Fitch Ratings-Hong Kong/London: Saudi Aramco's IPO will have little direct fiscal effect, but could help offset the economic impact of renewed government austerity measures by allowing the Public Investment Fund (PIF) to boost domestic investments, Fitch Ratings says. The effect on Saudi Arabia's external balance sheet will depend on the nature of PIF investments and the sources of financing for the IPO.
The IPO could generate proceeds of around SAR90-96 billion (USD24-26 billion or 3% of GDP) at the indicative valuation range of USD1.6-1.7 trillion. These proceeds will flow to the PIF, which will use them for domestic and foreign investments. The funds will be small relative to medium-term financing needs and we will not treat them as government revenue in our sovereign rating analysis.
We expect PIF's investment focus to be mainly domestic, which could help non-oil growth, although there is some risk of the private sector allocating capital to the IPO at the expense of other domestic investments. PIF's capacity to invest is also being augmented by the sale of a 70% stake in Saudi Basic Industries Corporation (SABIC) to Saudi Aramco for USD69 billion agreed in March, PIF debt issuance and dividends from its listed domestic equity holdings.
This could mitigate the impact from renewed central government austerity. October's pre-budget statement signalled an intention to refocus on budget discipline, planning a 3% yoy spending cut in 2019, and a further 9% cut by 2022 (more than 3% of non-oil GDP per year or cumulatively SAR120 billion by 2022). This would be negative for economic activity, although we think the government may struggle to achieve the envisaged cuts.
However, the timeline and economic impact of announced PIF projects is uncertain. They include a large theme park complex outside Riyadh, tourist developments on the Red Sea coast and Saudi Arabian Military Industries, a defence company launched in 2017 that is a key pillar of the Saudi Arabia's industrial development strategy.
Using the IPO proceeds for PIF investments abroad or domestic investments with high import content could put pressure on Saudi Arabia's official foreign exchange reserves, although this would be offset to the extent that the IPO attracts new foreign capital or repatriation of foreign assets by Saudi residents. Reserves, which we forecast at about USD500 billion at end-2019, have increased only slightly in the last two years despite large current account surpluses and debt issuance. This is partly because PIF and other public sector entities have bought foreign assets.
Foreign investments are a small but growing portion of total PIF assets (SAR980 billion at end-2018). The strategic nature and illiquidity of PIF investments may limit their availability for fiscal and current account financing in the near future. We do not consider the PIF as part of Saudi Arabia's general government sector and do not include its foreign investments in our measure of sovereign net foreign assets (SNFA), forecast at 74% of GDP in 2019. SNFA are still one of the highest among Fitch-rated sovereigns, supporting Saudi Arabia's score in our quantitative Sovereign Rating Model. The PIF does contribute to Saudi Arabia's strong overall public sector balance sheet (reflected in an upward adjustment of two notches in our Qualitative Overlay).
However, additional debt issuance by Saudi Aramco, for example to meet promised dividend payments or to fund the purchase of SABIC, will contribute to rising GRE debt, albeit from low levels, and the deterioration of the public sector balance sheet, alongside growing government net debt. This was one driver of our downgrade of Saudi Arabia to 'A'/Stable in September 2019, alongside regional geopolitical and military tensions. It remains a negative sensitivity.
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