Saudi Arabian bond sales will buy time to diversify from oil

Cars pass by the kingdom tower Sunday, June 14, 2015, in Riyadh, Saudi Arabia. Saudi Arabia's $585 billion stock market is opening up to direct foreign investment for the first time in its history on Show more

Saudi Arabia’s new bond programme highlights the distance the country’s diversification efforts have yet to go, as it struggles to adjust to the new normal of US$50 oil.

The country is planning $27 billion of new domestic bond issuances over the next year, according to reports, as it continues to fuel its fiscal deficits by burning through foreign exchange.

This is quite a reversal from just eight months ago.

For Saudi Arabia, between 2003 and the end of 2014, the money kept rolling in.

The kingdom has run sizeable fiscal surpluses since 2003, when the average oil price began its upwards path from about $30 per barrel to $110 per barrel in 2013.

This has boosted the country’s foreign exchange reserves and bolstered its sovereign wealth funds. Foreign exchange holdings peaked at 2.8 trillion Saudi riyals (Dh2.74tn) in August last year.

Saudi Arabian Monetary Agency Foreign Holdings, the country’s biggest sovereign wealth fund, grew its assets under management to $757bn this year, up from $23bn in 2004, according to estimates from the Sovereign Wealth Fund Institute.

The kingdom used this period of plenty to increase public spending by a compound annual growth rate of 11 per cent between 2004 and 2013, according to research from Deutsche Bank.

This spending aimed to boost the country’s non-oil industries, and to fund a host of economic megaprojects, including the King Abdullah Economic City.

But in July last year, the oil price rout began. From $115 per barrel in June, oil fell to $46 per barrel in January – and was at $48.61 on Friday.

This hit the country’s external earnings, blowing holes in both the current account and the government’s fiscal account.

The IMF estimates that Saudi Arabia has lost external earnings of more than 20 per cent of GDP in the past year alone.

That does not translate into a 20 per cent cut in output, because the Saudi government has vowed to maintain spending to plug the gap.

But it does mean that the country will considerably overshoot its own expectations for spending this year, and that it will run a budget deficit of about that amount, according to IMF estimates.

Saudi resources may not prove as long-lasting as the government had hoped.

The country has four years of foreign exchange reserves remaining, according to IMF figures, and relies on an oil price of $105 per barrel to keep its budget balanced.

The economy remains centred on oil. About 80 per cent of government revenues and more than 85 per cent of export earnings were derived from hydrocarbon industries between 2012 and 2014, IMF data shows – and that is after the effect of diversification efforts.

Government initiatives to invest in plastics, chemicals and downstream energy facilities, which are part of the hydrocarbon value chain, mean that even a considerable chunk of the country’s non-oil economy waxes and wanes with the oil price.

Meanwhile, efforts to move Saudi nationals into the private sector have proved difficult. More than 60 per cent of Saudi nationals are employed by the public sector, according to IMF data.

Implementation has been dogged with difficulties – with the Saudi ministry of labour introducing a law to combat “fake Saudisation”, in which private companies pretend to hire Saudis to comply with quotas.

These problems will take time to address, and with four years of reserves remaining, Saudi Arabia needs to buy more time in which to reform.

That is why the kingdom is tapping local investors to help it keep up spending.

The country has a debt-to-GDP ratio of 1.6 per cent – one of the lowest in the world, meaning that it has plenty of capacity to issue new debt.

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