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| 22 May, 2018

State budget deficit raises risks for Saudi economy

Non-oil revenues grow but expenses jump due to growth in subsidies, debt payments and benefits

A man walks past the Kingdom Centre Tower in Riyadh, Saudi Arabia April 12, 2016.

A man walks past the Kingdom Centre Tower in Riyadh, Saudi Arabia April 12, 2016.

REUTERS/Faisal Al Nasser

While Saudi Arabia’s latest budget figures show progress in terms of growth in non-oil revenues, a bigger deficit (on the back of soaring expenditure) still poses risks to the long term health of the kingdom’s economy.

Saudi Arabia’s budget deficit reached 34.3 billion Saudi riyals ($9.15 billion) for the first quarter of this year, or about 18 percent of the total projected for 2018, according to the finance ministry.

Revenues in the first quarter stood at 166.3 billion riyals, up 15 percent compared to the same period last year, but total spending reached 200.6 billion riyals - up 18 percent.

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“In addition to higher oil revenues, the non-oil income generated by the government has increased above expectations. Taxes have been the main driver,” Cyril Widdershoven, an economics and energy partner at Verocy, a consultancy firm advising on investment risks in the Middle East, told Zawya by email.

The introduction of value-added-tax (VAT) earlier this year, along with the levying of fees on dependents of expatriates, boosted the kingdom’s non-oil revenue to 52.3 billion riyals in the first quarter, up by 63 percent from the same period last year, according to the Ministry of Finance.

“The above picture means that the overall financial and fiscal map of the Saudi budget looks more promising than has been expected,” Widdershoven said.

Looking at possible higher oil prices, due to the ongoing OPEC-Russia production cut agreements and taking into account the possible removal of Iranian volumes from the market, prices are expected to remain higher, Widdershoven said.

“This, for sure, if majority of OPEC is not going to open up the taps to fully counter the Iranian issue,” he added.

“However, there is a risk that part of the increased revenues will be used for higher compensation for civil servants (including army) and social benefits,” he noted.

In percentage term, the largest increase in expenditure was in subsidies, which grew to almost 3 billion riyals, from just 46 million riyals in the same quarter last year.

Financial expenses rose by 229 percent in the first quarter of this year to over 4.1 billion riyals, mainly due to the servicing of increasing public debt, according to a report by National Commercial Bank (NCB).

Another category which witnessed a major increase in expenditure was social benefits expenses, which climbed by 184 percent. NCB’s note said this was largely a result of rises in cost of living allowances and the Citizen’s Account - a programme set up last year to help Saudi nationals facing economic hardship. According to the Saudi Gazette, some three million families and individuals have registered for the scheme.

Almost 18.8 billion riyals was spent on social benefits, NCB's report said.

“The government will need to keep an eye on its overall expenditure plans for civil servants and social benefits,” Widdershoven said.

“Even though Saudi Finance Minister Mohammed Al-Jadaan’s medium-term Fiscal Balance Program (FBP) goals for 2023 are reachable, keeping up a policy of countering taxes and reduction of subsidies by higher salaries and social benefits will not work in the end,” he added.

Cutting the budget deficit

The Ministry of Finance projected a deficit of 195 billion Saudi riyals, or 7.3 percent of gross domestic product (GDP) for the entire year of 2018, down from a 230 billion deficit in 2017. Saudi authorities plan to balance the budget by 2023.

The kingdom does not disclose the assumptions of oil prices in its budget projections, but the latest statistical report by the International Monetary Fund (IMF) raised the projected fiscal breakeven price for the kingdom to $87.90 dollars per barrel in 2018, up from $82.60 in 2017. For 2019, however, the fund projects a much lower price of $77.90 needed to balance the state budget.

A higher deficit would be a possible stumbling block for future progress and is also a risk for several reasons, Widdershoven noted.

“Firstly, oil prices and revenues are not a constant factor. Higher oil prices at present paint a picture of prosperity that could be hit hard if global market fundamentals change. To reduce debts before a new oil crisis appears is necessary,” he said.

Secondly, deficits are reasonably easy to counter at present by issuing international and domestic bonds, and the attractiveness of this is currently high, and costs relatively low, according to Widdershoven.

“If global markets, however, are going into a higher interest rate phase, the costs of counter(ing) government deficits by issuing international debt will become more costly and risky,” he added.

Stimulating growth

NCB said in its report on the Saudi budget that it expects “the significant increase in subsidies category will continue through upcoming years, as a result of the Citizen’s Account programme in order to reduce the impact of the reduction of subsidies on fuel, water & electricity and introduction of VAT on Saudi households”.

A stringent fiscal policy is needed to counter deficits, and at the same time, the Kingdom’s Vision 2030, National Transformation Plan and other programmes necessitate higher investment levels inside the Kingdom, according to Widdershoven.

“The kingdom should increasingly invest in SME sector programmes. At present, the majority of investments are still being done in oil-gas and traditional industries. There is still almost no SME sector in the country. Worldwide economic growth and diversification is always being done and supported by SMEs,” he said.

The number of small and medium-sized enterprises registered in the kingdom has declined since 2015, according to Salem Al-Zammam, the founder of economic consultancy Saudi Scope. Among the reasons for this are rising fees and the government's decision to link commercial records to social security and benefits, meaning that some small business owners who were not making a profit decided to stop trading rather than giving up benefits.

In December last year, Saudi Arabia’s King Salman bin Abdulaziz Al Saud approved 72 billion riyals ($19.2 billion) worth of measures to stimulate economic growth, which included the creation of a 2.8 billion riyal government fund to invest in smaller companies. It also included a policy of adjusting fees charged to SMEs for services, with a view to saving smaller companies up to 7 billion riyals.

“SMEs in Saudi face structural and strategic imbalance and this creates an ecosystem of obstacles and errors that would weaken any incentives programmes,” Al-Zammam told Zawya in Arabic by email.

Such obstacles include a weakness in programmes linking smaller companies to larger firms, specifically international companies operating in the Kingdom. This means SMEs lack access to innovation, opportunities to supply and potential funding from these firms, according to Al-Zammam.

“There is no integrated financing fund that brings SMEs together under one umbrella, as several countries successful in this field do. Therefore, there is an increase in the cost of financing and administrative obstacles,” he added.

The IMF projects a real GDP growth for Saudi Arabia of 1.7 percent and 1.9 percent in 2018 and 2019 respectively. The fund also expects a non-oil GDP growth of 2.3 percent and 2.1 percent respectively in 2018 and 2019, up from 1 percent in 2017.

“Building up a new economy can be done right now, as oil revenues are high, debt overall is still low, and interest in Saudi is growing,” Widdershoven said.

© ZAWYA 2018