The massive reforms announced Saudi Arabia to realign its economy to the path of development following the announcement of a record deficit $90 billion budget, many see the reforms as right step for the Kingdom’s economic well being and sustainability in 2016 and beyond.
“We think this is due to three main factors. First, it likely marks the end of material overspending practices given tighter controls. Second, it starts to introduce a credible medium-term fiscal consolidation strategy to address the oil price slump through revenue- and expenditure-side measures, the first round of which saw sweeping energy, water and electricity administered price changes. Last, it likely signals no near-term changes to energy or Fx policy, as reflected in the drop of SAR Fx forward points. Lower public spending should also contribute to slower real non-oil GDP growth,” says Bank of America Merrill Lynch in its report ‘Saudi Arabia Economic Watch: A landmark 2016 budget.’
The MoF preliminary estimate for the budget deficit for 2015 was better than expected, although questions remain. Compared to our 2015 budget deficit projections of 18.7% of GDP (cSAR440bn), the preliminary gap stood instead at SAR367bn (15.0% of GDP). Realized spending was SAR975bn, versus our projections of SAR1.1trn, and down by 14.5% versus actual 2014 spending levels. Overspending stood at 13.4% (SAR115bn), down from 29.8% in 2014, and, according to the MoF, mostly represents Royal Handouts (SAR88bn) and increased military and security projects (SAR20bn). The fiscal breakeven oil price thus likely stood at US$97/bbl in 2015, versus US$106/bbl in 2014.
Government debt reached SAR142bn (5.8% of GDP) at end-2015. Real GDP and real non-oil GDP growth were somewhat stronger than anticipated as they stood at 3.4% and 3.6% in 2015, from 3.6% and 5.0% in 2014 respectively (oil sector: 3.1%, government non-oil sector: 3.3%, and private non-oil sector: 3.7% in 2015). Note that building and construction was the second fastest growing sector in 2015 (5.6% vs 6.7% in 2014).
Understanding the source of the better-than-expected budget outturn for 2015 is important to better gauge the trajectory for spending and drawdown of Fx reserves. The MoF largely attributes the narrower than expected 2015 budget deficit to spending restraint over 4Q15. However, we note that preliminary budget figures have typically tended to be revised upwards mid-way through the following year. Also, we note the discrepancy versus the financing envelop raised over 11m15 (a total of SAR463bn or 18.9% of GDP, combining SAR365bn in drawdown of central government deposits at SAMA and SAR98bn in domestic debt issuance). The cash-based budget presentation for 2015 would also exclude any government arrears or delays to contractors, flattering the accounts. It also excludes off-budget spending; the MoF presentation excludes the SAR22bn in off-budget capex spending from the budget surplus fund financed by earmarked funds in previous years in the Budget Surplus Fund deposits at SAMA. Last, non-oil revenue increased by 29% versus 2014 to SAR127bn. This is largely due to undisclosed other revenues (a 150% increase of SAR16bn to SAR25.5bn) and higher investment revenues (increase of SAR15.2bn to SAR37bn, comprising transfers of SAR22bn from SAMA and SAR15bn from PIF). The sustainability of this source of revenues is yet unclear, although this higher intake, as well as the related transparent publication of the breakdown of non-oil revenues for the first time, is welcome.
The 2016 spending is conservatively projected at SAR840bn (2.3% lower than SAR860bn for 2015 budget and -13.8% versus 2015 actual) for a budgeted deficit of SAR326bn (13.0% of GDP). The breakdown of revenue is not given, but we do not believe it includes the impact of subsidy changes. Budgeted revenue numbers would be consistent with an internally budgeted oil price assumption of cUS$45/bbl on our estimates, and the budget itself would breakeven at cUS$80/bbl (excluding any material overspending). Should oil prices average US$50/bbl, our projected 2016F budget deficit could stand instead at SAR257bn (10.2% of GDP) and real GDP growth could slow to 2.3% (non-oil GDP: 2.8%). At US$35/bbl, the budget deficit would stand instead at SAR384bn (16.5% of GDP), assuming non-oil revenues still grow by 4% versus 2015 realized levels.
The 2016 budget focuses on spending rationalization and restraint, in our view. We believe the era of material overspending is likely firmly behind us. Spending controls have been introduced through the setup of medium-term budget ceilings and of the National Project Management Agency to optimize and review capex. A Royal Order was in addition simultaneously passed to prevent the issuing of an order of commitment or disbursement that exceeds the allocated budget. Also, note that the source of past overspending this past decade has been supplemental budgets passed during the fiscal year when the oil price turned above the internally budgeted oil price assumption. This is unlikely to be the case in 2016, in our view. Recall that the 1980s saw actual spending underspent versus the budget while the 1990s saw modest overspending.
It is however somewhat difficult to compare its breakdown and possible outturn to previous years as it is has been prepared in accordance with the Government Financial Statistics (GFS) of 2001/2014 for the first time (which would use accrual accounting basis) and involved re-classification of the general budget items. At first glance, and although the budget lines for 2014 are not comparable, most budgeted appropriations are down versus 2014 budgeted levels, although this is due to the creation of a new SAR183bn Budget Support Provision appropriation. Our understanding is that this is a contingent spending item established to help address shortages in revenue and give more flexibility to the budget by redirecting capital and operational expenditure. Official pronouncements have indicated that this item broadly consists of capex spending and its financing should broadly consist of previous budget surplus savings, although authorities intend to review this item’s feasibility and financing in early 2015.
Budget execution will now be paramount, and we see capex most at risk of cuts going forward. The budget intends only to slow the growth in recurring expenditures going forward. On-budget defense spending is a risk item in this regard, as the US$5.3bn disclosed increased military and security projects over 2015 amount to a US$15mn per day cost. Also, the 2015 realized spending could suggest on-budget capex spending was already cut by c50% to SAR185bn, although this could likely reflect delays in payments to contractors given the incongruence with rapid construction sector growth. The adherence to the budgeted lower spending for 2016 (-10/14%yoy likely, and -5% versus 2015 actual spending excluding one-off Royal handouts) thus also rests on the finalized spending numbers for 2015 and tight government controls to set a lower spending base.
The sweeping energy, water and electricity administered price changes decreed shortly after the budget announcement are a first step in the five-year fiscal consolidation and economic transformation strategy expected to be unveiled in early 2015. According to official pronouncements, this is likely to include PPP projects, privatizations, land tax, further review of energy, water, and electricity prices over the medium-term, review of current levels of fees and fines, introduction of new fees, completion of the necessary arrangements for the application of a VAT and introduction of excise taxes on tobacco and soft drinks. We estimate the natural gas price hike on petrochemical firms and gasoline and diesel price hike could add US$2.2bn and US$3.8bn to central government revenues if fully passed to the budget (a combined 0.9% of GDP). We estimate the direct impact of higher gasoline, water and electricity prices to add 1.3-1.5ppt to CPI inflation due to their low basket weights (c.1.5%, c0.4% and 1.6% respectively). We think a 5% VAT tax could add c2% of 2015 GDP in fiscal revenues over the medium-term.
