Friday 19 October 2018

Saudi Arabia’s 2018 budget walks a fine line: BofAML

DUBAI, December 20, 2017

Saudi Arabia’s 2018 budget is, on balance, expansionary as the pace of austerity eases further thanks to higher oil prices and more gradual fiscal reforms, said the Bank of America Merrill Lynch (BofAML) in its analysis.

 However, this is coming at the cost of a higher fiscal breakeven oil price and volatile oil prices could dent the hard-won credibility of the fiscal reform programme, BofAML added in its Saudi Arabia Economic Watch.

“Furthermore, we are more conservative than the authorities in our growth rebound projections. Energy policy is likely to remain focused on supporting the oil market rebalancing and enabling the government's shift to boost growth near-term, thus making the Opec+ June 2018 meeting key,” the report said.

Energy policy success crucial to fiscal space

Fiscal easing could prove premature if oil prices disappoint as higher expenditures drive the fiscal breakeven oil price higher, and private sector expectations now make changing course more challenging near-term. For now, stable Saudi energy policy and high oil prices support government efforts to lengthen the timeline for fiscal consolidation. The government's projected medium-term rebound in real hydrocarbon GDP growth likely supports a gradual exit strategy from the Opec+ agreement back to market share focus.

2018 budgeted revenue numbers would be consistent on our estimates with an internally budgeted oil price assumption of $60/bbl and oil production at 9.9 million bpd. The budget itself would breakeven at c$85/bbl on our spending assumptions. This is $5/bbl higher than 2017 but c$10/bbl lower than 2016 levels. The push to balance the budget by 2023 instead of 2020 represents a deviation of SR141 billion (5.5 per cent of GDP) from the previously planned fiscal trajectory to 2020, stemming from both higher expenditures and lower revenues.

Growth bottoms but no V-shaped recovery

Uncertainties linked to the impact of the anti-corruption probe on the private sector, the breakdown of the stimulus package, and the funding and timing of off-budget mega-projects keep us conservative on our growth assumptions. Authorities project real GDP growth of 2.7 per cent in 2018 with a robust expansion of 3.7 per cent in the non-hydrocarbon sector. In contrast, we see real GDP growth of c1.3 per cent, with non-hydrocarbon real GDP growth not exceeding 2 per cent. In 2017, real GDP contracted by 0.5 per cent as the real hydrocarbon sector GDP contracted by 4.3 per cent and non-hydrocarbon real GDP growth stood at 1.5 per cent. The latter masks large fiscal expansion in 4Q17 offsetting the business sentiment confidence shock of the anti-corruption drive, as non-oil real GDP growth stood at c0.5 per cent in 1H17.

The central government fiscal impulse may remain modest. The more accurate indicator of the underlying fiscal stance, the primary non-hydrocarbon balance (per cent of non-hydrocarbon GDP), is likely to remain flattish at -25.8 per cent over 2017-18, from -30.7 per cent in 2016. This reflects the fact that higher primary expenditures are being partly funded from higher non-oil fiscal revenues (VAT, expatriate fee) which act as a drag on domestic liquidity and activity. We see central government expenditures increasing by 8.5 per cent to SR1trillion in 2018 (c2.8 per cent increase in real terms), which would push non-oil real GDP growth up by c0.4ppt all else being equal.

The planned increase in central government spending is of mixed nature. We estimate the bulk of the increase represents the start of the Household Allowance programme (SR32 billion), higher capex (SR25 billion) and potentially the stimulus package (SR24 billion).

Stimulus impact on activity may lag fiscal costs

Higher capital expenditures are an undeniable support to the non-hydrocarbon sector activity. We are more cautious in terms of the impact of the 2018 tranche of the SR200 billion fiscal stimulus. Some 30-40 per cent of the stimulus package appears to represent higher capital allocations to various government funds. These expenditures, alongside other similar stimulus initiatives, are only likely to support growth indirectly (through lending) or through a longer-time period. In contrast, the fiscal impact of these initiatives could be immediate as the government capitalizes the various funds.

Mega-projects - little visibility, big upside to activity

The real upside to non-hydrocarbon activity likely lies in the off-budget mega-investment initiatives, which could add 2ppt to non-hydrocarbon sector growth if realized over 2018. Authorities have suggested further off-budget spending of SR83 billion from the Public Investment Fund (PIF) and SR50 billion by the National Development Fund. We understand the Neom project will likely be developed over 2019-2025, while the Red Sea tourism project and the Qiddiya entertainment will likely be developed in phases partly extending over 2017-2022. However, funding for the mega-projects remains unclear as of now, particularly as the PIF may require proceeds from Saudi Aramco's potential IPO to invest domestically.

