Saudi Arabia: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.
Publication Date:
24 Jul 2013
eISBN:
9781484362419
Language:
English
Keywords:
ISCR; CR; quote; worker; oil price; TFP; IMF staff estimate; ensuring expenditure efficiency; oil revenue; expenditure cycle; expenditure volatility; Fiscal stance; Fiscal risks; Oil; gas and mining taxes
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This Selected Issues paper on Saudi Arabia assesses Saudi Arabia’s role in the oil market and global economy. Saudi Arabia, the world’s largest producer and exporter of oil, has long played a systemically important role in the global oil market. Short-term fluctuations in Saudi Arabia’s oil production have partially reflected attempts to stabilize the global oil market. Saudi Arabia has on several occasions used its systemic role to raise production to fill global demand gaps created by large supply disturbances. The authorities have made significant investments in higher education to enable productive private-sector employment for new Saudi labor force entrants.

Abstract

This Selected Issues paper on Saudi Arabia assesses Saudi Arabia’s role in the oil market and global economy. Saudi Arabia, the world’s largest producer and exporter of oil, has long played a systemically important role in the global oil market. Short-term fluctuations in Saudi Arabia’s oil production have partially reflected attempts to stabilize the global oil market. Saudi Arabia has on several occasions used its systemic role to raise production to fill global demand gaps created by large supply disturbances. The authorities have made significant investments in higher education to enable productive private-sector employment for new Saudi labor force entrants.

Assessing Fiscal Policy and Fiscal Risks in Saudi Arabia1

Over the last ten years, Saudi Arabia has significantly reduced its vulnerability to fiscal risks. Saudi Arabia has built up considerable fiscal buffers, by smoothing short-term fluctuations in oil prices following a prudent and conservative budget formulation strategy. This has led to the reduction of the large debt stock accumulated during the 1980s–1990s, and the buildup of large external reserves. This paper reviews fiscal vulnerabilities arising from changes in oil prices, assesses the current risk management strategy, and evaluates the extent of fiscal risks based upon a monitoring framework outlined in Baldacci et al (2011). For most risk indicators, Saudi fiscal variables are found to be comfortably below the risk thresholds in this framework. Nevertheless, this risk mitigation approach also carries potential costs, particularly in terms of the absence of a medium term budgetary framework and more generally ensuring expenditure efficiency.

A. Fiscal Risks from Oil Prices

1. For several decades, Saudi Arabia has faced unique challenges managing fiscal risks. This is due to the dominance of the oil sector in the overall economy and the fiscal accounts. As a proportion of both GDP and total revenues, the oil sector provides the bulk of fiscal resources. For example, in 2012, oil revenues accounted for 92 percent of Saudi total revenues (Figure 1). At the same time, oil revenues exhibit high volatility and uncertainty compared to other tax revenues, and are exhaustible, raising important intertemporal fiscal issues.

Figure 1.
Figure 1.

Central Government Revenues, 2012

(Percent)

Citation: IMF Staff Country Reports 2013, 230; 10.5089/9781484362419.002.A003

Source: Country authorities.

2. High oil prices and large fiscal surpluses in recent years have placed limitations on the extent of non-oil revenue diversification. The non-oil tax regime is comparatively light. There is no personal income tax applied to Saudi citizens, nor is there a VAT. At the same time, the Saudi authorities have made efforts to diversify the tax regime, particularly in the area of corporate taxation.2 A comprehensive state revenue law was introduced in 2005 and further amended in 2010.3 Nevertheless, it has proved difficult for the authorities to justify raising non-oil revenues at a time when the overall fiscal balances have been in surplus and oil prices have continued to rise. Furthermore, raising non-oil tax revenues could in part undermine other policy objectives, notably diversifying the economy and increasing private sector employment.

B. Oil Revenue Volatility and Expenditure Management

3. Revenue volatility has posed considerable difficulties for the Saudi authorities. A short-lived drop in oil prices in 2009, which led to an overall deficit of 5.4 percent of GDP, highlighted the fiscal vulnerabilities associated with oil price shocks. Revenue volatility has also interacted with extended periods of depressed oil prices to complicate fiscal policy management. During the 1980s and 1990s, the oil price remained low for a sustained period of time, and government debt increased sharply.4

4. The ever-present short term fiscal challenge has been to shield Saudi public expenditures from excessive volatility of oil revenues (Figure 2). In particular, the authorities have tried to find mechanisms to reduce fiscal risks and avoid expenditure cycles driven by oil prices, whereby non-discretionary expenditures accelerate sharply during times when oil prices are high, creating structural fiscal difficulties if prices fall.

Figure 2.
Figure 2.

Oil Spot Prices, 1997–2013

(US$ per barrel)

Citation: IMF Staff Country Reports 2013, 230; 10.5089/9781484362419.002.A003

Sources: Datastream; and IMF staff estimates.

