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Published on December 29th, 2015 | by Thomas Lippman3
New Saudi Budget: The Good, the Bad, and the Potentially Ugly
by Thomas W. Lippman
It hardly came as a surprise that the Saudi Arabian government budget for the upcoming fiscal year, approved by the cabinet the weekend after Christmas, projects a yawning deficit. Economic analysts knew it was coming; the 326.2 billion riyal gap between expenses and projected revenue was only to be expected with the world price of oil running at less than $40 a barrel. In a country that depends on oil for 85 to 90 percent of state revenue, the government could have shaved a billion riyals here or there off the projected deficit but could not have balanced the budget without shutting down most services and development projects.
The Finance Ministry projected revenue at 513.8 billion riyals and expenditures of 840 billion, leaving a gap of 326.2 billion riyals, or about $87 billion. That is actually less than the deficit for the current year, about $98 billion, or 15 percent of GDP, one of the highest in the world. And financial markets deemed it relatively good news, as share prices rose because the deficit is less than analysts had projected.
Saudi officials from King Salman down have declared that they intend to maintain public services at current or higher levels and continue with previously budgeted capital projects. No layoffs of government workers or military personnel are expected. On the contrary, the Saudis have made clear that the costly war in neighboring Yemen, where Saudi Arabia is leading a coalition fighting the rebels known as Houthis, will continue until they achieve a satisfactory settlement.
The Saudis have also said that they have no intention of devaluing the riyal, which has been pegged to the dollar for decades. That’s because the kingdom has very deep pockets and has been drawing down its mammoth foreign currency reserves to cover most of the budget gap. Bankers report that the country’s reserves exceed $600 billion, in a country with only about 20 million citizens. And the kingdom has very little debt—about 2 percent of GDP, while it was nearly 100 percent of GDP in 1999, according to The Economist. Saudi Arabia has resumed issuing domestic bonds, and the Finance Ministry projects the debt to rise to 5 percent of GDP in the coming year.
Economic analysts at Saudi American Bank and Riyadh’s Jadwa Investment Group reported recently that they expect oil prices to stabilize in 2016 and begin to tick back up toward the end of the year as production declines in high-cost regions such as the Arctic, shale fields in the United States, and Canada’s tar sands, where oil is unprofitable at current prices. In the meantime, they said, the Saudi government is likely to keep its public promises to continue with previously announced spending for services and development.
That does not mean, however, that the Saudi government is not feeling any fiscal heat. Buried in the anodyne language of the Finance Ministry’s announcement are pledges to restructure the government’s financial agencies, curb the growth of government salaries, and “rationalize” spending. New policies to be implemented, the ministry said, include privatizing some government-owned enterprises, raising excise taxes on “harmful goods” such as tobacco and soft drinks, “completing the arrangements for the application of the value added tax,” and “reviewing government support, including revision of energy, water, and electricity prices gradually over the next five years, in order to achieve efficiency in energy use, conserve natural resources, stop waste and irrational use, and minimize negative effects on low and mid-income citizens and the competitiveness of the business sector.”
Put more bluntly, that means the government is going to chip away at the fundamental political bargain that has sustained the rulers’ control for decades: in an absolute monarchy where all decisions are made at the top, the people acquiesce in their disenfranchisement in exchange for cradle-to-grave economic goodies. There is no income tax on individuals; education and health care are free. And water, gasoline, and electricity are virtually given away, to the point that they are consumed beyond the country’s ability to produce them.
According to a Brookings Institution study published in July, “Saudi Arabia spends more on fuel subsidies than any other country in the world, except for Iran. These subsidies maintain low prices for electricity and gasoline, which tends to undercut the government’s demand-side energy efficiency incentives.” Regulations issued recently, the study said,
establish higher energy-efficiency standards for new products; however, these standards do not apply to existing inventory. As a result, the cost of energy-efficient products is likely to rise. High costs coupled with subsidized electricity and gasoline deter consumers from replacing inexpensive products— such as cars, appliances, and factory equipment— with more expensive, energy-efficient alternatives.
And because of a shortage of natural gas beyond the needs of industry, Saudi Arabia burns increasing amounts of its crude oil to generate electricity, cutting the amount of oil available for export. Along the same lines, subsidies for water encourage consumers to use more of it, thus creating more demand for the electricity required to operate the kingdom’s massive desalination plants.
Potential Political Volatility
The budget announcement said that changes in the subsidy system would be tailored to limit their impact on poor and moderate-income people. It gave no details of the planned changes, but within hours the official news agency posted on its Twitter account a report that the price of 95 octane gasoline has been raised to 0.90 riyals ($0.24) per liter, up from 0.60 riyals per liter—a hike of 50 percent. The increase takes effect this week, the news agency said on its Twitter account.
The reported new price is still far below the prevailing price levels in Europe, where most countries raise more money from Saudi and Kuwaiti oil through taxes than the producers do through prices at the pump. In fact, the official Saudi Press Agency quoted Khaled al-Falih, chairman of the state-owned oil company Saudi Aramco, as saying that prices “remain the lowest worldwide” despite the increase. And the same report quoted Water and Electricity Minister Abdullah Alhosain saying that that water rate increases will be so modest that more than half of all domestic users will still pay less than one riyal per day.
Saudi government officials and independent economic analysts have long recognized that the subsidy system was not economically sustainable even in a country as wealthy as Saudi Arabia. The kingdom has eliminated subsidies to wheat farmers and raised electricity prices for commercial and industrial use. But everyone in the Middle East over the age of 50 remembers what happened in 1977 when Egypt, under pressure from the International Monetary Fund, cut subsidies overnight on a wide range of goods and commodities. Egyptians took to the streets in lethal riots that forced the government to revoke the cuts. That lesson has lingered, and the cautious moves announced by Saudi Arabia indicate that it will proceed carefully down a path that is bound to be politically volatile.