States fund their budgets by their revenues regardless of whether these are hugely dominated by oil revenues or are from other sources such as taxes. If a state realises a deficit in its budget, it bridges the gap by either one or a combination of the following options: using its central bank’s reserves; withdrawing from its sovereign wealth funds; borrowing from its local market; and borrowing from international markets. The first is currently done by most petro-states due to low oil prices. Other states have refrained from transferring money to their respective sovereign wealth funds rather than withdrawing from them.
The third option is conducted via issuing bonds in a state’s own market while the fourth is doing the same, but by selling those bonds to government, institutional and other customers in international markets via recognised financial centres. In many instances, those are dominated in US dollars. A current exception was Nigeria’s intention to borrow in yuan by issuing bonds in the Chinese market.
For this article, I am interested in exploring the fourth option in relation to Saudi Arabia. The world is still recovering from its own financial crisis and so interest rates are low, extremely low. Additionally, countries like Sweden and most recently Japan have introduced negative interest rates.
In other words, people get charged for depositing their money in banks because central banks are charging the banks for keeping money with the central banks. I know ...
When Saudi Arabia announced that it’s facing a budget deficit of $98 billion (Dh359 billion), there were all sorts of OP-eds speculating what its next steps are going to be. Will it withdraw from its currency reserves? Will it withdraw from its sovereign wealth fund?
Others came up will all sorts of calculations on when SAMA, the authority managing Saudi Arabia’s currency reserves, will run out of cash. Saudi Arabia then announced its privatisation plan among other plans to boost revenues and reduce pressure on its public sector. But what about issuing debt?
As the Saudi riyal is pegged to the dollar, it needs to adjust its interest rates to that of the Fed when the Fed increases or decreases its rate. As the Fed reversed direction, it is very unlikely that it will reverse it again and head back to zero interest rate anytime soon.
Given current conditions in the financial markets, wouldn’t it be more efficient to borrow from international markets, especially for a country with a debt-to-GDP ratio of 5 per cent?
Negative rates should normally encourage people to spend money. And for those who don’t want to, being offered the opportunity to buy bonds is second best to deposits at banks. A country like Saudi Arabia, although currently downgraded by Fitch, is still rated in the As and is a long way from having a serious, risky debt-to-GDP ratio. In other words, Saudi Arabia can borrow at cheaper rates than other states who have higher debt-to-GDP ratios or those that have defaulted on their debt obligations previously.
Also, Saudi Arabia could issue a mix of short-term and long-term bonds. For the former, its return on foreign assets should cover its obligations while better market conditions at bonds’ maturity would enable it to sell its foreign assets at a premium, if needed, to meet its debt obligations. I am ruling out refinancing here because of the Fed just starting to raise interest rates.
As for long-term bonds, 10-year ones, Saudi Arabia’s privatisation and other plans would ensure the payment of the interest on those bonds. Moreover, a decade is a good time frame for oil markets to recover to a point where Saudi Arabia can fill any windfall if necessary.
The last question that I want to leave you with is: In what currencies should Saudi Arabia issue its bonds if it does? (Hint: who owns the biggest share of US treasuries?).
—The writer is a UAE-based economist. You can follow him on Twitter at @aj_alshaali.