Saudi Arabia and a prolonged oil price slump

Saudi Arabia and a prolonged oil price slump
6 min read
Comment: Amid prospects of a prolonged low oil price, a gloomy forecast looms for Saudi Arabia, writes Kristian Coates Ulrichsen.
Economic deficits are expected to grow in most Gulf countries amid falling oil prices [Getty]
Falling oil prices have once again sparked debate about political and economic repercussions for the oil producing states in the Gulf.

Sharp falls in government revenues look set to produce budget deficits in all six of the Gulf Cooperation Council (GCC) states, with the deficit in Saudi Arabia projected to be between 14 and 20 percent of GDP.

A recent report by the Brookings think tank suggested that "low oil prices, widening fiscal deficits, rising populations, political turmoil, religious intolerance and high youth unemployment conjure up a recipe for economic disaster" in the Middle Eastern oil states.

How resilient is Saudi Arabia to this gloomy forecast? What options do policymakers in the kingdom have at their disposal, and are they realistic in the medium-to-long-term?

One response that Saudi officials do not appear intent on implementing is currency depreciation. In recent weeks, the Saudi riyal has weakened on forward markets as traders bet that the currency might be forced into a devaluation caused by dwindling oil prices and global demand.
     The Saudi riyal has weakened on forward markets as traders bet that the currency might be forced into a devaluation

The Saudi Arabian Monetary Agency (SAMA) has dismissed such speculation and reaffirmed their commitment to the currency peg with the dollar, which has been in place since 1986. Moreover, the currency peg survived far greater levels of speculation, first during the long oil price slump of the 1990s and then again during the wild price swings in 2008.

Besides avoiding any sudden move that may be interpreted as evidence they are losing control, officials in Riyadh will also be wary of any move that risks stirring inflationary pressures and raising the price of foodstuffs and other staple goods.

Another policy option that likely will be resisted for as long as possible will be cuts to current spending on politically sensitive issues such as wages and subsidies.

Here, the dilemma for officials in Saudi Arabia (and other Gulf states) is that, while increases in government spending largely kept pace with rises in oil prices, they are far harder to bring down when revenues fall.

Public spending in Saudi Arabia has trebled over the past decade and resulted in a fiscal break-even price of between $87 and $109 per barrel of oil, depending on the forecaster, well up from a figure of about $20 in 2002.

Spending packages such as the $130 billion pledged by King Abdullah in the wake of the Arab Spring turmoil of 2011 contributed heavily to the increase in the break-even price.

However, in a system where the state redistributes income, often in the form of wages, subsidies and social "handouts" to its citizens, it is far harder to take something away than it is to give it, and doing so risks political upheaval at a time of great regional uncertainty.

In response to such budgetary pressures, Saudi government policy has undergone a subtle yet important shift in recent months. Whereas oil revenues traditionally have been used to finance government spending, officials in Riyadh have turned instead to a combination of drawing down foreign reserves and tapping capital markets through sovereign bond issues.

Net foreign assets held by SAMA - effectively the country's central bank - fell by more than 9 percent, from an August 2014 peak of $737 billion to $664 billion in June 2015.

The rate of drawdown prompted some alarm in government circles and led to a new shift in policy in July when the government returned to the bond markets for the first time since 2007.

In mid-July, the kingdom raised $4 billion in seven and 10-year conventional bond issues that were purchased by "quasi-sovereign" state-owned entities. A second bond issue on August 11 that raised a further $5.3 billion was opened up to local cash-rich commercial banks, which easily absorbed the issue, amid suggestions that Saudi officials aimed to raise some $27 billion in bonds by the end of the year.

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Riyadh's range of options

Such measures look set to be complemented by cutbacks in capital expenditures, which account for roughly one-third of total Saudi government spending. Reports from Riyadh have indicated that government officials are taking advice on measures that would shrink capital spending by up to 10 percent as part of a reassessment and scaling back of major infrastructure projects.

This would amount to a politically expedient move that would avoid the sensitivity of cutting back on current spending or on planned investments in sectors such as health, education and housing.

However, by leaving untouched issues such as fuel subsidies, which Riyadh-based Samba Financial Group estimates will cost Saudi Arabia SAR 195 billion ($51 billion) this year, the risk is that officials merely kick the difficult decisions down the road to an even-more fiscally stressed time.

Therein lies the policy dilemmas facing policymakers who, in short order, have moved from an initial intent to maintain the high budgeted levels of state spending to drawing down foreign reserves and now to deficit financing through the issuance of domestic debt.

Individually and collectively, those decisions illustrate how Saudi officials have a wider range of policy instruments in their toolkit than is sometimes perceived in the international media.
     Meaningful change may only come with difficult - yet probably unavoidable - reforms to reduce the burden on the public sector

These decisions can buy time and will enable the kingdom to withstand more years of low oil prices - without necessarily having to reduce production or risk market share, as happened in the 1980s when Saudi output plunged from 10 million barrels per day in 1980 to just 2.5 million in 1986.

And yet, meaningful change may only come with difficult yet probably unavoidable reforms to reduce the burden on the public sector as the employer of first resort, expand and energise the private sector as the primary engine of economic growth, and reduce or eliminate energy subsidies, as the United Arab Emirates courageously did when it successfully linked gasoline and diesel prices to global market levels on August 1.

A version of this article was originally published on the Baker Institute Blog on August 28, 2015.

Kristian Coates Ulrichsen PhD is the Baker Institute fellow for the Middle East. His research examines the changing position of Gulf states in the global order, as well as the emergence of longer-term, nonmilitary challenges to regional security.

He is a visiting fellow at the London School of Economics Middle East Centre and an associate fellow at Chatham House in the United Kingdom.

Follow him on Twitter at @Dr_Ulrichsen.

Opinions expressed in this article remain those of the author and do not necessarily represent those of al-Araby al-Jadeed, its editorial board or staff.