All eyes on KSA’s first budget since Vision 2030 reform plan

Economists expect Saudi Arabia’s 2017 budget to include further spending cuts, but that these will be less severe than this year, after the government likely succeeded in trimming its fiscal deficit by more than forecast.
The previous cuts, which included reductions in state employee benefits, big hikes in fuel and utility prices for both consumers and companies and dramatically lower infrastructure expenditure have helped steady state finances. If spending had continued at 2015 levels, the Kingdom’s foreign reserves would probably have been exhausted by 2021.
With oil prices again above $50 following OPEC’s November agreement to cut production, Saudi Arabia’s Finance Minister Mohammed Al-Jadaan is less constricted in trying to marry a conservative fiscal policy with Vision 2030’s aim of diversifying the economy.
Having replaced long-serving predecessor Ibrahim Alassaf in October, Jadaan’s debut budget is expected to reinforce the government’s commitment to more modest spending but also ease the pace of austerity to aid economic growth, according to a note from London’s Capital Economics, which predicts 2017 is unlikely to be as painful as this year.
In 2015, Saudi’s budget deficit was a record SR367 billion ($98 billion) — or 15 percent of GDP — as the government burned through SR975 billion but only brought in SR608 billion, which was about 100 billion riyals below target following the oil price slump. Crude prices remain at less than half their 2014 peak despite the recent rally.
State spending fell 12 percent in 2015 and likely 14 percent this year, trimming Saudi Arabia’s budget break-even oil price to $70 per barrel from $105 in 2014, according to Jason Tuvey, Middle East economist at Capital Economics. He expects the government will reduce 2017 spending by 5 percent versus 2016.
“Last year’s budget was more important in terms of making clear which path the government was going to tread to make the adjustment to low oil prices,” said Tuvey. “The key point is that the budget statement has taken on more prominence in recent years given the collapse in oil prices.”
Saudi Arabia originally planned for a budget deficit of SR326 billion in 2016, but Saudi Fransi Capital expects the deficit to be only SR231 billion as state revenues increased following the late-year oil price rally, which would go some way to vindicating the government’s austerity measures.
John Sfakianakis, director of economic research at the Gulf Research Center in Riyadh, also expects 2016’s budget deficit to be lower than originally forecast by the government.
“The challenge is to balance raising revenues whilst keeping expenditure discipline and trying to keep growth and confidence in good order,” he said.
Non-oil revenue will likely show a 6 percent rise, Fransi estimates, mostly due to slight increases in income from customs duties, petroleum taxes and document and port fees.

Balanced budget?
Although a lower deficit in 2016 is encouraging, Saudi Arabia faces a tough task to balance its budget by 2020. That aim is part of a series of reforms in the Kingdom, many under the umbrella of Vision 2030, which was unveiled by Deputy Crown Prince Mohammed bin Salman this year and includes many ambitious programs to wean the Kingdom off its oil dependence. These include creating 450,000 private sector jobs by 2020.
“Reducing the deficit and diversifying government revenue and the economy is a critical part of Vision 2030 and we saw measures to achieve these objectives already in the 2016 budget,” said Monica Malik, chief economist at Abu Dhabi Commercial Bank.
A sharp pull-back in government spending coincided with subsidy reforms introduced in December-January 2015-2016, which included increases in fuel, electricity and gas prices for industries. Subsidies, long considered part of the social contract in the Gulf, make up a large part of state expenditure, but encourage wastage and overuse. Further changes followed with cuts to ministerial salaries and government employee benefits.
“These were notable as they were originally seen as being an area off limits,” said Malik. “Fiscal policy in 2016 was very much about retrenchment, getting the budget deficit under control, which was painful for the real economy.”
Second-quarter GDP grew 1.4 percent year-on-year, the smallest year-on-year increase since early 2013. The non-oil sector performed better than expected, expanding 0.4 percent year-on-year following a 0.7 percent annual retraction in the first quarter, its worst performance in 25 years.
“We might see a more balanced budget, alongside further efforts to reduce the deficit,” said Malik, predicting further cuts to fuel and electricity subsidies.
“The OPEC deal was very significant for that — if there hadn’t been a deal, oil prices would be much lower and would limit the ability to ease the tight fiscal conditions.”
Listed companies’ total year-to-date earnings have fallen by only 2.5 percent versus 2015, research by Saudi Fransi Capital shows. This indicates that perhaps Saudi Arabia’s austerity measures haven’t hurt as much expected. The impact varies by sector, with building and construction down 26 percent, industrial investment dropping 41 percent and retail 22 percent lower, which reflect the effects of salary cuts and a big slowdown in infrastructure projects. But banking and petrochemicals, the two biggest sectors, were robust, as earnings declined only 1 and 10 percent respectively.
“Growth is a significant challenge. The private sector is expected to lead growth, but it has come under a lot of pressure. A framework to support private growth and public-private partnerships will be very important,” said ADCB’s Malik.
“Job creation will be another key challenge. Throughout 2016, job growth has weakened as the private sector is adjusting to the substantially softer demand environment and the government is looking to reduce its spending on wages.”
Another question is how the government funds the budget deficit, which in recent years it managed by spending a big chunk of its reserves and through local bond issues, while October’s $17.5 billion international bond sale was Saudi Arabia’s first.
Government debt will be 19 percent of GDP this year, Capital Economics estimates, up from 5.9 percent in 2015 and 1.6 percent in 2014.
The 2017 budget announced today may also make Saudi’s tax plans clearer. Value-added tax (VAT) should to come into force in 2018 in a GCC-wide initiative, although details are sketchy. Likewise, the Vision 2030, and the associated National Transformation Program (NTP) hinted at the introduction of income tax, although sources suggest this is not part of the government’s agenda.
The NTP also aims reduce wages to 40 percent of state spending by 2020, from 45 percent previously.
“When you roll back the state, the private sector needs to fill the void and that will take time, so the timeline for 2030 is very challenging,” added ADCB’s Malik.