Article source: gulfnews.com
Yet the slide in oil prices to below $60 a barrel means Riyadh is likely to report an “eye-watering” budget deficit of 17.5 per cent of gross domestic product this year, about $130bn, according to Capital Economics.
This is a sharp increase on the 2014 deficit of 2.3 per cent and the biggest shortfall since the early 1990s.
The reversal has coincided with a slide in Saudi Arabia’s foreign exchange reserves from a peak of $745.8bn in August 2014 to $686.4bn as of the end of April.
A simple rule of thumb suggests that, if nothing changes, these prodigious reserves will run dry in about five years (technically Riyadh does not use its FX reserves to fund its deficit, as some believe, but its holdings with the central bank, which it does use, would also disappear in five years at their current rate of depletion).
So, barring a dramatic rebound in oil prices, how shaky are the kingdom’s finances?
Saudi Arabia’s balance of payments position had, in fact, already started to deteriorate long before the slide in oil prices.
Figures from Capital Economics suggest that capital inflows peaked at 6 per cent of GDP just before the financial crisis and had turned negative by 2011. Outflows are now running at 8 per cent of GDP, a swing of 14 per cent of GDP.
This suggests that even a strong rebound in oil prices might not be enough to prevent further falls in the country’s FX reserves.
Three factors appear to be behind this deterioration in capital flows.
First, before the fall in oil prices, strong economic growth sucked in imports, reducing Saudi Arabia’s current account surplus.
Second, Jason Tuvey, Middle East economist at Capital Economics, notes that foreign direct investment inflows have fallen from almost 10 per cent of GDP before the financial crisis to just over 1 per cent at the end of 2014.
Tuvey says the reason for this is unclear, but “one possible explanation is that the opportunities created by Saudi Arabia’s decision in 2005 to ease foreign investment limits have now been exhausted”.
Alternatively, he suggests investors may have become concerned that the economy is increasingly reliant on high oil prices in order to generate economic growth.
Third, Tuvey notes that outflows of portfolio and other investment have “picked up sharply” since 2013.
“Lower oil prices, an overvalued domestic stock market and political uncertainty across the region appear to have triggered Saudi-based investors to buy up assets elsewhere in the world,” he says.
Although the recent opening up of the Saudi stock market to foreign investors could help offset this, few are holding their breath.
The deterioration in the finances of the government itself has been largely driven by two factors. Rather obviously revenues have been hit by oil prices falling below the $105 a barrel Riyadh needs to balance its books.
However expenditure has also been pushed up by bonus payments handed out to state employees and the military by the new king, Salman bin Abdul Aziz Al Saud, who was crowned in January.
This at least gives hope that the budget deficit will be somewhat smaller in 2016, assuming the handouts are not repeated.
Beyond that, Tuvey believes Riyadh can ride out low oil prices for two or three years, and can therefore afford to tighten fiscal policy relatively gradually, rather than dramatically slashing spending as it did when oil prices tumbled in the 1980s.
He also believes there is room for tax rises. At present Saudi nationals pay no income tax, other than a mandatory charitable donation of 2.5 per cent of their wages, known as zakat. The kingdom also has no valued added tax, despite periodic talk of a Gulf-wide system being established.
When it comes to spending cuts, he sees the axe falling on capital expenditure, which accounts for about a third of public spending, just over 10 per cent of GDP.
Riyadh has form here. In the early to mid-1990s it slashed capital spending by 98.6 per cent in the wake of the first Gulf war.
John Sfakianakis, director for the Gulf region at Ashmore Investment Management, agrees with this prognosis, but says Riyadh should also cut down on military expenditure, which accounts for a further 34 per cent of government spending.
Whether this will happen at a time when Saudi Arabia is engaged in military action in Yemen, when Islamic State of Iraq and the Levant, known as Isis, is operating close to its borders, and when Iran may be newly strengthened by rapprochement with the west, is a moot point.
The Saudi Arabian Monetary Agency, the central bank, did reveal on Sunday that the government had issued its first bonds since 2007, raising $4bn from local investors.
The country has ample room to go down this route, with gross government debt standing at just 1.6 per cent of GDP at the end of last year, a far cry from the 100 per cent-plus levels reached in the 1990s.
The small size of the bond issuance, set against a projected budget deficit of $130bn, though, raises questions of its own.
Sfakianakis believes part of the purpose is to help create a yield curve for corporate debt issuance. But Sama has yet to reveal either the yield or tenor of the debt, rather defeating this purpose.
Sfakianakis speculates the paper was of “medium to long-term” duration and was snapped up by banks at a yield of about 25-30 basis points above US Treasuries.
He suggests the bond issuance may also have been designed to take “a little bit of excess liquidity” out of the banking system, to fulfil a promise from the ministry of finance that it would issue bonds this year and to “test the market” for future issuance.
Marios Maratheftis, chief economist at Standard Chartered, believes Riyadh will go further and issue bonds to international investors, building on the government’s recent move to start opening its equity market to outsiders.
Whatever happens, Tuvey foresees the likelihood of growth slowing to 1 per cent or less, from its current level of 2.4 per cent, barring a rebound in oil prices.
With its population growing at almost 3 per cent a year, this would equate to a fall in living standards and potentially increase unemployment, currently at 11.7 per cent.
Given the long-term shadow the spectre of climate change casts over oil producers, some will worry what the future holds if a young, fast-growing, religiously conservative population finds its economic options limited.