Budget 2017: Timely, Targeted and Expansionary Fiscal Policy

by shariff mohammed | Mar 02, 2017

In 2016, actual government expenditures are expected to record their first back-to-back decline since 1999, falling by 15.6 percent to settle at SR825 billion. Actual spending will also be 1.8 percent below budget, which is an inflection from the historical tendency to post double digit budget overruns. The Saudi economy will register a moderate growth of 1.4 percent in 2016 on the back of higher oil production that averaged 10.4 MMBD. The government maintained a two pronged strategy of covering the funding gap via drawing down reserves and debt issuances. Net foreign assets currently stands at $536.6 billion while the government's debt increased to SR316.5 billion.

The government had adopted a targeted fiscal expansionary policy in 2017 after two years of fiscal consolidation that saw government spending falling by a significant 27 percent from an unsustainable SR1 trillion in 2014. The increased expenditure will be directed towards projects and initiatives that enhance the absorptive capacity of the economy. 2017 annual budget release estimates revenues at SR692 billion, a gain of 34.7 percent, while expenditures are expected to reach SR890 billion, increasing by 6.0 percent. Accordingly, the budget will register another deficit, albeit lower than the last two years, supported by both oil and non-oil revenues. According to our estimates, oil prices will average $55/bbl for the Arabian light spot price and production will average 10.05 MMBD, thus, we project revenues and expenditures to reach SR702.5 billion and SR882.8 billion, respectively, registering a deficit of SR180.2 in 2016. Gauging the macroeconomic risks through the debt level, adequacy of reserves and financial stability reveals that Saudi is well poised to encounter possible future shocks.

Macroeconomic and Fiscal Performance in 2016

The budget deficit eased on the back of fiscal discipline and efficiency measures. Fiscal consolidation contained total expenditures for the second year in a row to settle at SR825 billion, saving SR80 billion through the newly established Spending Rationalization Office. Reduced oil revenues and geopolitical challenges that underpinned military spending have offset the substantial growth in non-oil revenues. In 2016, revenues fell by 13.8 percent to reach SR528 billion, yet higher than the budgeted revenues of SR514 billion by 2.8 percent. Accordingly, the budget balance recorded a deficit of SR297 billion, representing 11.5 percent of GDP.

Non-oil revenues posted a record while oil revenues contracted on the back of lower oil prices. OPEC’s battle for market share against high-cost producers, with the Kingdom producing at record levels, as well as moderating global oil demand, pressured Arabian Light crude price that averaged $40/bbl in 2016YTD. Consequently, domestic oil revenues decreased to settle at SR329 billion, 26.3 percent below 2015’s level. However, the surprising inflection in OPEC’s strategy that abandoned “pumping at will” in favor of rebalancing the oil markets through a 1.2 MMBD production cut will be supportive for prices in the coming quarters. Meanwhile, non-oil revenues registered a record high at SR199 billion, a 20.0 percent Y/Y increase, driven by SAMA’s investment income that rose by 75.7 percent to register SR62.2 billion. Looking ahead, the myriad changes to municipal and visa fees as well as the 2.5 percent vacant land fees will be fully realized next year, which will propel the non-oil item.

The Kingdom is adamant to streamline spending to ensure fiscal sustainability. Government expenditures are expected to record their first back-to-back decline since 1999 this year. The broad-based fiscal adjustment resulted in a drop of 15.6 percent in actual expenditures, which was also 1.8 percent below budget, an inflection from the historical tendency to post double-digit budget overruns. The government had started to ease the CAPEX drive, given its elastic nature, evident from an expected SR100 billion drop in investments during this year, which brought total capital expenditure to an estimated SR183 billion, with $44.5 billion worth of projects put on hold. We expect current expenditures to have contracted to SR642 billion, a decline of 6.2 percent Y/Y, as the government started to streamline operating expenses and contain allowances. The full benefit from the Royal decree to freeze public salaries and constrain allowances will be reaped in 2017.

The external balance is expected to remain pressured given the inherent volatility of the oil markets. 2017 budget did not release the balance of payments data, yet we expect a deficit of $69.5 billion, equating to 10.1 percent of GDP. A stronger dollar, moderating domestic demand and contained commodity prices for most of the year will reduce the import bill by 12.5 percent on an annual basis to settle at $134.8 billion. However, low oil prices will curtail exports to $163.9 billion, an 18.9 percent decline, despite oil production peaking in July at 10.7 MMBD. Accordingly, the trade balance will fall drastically to $29.1 billion, 38.5 percent Y/Y decline. We expect exports to rebound in 2017 and beyond as oil prices edge higher, positively impacting the trade balance and restraining the current account deficits. The government maintained a two pronged strategy of covering the funding gap via drawing down reserves and debt issuances. As such, net foreign assets fell by $73 billion to $536.6 billion by end of October, yet as we expected last year the draw down was slower compared to $84 billion withdrawn during the similar period of 2015. Importantly, official net foreign assets remain at a healthy position, equivalent to approximately 48 months of imports.

International and domestic debt issuances propelled total outstanding public debt to SR316.5 billion, amounting to 12.3 percent of GDP, yet it remains significantly low compared to regional and international counterparts. The debt instruments included local issuances worth SR97 billion, a $10 billion international syndicated loan arranged in May as well as a $17.5 billion international debt issued in October. The newly created Debt Management Office at the Ministry of Finance had clearly diversified the debt portfolio by tapping into international capital markets, a shift from the long standing policy of only raising debt domestically. Critically, a crowding-out effect resulting in tighter liquidity amid the rising issuances of domestic bonds was a major concern, with the three months inter bank offer rate rising to 2.39 percent, a multi-year high by the end of October. However, SAMA had been proactive to mitigate this issue via different measures that included the injection of

SR32 billion into the banking sector, especially for small and medium-sized banks. In addition, the central bank in October limited the weekly subscription in T-bills from SR9 billion to SR3 billion and extended repo maturities to 90 days, complementing the maturities of 1, 7, and 28 days. These monetary policy decisions coupled with the Kingdom’s international bond sale, an emerging markets record, were beneficial to the banking system in reducing leakage especially that local banks subscribe in the monthly issuance of government bonds, thus, driving the inter bank rate lower to 2.1 percent in December.

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