High oil prices soften pressure on Saudi economy

BofA Merril Lynch

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LICENSE AGREEMENT
This Photograph taken by VisualMedia is supplied with an indefinite license for editorial purposes, but excluding advertorials or competitions. The license also covers internal communications requirements such as newsletters and non-commercial website use. Usage for external marketing / advertising purposes will attract additional fees that need to be negotiated dependent on requirements.

For further information please contact VisualMedia on +44 (0)20 7613 2555.

Note to Press:
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MANAMA: The loosening in fiscal discipline exposes the budget to the volatility in oil prices. The Royal Order pushes the 2018 fiscal breakeven oil price up by cUS$5-7/bbl towards US$85-90/bbl.

Jean-Michel Saliba, MENA Economist, in Bank of America Merrill Lynch’s Global Emerging Markets Weekly report said, however, oil prices remaining elevated in the mid-US$60/bbl could result in the 2018 budget staying flat to the 2017 levels in nominal terms (SAR230bn) and settle at c8.5% of GDP.

This assumes no off-budgetary spending in 2017, as the budget statement appears to indicate arrears were repaid within the budget envelope. Similarly, it is unclear if the SAR40bn capital increase to the Real Estate Development Fund (REDF) and the Industrial Fund in 2017 has been carried above or below the line.

Royal payments and security spending should drive overspending of cUS$20bn (3% of GDP) in 2018. Fiscal impulse could push real non-oil GDP growth towards c2.5%.

Fiscal breakeven oil price goes up by cUS$5-7/bbl to US$85-90/bbl. High oil prices soften the fiscal blow but possible permanent spending increases weaken reforms.

The introduction of discretionary and potentially sticky payments in the January 2018 Royal Order is likely to support a recovery in economic activity. While the 2018 budget only contained a limited fiscal impulse and mega-projects have little immediate visibility, the handouts are likely to support more decisively economic activity.

The royal payments would push 2018 real non-oil GDP growth up by a further c0.9ppt towards c2.5% on a pro-forma basis. The Cost of Living Allowances represent a large increase of c10% for earnings of Saudi nationals, boosting real incomes. When it comes to employed nationals, the Cost of Living Allowances alone nearly fully cover the higher cost of living due to fiscal reforms. We estimated here a monthly increase of SAR1,000-SAR1,2000 in the sensible consumption basket in gasoline, electricity and other goods.

The Royal Order payments are likely to drive overspending in excess of US$20bn (c3% of GDP) with respect to the 2018 budgeted amount. This includes our assumption of flattish military/security spending versus 2017 levels and our own calculations for the budgetary impact of the Royal Order. We include our estimated cost breakdown of the Royal Order alongside our assumptions in the table below.

The government’s estimate for the cost of the package is cSAR50bn (US$13.3bn; 1.9% of GDP), as reported by the local press. However, our calculations suggest the budgetary impact of the Royal Order could be close to SAR61.8bn (US$16.5bn; 2.3% of GDP). The cost to the budget could even climb higher to SAR70bn (US$18.7bn; 2.6% of GDP) if the central government decides to compensate PPA (Public Pension Agency) and GOSI (General Organization for Social Insurance) for the higher disbursements. As things stand, the additional disbursements could strain PPA’s overall balance (which recorded a SAR7.3bn or 0.3% of GDP surplus in 2016) but not GOSI’s overall balance (SAR29bn; 1.2% of GDP surplus in 2016).

Near term, the Royal Order payments may secure popular support for the 2018 fiscal reform measures. However, it is surprising that the Royal Order chose to compensate Saudi nationals through discretionary spending rather than through hikes in the Household Allowance program monthly transfer. This could well undermine the effectiveness and credibility of the Household Allowance programme, which was designed to compensate nationals on a means-tested basis. Nearly all announced payments risk having a permanent impact on the budget. They may not be phased out in a year, especially as they set a precedent and their re-introduction or continuation would be anticipated by Saudi nationals if further fiscal reform efforts push inflation higher.

The handouts will likely increase the difficulty of reforming the wage bill if it came to be needed. Authorities reported a 2017 wage bill of SAR440bn (US$117.3bn; 17.1% of GDP), ahead of the SAR412bn budgeted amount. This SAR28bn increase is in excess of the SAR18bn discretionary wage spending implemented last year (military personnel one-off bonus cost of SAR4bn, reversal of public sector allowance cuts cost of SAR7bn, and retroactive reinstatement of public sector allowances cost of SAR7bn). Labour force data may suggest that military/security personnel salaries, allowances and pension contributions could form c60% of the total compensation of employees reported by the central government, adding to public sector wage bill stickiness.

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