How is Saudi Arabia Reacting to Low Oil Prices?

The 2014 price crash together with the high spending of the last several years have been draining the government budget. Oil accounts for more than 80% of government revenues and with currently low oil prices, fiscal deficits are expected to surpass an estimated $118 billion in 2016 (about 16 % of GDP) and $97 billion in 2017.

International reserves are down by 20 % (standing at $587 billion as of March 2016); at this rate, reserves will be wiped out in four years. The Kingdom has borrowed significantly including $26 billion last year and a $10 billion loan finalized in April of this year; they are planning to raise another $15 billion through issuing bonds. This will put the ratio of debt to GDP to 26% in 2017 from low levels in 2014. The cost of borrowing has risen, following a lowering of Saudi Arabia’s credit rating by rating agencies. Estimates by the IMF show that an oil price of $105.60 is needed to balance the budget, which is more than twice current levels.
The government has taken austerity measures in the 2016 budget including a 14% cut in spending mostly on defense and fuel subsidies and an increase in oil revenues by producing more oil.15 In addition, budgetary allocations for health, education and municipality services have been reduced. The largest increases in fuel prices are 133% for ethane, 79% for transport diesel, and 67 % each for natural gas and low-grade gasoline.

Prices of electricity and water have also been raised by up to 60 % for higher tiers of residential consumption and by varying amounts for commercial and industrial users. The wage bill is reduced to less than 15% of GDP, curtailing public-sector wage increases and renegotiating all contracts, alongside cuts in capital expenditure. The overall effects of these measures are contractionary, lowering real GDP growth to a projected rate of 1.9% in 2016 from 3.5% in 2015. Prior to the oil crash, the economy grew by an average of 5% per annum.

To emerge from the era of low oil prices, the Saudi government has approved a comprehensive reform program articulated in the National Transformation Plan (NTP) - “Vision 2030” - which aims at diversifying the economy away from oil, within 15 years. The plan envisages the leveraging of assets of the state-owned oil company (ARAMCO) to fund wide-ranging public investments.

The vision had been planned with a price of $30 a barrel and focuses on three major areas. First, it seeks to triple non-oil revenues by the end of the decade through levying indirect taxes and fees on public services including the introduction of a VAT and developing non-oil sectors like mining, tourism and education.

Second, it will lower public spending by reducing subsidies, diverting spending on arms away from foreign partners and rationalizing public investment. Coupled with reducing the public wage bill by 5%, these reforms could amount to $53 billion in added revenues by 2020.

Third, the plan aims at diversifying the national wealth and diversifying the investment portfolio abroad. Of importance is privatizing part of the State-owned oil company Aramco, through an Initial Public Offering (IPO) - which produces 90% of government’s revenues - to raise funds.