Dubai: Fiscal policy is an important driver of external imbalances in the GCC. Analysts say the region has historically defended the currency pegs even in the face of twin deficits through multi-year fiscal consolidation drive and this time too governments are likely to use all fiscal tools before changing the forex policy.
Most GCC countries have initiated fiscal consolidation process. With the relatively low level of economic diversification, the GCC countries are in a position to reduce capital expenditure without impacting job of citizens
“Labor mobility and relative wage flexibility in parts of the segmented labour market provide adjustment means from a political economy perspective. Construction is a large regional employer, but the bulk of its employment is formed by blue-collar expatriates with perfect mobility, meaning that the initial phase of spending cuts does not unduly fall on nationals,” said Jean-Michel Saliba, MENA Economist, Bank of America Merrill Lynch.
Devaluation would improve the fiscal and external accounts, but the impact is likely overstated given the need for a large FX adjustment, the loss of a credible nominal anchor to the economy.
“In our view however, the potential negative consequences of devaluation outweighs any short term benefit in terms of budget revenues. Oil remains the dominant export for most GCC economies, including Saudi Arabia, although the UAE has a more diversified export base. Consequently, devaluation would have a limited impact on Saudi export competitiveness, which would quickly be eroded by the higher cost of imports, and higher inflation,” said Tim Fox, Head of Research, Emirates NBD.
Fiscal policy
While the current account deficit of Saudi Arabia is relatively small, its elasticity to the dollar too is small. It would require a very large devaluation to bring the current account to balance as noil exports are small. Furthermore, 30-40 per cent of imports are government-related, so they are affected by fiscal policy primarily, not relative prices. This means that the only external lever left to affect to restore external balance would be private sector imports.
More importantly, given the substantial resources available to SAMA [Saudi Arabian Monetary Agency], it is fully capable to defend the existing monetary policy regime for a foreseeable future. Saudi Arabia has substantial fiscal reserves, and low debt, which enables them to finance sizeable deficits for several years, without making any changes to their long-standing monetary policy regimes. Despite declining sharply in 2015, SAMA’s Net Foreign Assets stood at $628 billion (Dh2.3 trillion) at the end of 2015.
“Our analysis suggests that, based on a conservative oil price forecast of $30 per barrel, and oil production of 10 million barrels per day, Saudi Arabia could finance a budget deficit of around $133 billion per year entirely out of accumulated reserves until 2019,” said Khatija Haque, Head of Mena Research, Emirates NBD.
Spending levels
According to Emirates NBD forecasts, if the kingdom raised additional debt and/or privatisation revenue to finance 40 per cent of the deficit going forward, then it could maintain spending at 2015 levels (975 billion riyals) until 2022 before depleting its accumulated reserves entirely. While this strategy is not recommended, the analysis illustrates just how substantial a cushion Saudi Arabia has to withstand the current fiscal strain.
The Saudi government has already announced that it will move ahead with privatising airports and airport services this year, although it is unclear at this stage how much revenue this would raise. There has also been discussion around the potential privatisation of Saudi Aramco or its upstream/ downstream assets. Saudi Aramco is conservatively valued at $2.5 to 5 trillion, so even a 10 per cent IPO could yield $500 billion, nearly doubling the current level of SAMAs Net Foreign Assets.
“Even if the “crown jewel” of Saudi Aramco is not partially privatised, there are potential privatisation opportunities across most of the key sectors including health care, education, transport, petrochems which could provide additional liquidity and add to SAMA’s “firepower” when it comes to maintaining the USDSAR peg,” said Haque.
