A bank manager with a customer called Saudi Arabia might be getting a little worried. One of his wealthiest clients who gets most of his money from a single activity is suffering a sharp drop in income. Even before his earnings started dropping dramatically the client had planned to run up a small overdraft this year. Now he will need to cut spending sharply but it is hard to see how he can. Most of his withdrawals are for basic necessities for a large, young extended family that is growing rapidly. A bigger overdraft will have to be arranged.

Finance & National Economy Minister Ibrahim al-Assaf manages Saudi Arabia's finances and faces such worries this spring. Oil accounts for about 90 per cent of Saudi Arabia's exports and prices have plunged by 40 per cent in the first 12 weeks of this year compared with the same period in 1997.

The world is awash with oil and there are not enough buyers, even at today's bargain prices. Asian demand is depressed, the world economy is growing more slowly and OPEC production is about 2 million barrels a day (b/d) above the estimated call on its supplies. And there is no prospect, in the short-term at least, of an OPEC cutback to support prices while some members pump to capacity and Saudi Arabia refuses to play the role of swing producer.

'With so many issues still unresolved, a Saudi 1998 oil export revenue shortfall as large as $15 billion or nearly 30 per cent of its planned 1998 budget cannot be ruled out,' says Kevin Taecker, chief economist of Saudi American Bank in Riyadh.

An oil windfall in the previous two years, when the price of Arab light averaged $18 a barrel, made possible a 9 per cent increase in actual spending to SR 200,500 million ($53,470 million) in 1997. It even generated a tiny budget surplus. Spending was forecast at SR 196,000 ($52,270 million) and the deficit at SR 18 million ($4.8 million) for this year.

These estimates look wildly optimistic in the light of the oil price collapse and spending cuts are now inevitable. As about 85 per cent of the budget is current spending, capital spending faces the axe. Scaling back or deferring projects is already apparent at Saudi Aramco and government payments to contractors and suppliers are being delayed. Defence spending and weapons procurement, running at about $20,000 million a year, could be trimmed by slowing deliveries. Saudi Arabia's long-suffering farmers, who benefited from a settlement of old debts through a bond issue in 1994, may also face fresh delays in payments for this year's harvest.

Al-Assaf is reported to favour postponing the signing of any new contracts and reducing the scale of existing project commitments. Further delays in telecommunications, power and water projects are likely. In a late January report, Washington-based Petroleum Finance Company (PFC) said: '...it is likely that capital expenditures will be cut by 17 per cent in this year compared to actual 1997 capital spending levels. This will also temper the budget deficit to financeable levels.'

Instead of a forecast deficit of SR 18,000 million ($4,800 million), PFC expects the budget shortfall to double to SR 36,000 million ($9,600 million), nearly

7 per cent of gross domestic product (GDP).

Given Saudi Arabia's aversion to international borrowing, the deficit will be funded by further domestic borrowing. This will most likely take the form of borrowing from the banks and the sale of new bonds to the state's pension and social security funds and the banks. Estimates of the government's domestic debt vary but Taecker says it could be around $120,000 million, about 80 per cent of GDP. The estimate from PFC suggests that the extra borrowing needed this year will send the total domestic debt bill up to $127,000 million - 90 per cent of GDP.

Economists argue that this level of domestic borrowing is sustainable given the limited extent of the banks' exposure to government debt and their healthy foreign assets position. At the end of 1997 bank foreign assets stood at $28,700 million, a figure which falls to $15,800 million after deduction of the banks' own foreign liabilities. The situation has deteriorated slightly since the end of last year, with bank credit to the government up and the banks' net foreign assets down by about $2,000 million. Says Taecker: 'Even so, it is clear that the load of government debt on the Saudi economy is not very large.'

Although there is no shortage of options for the government to raise revenues, it has been reluctant to do so. Despite IMF urging that fees for government services and utilities should be increased to rates that reduce the level of subsidy, there have been no increases in charges since 1995.

The whole question of taxation is extremely sensitive: there is no income tax and corporation taxes are minimal. Many joint ventures enjoy extended tax holidays, one of many incentives to encourage inward investment. Privatisation is an option being developed in the telecoms sector, which is being corporatised, but even if this proceeds on schedule it is unlikely to lead to a sell- off for at least two years (Telecoms, MEED Special Report, 13:3:98).

Deficit

The current account surplus generated in 1996 and 1997, the first surpluses since the early 1980s, will not be repeated this year. Despite higher production volumes, export earnings will be down substantially because of lower oil prices. The services deficit will continue to expand: remittances and service payments are relatively stable but assets will be repatriated to fund the deficit. PFC is forecasting a current account deficit of $9,500 million for 1998, about 7.5 per cent of GDP, compared with a surplus of $232 million in 1997 and $213 million in 1996.

Real GDP growth will also tumble. According to PFC, average growth over the last two years was 4.4 per cent, but will be below 1.5 per cent this year. Oil production crept up during 1997 and Saudi Aramco has yet to exploit its full OPEC quota entitlement because of the slump in demand.

Although the current strategy for dealing with the oil glut does not include lower production by Saudi Arabia, a cutback may eventually come, either as part of a collective OPEC response or simply to save on the cost of floating storage for unsold cargoes.

Peter Kemp