Dubai: The launch of the Fiscal Balance 2020 Programme in the second half of 2017, the MSCI EM watch list announcement in mid-June and a possible Aramco IPO in 2018 are likely to mark the start of a fundamental transformation of Saudi Arabia’s economy and public finance, according to analysts at Bank of America Merrill Lynch.
Analysts say that although fiscal targets are unlikely to be met, the programme will help narrow fiscal imbalances to mid-single digits by 2020.
“Stabilising forex reserves will require oil prices rebounding above $50/bbl and a moderation in capital outflows. Despite forthcoming support measures, fiscal austerity is likely to keep growth muted,” said Jean-Michel Saliba, Meana Economist at Bank of America Merrill Lynch.
Analysts expect comprehensive reforms under Fiscal Balance 2020 Programme over the period from the second half of 2017 through 2020. These reforms are likely to fundamentally transform the economy’s growth model by removing some sources of competitive advantages in the private sector, altering the social contract, introducing taxation, as well as instituting a social safety net and selective government support to corporates.
“The authorities’ desire to support the private sector during the adjustment process inevitably brings tensions with the ambitious fiscal agenda. As such, we expect the government to announce a private sector support package that is likely to selectively shelter strategic sectors and systemic entities,” said Saliba.
Excluding a potential support package, economists estimate that the fiscal reforms could drag headline real GDP growth by 1.2 percentage.
Non-strategic corporates and expatriates are likely the main losers of reforms. The cumulative impact on expatriates of the expatriate dependent fee, gasoline, electricity and water reforms will likely constitute 9.1 per cent of expatriate income in 2017 and climb to 22.5 per cent in 2020. However, private consumption may hold up as Saudi nationals constitute about 75 per cent of total consumption.
The cumulative impact on corporates of the worker levies, energy and water reforms will likely climb to 10.9 per cent of corporate profits in 2020, or 23.8 per cent, if government support be excluded.
Although the ambitious Fiscal Balance 2020 programme targets are unlikely to be met, imbalances are expected to narrow to mid-single digits. While gross fiscal reform proceeds are estimated at 11.4 per cent of GDP, net fiscal proceeds are smaller at 3.8 per cent of GDP. As such, higher oil prices are needed to fill the remaining fiscal gap.
A sustained drop in oil prices is a key risk to the reform agenda. Oil prices above $50/bbl are conducive to helping reforms succeed while oil prices below $40/bbl are likely to endanger macro stability. Energy policy will look to support oil prices but 2018 market dynamics are more challenging. Near-term, policy priority remains bringing forward the rebalancing in the oil market and supporting oil prices. Oil price recovery is needed to narrow fiscal imbalances.
Analysts expect recent geopolitical tensions, following the GCC stand against Qatar may delay the launch of the next phase of energy pricing reforms beyond July. This is especially so as the liberalisation of residential electricity prices and increases in gasoline prices would coincide with the peak in domestic consumption.
The reversal of the allowance cuts is a setback in terms of perception of irreversibility and sustainability of the domestic reform program. However, it is unlikely to derail the reform drive as we believe the move was mostly for domestic consumption.
A major wage bill reform appears unlikely in the near future despite it being mentioned in the National Transformation Plan (NTP).
The next round of electricity and energy subsidy reforms is only planned to take place after a safety net has been put in place, so analysts say progress towards this milestone will continue although some slippage in terms of timeline may be possible. The reversal of the allowance cuts will likely translate into forex outflows. However , it is not a material fiscal loosening as cuts were probably around 0.2-0.3 per cent of GDP.