A clear economic feature of the last year or so has been the spectacular fall in the price of crude oil. In spite of the recent bounce the price of a barrel of Brent Crude Oil has fallen by some 51% over the past year to US $49 per barrel. This represents quite a transfer of income and wealth from the producing nations to the consuming ones. I noted an estimate on CNBC a week or so ago of between US $900 billion and US $1.3 trillion which seems on the high side to me. Today I wish to look at the impact on the nation which in oil terms at least is most associated with its price and outlook and that is Saudi Arabia.
The Budget is tightening
In many ways being Saudi Finance Minister must have seemed one of the easiest jobs in the world! After all the price of the country’s main resource crude oil remained with one brief exception over US $100 per barrel from early 2011 to the latter part of 2014. Thus the revenue gushed in. The Persian Gulf Fund put it thus a few years back.
Saudi Arabia has the biggest oil reserves in the world and it is the second largest oil producer after Russia. Oil production gives 40% of the country’s GDP and as much as 80-90% of its budget revenue, which means that Saudi Arabia’s ability to spend money is quite directly associated with oil prices.
According to the International Energy Agency Saudi Arabia produced 13.1% of the world’s oil based hydrocarbon supply in 2013 and was by far the largest exporter in 2012 with some 371 million tonnes or 18.7% of the world total. Of course between then and now has come the shale gas and oil revolution especially in the United States but for quite some time the oil based revenue situation for Saudi Arabia could hardly have been more favourable.
This morning however on CNBC the Saudi Finance Minister Ibrahim al-Assaf said this.
We have built reserves, cut public debt to near-zero levels and we are now working on cutting unnecessary expenses while focusing on main development projects and on building human resources in the kingdom.
He was deliberately vague about what expenses are now considered unnecessary but there is a clear change of emphasis and tenet. Also those who follow the Jim Hacker line of “never believe anything until it is officially denied” will find the next bit to be ominous. From the BBC.
Talking to broadcaster CNBC Arabia, he said the country was in a good position to manage low oil prices.
What about the reserves?
Saudi Arabia built up a strong position in terms of foreign exchange reserves which peaked at just under 2.8 trillion Riyals in August 2014. However the figures for July of this year (the latest) show that they have declined to 2.51 trillion Riyals. So plenty left but a hint that not even Saudi Arabia can carry on regardless for ever with a lower oil price.
A pegged exchange rate
Linked into the situation with the reserves is the level of the Saudi Riyal exchange rate which was pegged to the US Dollar at an exchange rate of 3.75 to 1 back in 2003. Here we see one of the weaknesses of a pegged exchange rate as the strong US Dollar has taken the Riyal with it just when it would have fallen and probably considerably in response to the fall in the oil price. An example of this has been the Russian Rouble where it now takes 68 of them to buy one US Dollar as opposed to the 37 of a year ago. Now there are all sorts of consequences from a plummet in your exchange-rate of that size with inflation being the most obvious but the only exchange-rate flexibility Saudi Arabia currently has depends on what happens to the US Dollar via the US economy. I guess they too are wondering what the Federal Reserve will do next week!
There has been speculation that the peg will be abandoned and several times this year it has come under pressure. But as you can see from the size of the reserves about Saudi Arabia can hold it for quite some time if it wishes.
Saudi Arabia has tended to overspend
As the money has flowed in then Saudi Arabia has not really needed to maintain much of a grip on public expenditure. The US-Saudi Arabian Business Council tells us this about last year.
Expenditures, originally estimated at $228 billion (SR855 billion), stood at $293.3 billion (SR1.1 trillion). This increase is 28 percent above the budgeted level but not significantly higher than the average amount of overspending recorded over the last ten years. This resulted in a budget deficit of $14.4 billion (SR54 billion) in 2014.
Food for thought there as we note that in what were much more favourable times there was a deficit albeit a small one. This was in spite of the fact that revenues were yet again gushing in.
While the 2014 budget originally envisaged revenues of $228 billion (SR855 billion), they actually amounted to $278.9 billion (SR1.046 trillion).
Many countries including my own would love that revenue situation! But of course the picture for 2015 looks very different if the year to September is any guide to the rest of it.
Saudi Arabia has set a state budget for 2015 with total revenues projected to reach $190.7 billion (SR715 billion) and total spending valued at $229.3 billion (SR860 billion) which is expected to result in a $38.6 billion (SR145 billion) deficit.
If we look at the way that the country overspent last year then one immediately wonders how much of an overspend there will be this and thereby how large the deficit will turn out to be. Last month the IMF pitched in with its estimate on the situation.
A central government fiscal deficit of 19.5 percent of GDP is projected in 2015, and while the deficit will decline in 2016 and beyond as one-off spending ends and large investment projects are completed, it will remain high over the medium-term.
As ever with the IMF it is about to get better! The real question if we look at the obvious political issues in the region is whether Saudi Arabia will feel under pressure to spend even more.
What about issuing bonds?
You can imagine that this has not been a Saudi priority for some time. But as Bob Dylan put it.
Then you better start swimmin’
Or you’ll sink like a stone
For the times they are a-changin’.
More prosaically Trade Arabia puts it like this.
Moreover, for the first time in eight years, the government is also expected to issue local bonds worth SR115 billion ($30.7 billion) through the second half of 2015 to cover around a third of the deficit.
This is underway as just over US $5 billion of bonds were issued a month ago. It is also true that there is plenty of scope to issue them as the IMF points out.
Nevertheless, government debt is very low and was 1.6 percent of GDP at end-2014.
So there are fiscal troubles in Saudi Arabia leaving it with a choice. One is to continue with its spending plans and support GDP growth in a manner similar to Keynesianism. The other is to take the IMF style approach and to cut back in a more austere manner. In some ways the IMF has a cheek as whilst exports have fallen Saudi Arabia has had many years of balance of payments surpluses.
As to the underlying economy it grew by 3.5% last year and have just seen this on the money supply.
Broad money supply (M3) rose by an annualized 10.5 per cent in June, indicating continued expansion of economic activity, said a report in Arab News, which cited NCB’s Saudi Economic Review for August 2015.
However this is also true.
the pace of annual growth has been in deceleration since the beginning of the year,
Thus there is something of a squeeze going on and I am reminded of the lyrics of the Clash.
The oil down the desert way
Has been shakin’ to the top
The Sheik he drove his Cadillac
He went a-cruisin’ down the ville