Standard & Poor’s Ratings Services estimated that Saudi Arabia’s hydrocarbon sector accounted for about 28 percent of nominal GDP in 2015, down from 42 percent in 2014, due to the sharp fall in oil prices.
Before the drop, the sector represented about 80 percent of exports and three-quarters of government revenues.
“Incorporating our oil price assumptions, we project real GDP growth will average 2 percent per year in 2016-2019, while our GDP per capita estimate for 2016 is $18,900,” S&P said in its observations released Friday.
On Friday, S&P also affirmed its ‘A-/A-2’ unsolicited long- and short-term foreign- and local-currency sovereign credit ratings on Saudi Arabia. The outlook is stable.
S&P said 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”.
Standard and Poors said the stable outlook on Saudi Arabia reflects the rating agency’s expectation that authorities will take steps to prevent any deterioration in the government’s fiscal position beyond S&P current expectations, over the next two years.
“We could lower our ratings if we observed further deterioration in Saudi Arabia’s public finances,” S&P said.
Such fiscal weakening could entail prolonged double-digit GDP deficits, a quicker drawdown of fiscal assets, or an unexpected materialization of contingent liabilities.
The ratings could also come under pressure if S&P observed a significant increase in domestic or regional political instability or a renewed marked weakening of terms of trade, according to the statement.
“We could raise the ratings of Saudi Arabia’s economic growth prospects improved markedly beyond our current assumptions,” S&P said.
S&P said that he ratings are constrained by underdeveloped public institutions, lower GDP per capita relative to similarly rated sovereigns, and limited monetary flexibility, according to the S&P statement.
“We project that the general government deficit will average about 9 percent of GDP in 2016-2019,” S&P stated.
The forecast takes into account the government’s 2016 budget measures.
“We acknowledge both upside potential and downside risk to these forecasts,” S&P added,
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.
The government has budgeted for a central government deficit of about 13 percent of GDP in 2016, compared with an outturn of 14 percent in 2015, with 2016 revenues falling by 16 percent and expenditures by 14 percent compared with the 2015 outturn, according to S&P.
This modest deficit consolidation reflects the government’s desire to allow automatic stabilizers to operate in order to support economic growth, in our view.
“We believe the authorities have based their budget on an oil price of about $45 per barrel. The government has established a support provision line within the budget in the amount of SR183 billion (8 percent 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,” S&P added.
“We expect the government’s fiscal consolidation plan will likely include postponing some capital spending projects, increasing non-oil revenues, and controlling current expenditures,” S&P said.
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 amounted to about 8 percent of GDP in 2015,” S&P said in its statement.
“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,” the rating agency added.
“On the revenue side, we understand that the imposition of taxes on undeveloped plots of land in urban areas is at an advanced stage,” it added.
This measure would both raise revenue and encourage private investment.
The government may also look at imposing value-added tax.
“However, we think this is likely to be a medium-term project, in line with discussions already under way with other members of the Gulf Cooperation Council customs union,” S&P added.
“Although Saudi Arabia’s fiscal profile has weakened on a flow basis, we believe it has remained strong on a stock basis,” S&P added.
Net general government assets (that is, the excess of liquid fiscal financial assets over government debt) peaked at 124 percent of GDP in 2015 (partly due to the estimated 13 percent decline in nominal GDP).
S&P forecasts that the government’s net asset position could decrease to 79 percent of GDP in 2019.
“Consequently, we believe Saudi Arabia is entering a period of adverse terms of trade from a strong position,” S&P said in its statement.
Over 2016-2019, S&P expects Saudi Arabia to finance its deficits by drawing down fiscal assets and issuing debt.
“For the purposes of calculating the annual change in government debt, we have assumed an even split between asset draw-downs and debt issuance, implying an average increase in nominal gross general government debt of about 7 percentage points of GDP per year,” the rating agency added.
Such a split would also imply that Saudi Arabia would report gross liquid financial assets of 111 percent of GDP by 2019, versus 129 percent at year-end 2016.
These fiscal assets include the central government’s deposits and reserves on the liabilities side of the balance sheet of the Saudi Arabian Monetary Agency (SAMA, the central bank), government institutions’ deposits, and an estimate of investment income. S&P also included in the calculation an estimate of government pension funds’ liquid assets.
S&P anticipates that GDP deflator growth will remain negative in 2016, at minus 8 percent, compared with minus 16 percent in 2015, alongside population growth of about 2 percent.
“We estimate that trend growth in real per capita GDP (which we proxy by using 10-year weighted-average growth) will amount to about 0.5 percent during 2010-2019, which is below that of peers that have similar GDP per capita,” S&P added.
“We foresee increasingly difficult operating conditions for Saudi banks over the next two years, due to the pressure on government spending and the expected impact on the domestic economy,” S&P said.
“In particular, we expect credit growth will contract to mid-single digits, given the strong correlation between oil prices, government spending, and credit growth. We also anticipate that asset quality will deteriorate but not endanger system solvency, owing to countercyclical buffers the regulator has imposed in recent years,” the rating agency added.
“Moreover, we expect some crowding out of private-sector credit by government borrowing needs,” S&P said.
Banks’ claims on the private sector rose to the still relatively low level of 89 percent of total deposits in February 2016, compared with 80 percent at the same time one year ago.
S&P classified the banking sector of Saudi Arabia in group ‘4’ under its Banking Industry Country Risk Assessment methodology, with ‘1’ indicating the lowest risk and ‘10’ the highest.
S&P anticipates a current account deficit equivalent to 14 percent of GDP in 2016.
Saudi Arabia’s external accounts mirror, in many ways, its fiscal accounts.
Like the fiscal accounts, they shift based on hydrocarbon prices.
Similar to its fiscal position, Saudi Arabia maintains strong external buffers.
S&P expects Saudi Arabia’s liquid external assets, net of external debt, to average about 214 percent of current account receipts (CARs) over 2016-2019. The Kingdom’s gross external financing needs are close to 45 percent of the sum of usable reserves and CARs over 2016-2019, suggesting ample external liquidity. That said, reserves declined to $593 billion in February 2016, from $714 billion in February 2015.
Given the Saudi riyal’s peg to the US dollar, we view monetary policy flexibility as limited.
The long-standing currency peg helps to anchor the population’s inflation expectations, but binds Saudi Arabia’s monetary policy to that of the US Federal Reserve.
“We expect that the peg will be maintained. We estimate reserve coverage (including government external liquid assets) at 117 percent of the monetary base and 22 months of current account payments in 2019,” S&P added.
The riyal’s real effective exchange rate has appreciated by 16 percent since early 2014 and stands around 40 percent over the December 2007 level, according to Bruegel data.
The riyal’s long-term real effective appreciation since 2007 has been the most pronounced among all GCC sovereigns.
“In our view, this indicates ongoing deterioration of international competitiveness in the country’s modest tradeables sector, which is likely to dampen non-oil GDP growth, absent any offsetting factors such as improved efficiency or technological capacity,” S&P added.