On 25 January, Saudi Arabia’s Commerce & Industry Minister Tawfiq al-Rabiah arrived in Geneva to hold talks with the World Trade Organisation (WTO). It was the first review of the kingdom’s membership in the WTO since it joined the global trade body in 2005.

As long as oil is above $70-75 a barrel, Riyadh will keep spending. It has the resources to do so even if the price falls

Monica Malik, EFG Hermes

In the intervening years, Saudi Arabia’s economy has nearly doubled in size. However, little of this is attributable to liberalising trade policies associated with WTO membership. Although the kingdom is ranked as the 17th most competitive place in the business world by the World Economic Forum, it remains a difficult place to visit, let alone do business.

Instead, the sharp rise in oil prices has been more influential in bolstering Riyadh’s finances. Crude has climbed from about $40 a barrel at the start of 2005 to nearly $100 a barrel at the start of 2011. That has led to revenues growing to record levels from SR564.3bn ($150.5bn) in 2005 to SR1.1 trillion in 2011.

Spending boom in Saudi Arabia

The rise in oil prices has helped finance a government spending boom, which has been used to achieve two main goals: to quell any signs of discontent and reinforce the legitimacy of the ruling Al-Saud family; and to diversify the economy away from oil and modernise its infrastructure.

The non-oil fiscal balance, a measure of the fiscal deficit minus oil revenues, has widened

As a result, expenditure is also up dramatically, from SR346.5bn in 2005 to a budget of SR690bn in 2012, and due to additional spending, the final figure is expected to be closer to SR750bn. Overspending is a distinct feature of Saudi Arabia’s oil-funded budgets; this often makes them meaningless just a few months after they are published.

In the new budget, healthcare and education are priority areas for spending. About 24 per cent of the 2012 budget, amounting to SR168.6bn, has been allocated to education and training – 13 per cent higher than for 2011. Health and social affairs have been allocated 13 per cent of the total, or SR86.5bn, which is an increase of 25 per cent over last year.

While the budget has boosted confidence domestically, the kingdom still faces a year of decelerating economic growth. As the global economy slows, so will Saudi Arabia’s oil receipts. Furthermore, rising production in Libya and Iraq will mean lower production in the kingdom. Economic growth is expected to fall from 6.8 per cent in 2011 (the highest level since 2003) to about 2.7 per cent this year as oil production drops. This will put the government under greater pressure to provide economic stimulus and, most importantly, jobs for its large young population.

Higher spending is making the kingdom vulnerable to future oil price shocks. For the budget to break even, the oil price only needs to be about $69 a barrel in 2012. Once additional spending is factored in, the level is more likely to be about $74 a barrel, according to the local Jadwa Investments, although Egypt’s EFG Hermes puts the figure at $87.5 a barrel. When Al-Rabiah’s predecessors were arranging the WTO deal, the breakeven oil price was about $30 a barrel.

Oil price vulnerability

This vulnerability, however, is unlikely to be an issue in the short-term. Monica Malik, chief economist at EFG Hermes, says that as long as oil is above $70-75 a barrel, Riyadh will keep spending. With foreign assets at Saudi Arabian Monetary Agency (Sama) totalling $519bn and no foreign debt, the government has ample resources to keep spending if the oil price falls.

The high government spending does create a reliance on growth continuing in the non-oil sector

Paul Gamble, Jadwa Investments

Political motivations will also keep Riyadh spending. In the wake of the Arab uprisings and protests among Saudi Arabia’s Shia population in the Eastern Province, government largesse has been the primary policy response, as opposed to real reform. In early 2011, the government announced additional spending measures worth about $130bn.

As a result, spending in 2011 was SR224bn above the budgeted level, driven by King Abdullah bin Abdulaziz al-Saud’s decision to pay citizens two months’ worth of salary as a one-off bonus, to create a minimum wage, to increase inflation subsidies and to introduce unemployment benefits, in addition to other initiatives.

