Wealthy Nations Daily Update - Saudi Arabia

Saudi Arabia’s bond issuance program has got off to a good start; a local issue of SAR 20bn (USD5.3bn) was recently sold to local banks and institutions following an issue of SAR 15bn in bonds in a private placement to institutions in June. These are the first notable bond issues since 2007 reflecting an increase in its budget deficit due to lower crude prices. Up to this point Saudi Arabia had been using its sizeable foreign exchange reserves to sustain government spending. As at the end of June foreign exchange reserves were USD672bn; this is down from a high of USD746bn in August 2014, or what was then approaching 100 percent of 2014 nominal GDP.

As the IMF notes in its June 2015 External Sector Report “The GCC economies, with fixed exchange rate regimes, have run very large current account surpluses and accumulated sizable buffers. Structural characteristics of their more oil-dominated economies mean that external adjustment is largely a matter of fiscal policy and that adjustment of domestic demand does not need to be accompanied by sizable REER adjustment. For these economies, including Saudi Arabia, expenditure adjustment in the near term is projected to be much less than the loss of oil revenue, and their current account surpluses have fallen sharply.”

Reserves can be used as a counter-cyclical buffer along with debt issuance as Saudi Arabia is starting from a position of strength with debt to GDP of 1.6% at the end of 2014. Such a low debt level gives Saudi Arabia huge financial flexibility. Fiscal adjustment needs to take place; the IMF is estimating a fiscal deficit of 19.5% of GDP for 2015, but this is then forecast to decline as “one-off” expenditure declines and large investment projects complete. This will be a key area to watch going forward, particularly if the oil price remains at current levels.

On our net foreign asset analysis Saudi Arabia has a NFA to GDP of 178%. Lower commodity prices, if governments don’t adjust spending, will affect the current account eventually, but it is the cumulative current account position (i.e. net foreign assets) that is more important in determining credit quality. Consequently it is the wealthy countries that can handle lower commodity prices much more easily than the indebted ones. Another way of thinking about this is to take two countries, each running a current account deficit of 5% of GDP. One, say Saudi Arabia, has net foreign assets of 178% of GDP and one, say Brazil, with net liabilities of 45% of GDP. It will only take one year before Brazil exceeds our 50% cut-off whereas for Saudi Arabia it would take ~45 years to reach the same level.

Interestingly, our analysis of the change in oil prices and changes in 5 year CDS shows that credit spreads tend to widen in proportion to spreads so high grade bonds tend to outperform as spreads widen. For example, Qatar, rated Aa2 by Moody’s, for which there is a liquid USD yield curve, has performed extremely well when one would have expected modest spread widening rather than tightening. Turkey, rated Baa3 by Moody’s, is an oil importer so lower oil prices should in theory cause spreads to narrow when oil prices fall but they have in fact widened.

Moody’s reaffirmed its Aa3 rating, with a stable outlook, for Saudi Arabia in July and note that the debt issuance program will promote “financial market deepening” with a “credit neutral” impact. Saudi Arabian debt, as a high quality credit, with a lack of outstanding issuance and poor index representation, is likely to be highly sought after.

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