Last weekend King Salman of Saudi Arabia put out a royal decree which has rescinded salary cuts and reinstated bonus payments to thousands of civil servants; around two thirds of the population work for the state. The official line was that the reinstatement reflects an improved fiscal position with the deputy economy minister, Mohammad al-Tuwaijri, saying the first quarter deficit was SAR26bn against projections of SAR54bn. The salary cuts are estimated to have saved SAR36-40bn since last October. This may beg the question of how committed the Kingdom is in terms of reform implementation but it also needs to be seen as a highly unpopular move inflicting a substantial income cut at a time when incomes were also being squeezed by reduced subsidies on fuel and energy and the prospect of VAT implementation in January 2018. Reports suggest there had been some calls for protests against the austerity drive. On the positive side this is likely to boost consumer sentiment and is supportive for growth.
In its latest review on 30 March, Fitch rated Saudi A+ with a stable outlook (down from AA-on a foreign long term basis) noting the deterioration in its public and external balance sheets, with the government deficit reaching 17.3% of GDP in 2016, and ‘continued doubts about the extent to which the government's ambitious reform programme can be implemented’. For the 2017 budget the government is targeting a central government deficit of 7.7% of GDP or SAR198bn; higher crude prices are seen as one of the main drivers behind the improvement. Fitch estimate the deficit will fall to 9.2% of GDP in 2017 and to 7.1% of GDP in 2018 and that general government debt would increase to 14.5% of GDP in 2018. This assumes a Brent Crude price of USD52.5 per barrel in 2017 and USD55 per barrel in 2018.
At this stage, providing oil prices continue to hold up, and as the deficit has been running ahead of the Kingdom projections, modest relaxation of some parts of an aggressive austerity program should not be overly concerning. Nevertheless, this will inevitably be an area that is closely monitored by the ratings agencies, along with geopolitical tensions in the region and any succession rivalries within the royal family. For us, Saudi remains extremely strong from a net foreign asset position and its ample reserves give it time to implement the necessary adjustments and structural reforms. Moreover, sovereign bonds such as the Saudi 4.5% 2046 issue trade over 2.5 credit notches cheap on a lowered rating suggesting a lot of downside is already factored in.
The current OPEC and non-OPEC production cut-back deal runs until the end of June this year and there have been some encouraging comments from the Saudi Minister of Energy and Industry, Khalid Al Falih that if the market does not stabilise this agreement could be extended. While the agreement members have shown a good level of compliance, higher oil prices have resulted in increased production from the US shale industry; for example the Department of Energy data for the US estimates that US crude production has increased by 550,000 b/d since the OPEC output cut. It will be important to get Russia to agree to the extension of the agreement given it had agreed to cut 300,000 b/d making it the largest of the non-OPEC producers in terms of cuts and 17.4% of the total cuts (of 1.72m b/d of which OPEC is 1.16m). However, it is coming in the summer months when Russian production levels are typically higher with new fields also due to come online so it remains to be seen to what extent they agree to an extension of the cuts.