A further SR250bn of the nearly SR300bn budget surplus in 2011 was put into a special fund managed by Sama to be used to finance the construction of 500,000 new houses. This, coupled with other investments in education, healthcare, transport and power and water, has pushed the capital expenditure in the 2012 budget up to a planned outlay of SR265bn, or 32.9 per cent of total expenditure.

Necessary expenditure for infrastructure

The rising capital expenditure is necessary to provide the infrastructure to develop the country and will probably start to decline again in a few years. “There is a vital need for Saudi Arabia to move forward with its social development investment plans and infrastructure upgrades, after 20 years of underinvestment,” says Malik.

The rising current expenditure is more of an issue. The introduction of a minimum wage, the creation of 60,000 new jobs at the Interior Ministry and an inflation supplement introduced in 2008 as a permanent part of salaries are all moves that have helped boost morale in the kingdom, but they will be difficult to roll back in the future.

Social spending in Saudi Arabia

The Finance Ministry does not give a complete breakdown of current expenditure (it also does not disclose other areas, such as defence spending) but economists say the bulk of the growth in the budget is a result of wage hikes and other social measures. “In the short term, a lot of these measures look very good for Saudis, but in the longer term, the government will have a spending issue to address and will want to avoid touching people’s income,” says a local analyst.

“Infrastructure spending will probably ease in the coming years as it is currently very high, but increases in the wage bill will be very difficult to reverse,” says Paul Gamble, an economist at Jadwa.

The non-oil fiscal balance, a measure of the fiscal deficit minus oil revenues, has widened, from 52.2 per cent of gross domestic product (GDP) in 2008 to 79.5 per cent of GDP in 2011. That indicates that the non-oil sector is actually getting further away from being able to fund the budget.

The IMF says that for the government to reduce unemployment (forecast to be more than 10 per cent in 2012) by 5 per cent over the next five years, non-oil growth will need to average about 7.5 per cent a year. According to Raza Agha, economist at the UK’s Royal Bank of Scotland, non-oil growth has averaged 4.5 per cent in the past decade.

“We have had a very strong year of non-oil growth in 2011 at about 8.6 per cent, the fastest rate in 30 years,” says Gamble. But he adds that “high government spending does create a reliance on the growth continuing in the non-oil sector”.

The glut of state spending will also increase inflationary pressures in the kingdom. This leads to the possibility of market-distorting measures, such as rent caps or lending restrictions, which Agha says could be counterproductive given Saudi Arabia’s need to stimulate private-sector growth and create jobs.

Economic diversity in Saudi Arabia

Although current indicators point to a longer-term deterioration in the kingdom’s finances, in the short term, the position looks more reassuring. Sama’s foreign assets alone would cover 2.5 years of fiscal spending at current levels. The government’s total debt is SR135.5bn, all of which is held domestically and is down by more than SR30bn from the end of 2010.

While spending is high, the government is increasingly focused on making the economy more efficient and diverse, particularly through developing alternatives to fossil fuel, which will enable it to stop burning so much of its oil domestically and save it for export. At a time when many developed nations are heavily indebted and face fiscal austerity, Saudi Arabia is able to invest in growth. Since construction prices are lower than they were a few years ago, now is a good time to do so.

The oil price, while facing some downside risks from the global economy, remains above $100 a barrel and is forecast to stay that way for the rest of the year. If that happens, Saudi Arabia should end 2012 with a surplus of about $40bn. This strength in the economy means Riyadh is unlikely to feel any significant pressure to put the brakes on spending any time soon, even if oil does go through some short periods of volatility.

The kingdom is now probably plotting the right course in spending to achieve its twin goals of stimulating the economy, while global growth slows, and progressing on much-needed infrastructure and economic diversification. Spending also serves as the velvet glove around the iron fist of repression to keep the country stable. The danger is that the government and the citizens could get addicted to big spending.

Riyadh will have to make faster progress on its stated goal of handing more responsibility for economic growth to the private sector and creating a more efficient economy. If it does not, it may find that it will have to stick to its budgeted spending plans much more closely in the future than it has had to in the past.