whilst the anti-corruption crackdown is a positive milestone that addressed endemic corruption anathema to investors and citizens, leveled the playing field, and added over $100 billion to state coffers, in doing so the state kneecapped major private sector players. Will they now return to business as usual to drive private sector growth? The specter of another opaque anti-corruption probe that leads to a potential business partner incarceration or nationalization will hover over investors in the short term, even if beneficial in the long term.

Foreign Policy

Foreign policy challenges abound. They include the expensive and deadly intervention in Yemen either coming to a peaceful conclusion, becoming a protracted conflict or an escalation of hostilities. This could lead to an escalation beyond proxies and directly with Iran. Yemen is currently in turmoil as United Arab Emirates-backed southern separatists and the Saudi-backed Hadi government clash while the Iranain-backed Houthi insurgency remain despite ending their alliance with Saleh loyalists.

The blockade of Qatar by the Saudi-UAE bloc has done little but deteriorate the Gulf Cooperation Council alliance while pushing the state towards Iran and Turkey. In the pursuit of cracking down ostensibly on terrorist financing and eradicating threats of political Islam, tensions may lead to further regional destabilization and friction with the United States. A friction that could heat up if U.S. plans to move its embassy to Jerusalem proceed, pressuring Saudi action for a Palestinian solution.

Lastly, while the acknowledgement of failed checkbook diplomacy in Lebanon and the rise of Hezbollah may warrant action, the approach taken by the Kingdom and the ensuing international debacle is a glaring black eye that stakeholders may wish to avoid repeating.

All this ultimately encompasses the restructuring of the social contract. Instead of the current cradle to the grave welfare (in exchange for lack of representation), the populace is not receiving much in the way of new assurances. Healthcare and education continue to be provided by the state, despite being open to privatization, with the largest allocated budgets after defense spending. However, a housing shortage of 1.5 million homes remains. Vision 2030 targets the development of 1.5 million homes by 2030, with the Kingdom allocating $17 billion to the housing sector in 2018. Additionally, they have rolled out a new mortgage law, introduced REITs, and enacted a 2.5 percent White Land Tax on undeveloped lands to spur construction. Keep an eye on this indicator under a new social contract.

The New Social Compact

To provide a semblance of a new social compact, it behooves the government to institutionalize reform and cooperation between the four pillars of society. The establishment of a National Economic Development Council comprising of representatives from the private sector, government, clerical establishment, and civil society would be a step in achieving this. It could act as a deliberative body that provides legislative suggestions to the Shura Council and Council of Economic and Development Affairs. In this context, it would benefit a growing private sector to establish its own Saudi Private Sector Association to ensure its voice has weight.

The Narrow Road scenario is long and winding with many challenges and opportunities ahead. It will take scenario planning by all actors and a deft handling of domestic and exogenous shocks to successfully execute the Kingdom’s transformation.

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Alex Damianou is a Pacific Council member and a macroeconomic and geopolitical consultant focusing on emerging markets.

This article was originally published by the Atlantic Council.

The views and opinions expressed here are those of the author and do not necessarily reflect the official policy or position of the Pacific Council.