Riyadh spending to safeguard the future

19 January 2010

In a bid to maintain its economic growth and diversify its economy, the kingdom is using its vast financial reserves to support an increasingly expansionist spending programme

In a sustained effort to maintain economic growth through the global financial downturn, late last year Saudi Arabia unveiled its largest ever budget for the year ahead. Total expenditure for 2010 is projected at $144bn, a 14 per cent increase in spending compared with the 2009 budget of $126bn.

The global financial crisis has led Riyadh to adopt an expansionary fiscal policy as part of a government programme to spend its way out of the current crisis. In 2008, the kingdom embarked on a $400bn five-year investment programme designed to stimulate its economy. The 2010 budget is continuing this theme, providing a significant boost to the kingdom’s projects sector with $69bn of investment in new and existing projects announced for 2010 – an increase of 16 per cent on the previous year’s figure of $59.5bn.

There are also double-digit spending increases for key areas of the economy, including health, transport, telecoms and water, -reaffirming Riyadh’s commitment to ensuring that strategic infrastructure projects are not delayed as a result of financing difficulties.

“The budget is continuing on the same line the authorities took last year, with an emphasis on long-term infrastructure projects,” says Jarmo Kotilaine, chief economist at Saudi’s NCB Capital, the investment arm of National Commercial Bank.

Key fact 

Riyadh has budgeted to spend 14 per cent more public funds in 2010 than it did in 2009

“It has been carefully designed to boost the long-term health of the economy, rather than just propping it up.”

With $36.7bn, or a quarter of public funds, education and training takes the largest share of the 2010 budget. This represents an increase of 13 per cent over 2009. In that year, Saudi Arabia built two new schools every day. New projects in this sector in 2010 include building a further 1,200 schools and the rehabilitation of 2,000 existing school buildings.

“The allocation of $36.7bn for education and training emphasises the government’s desire to invest in Saudi citizens, considering human development as the core of real development,” said Ali al-Attiyah, deputy minister of higher education, when the budget was unveiled in December last year.

The kingdom has been working hard to raise its education standards. Its teacher-student ratio of 1:15 is one of the lowest in the world, and with more than 65 per cent of its 22 million population less than 25 years old, Saudi Arabia faces a pressing need to generate jobs to ensure future economic and political stability.

“The government wants to create a market that has depth, and education is at the core of the kingdom’s attempts to diversify,” says John Sfakianakis, chief economist at Banque Saudi Fransi.

Predicted deficit

The non-oil sector’s contribution to gross domestic product (GDP) has overtaken the hydrocarbons sector in recent years, and with the suppressed oil prices in 2009, it outperformed the sector last year.

While the hydrocarbons sector shrank – Saudi Arabia’s oil sector GDP fell 40 per cent from $288bn in 2008 to $172.5bn in 2009 – the non-oil sectors of the economy recorded solid growth of 3 per cent.

Oil prices have been extremely volatile since the onset of the downturn, plummeting from a peak of $147 a barrel in July 2008 to $32 a barrel in December 2008. This sharp change in prices led to drastic crude oil production cuts, which slashed Saudi Arabia’s revenues by 54 per cent to $134.6bn in 2009.

This fall in oil revenues combined with 16 per cent higher than budgeted overall expenditure resulted in a deficit of $11.9bn in 2009 (approximately 3.3 per cent of GDP), compared with a surplus of $155bn (or 33 per cent of GDP) in 2008.

This was Saudi Arabia’s first budget deficit since 2002. With the Finance Ministry forecasting revenues of $125.3bn and expenditures of $144bn for the year ahead, the government is expecting to run a second consecutive budget deficit, of $18.6bn, in the fiscal year 2010.

However, economists remain divided over whether the next financial year will end in deficit or surplus. Many are confident of a surplus, given that Riyadh is budgeting on a conservative oil price of $44 a barrel.

“Despite increased spending, the actual deficit of $11.9bn fell short of the budgeted $17.3bn in 2009, thanks to a rebound in crude oil prices,” says Kotilaine.

Surplus forecast

Riyadh-based Jadwa Investment is forecasting a budget surplus of $3.5bn in 2010.

