Saudi Arabia’s King Salman has announced that the Kingdom will spend 7 percent more next year, at around US$295 billion (1.1 trillion riyals). This breaks the previous record set this year, with budget spending at US$261 billion and it might spark concerns about the economy’s sustainability as the increase for next year includes a hefty bill for cost-of-living allowances introduced this year.
The cost-of-living allowances were instituted at the start of this year, CNBC recalls in a report on the budget announcement, and they cost the budget an estimated US$13 billion. Their purpose is to stimulate economic growth, most directly through greater consumer spending, but also to strengthen support for Crown prince Mohammed whose policies aimed at an economic turnaround have met with mixed reactions. It’s no coincidence that the allowances target public servants and military personnel, besides pensioners and the poorest segments of society.
The record-breaking budget means Saudi Arabia’s deficit will be wider than expected by the International Monetary Fund a couple of months ago. Then, the IMF forecast the Kingdom’s budget gap at 2 percent, but only if the cost-of-living allowances were suspended. Since this will not be the case, the budget announced by King Salman has stipulated a deficit of 4.2 percent, or US$35 billion. This will be the sixth straight year of budget deficits for the country. However, the projected budget deficit is lower than this year’s, which stood at 4.6 percent, according to a recent announcement from the finance ministry.
The budget also stipulated GDP growth of 2.6 percent next year, versus 2.3 percent this year, with oil revenues rising to US$176.48 billion (662 billion riyals) from US$161.82 billion (607 billion riyals) this year. This is rather optimistic amid the current slump in oil prices that has persisted despite Saudi Arabia’s success in the latest OPEC production talks that ended with a commitment to reduce combined production by 800,000 bpd beginning in January.
While the size of this cut is smaller than the one agreed in 2016, 800,000 bpd is still a large enough dent in supply or at least it should have been. However, a bleak economic outlook for the world has weighed on bullish sentiment as has the continued rise of U.S. crude oil production. Russia’s obvious reluctance to begin cutting and cut fast enough to make a difference has not helped the Saudi case either. Even a major production outage in Libya over the last two weeks has not been able to arrest the price slide. Related: Saudi Oil Minister: Crude Stocks Should Drop Very Soon
Investment banks are one by one beginning to revise their forecasts for oil prices next year and these forecasts are lower. Usually, production outages in large OPEC producers such as Libya would have had an immediately bullish effect on prices, but now that this has changed as well, there aren’t a whole lot of tailwinds for the oil price that would offer some relief to Saudi Arabia.
The Kingdom still needs Brent at a lot higher levels to break even. The IMF estimated this breakeven at almost US$88 a barrel. But breaking even is not the main problem, as noted in a 2017 article by Saudi expert Ellen R. Wald for Forbes. There are other countries that run much higher budget deficits and still survive just fine. Yet the difference is, these countries, the U.S. being a case in point, do not rely almost exclusively on one revenue source, which makes them more flexible in managing their deficit. Saudi Arabia has ambitious diversification plans but these plans need funding and funding availability directly depends on oil revenues. They may indeed rise in 2019 if the Kingdom expands its market share, but if the budget authors have based their projections on expectations of higher oil prices, they may be in for a nasty surprise judging by the latest price movements.
By Irina Slav for Oilprice.com
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Those questioning the Saudi capabilities to control global oil prices seems to be indulging in self delusion. Of course, the state of the economy always has the final word on oil prices, but in a decent economy, the Saudis still call the shots.
It’s estimated that the Kingdom controls nearly 70% of Opec production. Add in Russia’s participation, and your closing in on nearly 40% of global production.
What does history tell us? In 2014, the Saudis decided to crush the oil prices by over producing, caving the price to near its ten year low, and holding it there for two years, against the cries for relief from producing countries and independents.
In 2016, in concert with Opec and Russia, the Saudis reversed course, and forced cutbacks, that saw prices rise to four year highs.
The Saudis remain the equivalent of a global federal reserve of oil. That means when the Kingdom wants oil prices to rise, it knows how to make that happen.
In such a situation, the Saudi budget deficit could easily double from the projected $35 bn to more than $70 bn or 10% of the country’s GDP. Since 2014, Saudi financial reserves have dwindled from $750 bn to less than $500 bn now badly needed to prevent a devaluation of the Saudi Rial against the US dollar.
With a fast-growing domestic demand for oil rising at annual rate of 7% and very limited capacity to raise production, Saudi oil exports can only decline. This means that oil revenues of $176.48 bn as stipulated in the new budget can only be achieved by oil prices rising far above $80 or a drastic cut in domestic consumption meaning a complete elimination of any remaining subsidies.
A diversification of the Saudi economy remains a pivotal target for Saudi Arabia according to Saudi Vision 2030. But this vision is losing its initial momentum particularly after the withdrawal of the IPO of Saudi Aramco. This means that the Saudi government will have to tighten its belt by cutting government expenditure and also by reaching a peaceful settlement in Yemen thus saving more than $70 bn in military operations there.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London