Saudi Arabia: As IMF warns over budget target, Vision 2030 faces deep challenges

Published in GSN, 25 May 2017

Riyadh has been gently criticised by the International Monetary Fund over its plan to deliver a balanced budget in the next few years, which the IMF believes could harm the economy’s growth prospects. The idea of a balanced budget by 2019 or 2020 forms the centrepiece of the government’s Fiscal Balance Programme, which is part of the wider Vision 2030 strategy drawn up by Deputy Crown Prince Mohammed Bin Salman (MBS) and his expensive array of international consultants. As more independent economists come to crunch the numbers associated with the expensively compiled and publicised programme, questions are being asked about whether the Vision 2030 programme is sustainable; whether it could just as well undermine as boost the political ambitions of its author, MBS; and whether it could lead to unexpected outcomes that will impact on the kingdom’s longer term stability.

The IMF rarely criticises the kingdom – a major financier and influential player behind the scenes. In a statement issued on 17 May following a visit to the kingdom, Tim Cullen, head of the IMF delegation to Saudi Arabia, said “The target of balancing the budget… does not need to be met in 2019 as set out in the Fiscal Balance Programme given Saudi Arabia’s strong financial asset position and its low debt. A more gradual fiscal consolidation to achieve budget balance a few years later would reduce the effects on growth in the near-term while still preserving fiscal buffers to help manage future risks.” Cullen suggested the government should only gradually implement energy price reforms, to give households and businesses more time to adjust – ironically, a strategy more in keeping with the kingdom’s traditional conservatism than the Washington multilateral’s espousal of market economics.

Critics are starting to ask deeper questions about the direction of Vision 2030 and the calculations underpinning it. According to a widely respected political economist, economic pressures arising from Vision 2030 could lead to a politically costly riyal devaluation within three to five years. What he sees as incoherent policies, drawn up by diverse advisors each seeking to please their sponsor, MBS, could hike inflation and prices. Economic pitfulls could, in turn, undermine MBS’s ambitions to lead Saudi Arabia in decades to come. A failure of Vision 2030 might comfort potential dynastic rivals from Crown Prince Mohammed Bin Nayef down and quieten concerns that King Salman Bin Abdelaziz might promote his favoured son to become heir apparent sooner rather than later (GSN 1,036/16).

The period of Al-Saud collective rule that typified the kingdom between 1962 and 2015 “is well and truly over”, the political economist argued. Other academic observers agree with this analysis, arguing that the Al-Salman have created a very centralised power structure. This promotes accelerated decision-making by previous Saudi standards, but quick decision-making can also misfire – as the recent U-turn on public sector wages suggests. Wrong calls will test whether MBS and his policies are indeed as popular among the predominantly young population as officially sanctioned opinion polls suggest – or whether they could trigger a backlash.

One problem with Vision 2030, critics say, is that there is little buy-in from some 3.5m state employees (who are not incentivised by the plans in their current format) and little bottom-up impetus for change. These criticisms are being voiced on social media, which suggest a groundswell of opposition could develop. But over-focusing on Twitter may lead to overstating the extent of opposition, an academic Saudi-watcher says. Saudi Arabia is clearly confronted by a generational divide, and this expert is among those who believes there is widespread identification with MBS among under-30s. This is the key demographic, in an economy whose working age population is growing at around 2%/yr.

It’s the oil price stupid

The success of Vision 2030 is based on accelerated non-oil growth, but the chances of Riyadh balancing its books in the next two or three years (and probably much longer still) hinges on the direction of oil prices. Organisation of Petroleum Exporting Countries (Opec) ministers were expected to stick with their broadly successful policy of production cuts when they met in Vienna on 25 May, as GSN went to press. But while positive signals from Vienna would serve to firm the price, Brent crude (as quoted for its International Commodities Exchange July 2017 contract) stood at only $54.02/bbl as of 22 May, and few pundits expect a major sustained hike upwards.

The extent that oil revenues remain critical for the economy was underlined by Ministry of Finance data published on 11 May; the MoF’s first ever quarterly budget statement showed a 115% rise in oil revenues compared to Q1 2016, contributing to a 70% fall in the budget deficit to SR26.2bn ($7bn). The rise in oil revenues to SR112bn was due to the rebound in prices over the past year, rather than any major changes in output; it highlights the continued dominance of oil for government revenues. Non-oil revenues rose by only 1% to SR32bn.