Fiscal discipline, higher revenues narrow 2017 deficit

The fiscal deficit has continued to narrow over 2017 although partly due to cyclical and one-off factors. The 2017 fiscal deficit stood at SR230 billion (c$61.3 billion; c9 per cent of GDP), narrowing markedly from 2016 levels (SR416 billion; $110.9 billion; 17.2 per cent of GDP). Overall spending discipline and higher revenues have narrowed the fiscal balance. Authorities have benefited from a high fiscal transfer ratio from Aramco, despite a c250k bpd cut in oil exports during 3Q17.

This may be due to a higher share of profits (pro-cyclical) or savings (likely unsustainable) being remitted from Saudi Aramco to the budget. Non-oil revenues increased by a whopping 37.8 per cent yoy to SR256 billion ($68 billion; 10 per cent of GDP). This is surprising and 21 per cent higher than budgeted (SR44 billion; $11.7 billion; 1.7 per cent of GDP). This is due to likely one-off increases in investment income from Sama or the PIF in 4Q17 which may not be sustained in 2018.

Spending remained generally tight in 2017, despite a major loosening in 4Q17

Spending in 2017 was 1 per cent lower than 2016, and 4 per cent above budgeted levels. However, this masks a major fiscal loosening in 4Q17 as we estimate that 4Q17 spending represented 38 per cent of total spending, leading to a doubling in the quarterly fiscal deficit in 4Q17 to SR108 billion. The overspending was mostly on military (SR14 billion; $3.7 billion), education and health/social development appropriations. Spending increases likely benefited from the redirection of funds earmarked to the Household Allowance programme. The latter is due to start in December 2017 and its size may now reflect easing fiscal austerity. Capex spending was hard-hit in 2017 as it contracted by 4.5 per cent to SR180 billion (7.1 per cent of GDP). The contraction is more pronounced (15.7 per cent) in reality as the 2017 capex spending now consolidates previously off-budget spending from the budget surplus fund (SR25 billion in 2016).

Watch central government deposits at Sama over 4Q17

Budget transparency has improved markedly. Still, 4Q17 data on central government deposits at Sama will be key to reconcile cash-based preliminary deficit figures with the financing raised during the year. For now, the extent of off-budget spending in 2017 is unclear as the authorities mention a SR40 billion capital increase to the Real Estate Development Fund (REDF) and the Industrial Fund was carried out in 2017. Authorities have also mentioned all government arrears were repaid. As of October/November 2017, the financing envelop combined SR75 billion in drawdown of central government deposits at Sama, SR53.7 billion in gross domestic debt issuance and SR80.6 billion in external debt issuance. Authorities suggest a total of SR100 billion was withdrawn from central government deposits at over 2017, but this does not appear to be fully consistent with the large fiscal deficit over 4Q17.

2018 deficit maintains the balance

“We expect the 2018 fiscal deficit to remain flattish to the 2017 outturn at SR239 billion (8.9 per cent of GDP) on the assumption of oil prices of $56/bbl. Authorities target instead a deficit of SR195 billion (7.3 per cent of GDP), but mainly on account of higher projected oil revenues,” BofAML said.

The latter is targeted to increase by 11.8 per cent versus 2017 realized oil revenues, likely also partly on account of proceeds of domestic energy pricing reform. Non-oil revenues are budgeted to increase by SR35 billion versus 2017 realized non-oil revenues. As the introduction of a 5 per cent VAT and of the expatriate fee are projected to bring in proceeds of SR23 billion and SR28 billion respectively, this likely suggests there was a one-off element in the outturn of 2017 non-oil revenues.

2018 spending is projected at SR978 billion (9.9 per cent higher than the SR890 billion for the 2017 budget and 5.6 per cent versus 2017 actual). The military, education, and health and social development sectors maintain the largest appropriations (21.5 per cent, 19.6 per cent, and 15.0 per cent respectively). We expect total spending to increase by 8.5 per cent yoy to SR1trillion in 2018 (3 per cent overspending; SR27 billion), as we pencil in the wage, military and security bills flat to their 2017 outturns (while their budgeted levels would witness a drop versus 2017 outturns).

Authorities intend to finance 60 per cent of the budget through debt (domestic and international) issuance and 40 per cent through drawdowns of central government deposits at Sama.

“Alongside our deficit projections, this suggests that international debt issuance in 2018 is likely to hover around 2017 levels,” BofAML concluded. – TradeArabia News Service

Tags: Opec | Sama | BofAML |

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