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OTG: Saudi Arabia – Deficits, Debt and Deceleration

By Standard Chartered Bank

Summary

A second year of low oil prices is weighing heavily on Saudi Arabia’s economy. Growth momentum should slow significantly under the weight of lower government spending. We reduce our growth forecast to 1.5% this year (from 2.7%).

We expect the fiscal balance to reach a deficit of 12.3% of GDP, versus 15% in 2015. 2016 is set to be a year of fiscal consolidation. The fiscal adjustment effort will likely initially focus on expenditure. To this end, the government appears to be sending a strong message about the need to cut spending – defence and security spending is budgeted 31% lower than in 2015 and energy subsidy reforms have been kick-started. Measures are also underway to bolster the revenue side, but these will probably take longer to come into effect. Contractionary fiscal policy and spending cuts support the fixed exchange rate regime by compressing imports and reducing demand for foreign currency resources.

We expect further tightening in monetary conditions this year as the government continues to finance the budget partly by issuing local-currency (LCY) government bonds. We anticipate that the government will rely more on debt issuance this year than in 2015, including by tapping international capital markets and via loan syndications.

We estimate that the current account (C/A) turned to a deficit of 7.5% of GDP last year for the first time since 1999 on the terms-of-trade shock. We expect the C/A to remain under pressure this year, with a deficit forecast at 6.7% of GDP. For 2016, we estimate the C/A breakeven oil price at c.USD 65/barrel (bbl).

Although financial markets question the sustainability of the Saudi Arabian riyal (SAR) peg to the USD, we expect no change in Saudi Arabia’s currency policy. Reserves, although declining, are adequate. Given that exports are dominated by hydrocarbons, currency devaluation would yield limited competitiveness gains. Furthermore, the SAR peg stands to benefit from fiscal consolidation and tighter monetary conditions, both of which should reduce pressure on reserves.

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