As the region’s largest economy, Saudi Arabia is often used to gauge the Middle East’s fiscal health, especially in times of lower oil prices, where budgets are trimmed of any excess to help balance the books.

However, to do so in 2015 would not give an accurate reading of the region’s current economic position. Riyadh seems intent on pursuing what some may call an isolationist position where extremely high public spending continues unabated despite oil prices falling to six-year lows of less than $50 a barrel, from $110 a barrel in June.

An historically high budget of $229bn has been set for 2015 and, with revenues expected of only $190.7bn, this means a deficit of $38bn is forecast. The strategy to increase public spending may be counter-cyclical, but there are genuine reasons why the kingdom has decided to maintain its public largesse.

Social infrastructure

Riyadh is locked in to several extremely expensive initiatives aimed at improving the country’s social infrastructure. It knows that downing tools on the huge medical centres, universities and social housing projects under construction across the kingdom now would be a grave mistake and would endanger the welfare of future generations.

“Riyadh is well aware of the implications of cancelling these projects, but there has never been any indication that the government wishes to do this,” says Fahad Alturki, chief economist and head of research at the local Jadwa Investment. “We envisage none of the major social infrastructure projects being cancelled.” 

Another factor is that typically, when crude prices fall, the private sectors in most of the main oil-producing countries shut up shop and refrain from making any significant investments until uncertainty has receded. Riyadh knows this and by actually increasing its budget for 2015, it has sent a clear message that it is prepared to back anyone in the private sector who is also prepared to keep investing.

Non-oil growth

Proposed government spending in 2015 is the equivalent of 36.3 per cent of GDP, compared with an average of 31.9 per cent over the past 10 years. Jadwa Investment states that the economy will continue to perform strongly in 2015, especially the non-oil sectors. Nonetheless, growth will be slower paced than in previous years at 2.5 per cent, compared with 3.7 per cent in 2014, due to the lower oil prices.

“Non-oil growth will be the primary driver in 2015,” says Alturki. “The oil sector is expected to contract by 0.6 per cent.”

The 2015 budget has also cut investment spending by 35 per cent to $49.2bn in 2015, the first reduction since 2002. Capital investment has been growing by 25 per cent a year for the past decade, a figure that was unsustainable in the long term. The $49.2bn figure still represents a 36 per cent increase on five years ago, but is a clear indication that some caution remains.

Potential slowdown

What impact this lower investment spending will have is not yet known, but it is likely some projects that are deemed non-essential will be slowed down. This strategy is already apparent in the kingdom’s hydrocarbons sector. The $3bn Ras Tanura refinery upgrade has been postponed by oil major Saudi Aramcoand the $3bn Khurais oil field expansion has seen its execution phase lengthened by a year in order to manage the cash flow better.

“Aramco has not got an endless supply of money and it needs to rein in its spending like everyone else,” says a Saudi-based oil consultant. “The rest of the kingdom is likely to follow the example.”

Exactly where the belt will be tightened is unclear. Regional projects tracker MEED Projects states that there are $127bn-worth of non-hydrocarbons projects at the design and main contractor bid phase in the kingdom.

Not all of these projects are expected to be awarded this year, but it gives a clear impression of the work that is still up for grabs in 2015-16. The vast majority of these schemes are government-led and spread across sectors such as housing, health, rail and utilities.

Longer time scales

The kingdom has more than $16bn-worth of upcoming projects in the power and water
sector, and while it may be that some of the schemes are slowed down, it is extremely unlikely any will be actually cancelled.

What could be the decisive factor is the slowing down of large industrial schemes in other sectors, meaning power demand will not be as high as previously forecast. This could give the utility sector some breathing space and allow it to emulate Aramco by spreading projects over longer timescales.

Transport is another key sector, but with almost $50bn-worth of schemes at the design or main contract stage, there is scope for scaling back some of the more ambitious projects for a couple of years until some stability returns to oil prices. Several huge metro projects in cities such as Jeddah and Medina have combined budgets of more than $20bn. Metro schemes traditionally have construction periods spread over several phases and this would allow some scope for savings in the short term.

Other projects, such as road expansions and rehabilitations may be deemed non-essential and also put on the backburner in order to prioritise more essential spending elsewhere.

Construction projects

The construction sector is nearly identical to transport, with project spending also expected to be just shy of $50bn. Just under $14bn is mooted for health and education spending, and this is unlikely to be affected. Other blue-ribbon schemes, such as the plan to build 11 stadiums across the kingdom, may slow down slightly, but are extremely unlikely to be cancelled.

“The stadiums are being built under a royal decree and it will take another royal decree to change that,” says a Saudi-based contracting source. “So while it may not move as quickly as before, it is still moving.”

Jadwa Investment expects non-oil GDP to grow by 5.3 per cent in 2015, lower than the average of 7.2 per cent witnessed over the previous five years, but still extremely positive when compared with other Gulf nations.

However, in the face of sub-$50-a-barrel oil prices and sluggish growth in several of the world’s largest economies such as China, Japan and the eurozone, Riyadh will have to maintain its strong support to the domestic economy.

Political issues

Across the region, there are still several key issues that remain unresolved, including continued insurgency in Syria and Iraq, as well as a fragile political climate across much of North Africa.

These factors will certainly dampen sentiment among international companies and will likely have an impact on foreign direct investment across the Middle East, including Saudi Arabia. Riyadh’s bullish reaction to falling oil prices took the world by surprise and it is highly unlikely it will change its position in 2015. Oil production is expected to hover around the 9.6 million barrel-a-day mark despite continued concerns about an oversupplied market. 

The kingdom’s renewed commitment to utilising its vast cash reserves (estimated at $736bn) to maintain public sector spending means the impact of lower oil prices will be softened. When compared with other economies across the Middle East, Saudi Arabia is one of the few that has a real chance of escaping the next two years relatively unscathed.

However, if oil prices remain in the doldrums for the medium-term, it is also exceedingly likely 2015’s budget will be the highest the kingdom will see for some years to come.

Follow Kevin Baxter on Twitter: @MEEDKevin