Economic growth in Saudi Arabia is to slow in 2016 as government spending adjusts to lower oil prices says the Washington-based IMF.

“[Growth is] projected to slow to 2.7 per cent in 2016 as government spending begins to adjust to the lower oil price environment,” says Tim Callen, who led the IMF team that held from May 17-28 the 2015 Article IV Consultation with Saudi Arabia. “Over the medium-term, growth is expected to be around 3 per cent. Inflation is likely to remain subdued.”

The project slowing of GDP growth puts renewed focus on the kingdom’s economic diversification plans. “The decline in oil prices has emphasised the importance of economic diversification,” says Callen. “Policies are continuing to strengthen the business environment, but more needs to be done to encourage firms to focus more on tradable rather than non-tradable production in the non-oil sector.”

For 2015, the impact of falling prices has been slight. “The decline in oil prices is resulting in substantially lower export and fiscal revenues, but the effect on the rest of the economy has so far been limited,” says Callen. “Real GDP growth is projected by IMF staff at a healthy 3.5 per cent this year, unchanged from 2014, with an increase in oil production and continued government spending expected to support the economy.”

MEED reported at the end of May that the value of contract awards in Saudi Arabia has increased by 27 per cent this year, to $22bn from $17bn, although consultants say there has been a refocus on investments that will have a positive impact on GDP.

Defence spending has also been maintained as regional tensions will Iran persist and military operations in Yemen continue.

The kingdom’s defence budget has been expanding at a rate around 14 per cent a year over the last decade and accelerated to a rate of 19 per cent a year since 2011, according to a report by New York-listed research firm IHS on 2 June.

“Despite Saudi Arabia’s heavy exposure to oil price fluctuations, there have been very few signs of any severe reactionary adjustments to government spending trends,” says Craig Caffrey, principal defence budget analyst at IHS Jane’s Aerospace, Defence & Security.

IHS also forecasts Saudi Arabian defence-specific spending to increase to about $60bn a year by 2020 from its present $49bn, which will make it the fifth-largest spender in the world.

The ongoing government spending will put pressure on the kingdoms finances. “Government spending in 2015 is expected to remain strong, partly due to a number of one-off factors, while oil revenues have declined. As a result, IMF staff projects that the government will run a fiscal deficit of around 20 per cent of GDP in 2015,” says Callen.

Deposits with the Saudi Arabian Monetary Agency (Sama) have declined to finance the deficit. “Going forward, the decline in government deposits will slow as the government starts to issue debt to finance the deficit,” says Callen.

According to research report from local firm Jadwa Investment, foreign currency reserves dropped by $49bn in the first four months of 2015 to $683bn at the end of April from $732bn at the end of 2014. During March and April this year, reserves fell by $31bn.