Saudi Arabia: An Expansive Spending Plan, Mixed Messages for Private Sector

Saudi Arabia released its 2018 budget with great fanfare today, including a meaningful increase in spending directly and via off-balance sheet funds such the public investment fund (PIF). With the oil sector no longer a drag and the non-oil sector benefiting from government pump-priming, economic growth should accelerate, from near-recessionary levels, part of a broader trend among oil producing nations. Still, private sector contribution is likely to lag as credit demand struggles, government funds dominate and questions remain about the rules of the game after the anti-corruption crackdown. Changes to energy policy are unlikely.

The budget included the largest planned spending (figure 1) of any budget, 978 billion riyal ($260 billion) and an additional 150 billion riyal in spending from various development funds. It comes close to the actual spending peaks of the early 2010s boom years. Given the spending increase in Q4, and a tendency to overspend budgets, actual spending in 2018 may again outstretch plans and in the longer 5 year plan. Adding in the spending from the PIF, there’s likely to top that. This will reinforce the bounceback in growth after several years of moderate recession and austerity. It may be less effective in generating private sector activity, which is likely to lag consumption and government investment.

Figure 1: Actual and Government Spending (USD billion)

Source: Saudi Arabian Ministry of finance, Author’s Calculations

The more expansive stance is not unique to Saudi Arabia. Most of its GCC and energy producing peers will also have more expansive or at least less austere budgets in 2018, helped by stronger oil and gas prices and still relatively easy global credit conditions that make it easier to issue debt. In Nigeria and Russia as well as Bahrain and Oman, less austerity is likely rather than stimulus. Still these decisions reinforce several trends for 2018 including a belated recovery for many commodity producing nations (catching up to the broader expansion seen in 2017), a bottoming out/improvement in EM investment and some pickup in inflation. All of these generally support EM and local equity over bonds.

​Many people are asking me “will it work” Will the reforms be enough? There’s some good news – continued phase in of new taxes, slow moves to reduce fuel subsidies,  new long-term fiscal planning and a more measured approach to spending. The challenges come from absorbing and deploying the new funds and the lingering issues from this period of intensive change.

The Saudi plan follows several recent announcements to support private sector growth via credit measures including subsidized business loans and mortgages, aiming to encourage exports. I’m less convinced that these credit fueled measures will help generate new investment from the private sector, with the government becoming even more of a growth driver (fiscal spending has long been the key driver of growth in Saudi Arabia).

Many are raising concerns about the new longer time to balance the budget and the increase in debt. On their own, a greater increase in debt or delayed fiscal consolidation is not necessarily a bad thing, the key is what these policies finance. Too much fiscal consolidation and delayed government transfers would be contractionary and make it harder to spur a positive feedback loop (an argument the IMF has made in much of its work this year). Key catalysts include – the implementation of planned infrastructure, and the intake from new non-energy taxes. These will be key to the credit cycle.

Although some of the spending will be fueled by new debt, expect the draw down of local and foreign assets to remain high, especially as some of the consolidated new funds (for education, health and social development are deployed.  It’s likely that more of Saudi Arabia’s foreign investment will be in sectors targeted for local development, involve technology transfer and increased local content regulations. The authorities may thus have to choose between their goals of increasing employment, building out infrastructure, growing investment returns and diversifying the revenue base.

There are several reasons to be skeptical about the feed-through to private sector investment.

1. Anti-corruption spillovers. Questions linger about the penalties and consequences of the anti-corruption drive and what the new rules of the game are both for locals and foreigners. With concerns on the next steps, wealthy Saudis and some foreigners may be reluctant to invest, reinforcing the importance of government funds. Examples from other countries suggests a temporary drag at best, longer if the rules aren’t clear.
2. Credit demand issues: credit to the private sector has been flat to contracting for the last few years, as government borrowing or projects increased. The government funds can address the credit supply issues (concern about private sector credit worthiness and partly reverse systemic credit access  but may not do much for demand from corporations.
3. New tax implementation: The budget and plans include the implementation of planned new taxes including the VAT as well as compensatory transfers to the poorest households. These policies, while positive for the long-run are likely to have near-term challenges.
4. Regional political divides and increasing rivalry:  The concurrent diversification across GCC countries has long weighed on local liquidity, a trend, which is likely to continue.
5. Questions on foreign investment terms. Saudi authorities have announced several new mega projects which would rely on foreign investment. There seems to be a disconnect between the goals of adding new housing supply and infrastructure, maintaining control and adding local content and jobs. This suggests that implementation may lag.

In the GCC, especially Saudi Arabia and the UAE, greater government spending on infrastructure will only offset the imposition of new taxes and energy price hikes. These should have the greatest effect on expat workers (and their employers) rather than citizens, as some of the latter will be eligible for compensatory waivers. Although new tax levies are likely to be modest, their imposition is likely to add some volatility to the next few quarters macro trends.

The more expansionary stance suggests that debt issuance is likely to remain high in regional corporate and sovereign markets, rivalling 2017’s record volumes. This will raise questions about the ability to absorb the new issuance at home if not outside the region.

While Saudi Arabia’s debt stock is still low (and the government plans to cap public debt at 25% of GDP in the forecast period), the pace of increase is high. This suggests more debt associated with quasi-private entities and projects. It remains to be seen Equity issuance (via IPOs) is also rising, raising some concerns about local markets ability to absorb the issuance. These trends suggest local interest rates (bank and sovereign debt) are likely to grind higher at the longer end, while following the Federal Reserve’s rate hikes elevates the shorter end. The global search for yield should make regional issuance relatively attractive nonetheless.

The more expansive fiscal stance and greater capital and consumption spending should increase imports. This suggests that the current account deficit could take longer to close and should be only near balance and that reserves drawdown will continue. Asian countries especially China and South Korea which dominate imports to Saudi Arabia and the MENA region more generally, should benefit, as well as Europe though heavy military spending and some targeted measures suggest some increase in imports from the U.S. Increase in local military procurement is likely to be slow and focused on technology transfer.

This budget suggests greater comfort level with the oil price and demand outlook, but also a renewed push to move quickly on economic growth at home. The need to deliver more quickly on local jobs and housing remains high. This is not an expansionary budget of old, but is more measured. What hasn’t changed is the reliance on government pump priming and the importance of tradeoffs between quick roll-out, maintaining government and local control. That many of Saudi neighbours are also trying to make similar adjustments may increase the cost of capital.