Riyadh’s budgetary dilemmas

Could the Saudi spending boom be making way for a more careful approach as economic priorities change? Published in The Gulf, February 2013

When Saudi Arabia’s finance ministry unveiled its 2013 budget in late December, it seemed that the country was set to continue with its public sector-led spending boom. The government said it was planning to spend SR820 billion ($219 billion) over the course of the year, a record for a Saudi budget. Revenues, too, were high, at a projected SR829 billion.

Among the key areas of expenditure are education, which has been earmarked SR204 billion, and health and social services which accounts for a further SR100 billion. Between them these two categories will account for 37 per cent of total spending. Transport and infrastructure will receive a further SR65 billion while municipalities will receive SR36 billion.

Greeting the announcement of the new budget, the economy and planning minister Mohammed bin Suleiman al Jasser said “continuing to give special priority to human development ... is the basis of the overall development and also promotes investment, thus giving the national economy more strength and durability.”

The picture is even more rosy once you consider that, as the government tends to base its budget on a conservative oil price, actual revenues and expenditure both tend to be far higher in reality. According to Fitch Ratings, actual revenues have exceeded budget revenues by an average of 82 per cent over the past five years, while spending has exceeded the budget by an average of 24 per cent over the past decade.

Most economists expect the government to overshoot in both areas this year too. It is thought to have based its budget calculations on an oil price equivalent to between $60 and $75 per barrel for Brent crude and production of around 9.6 million barrels per day.

With Brent currently trading at close to $110 per barrel, it means the government’s income is likely to be substantially higher than the budget suggests. In a briefing note published on 29 December, Fahad Alturki, senior economist at the local Jadwa Investment, predicted that actual revenues this year will be SR1,154 billion while expenditure will reach SR871 billion.

But all these numbers only tell part of the story. Another important element in terms of the longer-term direction of the economy is the fact that growth in government spending has started to slow, at least in terms of capital spending.

“Spending growth last year was 3.2 per cent which, given what’s gone before, is quite a slowdown,” says James Reeve, deputy chief economist at local bank Samba. “Of course that’s on the back of a 26 per cent increase the year before. From what the government said about what it spent last year, it seems current spending increased by about five per cent but capital spending probably declined a little bit. That gives a flavour of what’s going to happen in the next couple of years.

“Current spending is not going to be unduly affected, so I think retail sales will continue to grow quickly and trade and transport will continue to do pretty well. It’s more on the contracting side where I think there’s going to be a bit of a slowdown.”

There are a number of reasons why the government might put the brakes on capital expenditure. One problem is the fact that the budget breakeven price for oil has climbed steadily in recent years. This year the government is estimated to need a price of $74 per barrel to balance its budget, according to Fitch. In 2008 it could break even at just $40 per barrel.

The central bank has substantial reserves of some $635 billion which it could use to make up any shortfall, so a deficit would not cause any problems in the short term, but spending cannot keep rising indefinitely. The government will also be aware that oil prices could dip as greater output comes on stream from a rejuvenated Iraqi oil sector. In that scenario, Saudi Arabia may be forced to reduce its own output to help maintain high prices. In addition, domestic energy demand is increasing fast, which will reduce the amount that is available for export unless more reserves are discovered.

In that context, it is not surprising that Riyadh might start to re-evaluate some of its spending plans, although it is expected to be very careful how it does so lest it provoke protests from disgruntled citizens. As a result, even if capital investments do slow down, public sector employment and other areas of current spending are likely to continue apace.

“I think they’ll make every effort to expand the ministries, particularly with the uncertainties at the top of the tree at the moment and the regional situation,” says one observer. “I don’t expect any cutback in the policy of making sure graduates aren’t out on the streets. And they’re going to keep spending on wages and subsidies.”

Despite these pressures, there will be some positive aspects for the government if its budget starts to match the reality of its finances more closely. Basing a budget on an ultra-conservative reading of the oil markets, as the government has done in the past, might allow it to then announce massive growth in revenues but it can also make planning much more difficult. A price of $60 to $75 is closer to the market rate and will reduce that problem.

“Using a more realistic oil price assumption is healthy,” says Alturki. “Revenues generally provide the base from which expenditure is calculated. Unrealistically low oil revenue and spending assumptions have contributed to high levels of overspending in recent years.”

Whatever the pressures on the government, it remains in a very strong fiscal position. The Saudi finance minister, Ibrahim bin Abdulaziz al Assaf, used the opportunity of his budget announcement to give some official estimates of the economy’s performance in 2012, saying that gross domestic product (GDP) had grown by 6.8 per cent, with non-oil growth rising 7.2 per cent.

Such expansion at a time when much of the world is struggling highlights once again the fortunate position that Saudi is in due to its oil wealth.