Budget deficit worries recede for KSA and other Gulf countries

Saudi Arabia has achieved the biggest improvement to its public finances in 25 years, according to the authoritative London-based think tank Capital Economics (CapEcon).

The boost to the Kingdom’s economy has come about through a combination of cost-cutting, subsidy reduction and stimulus measures for the non-oil sector of the economy. It also reflects the partial recovery in oil prices since they began to collapse in the middle of 2014, hitting a low of $32 per barrel in January 2016.

By contrast, oil now stands at $53 per barrel, and many experts believe it will rise to $60 by the end of 2017. Saudi Arabia’s budget for the current year was calculated on a projected oil price of $50 a barrel, so the picture could look even better at the end of the year.

It is not just a Saudi phenomenon, said CapEcon’s Jason Tuvey. “Budget positions across the Gulf should improve over the next couple of years — and many will return to surplus — supported in large part by higher oil prices. As a result, governments across the region are likely to ease up on fiscal austerity, while the pace of debt issuance is set to slow,” the analyst said.

All states of the Gulf Cooperation Council (GCC) have introduced measures aimed at countering the fiscal effect of the low oil price, which caused budgets to swing from large surpluses to deficits virtually overnight. Labeled an “austerity” program by some economists, the strategy amounted to a determined effort to adjust to a new reality of lower energy prices, and prompted initiatives in all GCC countries to accelerate the pace of economic diversification away from oil dependency.

The improvement is calculated by assessing the change in non-oil budget balances as a share of non-oil gross domestic product (GDP), over the course of 2015 and 2016. In Saudi Arabia, the balance has improved by 25 percent, the biggest jump since the 1990s, according to CapEcon.

Saudi Arabia and Oman show the biggest improvements on this scale, but tightened fiscal policy has also had a significant effect on the economies of Kuwait and the UAE (each with a swing of around 5 percent).

Bahrain has only managed to make a small inroad into its underlying budget position, despite its public finances being by far the worst in the Gulf. Qatar — which is committed to big state-funded projects over the next few years — actually swam against the trend, loosening fiscal policy, although its big reserves mean this is not seen as a major cause for concern.

The end of austerity

Budget positions will continue to improve for the rest of the year and next, CapEcon predicts, partly because of a continued rise in the oil price — which the firm expects to hit $65 per barrel by the end of 2018. This could translate into a 6 percent increase in the Saudi GDP by the end of next year.

At these oil price levels, all budget positions in the region will improve over the next couple of years. The UAE, Qatar and Kuwait should return to surplus this year, and the overall Saudi deficit will narrow sharply. Shortfalls will remain in Bahrain and Oman, the two smallest economies in the Gulf.

There are several lessons to be taken from the improvement in public finances. One is that the bulk of the adjustment to new oil prices has already taken place, and any further “austerity” is unlikely. The region has had its “short, sharp shock,” and taken it well. The days of oil priced at $100-plus are unlikely to return, but regional economies are better placed to handle any future shocks.

With non-oil sectors showing growth in most regional economies (though Bahrain is still a laggard), the effect has been to speed up the big strategic move away from dependence on oil revenue. Energy will always be the dominant factor in regional economies, but growth in the non-oil sectors will mean they will look more and more like “normal” economies in the future. That trend is to be applauded.

But there is a potential negative to this too. One of the ways in which regional economies have started to look more “normal” since the oil price decline has been the greater recourse to global capital markets by sovereigns and corporates, seeking to fill the gap in their finances caused by lower energy revenues and slower economic activity across the board.

Saudi Arabia has led the way in this, with the huge $17.5 billion sovereign bond issued last year regarded as a milestone in the maturity process of regional markets. Improving public finances mean that the fiscal pressure to engage with global markets is reduced. The appetite for further bond issuance will also be reduced by higher US and global interest rates.

Nobody is suggesting Saudi Arabia or the other Gulf states should turn into nations of debtors, but integration into global debt markets is another mark of economic maturity and diversification. Bonds and other forms of capital raising, like privatizations, should be retained as essential tools for policymakers.