Thinking ahead: Government spending must take into account numerous short- and long-term factors

With a balanced budget for 2014, Saudi Arabia plans to spend everything it expects to earn. However, the biggest influence on revenue is the price that the Saudi Arabian Oil Company is able to charge for a barrel of its oil, meaning there is a significant margin for error in fiscal planning. In 2013 the government earned more and spent more than it had planned. The SR855bn ($228bn) it plans to spend in 2014 is 4% higher than the SR820bn ($219bn) it budgeted for 2013, and in line with the IMF’s GDP growth prediction of 4.4% for 2014. Yet planned expenditure is 7.5% less than was actually spent in 2013. That expenditure was easily offset by income of SR1.13trn ($302bn). Anticipated income for the 2014 budget is 24% lower than 2013’s revenues, and amounts to SR855bn ($228bn).

Jadwa Investment reports that spending has averaged 24% higher than budget forecasts over the last 10 years, although overspending in 2013 was just 12.7%, the lowest figure since 1999. The Saudi government has been traditionally conservative when estimating oil prices, with the actual price an average of 70% higher than the figures used in the budget for the last decade.

Room For Manoeuvre

Two factors that temper any atypical optimism on the part of the Kingdom’s financial planners are the surpluses the country has built up in recent years and its spare capacity in oil production. A budget surplus of SR206bn ($55bn) was recorded in 2013. The Saudi Arabian Monetary Agency’s net foreign assets stand at $730bn in 2014, enough to finance more than three years of imports. Surpluses have also been used to draw down national debt, which now stands at less than 4% of GDP. However, in the short term oil production can be increased to meet any shortfall in revenues. The Kingdom’s oilfields can pump an extra 2m barrels per day (bpd) within 30 days. This has traditionally been used as a mechanism to soften the global impact of supply shocks, but could equally be used as an interim measure to ensure fiscal stability.

Oil Futures

Although prospects for the immediate future are positive, the IMF points out that the biggest medium-term economic threat to Saudi Arabia relates to global oil prices, which have a history of volatility. Oil still accounts for 90% of budget revenue and 80% of export revenue, and Jadwa Investment estimates that for the 2014 budget a price of $81 per barrel for Saudi crude is needed to balance the books. Increases in government spending mean that the breakeven price has risen by almost $50 per barrel in the past five years.

Downward pressure on oil prices could be caused by a rise in global supply or a fall in demand triggered by an event such as a repeat of the 2007-08 financial crisis. The lifting of sanctions against Iran or improved political stability in Libya, Iraq, South Sudan or Algeria could all contribute to an increase in global output. Technological advances are also unleashing new supplies, most notably in tight oil production in the US and Canada. Saudi Arabia has not seen its exports to the US dented, even in a year that saw the shale boom produce the biggest increase in US oil output in history. However, by 2020 the production of large quantities of shale oil and gas in Russia, Argentina and South Africa could have a more significant impact on the market.

Jadwa Investment is upbeat about oil price prospects for 2014, predicting a rise in global demand of 1.3% year-on-year to 92.1m bpd. It said demand in OECD countries is expected to decline for the fourth straight year by 0.19m bpd in 2014, but that demand in non-OECD countries will rise by 1.32m bpd in the same period.

Domestic Consumption

However, it is what happens on the home front that presents policymakers with a more challenging set of issues around the three “Es” of education, employment and energy consumption. The impact of trends can be seen by looking at predictions for 2018. By then Saudi Arabia can expect to have an additional 1.6m young people joining a labour market that already has a 12% unemployment rate for Saudis, and by then the country can expect to consume 20% of its total oil output, up from 16% in 2014.

While citizens can take advantage of free tertiary education at a growing number of local institutions and can take their pick of university courses abroad paid for by the King Abdullah Foreign Scholarship Programme, there is concern that many of these students are not preparing themselves with the skills set needed to compete in the private sector. “You cannot change a country overnight, but the rate of change is accelerating. There is a realisation that we must act now to address the needs of the Kingdom’s citizens and create sustainable, long-term economic growth. This means the government and the private sector must work together to overcome challenges and create new opportunities,” Abdulrahman Almofadhi, the secretary-general of the Public Investment Fund, told OBG.

The twin issues of improving access to vocational training and helping young people find rewarding roles in the private sector are being tackled by the Human Resources Development Fund (HRDF). Its ultimate goal is to enable the economy to diversify away from oil. “A very important initiative is how to transform Saudi Arabia into a knowledge-based economy to make sure we are more productive,” Ibrahim Moaiqel, director-general of the HRDF, told OBG. “We need to use knowledge and technology to replace unskilled labour.”

Changing Habits

Energy consumption enabled by cheap, subsidised hydrocarbons is rising at alarming levels across the board, putting the country near the top of world league tables in per capita use of everything from electricity and water to food and fuel for cars. In an arid, hot desert climate cheap oil is used to produce electricity to power air conditioners. Oil is also used to desalinate water. A university study showed that Saudis are only paying 5% of the production cost of the water they use in their homes and that in 2010 the government spent $2.96bn just to subsidise municipal water. The study also predicted this will rise to $6.47bn by 2020. In the summer of 2013, Abdullah Al Hussayen, Saudi Arabia’s minister of water electricity, warned that Saudis were using 265 litres of this highly subsidised water per person every day.

However, the IMF has warned that introducing the idea of reducing subsidies and increasing tariffs is problematic. “International experience with energy price reform suggests that such a policy adjustment will need to be well planned, phased and clearly communicated to the population and businesses,” said the report. According to John Sfakianakis, the chief investment strategist of Mohammed Alsubeaei & Sons Investment Company, it is a pressing concern. He told OBG, “The challenge on energy is real and it is not just oil, it is water and electricity. Every year the country is losing $150bn in lost opportunity through its use of oil, water and electricity.” Cheap oil, subsidised drinking water, free education and tax-free public sector jobs have all been used to pass on Saudi Arabia’s hydrocarbons windfall to its people, but there is every sign that sharing the benefits will become more challenging for policymakers faced with a growing and increasingly young population who have grown up accustomed to abundance.