Mohammed Al-Jaadan’s first budget as finance minister provided an interesting exercise in expectation management and spin. The government tried to present the budget as an expansionary one, allowing the kingdom to catch its breath after several years of tough austerity which have strained the social contract between the Al-Saud and their citizenry. However, analysis of the detail suggests the reality is rather different.
The figures in the official statement, published on 22 December, said spending would rise by 8% this year to SR890bn. But this is only true if one ignores some SR105bn that was spent in 2016 that hadn’t been included in that year’s budget. (This comprised mostly delayed payments to contractors.) Taking such details into account, this year’s spending plans represent a 4% cut compared to 2016 and more austerity is likely to lead to another year of underwhelming economic performance.
Most observers expect growth of just 1%-2% in 2017, adding to pressures – now widely expressed by Saudi citizens – on the architect of economic reform, Deputy Crown Prince Mohammed Bin Salman (MBS).
“We don’t classify the 2017 budget as expansionary. The plain fact is that the government says it will spend less this year than it did in 2016,” said Samba bank deputy chief economist James Reeve.
Saudi budgets rarely stand the test of time; the government tends to overspend and, during the boom years at least, it also wildly underestimates how much revenue it can draw in from oil sales. Between 2012 and 2016, the government spent SR1trn more than it had budgeted. This year’s budget seems to be based on an average oil price of anywhere between $50/barrel and $62/bbl, according to various economists surveyed by GSN.
The government has not released its average oil price figure, despite boasting of increased transparency around the budget process. A $50-62/bbl guide price wouldn’t leave any room for error, given that crude is currently trading close to $55/bbl, Iran is ramping up output and US oil shale producers will respond strongly to any further rises.
Education and defence spending cuts
Other aspects of the budget also raise questions. The two biggest areas of spending are, as usual, security and education; both are being pared back. Education spending is due to be cut by 3% to SR200bn which ought to be manageable. Defence spending – which is split in the budget between military costs, and security and regional administration – is due to be reduced by 6%, from SR306bn in 2016 to SR288bn this year. That comes despite the cost of prosecuting wars in Yemen, Syria and countering the threat of instability in Iraq, and rising regional tensions between Riyadh and Tehran. Trying to curtail military spending in such an environment is, at the very least, ambitious and probably unrealistic. Other areas are due to see a sharp acceleration in spending. The government’s outlay on health and social development is earmarked to climb 19% to SR120bn, while infrastructure and transport will benefit from a 39% increase to SR52bn.
Overall, the government says its plans will result in a deficit of SR198bn, equivalent to 7.7% of GDP. Others suggest it will be bigger. Dubai-based Emirates NBD’s head of Middle East and North Africa research Khatija Haque calculates the deficit will come in at SR256bn, or 9.6% of GDP. Samba also thinks the deficit will be slightly above official estimates. “I would expect the budget deficit to be somewhat larger than the authorities are forecasting, but not materially so,” Reeve said.
Barring unforeseen set-backs, the deficit should be lower than in recent years; it was 15.9% in 2015 and 13% last year. In the longer term the government is aiming for a small budget surplus by 2019 or 2020. Whether it will hit that remains to be seen, but it won’t be a surprise if it misses – the government continues to be in a very tight spot.
Despite the austerity measures implemented to date, spending requirements remain huge and any substantial rise in non-oil revenues remain elusive. The government is eyeing up the introduction of a value-added tax (VAT) sometime in 2018, in line with other Gulf Co-operation Council (GCC) states; it has identified a number of other areas where income can be raised, including more levies on employers with foreign workers and a ‘sin tax’ on sugary drinks and tobacco products. It is unclear how much these measures will bring in – and there are concerns they could contribute to inflation and fuel disquiet about the economy’s underperformance and lack of decent prospects for many locals.
Growth is constrained
The recipe of measures announced – including the Organisation of Petroleum Exporting Countries (Opec) production cut agreed in December – means the economy is likely to have another underwhelming year in 2017. Capital Economics reckons the economy will grow at its slowest pace since the global financial crisis. Last year’s growth of 1.4% was driven by the oil sector, thanks to higher output and a firming up of prices.
In contrast, the non-oil sector had its worst performance since the late 1980s, with the austerity programme capping growth at just 0.2%. This year the situation is likely to be reversed. Oil output will fall in H1 2017, assuming the Opec deal is adhered to, but the non-oil sector has a chance of bouncing back a little. The issue of late payments to contractors in the construction sector is being slowly addressed and the next wave of subsidy cuts is being held off until a new system of compensation for poorer households is up and running. But this will just be a temporary respite. The government says that to meet its balanced budget target it wants electricity, fuel and water prices to be at market levels by 2020 – and billions more are due to be slashed from ministerial budgets by then. The government has hired consultancy firm PwC to cut $20bn from its project spending, Bloomberg reported on 9 January.
That report followed rumours that rival consultancy firm McKinsey & Company had fallen somewhat out of favour in Riyadh. McKinsey had been closely linked to MBS’s Vision 2030 plan (GSN 1,014/4). Many Saudis see that programme lying at the heart of the austerity drive. (McKinsey insists it “did not formulate the government’s Vision 2030 and any reports suggesting otherwise are inaccurate”.)
The big question is whether Al-Jaadan and his colleagues will be able to hold their nerve. Abdullah Bin Abdulrahman Al-Hussein lost his job as water and electricity minister after the first wave of water price reforms in April 2016 (GSN 1,014/9). The government says it has learnt lessons from the first phase of price reforms and that there will be no more water price changes until the metering and billing systems are able to cope. Other ministers know that if any more problems emerge, responsibility will be laid firmly at their feet rather than with the strategy or its principal advocates.