Saudi economy more resilient than thought

Despite the global economic tensions and a sharply reduced oil price, the Kingdom continues to maintain its high credit and investment grade. Ratings agency Moody’s has just confirmed Saudi Arabia’s Aa3 sovereign rating.
The report the agency has issued to back up its strong assessment of the economy is extraordinarily positive. This bullish view is not simply based upon the core numbers. It is clear that the Kingdom’s past performance in managing economic downturn has informed the ratings agency’s judgment. Moody’s makes the key observation: “Saudi Arabia’s economy is far more resilient than meets the eye”.
Despite the stunning infrastructural transformation, the management of Saudi finances has always been conservative. Ambitious new industrial cities, state-of-the-art public transport systems, amply-funded universities with world-class research facilities have been just part of the very visible face of change. There has been another, less obvious, side.
The Saudi financial sector has been fostered carefully. Banks have never been encouraged to expose themselves dangerously to market cycles. Capital formation through the stock market has been vigorous but carefully monitored. The entry of foreign investors has been limited to large funds with a proven track record. Wild speculation in financial products unrelated to core assets has been controlled. As Moody’s makes clear, the result is that banks are very well provisioned by 190 percent. And the private sector is not burdened by huge debts.
In terms of government finances, the Kingdom’s debt to GDP ratio is among the lowest in the world. The average global figure is 87 percent. In Saudi Arabia, the 2014 year-end figure was just 1.6 percent. This year that number will rise to 6.4 percent, as the government covers an expected fiscal deficit of SR411 billion ($110 billion). The $660 billion reserves represent fully two years of budget cover.
At the heart of Moody’s analysis is the changing balance between the oil and nonoil economy. Hydrocarbons still account for 80 percent of revenues. The nonoil sector must continue to increase its contribution to GDP and thus ease the budget deficit. Huge investment of time, effort and money has been made in encouraging the nonoil economy. Without that consistent encouragement of the sector, the challenges today would be far greater. The nonoil sector is dominated by private enterprise. It ought to be strong enough to stand on its own feet as government support is cut back. Saudi Arabian Monetary Agency (SAMA) Gov. Fahd Al-Mubarak has said that there will be no let-up in the emphasis on boosting nonoil business.
The reduction in infrastructure investment will be the most obvious evidence of the conservative readjustment of the country’s finances. It is not yet completely clear what projects will be slowed or put back. There are contractual costs to any revisions. These must be weighed when deciding what financial savings must be made. As one eminent professor of government finance once said: “It costs money to save money”.
There have been suggestions that the government can make savings by cutting subsidies or introducing a Value Added Tax. It has long been argued in some quarters that subsidies on power and water have encouraged profligate consumption. A strong environmental case has been made for charges that better cover the costs of these utilities.
Nobody likes to pay more for anything. Resistance to higher charges is understandable. This is especially so in nonoil sector. Under World Trade Organization rules, businesses are having to compete in a global market place. But there is another way of looking at the subsidy bill, especially at a time of economic downturn. If the government continues to pick up the greater part of the tab, it means it has less money to spend on productive investment. That therefore impacts on the Kingdom as a whole. In the end, business and individuals still pay for the subsidies. The only issue is at which point in the charging process the payment is most productive.
International ratings agencies such as Moody’s focus on government budget deficits. Rightly or wrongly, throughout the world, they tend to be leery of subsidies. They see them as distorting economic activity. This, however, ignores a government’s ability to fund them from income, rather than debt. The Kingdom will need to increase slightly its modest borrowing. The clear danger is that the ratings agencies will choose to see no reduction in subsidies as a risk to Saudi finances. However unfair this may seem, the case for sustaining subsidies at their present level needs to be examined carefully.