Neutral outlook for Saudi economy in 2017

Published in MEED, 22 January 2017

Riyadh’s new budget continues the process of fiscal tightening, although capital spending will rise

The Saudi government tried its best to counter critics of its economy policy when it announced its 2017 budget on 22 December. Recently appointed finance minister Mohammed al-Jaadan presented a plan that, at first glance, involved an 8 per cent rise in spending to SR890bn ($237bn), up from SR825bn in the previous year’s budget.

However, the reality is that spending is set to fall. The actual amount spent last year was SR930bn. The difference comes from the fact that the official figures for 2016 excluded some spending – such as payments to contractors – that had been delayed from 2015.

“Based on the inclusion of these payments, there will be a 4.3 per cent contraction in government spending this year, compared with last year. So this continues the trend of fiscal tightening in our view,” says James Reeve, deputy chief economist at local bank Samba Financial Group.

There were some genuine signs of improvement, however, with revenues projected to rise 31 per cent to SR692bn. Of that, oil revenues account for SR480bn, 46 per cent higher than in 2016. That appears to be based on an average oil price of anywhere between $50 and $62 a barrel, according to economists, and a higher share of Saudi Aramco’s profits being handed to the government. Non-oil revenues are expected to rise 6.5 per cent to SR212bn.

The combination of a rise in revenues and a relatively small dip in spending means the deficit could half in size next year to SR198bn, equivalent to 7.7 per cent of GDP. That is a potentially significant step on the way to the government’s aim of achieving a balanced budget by 2020 under its fiscal balance programme.

The figures for the coming year may yet turn out to be overly optimistic, however. Saudi budgets always need to be taken with a large pinch of salt, as the government has a long track record of underestimating its revenues and expenditures. For this year, Dubai-based Emirates NBD says it expects revenues to come in slightly higher at SR694bn, but expenditure to be significantly greater, at SR950bn, leading to a budget deficit of SR256bn, or 9.6 per cent of GDP.

Even with these caveats in mind, the budget still offers a useful insight into government priorities. And, according to some observers, it should lead to a year of relative economic stability, with growth predictions ranging from 1-2 per cent, in line with the 1.4 per cent achieved in 2016.

“Saudi Arabia’s budget suggests that, following a significant improvement in public finances over the past couple of years, the fiscal stance will be broadly neutral in 2017,” says Jason Tuvey, Middle East economist at the UK’s Capital Economics. “The economy should embark on a gradual recovery.”

Other observers take a similar, cautiously optimistic, stance. “We don’t expect a significant boost to growth from increased spending in 2017,” says Khatija Haque, head of Middle East and North Africa research at Emirates NBD. “However, the drag on growth from last year’s spending cuts is also unlikely to be repeated, if the oil price meets our forecast of $55 a barrel this year.”

Among the more notable aspects of the budget is a commitment to increase capital expenditure. Cuts to project spending over recent years have been a significant contributor to a wider economic slowdown and to problems at large contractors including Saudi Binladin Group and Saudi Oger. The local Jadwa Investment estimates that capital spending will be raised significantly to SR260bn in 2017, compared with just SR76bn in the 2016 budget.

Spending in some key areas is due to decline in the year ahead, however, including in the two largest areas of the budget: education and security. Education expenditure is due to fall by 2.7 per cent to SR200bn, compared with SR206bn in 2016.

Meanwhile, military spending is projected to fall by 7 per cent to SR190.1bn, and the closely related security and regional administration spending is earmarked to drop by 4 per cent to SR96.7bn. These two lines of the budget are particularly susceptible to change – if the conflict in Yemen continues on its current path and if other regional security challenges flare up, Riyadh is likely to be forced to increase rather than cut its military outlays.

Other areas are due to benefit from a rise in their budget allocation. The biggest increase is earmarked for municipality services, where spending is due to grow to SR47.9bn in 2017, almost double the SR25bn figure from last year. This covers the Ministry of Municipal & Rural Affairs as well as various municipalities around the country.

Other areas to see significant rises include healthcare and social development, where spending will climb by close to 19 per cent to SR120bn. Infrastructure and transport will also receive a boost of almost 39 per cent, taking its spending total to more than SR52bn. This encompasses 116 schemes costing a total of SR16.6bn to build roads, railways, airports and ports, as well as the continued development of the industrial cities of Jubail and Yanbu.

The amount dedicated to what are described in the budget as economic resources and general public programmes is due to increase by 26 per cent to SR155bn for next year. This covers things as varied as the SR51bn project to expand the Grand Mosque in Mecca and the expansion of access to clean drinking water, new desalination plants and renewable energy schemes.

The budget also includes an additional SR42bn in funding for initiatives under the National Transformation Programme (NTP), up from SR9bn in 2016. A further SR217bn is due to be spent on the NTP by 2020, taking the total outlay to SR268bn.

All that suggests the government is taking a more piecemeal approach to its austerity drive, even if it is still planning to cut overall spending. To date, the cutbacks have seen public spending reduced by a cumulative 25 per cent over the past two years. However, Tuvey says that if the kingdom is to hit its target of a balanced budget by 2020, there will need to be more fiscal tightening in the years ahead. “While austerity seems to have been put on the back-burner, it is likely to resume from 2018,” he says.

The government is being helped by the steady rise in oil prices over the past year and its coffers will also benefit from the planned introduction of more non-oil revenues, such as a ‘sin tax’ on harmful products such as tobacco and sugary drinks from the second quarter of 2017 and value-added tax (VAT), which is due to be introduced in early 2018. The government is also raising more from levies on firms hiring expatriate workers. Overall, it says these additional revenues should bring in SR152bn a year by 2020.

Nonetheless, more debt will need to be raised and SR120bn in new bonds have been outlined in the budget. According to Jadwa Investment, that will take the national debt to SR433bn. That is equivalent to a still very manageable 16.3 per cent of GDP and the government’s medium-term approach suggests it is keen to ensure debt levels remain under firm control.

In that sense, the publication of the fiscal balance programme in December is arguably more significant than the budget itself. The programme is based on a few key ideas, such as boosting non-oil revenues, cutting government spending, eliminating misdirected subsidies and promoting private sector growth.

Subsidy reforms delivered savings of about SR27bn in 2016. That is now set to accelerate and total savings from energy and water price reforms are due to reach SR209bn a year by 2020. The government says it plans a gradual increase in prices for electricity, fuel and water for both households and businesses in the years ahead until they reach market levels. The impact will be partially eased by direct cash transfers to poorer households, along with stimulus packages to the private sector.

The government is also hoping to save SR21.4bn a year by 2020 by “rationalising” operational expenditure at the ministries of health, education, and municipal & rural affairs. A further 14 government entities are drawing up plans to make similar cuts. Riyadh is also examining some SR1.4bn of capital expenditure projects to see where cuts can be made there.

It adds up to an ambitious set of plans. Delivering on the spending priorities for 2017 looks to be fairly straightforward, but things are likely to get harder in subsequent years and the government may yet have to readjust expectations. “We don’t expect a balanced budget by 2020, but it will not be far off,” says Reeve. “A deficit of less than 3 per cent of GDP is doable.”