When the Washington-based IMF warned in September 2012 that Saudi Arabia’s massive fiscal surpluses could drop into a deficit by 2016, it caused widespread surprise. The kingdom is popularly considered to have one of the strongest economies in the region and the outlook for it is better than many developed countries.
So much attention was attracted by the IMF warning that it even prompted Saudi Finance Minister Ibrahim al-Assaf to respond. He called the projections a “doomsday scenario” that combined a continued expansionary fiscal policy with a drop in oil prices. “They have been working on scenarios assuming, I would say, a doomsday scenario, which I don’t agree with,” said Al-Assaf in October 2012, following a meeting with IMF head Christine Lagarde. “We appreciate they are raising these issues in order to be ready.”
Although they may be based on a pessimistic outlook that fails to materialise, the IMF’s concerns highlight worrying trends within Saudi Arabia’s economy. If spending is left unchecked and reliance on the oil sector remains high, Riyadh’s financial situation could rapidly deteriorate.
Current trends point towards an economy that is becoming dependent on high government spending, as evidenced by the budget for 2013, which was announced in late December. Typically, Riyadh’s budgets are more interesting for their historical perspective than their insights into future policy. Details of economic performance over the previous 12 months are both timely and transparent. In forecasting the next year, the budgets tend to be conservative to the extent of almost being meaningless.
When the private sector looks to the government for triggers, they are looking to a state still reliant on energy prices
Dima Jardaneh, Standard & Poor’s
Spending for 2012 was put at SR853bn ($227bn), a SR163bn overspend on the budget for that year. At SR1,239.5bn, revenues also massively overshot the forecast of 12 months earlier. For 2013, the government has budgeted spending of SR820bn. Despite this being less than actual spending for 2012, it was a record for Riyadh’s conservative forecasting and 19 per cent above last year’s budget. Being wise to the fact that budgets in the kingdom are more about conveying a sentiment than attempting an accurate forecast, investors on the Saudi Stock Exchange (Tadawul) bought more shares. That rising confidence helped push up the Tadawul All Share Index 0.2 per cent on the day the budget was announced.
Analysts expect actual spending in 2013 to be closer to SR870bn and revenues about SR1,100bn, much higher than the state’s forecast of SR829bn, but also lower than actual revenues in 2012 as a result of lower oil production.
The big concern that analysts say policymakers need to address is the high proportion of current spending in Riyadh’s budget. “The proportion of current spending to total spending is on the rise and there is a clear need for that to be addressed, coupled with better medium-term planning,” says Dima Jardaneh, a sovereign analyst at ratings agency Standard & Poor’s (S&P).
Investment spending for 2013 was budgeted at SR285bn for 2013, or about 35 per cent of total spending. The lion’s share of the budget will be spent on wages, subsidies and such. Although, in the short-term, this is good politics for the ruling Al-Saud as it gives the impression that vast oil wealth is trickling down to the average family, it has more worrying implications for the longer term. Cuts to current spending are unpopular at the best of times and in a period of widespread political unrest around the region, the House of Saud will be loath to make any moves that directly hit the common man. That means in the event of a drop in oil revenues, capital spending will be the first to suffer.
James Reeve, an economist at the local Samba bank, suggests capital spending will start to fall over the 2013-15 period. In a recent report, he said the government was more likely to respond to lower oil revenues by “attempting to fit spending to the new realities and rein in capital investment,” rather than dip into its coffers.
The proportion of current spending to total spending is on the rise and there is a need for that to be addressed
Dima Jardaneh, Standard & Poor’s
Saudi Arabia has not been afraid to spend its savings in the past, when help was needed to prop up the budget in fallow years. In 2009, it posted a deficit as spending was kept high despite plunging oil prices, although this was informed by the view that the collapse in oil prices was temporary – as it turned out to be. The kingdom also has plenty of savings stashed away for times when oil revenues do not cover its needs. The Saudi Arabian Monetary Authority (Sama) maintains assets of more than $650bn, enough to fund the entire budget for about two and a half years.
