Saudi government largesse sends economists back to the drawing board

THE armies of economists who produced reams of analysis of the Saudi Arabia budget for 2018 back in December need not have bothered. 
Within weeks, their calculations have been turned upside down by a series of measures from the government that radically reshaped the economic outlook for this year, with some positive consequences, but others not so welcome.
The good news comes for two important constituencies: Saudi households and Saudi businesses. Both will benefit from the government’s largesse in offsetting big price rises via value added tax and the reduction of subsidies on fuel and power, even though they will have to deal with the prospect of higher inflation.
And both will also gain from the direct stimulus to the economy that results from the latest handouts, which could lift gross domestic product (GDP) growth in the Kingdom by almost a full percentage point to as much as 3.5 percent.
The less benign effects will be felt largely by policymakers who have pinned their ambitions on reaching a balanced budget by 2023, and by the strategists who want to reduce the Kingdom’s dependence on the public sector and the oil economy. The recent measures will provide a boost for public sector workers, and only indirectly affect the non-oil economy.
They will also raise the theoretical break-even price of oil to as much as $90 per barrel, more than $20 higher than it is trading today.
There is a consensus that the recent measures will provide a further stimulus to economic growth. “The handouts are likely to support more decisively economic activity,” said Jean-Michel Saliba, Middle East economist at Bank of America Merrill Lynch.
“The Saudi government looks set to loosen fiscal policy this year which should support a pick-up in economic growth,” agreed Jason Tuvey of London consultancy Capital Economics.
They are pencilling in non-oil GDP growth of around 2.5 percent this year, higher than previously estimated but still lower than the official forecast of 3.5 percent made in the budget statement last month.
The cost of living allowances announced for government and military employees will boost earnings by around 10 percent, roughly compensating for the price increases due to VAT, fuel and power, according to Saliba’s estimates.

The good news comes for two important constituencies: Saudi households and Saudi businesses. Both will benefit from the government’s largesse in offsetting big price rises via value added tax and the reduction of subsidies on fuel and power. 

Frank Kane

That is a direct and positive stimulus to the spending power of public sector employees, but the overall effect on the economy — increasingly driven by consumer spending — will not be as great as it would have been without the recent price hikes.
“While the government is loosening fiscal policy this year, the overall impact of households is likely to be neutral. As a result, we expect household spending to remain sluggish in 2018 and a weak spot in the broader economic recovery,” said Tuvey.
One other significant effect of the increases will be felt by expatriate workers in the Kingdom. Not only will they not receive the benefit earmarked for Saudi citizens, but they will also have to pay VAT and higher fuel prices, while also contending with the increased expat levy this year, totaling SR400 ($106.6) per month. What effect this will have on foreign direct investment remains to be seen. “Expatriate households look set to be the main losers,” said Tuvey.
On a macro-economic level, the main effect will be to increase the public spend in the current year. The December budget statement was already regarded as expansionary, after three years of oil-price driven austerity, but subsequent additions to expenditure — by the Public Investment Fund and other government agencies not included in budget figures, even before the recent measures — guarantee a year of fiscally-led growth.
The deficit required to fund that could increase to $20 billion, according to Saliba, or 3 percent of GDP. The commitment to balance the budget in five years’ time, confirmed in the December budget statement, looks even more ambitious.
The variable, of course, is the price of oil, which has been moving steadily upwards in recent weeks. “The recent jump in oil prices no doubt reassured the authorities that they could afford to react to signs of public discontent (regarding price increases),” said Tuvey.
“The loosening in fiscal discipline exposes the budget to the volatility in oil prices. The Royal Order (granting the allowances) pushes the 2018 fiscal breakeven oil price up by about $5-7 per barrel, toward $85 to $90,” said Saliba. Not even the most bullish analysts of crude have suggested it could go anywhere near that, barring major geo-political shocks.
But weaker fiscal control does not appear to have affected how international finance sees the Kingdom’s economy, at least for the time being.
Standard & Poor’s, the credit ratings agency, continues to assess the Kingdom’s creditworthiness as “stable” with grades of A- and A2. “We think the risks emanating from recent shifts in Saudi Arabia’s political power structures and societal norms, alongside various regional stresses, are balanced by the possibility that these structural reforms could empower Saudi citizens and make Saudi Arabia more attractive to investors over the medium term,” said S&P analyst Trevor Cullinan.

• Frank Kane is an award-winning business journalist based in Dubai. He can be reached on Twitter @frankkanedubai