The kingdom may have to make some unpalatable choices if the fiscal squeeze continues.
Special Report contents:
- Saudi Arabia: Balancing austerity with growth
- Saudi projects market faces slow 2016
- Riyadh surrounded by problems
- Cautious optimism for Saudi Arabias mining prospects
- Riyadh expected to maintain oil strategy
- No gain without pain for Saudi projects sector
- Databank: Saudi Arabia key economic indicators
The budget that is due to be published by the government of Saudi Arabia in December will be examined more closely than most.
The kingdoms published fiscal plans are often unrealistic, in terms of both projected oil receipts and how much will be spent, but they do at least give an indication of Riyadhs policy direction.
Key fact
Saudi Arabia will run a deficit of about 20 per cent of GDP this year
Source: IMF
This year, with the collapse in oil revenues, the pressure is on for the government to find some big savings. The Washington-based IMF has forecast that Saudi Arabia will run a deficit of about 20 per cent of GDP this year.
The December budget, which will outline the spending priorities for the coming year, could provide a useful indication of how the government will deal with the shortfall next year, and what it might do to try and bring it under greater control.
Change needed
There has to be a shift in the fiscal stance, says Simon Williams, chief economist for the Middle East at UK bank HSBC. The drop in revenue is too deep and looks set to be too long-lasting to ignore.
There are only a few policy options to deal with the mismatch between revenues and expenditure, and not all of them are available. On the revenue side, oil production is already running close to full capacity and cannot be increased to any great extent. Increasing non-oil revenues through taxation is also unpalatable (see boxout).
That leaves spending cuts as the main option, which is what the government is doing. However, it is being cautious about where the axe falls.
The adjustment in Saudi Arabia is primarily focused on capital spending, says Paul Gamble, director of the sovereign group at UK/US-headquartered Fitch Ratings. Capital spending is very large. Its more than 10 per cent of GDP. Its going to take time for capex [capita expenditure] to come down because there are a lot of big multi-year projects going on, but thats the key area of adjustment.
Some changes to current expenditure could also be in the pipeline.
Risky reform
Spending on public sector wages is being protected and subsidies have, for now at least, not been touched. However, Riyadh has floated the idea of cutting fuel subsidies and there may be a slowdown in the rate of hiring in the public sector. Any such moves will be welcomed by the IMF, which has said that reducing the cost of public sector employment is one of several steps the kingdom needs to consider.
The drop in oil prices means the government needs to adjust its fiscal policy, said Tim Callen, head of the IMFs mission to Saudi Arabia, in a conference call with the media in September, following the funds latest annual review of the kingdoms economy.
The needed fiscal adjustment, in our view, should include an expansion of non-oil revenues, improved efficiency of public investment, energy price reform and firm control of the public sectors wage bills.
Another area of spending that is opaque but almost certain to be growing at an unsustainable rate is military expenditure. This is not included in the published budget and it is not clear how much is being spent.
The International Institute for Strategic Studies (IISS), a London-based think-tank, estimates the Saudi government runs the third-largest military budget in the world, with an outlay of some $81bn in 2014. It is likely to be substantially higher this year as a result of the conflict in Yemen.
Defence spending
Saudi defence spending has been in the region of 12 per cent of GDP, which is very high by international standards and that was before the Yemen war, says James Reeve, deputy chief economist of local bank Samba. Theres no doubt theres scope for that to be reduced.
Alongside the spending cuts, the government has been drawing down its savings and raising new debt. The foreign currency reserves held by the Saudi Arabian Monetary Agency (Sama), the kingdoms central bank, dropped from $746bn in August last year to about $665bn in August this year.
Saudi Arabia macroeconomic forecasts | |||||||
---|---|---|---|---|---|---|---|
2014 | 2015e | 2016f | 2017f | 2018f | 20119f | 2020f | |
Nominal GDP ($bn) | 746.2 | 639.6 | 658.5 | 734.2 | 817.4 | 858.8 | 926.4 |
Real GDP (% change) | 3.5 | 3.1 | 0.6 | 2.5 | 3.4 | 1.4 | 3.9 |
Fiscal revenue (SRbn) | 1,044 | 758 | 791 | 1,009 | 1,061 | 1,110 | 1,186 |
Fiscal spending (SRbn) | 1,141 | 1,229 | 1,223 | 1,264 | 1,330 | 1,345 | 1,422 |
Fiscal balance (SRbn) | -97 | -471.5 | -431.5 | -255.2 | -268.6 | -234.9 | -235.9 |
Fiscal balance (% of GDP) | -3.5 | -19.7 | -17.5 | -9.3 | -8.8 | -7.3 | -6.8 |
Public sector gross domestic debt (SRbn) | 98.9 | 197.8 | 385.7 | 559.3 | 727.1 | 872.5 | 1003.3 |
Public sector gross domestic debt (% of GDP) | 3.5 | 8.2 | 15.6 | 20.3 | 23.8 | 27.1 | 28.9 |
Sama net foreign assets ($bn) | 724.3 | 593.9 | 520.3 | 537.3 | 547.3 | 564.5 | 582.2 |
Sama net foreign assets (% of GDP) | 97.1 | 92.9 | 79 | 73.2 | 67 | 65.7 | 62.8 |
e=Estimate; f=Forecast; Sama=Saudi Arabian Monetary Agency. Source: Samba |
The pace of drawdowns has, however, been slowing in recent months. Jadwa Investment, a Riyadh-based investment bank, says average net withdrawals from government accounts in the first half of the year were running at $13.7bn a month, but by August they had fallen to $1.9bn.