5. To partly address this difficulty, in recent years the Saudi budget has been based upon conservative assumptions for both the oil price and expenditures. As the fiscal year has unfolded and revenues have invariably over-performed relative to initial conservative assumptions, additional expenditures have been approved. As a consequence, the Saudi budget has been consistently lower than the actual out-turn by a considerable margin. Since 2006, actual expenditures have been, on average, some 26 percent higher than budgeted expenditures (Figure 3).

Figure 3.
Figure 3.

Saudi Arabia Expenditures, 2006–12

(SAR billion)

Citation: IMF Staff Country Reports 2013, 230; 10.5089/9781484362419.002.A003

Source: Country authorities.

6. This conservative budget formulation strategy has helped contain expenditure volatility. In terms of real expenditures, volatility has fallen significantly over the last twenty or so years. During the period 1998–2004, the variance of real expenditure growth was 1.8. During 2005–12, the variance had fallen to 0.4. However, additional within year budget expenditures continue to move pro-cyclically with respect to oil prices. A simple comparison between changes in oil prices and the additional within year expenditures suggests a strong positive relationship (Figure 4).

Figure 4.
Figure 4.

Oil Prices and Additional Within-year Expenditures

(Percent)

Citation: IMF Staff Country Reports 2013, 230; 10.5089/9781484362419.002.A003

Source: Country authorities.

7. The current budget strategy provides an important bulwark for managing fiscal risks. In principle, it provides the ministry of finance with additional flexibility to contain expenditures should oil revenues fail to materialize. At the same time, an excessively large discretionary component to expenditures may impede the development of an effective medium term expenditure framework, since a significant proportion of expenditures are tied to within-year oil revenue developments. Moreover, the discretionary component of the budget may also raise expectations within line ministries that within year unanticipated expenditures can always be accommodated, thus reducing incentives for effective pre-budget assessment of future financial needs. Therefore, a smaller discretionary component of expenditures could enforce stronger expenditure management at the line ministries and provide the basis for developing a medium term expenditure framework.

8. There is some evidence that the flexibility of this buffer has weakened over time. In 2006, purchases of goods and services accounted for almost 80 percent of additional within year expenditures. This ratio declined to around 40 percent in 2012, while the proportion of additional within year expenditures allocated to capital items has increased to 40 percent, and compensation of employees accounted for 20 percent. Both capital and wage expenditures are budget items that involve multi-year commitments and should be included in the initial budget assessment.

C. The Fiscal Stance 2003–13

9. An examination of the Saudi fiscal stance over the last ten years highlights the strengths and weaknesses of the current risk management strategy. To provide an overall assessment of the recent fiscal stance it is important to rely on several fiscal indicators. In oil producing countries, the overall or primary balances are not a good guide for assessing the fiscal stance, as they do not adequately capture the impact of policy changes on aggregate demand or on adjustment efforts since exogenous changes in oil prices dominate any changes in fiscal policies.

10. A structural balance rule provides governments with a fiscal anchor that smoothes oil price volatility while calibrating spending and saving decisions based on the long-term trend of oil revenues.5 Structural balances also help in the assessment of the fiscal stance corrected for the impact of the oil cycle on revenues. In the short-term, a cyclically neutral fiscal stance is when authorities target a particular structural balance. It follows that improvements (worsening) in the structural balance in years when oil prices are in a downswing (upswing) would be considered procyclical; worsening (improvements) in the structural balance in years when oil prices are in a downswing (upswing) would be considered countercyclical.

11. In Figure 5, structural revenues are calculated by assuming that the long-term oil price is the average oil price from the past five years. Long-term oil output is computed as a three year moving average including the current year. Based on this rule, the authorities have achieved a slightly negative (-1.3 percent of non-oil GDP) structural balance on average since 2003, reflecting a significant structural deficit in the earlier years. A structural surplus has been achieved on average since 2006. In recent years, Saudi fiscal developments can be characterized as:

Figure 5.
Figure 5.

Saudi Structural Revenue and Spending Decomposition, 2003–131

(Percent of non-oil GDP)

Citation: IMF Staff Country Reports 2013, 230; 10.5089/9781484362419.002.A003

Source: IMF staff estimates.1 Structural oil revenue is computed using the average oil price from the last 5 years and the 3-year average output (including current year).

  • Strong expenditure growth 2003–08. As oil prices rose rapidly, real expenditures increased as well, but less than structural revenues. Structural balances improved and became positive in 2006–08 (Table).

  • Expenditure stabilization 2009. For a short period, oil prices fell dramatically, pushing the overall balance into deficit. Relying on fiscal buffers accumulated during the period of high oil prices, the authorities stabilized the expenditures as a percent of non-oil GDP. The structural balance deteriorated slightly, implying a countercyclical stance in light of low oil prices.

  • Fiscal expansion 2010–11. More recently, the fiscal stance was expansionary and pro-cyclical as events of the Arab Spring in 2011 spurred a large increase in expenditures and the structural balance turned negative.

  • Consolidation 2012 onwards. In 2012, the structural deficit narrowed. Given the announced budget for 2013, the structural balance is projected to move into a small surplus.

Table.

