Saudi Arabia – Fiscal Sustainability in Focus

The COVID-19 numbers have ticked upward in May, but the daily figures for both cases and deaths remain far below the peak levels reached early in the year and appear to have stabilized. With the health threat seemingly under control and a national vaccination program proceeding at a rapid pace, government officials have once again turned their attention to implementing a diversification program designed to reduce the kingdom’s vulnerability to volatility in oil prices.
The government is planning $7.2 trillion in domestic spending through 2030, while ensuring that state-owned companies have more resources to make capital investments by reducing the dividends that the firms pay into the treasury. Ensuring the availability of the necessary fiscal resources hinges on slashing a budget deficit that ballooned to 11.4% of GDP in 2020, the result of a steep fall in oil income and increased spending required to deal with the health crisis and protect households from the associated economic damage.
Officials have made a good start. The tripling of the VAT in July 2020 and various other tweaks to the tax rules are expected to boost inflows on a sustained basis as the economy recovers. In combination with cuts to spending on defense and capital investment and the positive impact of a planned increase in crude output on oil revenues over the coming months, the budget deficit is forecast to narrow to just 3.2% of GDP this year.
Annual FDI has been significantly lower since Crown Prince Mohammed bin Salman (MBS) launched his Vision 2030 diversification program in 2016, in part the result of Riyadh’s adoption of a markedly more aggressive foreign policy posture that has produced a stalemated war in Yemen, a failed blockade against Qatar, and a worrisome escalation of tensions with Iran. The accompanying increase in security risks for investors and negative international attention has cooled the ardor of foreign suitors, and the negative impact has been amplified by credible allegations that MBS directly ordered the October 2018 murder of Jamal Khashoggi, a US-based Saudi journalist who was critical of the governing in Riyadh.
MBS has reached a truce with Qatar and is attempting to extricate his country from the conflict in Yemen, but the risk of conflict with Iran is likely to persist as the latter’s hardline clerics tighten their grip on the levers of power. The crown prince has managed to escape punishment for the Khashoggi murder, but the change of administration in Washington could bring increased pressure for Saudi Arabia to improve its record on human rights, contributing to tensions with the US that reinforce the hesitancy of investors.
The oil sector continued to create a drag on overall growth in the first quarter of 2021, with a 12% (year-on-year) contraction, the result of a continued voluntary cutback in crude production. The weakness of the oil sector more than offset the positive contribution from the non-oil economy, resulting in an overall real decline of 3.3% in the January–March period.
The OPEC+ group has agreed to ramp up total crude production by 2 million barrels per day (bpd) over a three-month period starting in May, with about one-half of the increase coming from Saudi Arabia, which slashed its production by 1 million bpd under an agreement reached a year ago. That bodes well for a return of economic growth over the remainder of 2021, but the full-year expansion will be held to just 3%.
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