The reason for that slowdown is the bond programme the government launched in June. That month Riyadh issued a SR15bn ($4bn) bond, its first such issue since 2007. Overall, the government is expected to sell SR100bn of bonds to the local market this year, and a further SR190bn next year, according to Samba.
Credit profile
With debt of just 1.6 per cent of GDP, according to the IMF, there is plenty of scope for this to continue.
The economic problems feel even more engrained than they did in the 1980s, when oil last fell so sharply
Simon Williams, HSBC
However, US ratings agency Moodys Investors Service warned in a report issued in October that while Riyadh has room to issue more debt, widening deficits are weighing on the kingdoms credit profile. Other agencies have made similar warnings.
We put Saudi Arabias AA rating on negative outlook on 24 August, reflecting a pretty significant fiscal deterioration, says Fitch Ratings Gamble. The buffers are still very large in Saudi Arabia, but they are being eroded.
Any ratings downgrade would be a symbolic blow to the kingdom, but it would not have any great consequences given Riyadhs relatively low debt level and the fact that sovereign debts are being sold into the domestic market rather than to international investors.
Reassuring outlook
Given that, and the large savings Saudi Arabia has, the overall fiscal picture looks to be manageable for now.
If you look at the top-line numbers, its not such a bad picture, particularly now that theyve started to issue public debt, says Reeve. It pushes out the day of reckoning by quite some way.
In our forecasts, domestic debt is to likely to reach about 30 per cent of GDP by 2020, assuming that roughly half of the fiscal requirement is financed by domestic debt and the rest by draw-downs of net foreign assets. If you think of comparable emerging markets, then 30 per cent of GDP is pretty comfortable.
The situation the government is facing may be a difficult one, but it is not unprecedented. Saudi Arabia had to deal with large deficits in the 1980s and made swingeing cuts to its spending then.
During the 1980s, capital spending was cut by 98 per cent from peak to trough and it didnt return to its previous peak until 2009, says Jason Tuvey, Middle East economist at UK-based Capital Economics.
Future challenge
The difference this time is that the population is far larger and the cost of the welfare state far greater. Cutting capital expenditure may be relatively straightforward, but if low oil prices persist into the future then the current expenditure bill will also have to be adjusted downwards. That will prove a far greater challenge for the Finance Ministry as it tries to draw up other budgets in the future.
If weak oil prices persist, Saudi Arabia is facing the worst terms of trade shock in a generation, says Williams.
Debt is low and the kingdoms savings are high, and I expect these balance sheet strengths to protect them for now. But the economic problems feel even more engrained than they did in the 1980s, when oil last fell so sharply. Public spending is much higher, the deficits are larger and the population is much bigger and still growing fast.
Riyadh likely to stay cautious on subsidy cuts
In late October, veteran Saudi Oil Minister Ali al-Naimi confirmed the government was looking at the possibility of cutting fuel subsidies. It is a path that has already been taken by the UAE, but how quickly it could happen in the kingdom remains open to question.
The issue goes to the heart of the political structure of the country. The implicit pact in Saudi Arabia is that the Al-Saud family has unassailable power in return for looking after the population with a cradle-to-grave welfare state.
If subsidies are cut or there is any widespread imposition of taxation, this could lead to unrest and calls for greater political representation.
That means the government is likely to move very cautiously when it comes to subsidy cuts, and may not introduce them until, for example, there are better public transport alternatives in place for locals. Few expect them before 2017 at the earliest.
The oil minister has suggested subsidy cuts may be in the pipeline, but Id suspect any moves on that will be delayed for as long as possible, says Jason Tuvey, Middle East economist at London-based research firm Capital Economics.
It is a similar story when it comes to taxation. The discussion of late has been mostly focused on the possibility of a Gulf-wide sales tax being introduced, but the political situation means many observers doubt that value-added tax (VAT) will be brought in anytime soon either.
I find it difficult to see this being implemented, says Paul Gamble, director of the sovereign group of UK/US-headquartered Fitch Ratings. The sense we get is that all would like to implement it at the same time and some are not in a hurry to do that.
However, if low oil prices persist into the future, Saudi Arabia will not be able to delay such moves for ever. Subsidies cost the government an estimated SR14bn ($3.7bn) a year, according to the Washington-based IMF and on current projections that will rise to SR19bn by 2020.
Simon Williams, chief economist for the Middle East at UK bank HSBC, says the current fiscal environment means the government will have to address this issue at some point.
Reducing fuel subsidies would be a start but its not enough, he says. The welfare programme will need to be examined in much broader terms.
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