Dubai: Saudi Arabia’s government is projected to run a fiscal deficit of around 20 per cent of GDP in 2015 according to the International Monetary Fund (IMF).

The IMF in its Article IV consultation with Saudi Arabia has concluded that the government spending in 2015 is expected to remain elevated despite a sharp decline in oil prices which could put pressure on government finances resulting in a surge in fiscal deficit.

“The decline in oil prices is resulting in substantially lower export and fiscal revenues, but the effect on the rest of the economy has so far been limited,” said Tim Callen, team leader of the IMF Article IV consultation.

Real GDP growth is projected by IMF staff at a healthy 3.5 per cent this year, unchanged from 2014, with an increase in oil production and continued government spending expected to support the economy.

Saudi’s economic growth is projected to slow to 2.7 per cent in 2016 as government spending begins to adjust to the lower oil price. Over the medium-term, growth is expected to be around 3 per cent and inflation is likely to remain subdued.

“Government spending in 2015 is expected to remain strong, partly due to a number of one-off factors, while oil revenues have declined. As a result, IMF staff projects that the government will run a fiscal deficit of around 20 per cent of GDP in 2015,” said Callen.

Government deposits with the Saudi Arabian Monetary Agency (SAMA) have declined in recent months to finance the deficit and smooth the pace of fiscal adjustment. According to the latest Sama statistics the cumulative year to- date drop in deposits of the central government at Sama has reached a large $63.8 billion while the cumulative drop in its net foreign assets has reached $45.9 billion at the end of April this year.

Under the current economic circumstances the IMF said this [high government spending combined with fiscal deficits] is an appropriate policy given the large stock of deposits and very low government debt, but the IMF official said a sizeable fiscal policy consolidation will be needed over the next few years to put the deficit on a gradual but firm downward path.

Analysts said the government spending pattern suggests continued support for the economy in the near term but growing fiscal gap calls for consolidation of government finances.

“Economic activity is likely to remain cushioned in the near-term but at the cost of wide and unsustainable fiscal deficits, in our view. The absence of material fiscal adjustment is likely to imply a need for a sharper adjustment down the line if oil prices remain low for long,” said Jean-Michel Saliba, Mena Economist at Bank of America Merrill Lynch.

The IMF also calls for a longer term fiscal consolidation plan for the Kingdom. “A strong fiscal framework that sets the annual budget in a medium-term framework and clearly establishes fiscal policy goals would support the fiscal adjustment. Improving the efficiency of government spending, comprehensive energy efficiency and price reforms, and expanding non-oil revenues will need to form central elements of the fiscal consolidation strategy,” said Callen.

Market funding

The rapid drawdown in reserve assets suggests that sooner than later the government is likely to opt for domestic borrowings. This is expected to gradually arrest the decline in government deposits.

Analysts said with a highly liquid and well capitalised banking system, Saudi financial system can easily absorb the sovereign domestic borrowing without major impact on their lending to the private sector. Government debt issuance is expected to boost the banking sector profitability as these debt instruments provide banks with low risk weighted and longer duration lending opportunity which could enhance earnings.

The recent opening of the Tadawul (Saudi Stock Exchange) to qualified foreign investors this month is a welcome development that will help deepen the equity market and broaden the investor base. “The depth of the local debt market will be enhanced by the issuing of more debt and sukuk. Government debt issuance to finance part of the fiscal deficit would help in starting to build a benchmark yield curve, an important step in developing the debt market,” said Callen.

The decline in oil prices has emphasised the importance of economic diversification. Policies are continuing to strengthen the business environment, but more needs to be done to encourage firms to focus more on tradable rather than non-tradable production in the non-oil sector.

“The government is undertaking an ambitious reform program to increase the employment of nationals in the private sector. With a young educated population entering the labour force in large numbers each year, creating a sufficient number of well-paying jobs is a critical challenge to support sustained and inclusive growth. With employment in the government sector at a very high level, more jobs for nationals will need to be created in the private sector to employ the new labour market entrants.