“We expect the oil price to be higher than that used in the budget and therefore those oil revenues will exceed the budgeted total,” said a study, Saudi Arabia’s Budget for 2010, published by Jadwa in December last year. “We forecast total oil revenues to the budget at $165.6bn and non-oil revenues at $24bn.

“Spending will be in excess of the budgeted level. Actual spending has averaged 21 per cent above budget over the past 10 years and even though oil prices were below the budget assumption for part of last year, the budget was still overspent by 16 per cent. We project total spending in 2010 at $164.2bn.”

However, Keith Savard, chief economist at the London office of Samba Financial Group, believes such projections are too optimistic and have not factored in the state-owned energy company Saudi Aramco’s use of the revenues towards its investment programme.

“We are expecting a small deficit of about $12bn [2.8 per cent of GDP],” says Savard. “The authorities’ oil revenue projection is not especially conservative if one assumes that Aramco will hold back the same -proportion of oil export earnings for its own investment -programme as it did in 2009, a -reasonable assumption given its pressing gas development needs.”

The decline in the value of Saudi Arabia’s foreign assets mirrored the change in oil prices in 2009. With these hovering between $40 and $50 a barrel in the first five months of 2009, compared with a 2008 average of $91, the central bank, the Saudi Arabian Monetary Agency (Sama), reported a decline in the value of its net foreign assets from $431.1bn in January 2009 to $382.1bn in July last year.

With private investment likely to remain sluggish this year, the public sector is expected to increase its support and act as the main driving force in 2010. Much will depend on the direction of oil prices, but the fact that authorities are anticipating a larger deficit than last year is certainly instructive. 

“The oil price remains the key risk factor for the economic outlook in 2010,” says Kotilaine. “The performance of the economy will move more closely in correlation with the price of oil than the government would like to admit.”

“It [the budget] has been designed to boost the health of the economy, rather than just propping it up”

Jarmo Kotilaine, chief economist, NCB Capital

Some economists believe whether Saudi Arabia runs a deficit or not should not cause much alarm. Riyadh has reaped the rewards of the oil boom, accumulating about $400bn in foreign reserves, according to Banque Saudi Fransi. Cushioning the projected deficit of $18.6bn in 2010 is within Riyadh’s means.

“The government has enormous financial resources – well over 100 per cent of GDP – plus considerable scope for fresh domestic debt issues,” says Savard. “Our stress-testing indicates that the government could run sizeable deficits for many years if it needed to.”

However, there are other fiscal concerns. Inflation averaged 4.4 per cent in 2009, which is high for an economy that experienced just 0.15 per cent growth.

Analysts are forecasting inflation will grow to 4.6 per cent in 2010, due to the fact that non-oil commodity prices remain high, the dollar remains weak and there is an ongoing shortage of housing that will continue to push up rents.

“Renewed pressures in this area are a major risk as the recovery begins to gather pace,” says Kotilaine. “Saudi Arabia has fairly limited armour with which to counteract this because of being pegged to the dollar.”

There is also ongoing concern over the recovery of the private sector, which has experienced a marked slowdown, falling from 4.7 per cent growth in 2008 to 2.5 per cent last year.

Kotilaine is expecting a revival in private sector activity this year to record a growth of about 3.75 per cent.

Savard is a little more optimistic, predicting growth of around 4 per cent. “Constricted financing will certainly constrain private sector investment in 2010, just as it did in 2009,” he says. “We see growth in this sector coming more from consumption than investment.”

However, industry insiders are confident that Saudi Arabia has adopted the right strategy for overcoming the downturn and sustaining growth, and has learnt from past mistakes. In the previous downturn in the 1980s and 1990s, the kingdom reined in its spending in line with falling oil revenues. This served to deepen economic stagnation.

“In good times, Saudi Arabia learnt to save a lot of money,” says Sfakianakis. “But equally, it has also learnt to spend money during the bad times.”

There are signs that Saudi Arabia is close to returning to the good times. Jadwa forecasts that real GDP will grow by about 4 per cent in 2010 while nominal growth could be as high as 13.5 per cent because of stronger crude oil prices. This is a promising forecast by comparison with the 22 per cent decline in 2009. 

Given its vast monetary reserves, the kingdom is clearly in a privileged position to tackle the challenges of the current climate – whether the good times return sooner or later.

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