The significance of new Saudi economic measures

Friday 22/01/2016
Saudi Basic Industries Corporation (SABIC) headquarters in Riyadh.

Washington - Facing a $98 billion budget deficit for 2015 and a pro­jected 2016 deficit of $87 billion, Saudi Arabia an­nounced cuts in energy subsidies. The year-old govern­ment of King Salman bin Abdulaziz Al Saud also shocked the global fi­nancial community and oil markets by suggesting that Saudi Aramco could be opened to limited foreign investment.
Raising domestic energy prices and privatising state firms are part of reforms that the Saudi government had promised would be announced early in 2016. The kingdom’s oil policy has led to pro­ducers pumping oil at record lev­els amid weak demand and prices have plummeted to less than $30 a barrel. Saudi Arabia and its Gulf Cooperation Council (GCC) al­lies within the Organisation of the Petroleum Exporting Countries (OPEC) have resisted efforts by oth­er OPEC members to rein in output so prices would rise.
The prospect of making Saudi Aramco shares publicly available was raised by Saudi Deputy Crown Prince Mohammed bin Salman bin Abdulaziz in an interview with the Economist in January. Prince Mo­hammed, who is also defence min­ister and chairman of the Economic and Development Affairs Council, is zealous about transforming the Saudi economy and is believed to be the driving force behind curbing energy subsidies and advancing privatisation.
Faced with a huge budget deficit, the Saudi government must find ways to raise non-oil revenues and expand the kingdom’s private sec­tor. Currently, the majority of Saudi nationals work in the public sector and in 2015 about half of govern­ment expenditures — approxi­mately $120 billion — was spent on salaries, wages and allowances. Energy subsidies are estimated to have cost the kingdom $107 billion, 13.2% of its gross domestic product (GDP), in 2015, according to the In­ternational Monetary Fund (IMF).
Although the Saudis had sug­gested in late 2015 that they would privatise some state companies, few expected Saudi Aramco to be included as the firm is so central to the country’s economy.
Questions remain about whether Saudi Aramco’s upstream business would be included in privatisation. The Saudis traditionally have been secretive regarding crude develop­ment and production and Saudi Aramco is not fully transparent in its operating procedures or finan­cial disclosures. It is possible that the state oil firm could spin off its refining operations and other non-crude production businesses for public investment.
Saudi Aramco issued a statement saying the company “has been studying various options to allow broad public participation in its eq­uity through the listing in the capi­tal markets of an appropriate per­centage of the company’s shares and/or the listing of a bundle of its downstream subsidiaries”.
The Saudi government has re­portedly also been considering sell­ing more public shares in partially privatised companies, such as the petrochemical firm Saudi Ara­bian Basic Industries Corporation, the Saudi Telecommunications Company and the Saudi Electric­ity Company. There were reports in November that the government would begin privatising airports and related services in the first quarter of 2016, beginning with Ri­yadh’s King Khaled International Airport.
While the cut in energy subsi­dies is unlikely to be popular in the kingdom, since citizens have become used to cheap energy and low-cost utilities, previous efforts by the Saudi government to raise domestic energy and utility prices turned out to be half-hearted. In­deed, 20 years ago the government of Fahd bin Abdulaziz moved to re­duce energy-related subsidies.
The goals of the 1995 subsidy cuts were to create $2.5 billion in revenues and to dampen burgeon­ing domestic demand for refined products and crude. Saudi citizens experienced a doubling in retail gasoline prices and subsidy reduc­tions initially did help stem domes­tic demand for oil, which trans­lated into more refined products available for export.
However, the government proved unwilling to maintain the price increases in real terms or im­pose more subsidy cuts in subse­quent years and domestic energy demand rebounded.
The question in 2016 is whether the government will feel confident enough to enact deeper cuts to energy subsidies over the coming years or whether fears of domestic backlash will halt the reform effort. Mindful of the effects subsidy cuts will have, the government is ex­pected to extend welfare payments to its poorest citizens and offer low-interest loans to businesses hardest hit by electricity price in­creases.
While the projected 2016 budget deficit is $11 billion less than in 2015, it indicates that the govern­ment has no intention of reducing oil production despite tepid global demand and oversupplied markets. The deficits, however, have forced the government to deeply tap into its foreign exchange reserves, which have fallen from $739 billion late in 2014 to $654.5 billion.
The IMF in October warned that Riyadh may have only five years of financial assets left should the oil price slump continue and the kingdom maintain its spending habits. One area in which the Saudi government is certainly not cutting expenditures is defence-related spending, which is expected to in­crease to approximately $60 billion a year by 2020 from around $49 billion. The government budgeted nearly $57 billion for defence ex­penditures for 2016.
The IMF and other financial in­stitutions have long recommended that the Saudis eliminate energy-related subsidies, reduce depend­ency on oil income and grow the private sector. But Saudi citizens might balk at increased prices and other austerity measures when it is evident to most that their govern­ment’s oil and economic policies have helped create the financial crisis in the kingdom.