MANAMA: S&P Global Ratings affirmed its ‘A-/A-2′ unsolicited long and short-term foreign and local currency sovereign credit ratings on the Kingdom of Saudi Arabia. The outlook is stable.
The ratings on Saudi Arabia are supported by its strong external and fiscal stock positions, which we expect will be maintained despite significant current account and fiscal deficits. The ratings are constrained by limited public sector transparency, lower GDP per capita relative to similarly rated sovereigns, and constrained monetary flexibility.
“We project that, reflecting the sharp decline in oil prices since the summer of 2014, the general government deficit will average about 9% of GDP in 2016-2019. Our forecast for the annual change in general government debt (which is our preferred fiscal metric because in most cases it is more comprehensive than the reported headline deficit) is for an average increase of about 5% of GDP. In the case of Saudi Arabia, the change in general government debt is lower than the deficit as we have assumed an even split between asset draw-downs and debt issuance in terms of deficit financing. We acknowledge both upside potential and downside risk to these forecasts. Upside potential stems principally from oil prices. The downside rests with the scale of the required fiscal consolidation and the broader impact it will likely have on the economy.
“Highlighting the government’s difficult policy choices, we note evidence that lower government spending is adversely affecting the country’s private sector.
“In particular, there have been reports of a rise in public arrears to private sector construction companies. As a result, companies have been cutting their workforce and withholding salaries. We expect banking sector asset quality to deteriorate but not sufficiently to endanger system solvency, owing to countercyclical buffers the regulator has imposed in recent years.
“Our base case assumes that large construction companies such as Saudi Oger and Saudi Binladin Group, which are currently experiencing financial difficulties, do not default on loans to the Saudi banking system. The building and construction sector accounts for about 8% of total loans, equivalent to roughly one-third of the banking sector’s capital base. Banks’ nonperforming
loan ratios are around 1.0%-1.5%, which we expect will rise to 3%-4% over the next two years. We classify the banking sector of Saudi Arabia in group ‘4’ under our Banking Industry Country Risk Assessment methodology, with ‘1’ indicating the lowest risk and ’10’ the highest.
“Bank deposits have decreased and liquidity conditions have tightened, with interbank rates almost tripling since early 2015 to above 250 basis points (3-month SAIBOR). As a result of the increase in the cost of funding, we expect banks’ profitability to come under pressure. On Sept. 26, 2016, the
Saudi Arabian Monetary Agency (SAMA) stepped up efforts to provide liquidity, giving banks about 20 billion Saudi riyals (SAR) of time deposits “on behalf
of government entities.” SAMA’s action follows prior deposit injections of about SAR15 billion earlier in 2016. SAMA also introduced seven-day and 28-day repurchase agreements, to allow banks better access to short-term borrowing at lower and more stable cost. We note that the majority of banks continue to rely on funding from non-interest-bearing deposits rather than wholesale
funds.
“The government’s withdrawal of deposits and domestic issuance of around SAR20 billion in debt each month since August 2015, partly absorbed by Saudi banks, has added pressure to banking system liquidity. To diversify funding sources and improve domestic banks’ liquidity conditions, the government issued a $10 billion syndicated loan earlier in the year and is also expected to issue a $10 billion-$15 billion Eurobond later this year. Foreign currency debt sales should also help to slow (but not reverse) the expected gradual decline in foreign exchange reserves over the next several years. We expect reserve levels to cover about two years of current account payments on average over 2016-2019.
“The government has budgeted for a central government deficit of about 13% of GDP in 2016, compared with an outturn of 15% in 2015, with 2016 revenues falling by 16% and expenditures by 14% compared with 2015. Our reported general government balance now includes an estimate of investment income. We previously included this financial flow directly in our estimate of general
government liquid assets. This reclassification of investment income has not affected our overall assessment of Saudi Arabia’s public finances, but results in the difference between our central government and general government deficit
projections.
“We believe the authorities have based the budget on an oil price of about $45 per barrel. We have included the government’s 2016 budget measures in our assumptions. These include postponing some capital spending projects, increasing non-oil revenues, and controlling current expenditures. The
government has embarked on a program of subsidy reform, with fuel, water, and electricity prices set to rise gradually over the next five years. As a result, we understand it will reduce subsidies, which had amounted to about 8% of GDP in 2015. Concurrently, through these increased utility tariffs, we expect to see stronger profitability at government-related entities, in turn resulting in higher dividends for the government.
“On the revenue side, the imposition of taxes on undeveloped plots of land in urban areas should raise revenue and encourage private investment. We understand the tax will be deposited at a special account at SAMA, with proceeds used to fund housing projects. The government has established a
support provision line within the budget of SAR183 billion (8% of GDP or $49 billion equivalent), which it could use to redirect capital and operating expenditures to both ongoing and new projects and to meet any emerging expenditure needs. We expect the introduction of value-added tax to be a
medium-term project, in line with discussions already under way with other members of the Gulf Cooperation Council customs union (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates).
“We note, however, the strong signal of intent provided by the government in late September in support of the National Transformation Program 2020 (NTP) target of reducing public sector wages to 40% of total spending. The government announced the reduction or ending of some bonuses and financial benefits for state employees and the reduction of ministers’ and Shura Council
members’ salaries by 20% and 15%, respectively. Salaries of lower ranking civil servants are expected to be largely frozen, and a cap placed on overtime
payments and annual leave. The new rules are expected to come into force in October 2016. In our view, these measures should moderate the government wage bill over the medium-term.
“Over the next three years, we expect Saudi Arabia will finance its deficits by drawing down fiscal assets and issuing debt. Such a split implies that Saudi
Arabia would report gross liquid financial assets of 105% of GDP by 2019, versus 123% at year-end 2016. These fiscal assets include the central
government’s deposits and reserves on the liabilities side of the balance sheet of SAMA, government institutions’ deposits, and an estimate of investment income. We also include in the calculation an estimate of government pension funds’ liquid assets.