Saudi Arabia Eases Austerity Just as Oil Prices Decline

All allowances, bonuses and financial benefits for civil servants and military personnel cancelled, amended or suspended in September 2016 have been restored and backdated by a royal decree issued by King Salman ("Saudi Arabia slashes ministers' pay, cuts public sector bonuses", Reuters, Sept. 26, 2016).

The decision coincides with the alteration of the succession in favour of the king’s son Mohammad bin Salman and relieves the previous crown prince of all his posts.

The distribution of largesse to coincide with changes in the succession is common in monarchical systems to cement loyalty to the ruler and the chosen heir.

Saudi successions have normally been accompanied by generous financial packages for employees on the government payroll and distributions have also been made at other times of political stress.

The government has been gradually relaxing some austerity measures in recent months and signalling it would go further.

The decision to pair the change in succession with a relaxation of austerity is not surprising but there are questions about its affordability in the medium term.

 

Austerity
Austerity measures were introduced by the government in response to the sharp drop in oil prices and revenues.

Saudi Arabia’s earnings from petroleum exports shrank to $134 billion in 2016, from $322 billion in 2013, the last full year before oil prices slumped (“Annual Statistical Bulletin”, OPEC, 2017).

As spending outstripped income, the country’s foreign reserves were depleted by $116 billion in 2015 and another $81 billion in 2016, according to statistics from the Saudi Arabian Monetary Agency.

Saudi Arabia’s official foreign assets have fallen by a third to $500 billion at the end of April 2017, from a peak of $746 billion in August 2014 (“Monthly Statistical Bulletin”, SAMA, April 2017).

The combination of spending controls, increases in taxes and utility fees, and higher oil prices at the end of 2016 and in early 2017 narrowed the budget deficit and stemmed the depletion of reserves.

But austerity has provoked complaints from Saudi citizens and a broad slowdown in the private-sector economy, which relies heavily on government spending and oil revenues as the ultimate source of almost all activity.

According to a statement carried by the official Saudi Press Agency, the decision on Wednesday to reverse cuts for civil servants and military personnel was necessary to ensure a decent life for the kingdom’s citizens.

 

Sustainability
Foreign reserves declined by $35 billion in the first four months of the year; the reversal of austerity coupled with lower oil prices means the decline could accelerate in the rest of 2017.

Saudi Arabia still has room to manoeuvre. The kingdom’s remaining reserves stand at $500 billion. It has little foreign debt. And the eventual sale of shares in state oil firm Aramco should raise additional funds.

But reserves are depleting at an unsustainable rate of $100 billion per year, plus or minus $20 billion.

Saudi Arabia maintains a fixed exchange rate to the U.S. dollar, which means the country probably needs to keep minimum reserves of $200-300 billion to preserve confidence or risk a run on the peg.

In the meantime, the country is bogged down in an expensive armed conflict in Yemen which appears to have reached a stalemate.

Military and political competition with Iran, the kingdom’s traditional enemy, is escalating, and Saudi Arabia has promised to buy billions of dollars of extra armaments from the United States.

The government has outlined ambitious plans to move the economy away from dependence on oil and public-sector jobs to non-oil industries and the private sector.

The decision to restore public-sector salaries and bonuses is inconsistent with the policy of encouraging a shift to private-sector employment.

Pacing Reforms
So far the economic transformation plan has been long on rhetoric and short on substance. Tough decisions on spending lie ahead and will test the government’s resolve.

The recent Article IV consultation between the Saudi government and the International Monetary Fund concluded the kingdom could afford to take longer to balance its budget (“IMF staff completes 2017 Article IV mission to Saudi Arabia”, IMF, May 17).

“The government is adapting its fiscal policy to lower oil prices. The aim of bringing about a large, sustained, and well-paced fiscal adjustment to achieve a balanced budget is appropriate,” the IMF said in May.

“The target of balancing the budget, however, does not need to be met in 2019 ... given Saudi Arabia’s strong financial asset position and its low debt.”

“A more gradual fiscal consolidation to achieve budget balance a few years later would reduce the effects on growth in the near term while still preserving fiscal buffers to help manage future risks.”

But given the government’s swift turnaround on austerity, it remains unclear how it will close the persistent budget and current account deficits.

If something cannot go on forever, it will stop, noted the late Herbert Stein, chief economic adviser to then-U.S. president Richard Nixon.

The kingdom has comfortable financial reserves but they will not last forever.