Growth is also still in good shape. The Finance Ministry’s 2013 budget announcement included a revision of the growth figures for 2011 up to 8.5 per cent from 7 per cent. Growth in 2012 was put at about 6.8 per cent. There was also evidence that the private sector is picking up. Growth in the oil sector, at 5.5 per cent in 2012, was outpaced by a 7.2 per cent expansion in the non-oil sector. The government sector grew by 6.2 per cent, but private sector growth was 7.5 per cent. The Finance Ministry says, in real terms, the private sector now contributes 58 per cent of gross domestic product (GDP).
The hope is that the current investment programme will further expand the private sector and create an economy much less reliant on government spending. Whether it will do so may not be clear for many years. Although GDP is less driven by the energy sector, which makes up about half of total GDP, it still provides the bulk of government income. About 90 per cent of government revenues come from oil.
“You can see that in real terms the contribution of oil to GDP is declining, but government revenue is still dominated by the energy sector,” says S&P’s Jardaneh. “So when the private sector looks to the government for triggers, they are looking to a state that still relies on energy prices to drive its spending policies.”
As the rise of the Tadawul shows, confidence is closely tied to government spending.
To diversify the economy, Riyadh is putting a lot of effort into improving education. Spending in the education sector represents the largest single part of the budget, receiving SR204bn of the total budget for 2013, although defence spending is probably larger but not disclosed. Together, healthcare and education account for 37 per cent of all spending.
The funds will cover the development of 539 new schools, plus the 1,900 currently under construction, and 19 new hospitals, among a raft of schemes that also includes rehabilitating old buildings, opening 15 new colleges, building new sports facilities and sponsoring Saudis studying abroad to the tune of $6bn. New transport projects have been allocated $8bn and these include developments in Jubail, Yanbu and Ras al-Khair, airport upgrades across the kingdom, and the addition of 3,700 kilometres of new roads. A separate amount will also cover “appropriations for studies and design of public transport projects in Mecca and Riyadh”, which is thought to refer to metro and rail projects in the two cities.
The budget also allocates SR57bn for the water, agriculture and industry sectors, including SR24bn for new projects in the water sector.
All budget allocations received a double-digit percentage increase on last year, although without a breakdown of actual spending for previous years, it is difficult to judge how significant the rise in spending really is. Actual total spending for 2012 rose by just 3.2 per cent compared with 2011, “a real-term decline”, says Reeve, although that follows 2011’s extraordinary 26 per cent spending rise. He adds that project spending was probably flat in nominal terms in 2012 and declined in real terms.
Data from regional projects tracker MEED Projects shows the total value of contract awards in Saudi Arabia more than halved in 2012. Although this does include private sector schemes, it is a good indication that state project spending probably fell. This is, largely, believed to be due to the impact of institutional changes in 2011-12, namely the reshuffling of some senior figures after the deaths of Crown Prince Sultan in late 2011 and his successor Crown Prince Nayef in mid-2012.
The biggest risks to the Saudi budget actually come from external factors. If oil prices remain high and production volumes are sustained, there will be less need in the short term to curtail capital investment. In that case, capital spending would start to pick up, and big schemes from the likes of Saudi Aramco, Saudi Basic Industries Corporation and Saudi Electricity Company are in the offing.
In the mid term, Saudi Arabia will have to prepare itself for being less reliant on the state, which in turn has to become less reliant on oil revenues to sustain its economy.
The transformation of the kingdom’s economy over the past decade has been remarkable. It has built up vast reserves, paid off debts, and diversified into downstream hydrocarbons industries. The September 2012 warning from the IMF may be based on a particularly pessimistic scenario that may not arise by 2016, but it is a real risk that needs to be addressed sooner or later.
Spending for 2012 reached SR853bn, a SR163bn overspend on the budget