The new norm?

Low oil prices could herald a period of spending cuts in Saudi Arabia and elsewhere in the Gulf. Published in The Gulf, February 2015

The vagaries of the oil market are starting to haunt the Gulf once again. Crude has been selling for less than $50 per barrel this year, a level that hasn’t been seen since early 2009, and governments are starting to take note.

Among those having to adjust their outlook after years of profligate spending are officials in Riyadh. According to local bank Jadwa Investment, Saudi Arabia needs oil to average $97 per barrel this year if it is to avoid slipping into the red. There are similar pressures across the GCC.

“Following a period of large current account surpluses, large deficits look set to become the new norm,” says Jason Tuvey, Middle East economist at London-based Capital Economics. “If oil prices were to stay at $50 per barrel over the next year, the Gulf’s aggregate shortfall would reach around 7.5 per cent of GDP.”

Riyadh is in many ways in the most interesting position. It is the largest oil producer, but it also has the largest economy and the biggest population to worry about. Any problems that other Gulf states are experiencing are magnified several times over in Saudi Arabia.

As is often pointed out, Saudi Arabia does of course have huge financial reserves to fall back on. The Saudi Arabian Monetary Agency, the central bank, has $730 billion of foreign assets, equivalent to 100 per cent of GDP. Even if it doesn’t want to dip into those savings it can issue bonds. Debt is currently around 1.6 per cent of GDP so there is plenty of breathing room there.

Even so, the collapse in crude prices will be giving policy makers in Riyadh pause for thought. To date they have been sticking to the lavish spending plans that have become the norm over recent years, but there are signs that a change of approach is in the pipeline.

The recent budget, endorsed by the cabinet on 25 December, includes spending of SR860 billion ($229 billion), up slightly on the SR855 billion in last year’s budget. However, the government tends to heavily overspend so these figures should not to be taken too literally. Last year the actual outlay was SR1,100 billion.

The difficult thing is judging if the government will again overshoot this year or rein things back. Opinion is divided among onlookers. Local bank Samba says spending is likely to increase by seven to eight per cent compared to last year, but economists at Citigroup are forecasting expenditure will decline by 18 per cent this year, with the axe falling mainly on capital spending.

The government also tends to use a conservative oil price when predicting its revenues for the year ahead, but the recent slump means that is not the case today. The budgeted revenues of SR715 billion suggests the government is assuming a price of around $60 per barrel according to economists. At the time of writing that was well above the market rates.

Unless prices rise very quickly, a large budget deficit seems all but inevitable. Jadwa Investment says that even with an average price of $79 per barrel the government will suffer a shortfall of SR167.6 billion this year.

“It was another expansionary budget with spending maintained at a very high level, underscoring the government’s determination and ability to support economic activity despite the prevailing subdued oil pricing environment,” says Fahad Alturki, chief economist at Jadwa. “The decline in oil prices will mean a narrowing current account surplus and a larger-than-budgeted fiscal deficit.”

What makes the ongoing oil price collapse unusual is that Saudi Arabia has done nothing to try to reverse the trend. Riyadh is one of the few countries that can adjust its oil production on a scale that can swing the market. But instead of cutting output to protect prices, it seems to be playing a longer-term game of protecting its market share against the threat from US shale production.

In an interview with the official Saudi Press Agency on 18 December, petroleum & mineral resources minister Ali al Naimi said “it is difficult, if not impossible, that the kingdom or Opec would carry out any action that may result in a reduction of its share in market and an increase of others’ shares.”

All this highlights the government’s continued failure to diversify the economy. Despite massive investment in infrastructure, education and the like, the country is still heavily dependent on oil and gas income. Hydrocarbons account for 85 to 90 per cent of government revenues and government spending is in turn the main engine driving the economy forward - if that is cut back heavily, it could lead to a more general slowdown.

There were already signs that the Saudi economy was starting to lose momentum. Capital Economics suggests the economy grew by three per cent year-on-year in November, its slowest pace since 2009.

For other Gulf countries the situation is rather more uncomfortable. Bahrain and Oman are the most exposed to low oil prices and have little in the way of savings to fall back on, but all the countries are suffering. Citigroup says it expects government spending to fall sharply across the GCC this year.

If spending is cut too aggressively, particularly on items of current expenditure like subsidies and government salaries, the risk of social and political unrest will also rise.

Much hinges on what happens to oil prices, but the latest predictions from analysts do not offer much comfort, with most forecasts ranging between $55 and $70 per barrel over the course of this year. Ratings agency Moody’s Investors Service is at the lower end of that range, predicting $55 per barrel this year, rising to $65 in 2016 and $80 for the medium term.

“We see no catalysts that would change the supply-demand equation in the near term,” says Steve Wood, managing director for corporate finance at Moody’s.

With all of this, some historical perspective is worthwhile. In 1999 oil sold for an average of just $18 per barrel and Saudi government debt was 100 per cent of GDP. The fiscal pressures may be building up again, but the government has at least built up its savings since then, even if it hasn’t managed to reduce its dependence on oil.