The MoF’s next quarterly report is unlikely to be quite as positive, given the kingdom’s commitment to oil production cuts agreed via Opec and the recent U-turn over civil service allowances (GSN 1,035/1). Wages and salaries – the largest single item among government expenses – were down by 5%, or SR5.1bn, in Q1 17 compared to the first quarter of last year. The government has estimated that reinstating public sector allowances as announced by King Salman on 22 April, will cost SR7bn over the rest of this year.

The figures show an economy which is still, and will remain, deeply dependent on the state and its oil rents. Vision 2030 is based on an accelerated role for the private sector, in generating tax yields as well as contributing to output, in the next four years. However, critics argue this could add to pressures. The political economist suggested that achieving its fiscal targets “could bring deep recession”. He calculated a 2.5% shrinkage in 2017-18 if the authorities do all they said in the fiscal balance programme, which would “take a huge share of private sector demand out of the system”.

This could hasten Saudi Arabia’s unhooking from the long-standing dollar peg. Although such a move is consistently denied, analysts observe that western hedge funds have taken increasingly substantial short positions betting against the riyal. A devaluation still may not be immediate, but could happen in the medium-term, at which stage it could create socio-economic disruption, even if these pressures do not in themselves bring down the wider system.

Increased borrowing

The Q1 deficit has been financed by withdrawing cash held at the Saudi Arabian Monetary Authority (Sama – central bank), which has also been financing spending by MBS’s favoured vehicle the Public Investment Fund. While Sama’s reserves (including overseas assets and riyal-denominated deposits) are in decline, substantially more international and local borrowing is expected. In a year marked by substantially increased emerging markets sovereign borrowing, investment bank JP Morgan in a report published on 9 May, forecast that “for the remainder of the year, we expect the largest issuance to continue to come from the [Gulf Co-operation Council] GCC region, as well as a pick-up in issuance from Asia, namely Saudi Arabia ($6bn), Malaysia ($5bn), Indonesia ($4.5bn) and Abu Dhabi ($4bn)”.

No wonder banks are excited. Saudi Arabia raised $17.5bn from a conventional sovereign bond last October – the largest ever raised by an emerging markets borrower, eclipsing the previous record-holder, Qatar. 
As well as another conventional bond, Riyadh is planning to tempt fixed income investors with a dual-tranche Islamic sukuk, carrying five- and ten-year maturities, in the coming weeks. According to the prospectus, 51% of the bond proceeds will go into a mudaraba agreement (Islamic investment management partnership), with the rest channelled into a murabaha facility by the trustee, Cayman Islands-incorporated KSA Sukuk Ltd, to purchase Sharia-compliant commodities. Reports observed that this hybrid structure replicates a riyal-denominated sukuk launched by Saudi Aramco in early April. The bond’s global co-ordinators are Citigroup, HSBC and JP Morgan, with BNP Paribas, Deutsche Bank and NCB Capital as lead managers and book-runners.

U-turn, we all turn?

The cost of reinstating public sector allowances is not necessarily a great problem in itself, despite its SR7bn price tag – unless it heralds a lack of commitment to other reform efforts. “From a fiscal point of view we don’t think [the revised policy on allowances] changes the picture significantly because the revenue performance was much stronger in the first quarter,” said Moody’s Investors Service head of Middle East sovereigns Steffan Dyck: “We think it’s more a risk from the perspective that it sends a signal.”

Other areas of spending have remained more tightly controlled, or, ironically, have benefitted from the state’s inability to implement projects. Local bank Jadwa Investment estimates that only SR29bn of the SR231bn capital expenditure planned by the government this year was spent in Q1 17.

Such details may bolster the view that the government is pushing ahead with fiscal adjustments too quickly, while making big promises that cannot be delivered. Levels of delivery remain poor, while those spending cuts and price hikes that are implemented threaten relative deprivation for millions of poorer Saudis. The political economist points to the Nielsen Global Survey of Consumer Confidence and Spending Intentions which shows that Saudi consumer confidence indicators are in decline, despite the oil price upturn.

Anecdotal evidence suggests that measures like the planned Saudi Arabian Oil Company (Saudi Aramco) initial public offering (IPO) have little public support, including among employees. Neither will they provide massive fiscal support: depending on how it is priced, the Aramco IPO could be worth less than one year’s drawdown of foreign reserves at Sama’s rate of spending. Commerce and investment minister Dr Majed Bin Abdullah Al-Qasabi on 20 April told a panel at the Centre for Strategic and International Studies in Washington that winning and sustaining the buy-in of stakeholders and constituents was a core requirement for Vision 2030’s success. The ability of bodies like the previously under-performing PIF and the support of public sector employees will be essential to make this work.