Lecture| Saudi Arabia: Economic Challenges in a Time of Low Oil Prices
OxGAPS hosted a lecture by Tim Callen, IMF Mission Chief to Saudi Arabia, entitled ‘Saudi Arabia: Economic Challenges in a Time of Low Oil Prices’. The lecture took place at the Investcorp Building’s MEC Lecture Theatre at St Antony’s College on 18 November, 2015, and was chaired by Adel Hamaizia (St. Antony's College, Oxford). Mr Callen started the lecture with an overview of Saudi Arabia’s economic context, providing some historical comparisons with the present, and stating that although the IMF’s Article IV consultation published earlier in the year formed the basis for his assessment, fiscal matters had evolved since the report.
Oil prices have dropped to around the $50 per barrel mark in the past year from around $110 per barrel. Oil forms the basis for the Saudi economy, making up almost half of GDP and over 75% of export revenue. Furthermore, the non-oil economy is also semi-reliant on the Kingdom's main natural resource, for example through the chemical industries, and by way of government expenditure being largely funded through oil revenue. Callen then set the current situation in its historic context with the oil price drops of 1980s, late 1990s and 2009 being overlaid to directly compare similar incidences in the past and what impact they had had on Saudi Arabia. A Panel VAR model was used to look more closely at the direct links between economic indicators in Saudi Arabia such as credit growth or ratio of non-performing loans (NPL) and changes in oil price.
Recent Economic Developments and OutlookSaudi government spending has been a huge driver of non-oil economic growth in recent years through funding construction and infrastructure projects, increased government wages and social benefits, most notably in 2011 when there was a $120 billion spending increase in response to the ‘Arab Spring.’ Callen interpreted the drop in the PMI index in 2014 as well as the decreasing GDP growth rate since as indicators of a wider slowdown in the Saudi economy from before the oil price drop, and that this would only be exacerbated as the impact of the oil price drop made itself felt in coming years.
The Fiscal Outlook – Why Fiscal Consolidation is Needed
Callen acknowledged that the Saudi government had considerable fiscal buffers and was in a very strong net creditor position at present. This could be seen in the $450 billion of domestic cash deposits before the recent economic downturn, though he estimated those were probably up to 25% lower now, with external reserves exceeding $650 billion. This was the result of a concerted effort since the late 1990s to turn around the Saudi state’s finances.
The Saudi government’s expanded distribution capacity has significantly increased the breakeven oil price needed for the country to maintain its fiscal position and external balance in the past five years (see fig. 1). Combined with the recent drop in oil prices this has meant that the Saudi government was facing a 17-18% deficit; $120-130 billion gap in real terms.
Fiscal Consolidation – What Could Be Done?
Even with considerable buffers, Callen stressed that fiscal adjustments were needed in the longer term since the size of deficit meant that even such large reserves as Saudi Arabia’s could be lost. The 2016 Saudi budget was taken as the basis of discussion since the 2015 budget was distorted by one-off costs, for example the $30 billion stimulus paid out on King Salman’s accession to the throne in January.
There are four key areas where fiscal consolidation could be made: raising domestic fuel prices, increasing non-oil taxes, improving public investment efficiency and restricting government expenditure, particularly the wage bill. The current indirect oil subsidies provided by Aramco’s low domestic prices are thought to be costing Saudi Arabia 2.5% of GDP if compared to average Gulf Cooperation Council (GCC) prices, assuming demand remained constant, and a significant 6% when compared to US pre-tax retail prices. VAT was the focus of potential non-oil taxes given its possible implementation in the medium term after recent indications of a co-ordinated regional move. Other possibilities include corporation taxes, foreign company taxes, property taxes or ‘white land’ taxes. Saudi Arabia’s budgeting is also notoriously poor, consistently overrunning by 25% or more than was originally planned; better management would increase confidence and support forecasting and planning even if it didn’t cut spending per se.