The squeeze on Saudi Arabia’s state finances is mounting as oil prices fall but the latest official figures suggest the world’s top crude exporter still has at least several years before it faces a budget crunch.
Brent oil sank last week below US$50 a barrel, near six-year lows, from $70 three months ago. That promises to increase the rate at which the kingdom is drawing down its foreign reserves to cover its budget deficit.
A study by a former Saudi central bank official says the world might have entered a sustained period of low oil prices, leaving Riyadh vulnerable down the road.
“Oil revenues alone are unlikely to keep pace with future spending needs,” says Khalid Alsweilem, a former chief investment officer of the central bank and now a fellow at the Harvard Kennedy School’s Belfer Center in the United States.
But central bank data released last week showed the kingdom is still far from any fiscal crisis. Net foreign assets at the bank – the best indicator of Riyadh’s fiscal strength, since the bank acts as a sovereign wealth fund – fell $59.8 billion from the end of 2014 to $664.5bn in June.
Brent oil averaged $60 during the first half of this year. If it now stays around $50 and the government continues spending at current record levels, the pace of reserve depletion will increase, perhaps to around $140bn annually.
The country faces a challenge in Asia as it battles to maintain market share: the Russians are coming and other Opec members want a bigger slice.
It is a market the Saudis have vowed to defend, leading the decision by the Opec to sustain output as surging US production crippled prices and pushed cargoes to Asia. While the origins of this competitive shift started with the American shale boom, the return of Iranian exports poses another test for the kingdom.
“No other region needs more oil in the future than the Asia Pacific,” says Sushant Gupta, the head of Asia downstream research at Wood Mackenzie in Singapore.
“It’s an absolutely important market for Saudi Arabia.”
Asia is the biggest export destination for Saudi Arabian crude and its share of the market was about 65 per cent in 2014, according to Wood Mackenzie. In China, the world’s second largest oil consumer after the United States, Russia and Iraq have emerged as key rival suppliers.
While the Saudis face fierce competition in China, the kingdom has a firm hold on South Korea, commanding about a third of the market as other Opec members battle for share. Qatar is challenging Kuwait for the number two spot after Iran slipped out of the top five.
Japan is a tale of the top two. Like South Korea, Saudi Arabia has consistently held about a third of the market but the UAE is closing the gap. Iran drifted out of the top five in 2012 as Russia clawed back share and Kuwait maintained a steady stream of cargoes.
“The Asia Pacific will require a lot more crude and producers really need to be on the front foot to secure the demand for their own oil,” Mr Gupta says.
Saudi authorities will want a minimum level of fiscal reserves to reassure financial markets they can protect the Saudi riyal’s peg to the US dollar. They have not disclosed that level, but 18 months of imports – more than twice the import cover of most countries – would work out to about $225bn.
Such calculations suggest that at $50 oil, Saudi Arabia could carry on as it is for about three years without being forced into major spending cuts.
Riyadh’s July decision to resume issuing sovereign bonds for the first time since 2007 could extend that time frame, perhaps reducing reserve depletion by some $50bn a year, depending on which private sector funds were used to buy the bonds.
With public debt of just $12bn or 1.6 per cent of GDP at the end of 2014, Riyadh has plenty of room to issue bonds. It could cover two years of record budget deficits entirely with bonds and still have a low debt level by international standards.
So, while low oil prices are uncomfortable, they are not yet a game-changer for Saudi Arbia – and for now at least, budget pressures alone do not look likely to force Riyadh to reconsider its decision last year to let oil prices fall as it seeks to protect market share.
“There is no short-term crisis – Saudi Arabia’s ability to cover the fiscal deficit is still strong,” says Monica Malik, the chief economist at Abu Dhabi Commercial Bank.
Financial markets agree. The riyal forwards market shows no sign of jitters over the currency; credit default swaps, used to insure against a sovereign debt default, are lower than they were at end-2014 and at levels seen in late 2013, when oil prices were sky-high.
Standard and Poor’s cut its credit outlook for Saudi Arabia in February to negative from stable. But Moody’s and Fitch have kept their outlooks stable, on the grounds that Riyadh’s financial reserves will let it weather a period of cheap oil.
Ms Malik says any concern about Saudi finances stem from the fact that two key variables are moving in the wrong direction: oil is falling, while the government has not yet started to restrain spending or shown how it would do so.
So she and many economists think Riyadh will start reducing spending in some areas as soon as next year. A young and growing population means little or no scope to cut social services; instability in the region will keep spending on security high.
But elsewhere there is room to save considerable amounts of money. One-off handouts to the population, such as bonuses to state employees and pensioners to mark the accession of King Salman in January this year that cost some $25bn, are likely to decrease.
Bigger savings could come from starting to bring down the state’s huge spending on energy subsidies, which will total $107bn this year, the IMF estimates.
Raising petrol and electricity prices would be politically sensitive, though the UAE has done both this year. The Saudi government has shown it is willing to tackle economic reform in some areas such as taxing land.
State capital spending, which Mr Alsweilem said jumped to $83bn in 2013 from $10bn in 2004, could be cut in some areas without hurting the economy. Construction industry sources say some low-priority projects, such as a plan to build football stadiums around the country, have already been scaled back.
There may also be a new emphasis on generating non-oil revenues. Mr Alsweilem proposed the creation of two new sovereign wealth funds to earn returns on the kingdom’s money, while introducing new fiscal rules to decouple state spending from oil revenues.
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