Saudi Arabia: Fiscal Balances, 2006–13

article image
Sources: Country authorities; and IMF staff estimates.

12. The non-oil primary balance also provides a robust guide to the impact of fiscal policy on aggregate domestic demand. Moreover, in line with the permanent-income-hypothesis (PIH), the authorities can target a non-oil primary balance that allows for the accumulation of savings for future generations as oil is an exhaustible resource. However, the PIH is sensitive to assumptions regarding future oil prices and other parameters, and can be difficult to explain to the public as a fiscal anchor when oil revenues are large.

13. Based on the non-oil primary balance, the government has begun to set the budget on an adjustment path. The non-oil primary deficit narrowed slightly in 2012 and is expected to fall significantly further in 2013 as expenditure growth slows. Considering the PIH, the actual non-oil primary deficit (projected at 56.6 percent of non-oil GDP in 2013) is considerably higher than would be required to accumulate enough savings for future generations (Figure 6). In this context, it is useful to note that the non-oil current balance has remained relatively steady in recent years, as public investment has increased. To the extent that government expenditure is directed toward productive investment and generates returns and tax revenues, it would reduce the fiscal adjustment that is needed for intergenerational equity purposes.

Figure 6.
Figure 6.

Projected and Sustainable Non-oil Primary Deficit, 2010–18

(Percent of non-oil GDP)

Citation: IMF Staff Country Reports 2013, 230; 10.5089/9781484362419.002.A003

Source: IMF staff estimates.

D. Assessing Fiscal Risks

14. In order to look beyond the fiscal risks presented by changes in oil prices and the overall fiscal stance, a set of Saudi fiscal indicators is compared to a peer group of emerging market economies. The choice of indicators was based on a consistent conceptual framework developed by Baldacci et al (2011). These indicators are grouped into clusters which seek to answer three key questions regarding fiscal sustainability:

  • Basic fiscal variables: Are the debt dynamics and current policies consistent with fiscal solvency?

  • Asset and liability management: Does the composition of government’s assets and liabilities expose countries to large rollover needs?

  • Long-term fiscal trends: To what extent will demographic related challenges affect projected fiscal variables and impact solvency risks?

15. For each indicator, a crisis threshold is estimated on the basis of a univariate procedure that maximizes the likelihood of predicting a fiscal crisis. This threshold, when exceeded, indicates a higher degree of fiscal stress. In order to make the data comparable across indicators, the data is expressed as Z-scores, where the score for fiscal variable x at time t is defined as:

Zt=xt−x¯σx

where σx and x¯ is, respectively, the standard deviation and mean of the fiscal indicator for peer group of emerging economies covering the period 2001–11.

Results

16. The assessment of the fiscal risks facing Saudi Arabia shows a relatively comfortable fiscal position. The distribution of out-turns for a peer group of emerging economies are plotted for each indicator, along with the out-turn for Saudi Arabia, as well as the risk threshold (Figure 7 and 8).

Figure 7.
Figure 7.

Saudi Arabia: Fiscal Risk Indicators, 2012

(Z-scores)

Citation: IMF Staff Country Reports 2013, 230; 10.5089/9781484362419.002.A003

Sources: WEO; and IMF staff estimates.Notes: Red line indicates the risk threshold. The blue line represents the 2012 out-turn for Saudi Arabia. Each chart represents the z-scores for each variable for a peer group of emerging economies covering the period 2001–2011.
Figure 8.
Figure 8.

Saudi Arabia: Fiscal Risk Indicators, 2012

Citation: IMF Staff Country Reports 2013, 230; 10.5089/9781484362419.002.A003

Sources: WEO; and IMF staff estimates.Red line indicates the risk threshold. The blue line represents the 2012 out-turn for Saudi Arabia. Each chart represents the z-scores for each variable for a peer group of emerging economies covering the period 2001–2011.

  • Long term fiscal risks—Reflecting the deep recent reductions in gross public debt, coupled with the large fiscal surpluses, Saudi Arabia is well below the risk threshold for gross public debt and the cyclically adjusted primary balance. In the case of the interest rate-growth differential, Saudi Arabia is slightly above the threshold. This reflects the forward looking nature of this indicator. The latest WEO projections point to a slight downward movement in oil prices over the medium term, which will result in the terms of trade falling and the growth rate of nominal GDP being subdued over the medium term and below that of real GDP. However, when government debt is low, as in the case of Saudi Arabia, the interest rate-growth dynamics are not important for fiscal sustainability.

  • Public Sector Asset and Liability Management—The risk indicators in this cluster emphasize the strong fiscal buffers built up over the last 10 or so years. In terms of gross financing need, Saudi Arabia has minimal debt-rollover requirements while the large surpluses have meant that foreign exchange reserves have increased markedly. In recent years, Saudi Arabia has not issued any short term public debt thus eliminating an important vulnerability seen in many other countries.

  • Long-term fiscal risks—Saudi Arabia’s strong demographic trends indicate that long term fiscal risks are low. The fertility rate is well above the replacement ratio. Future projections of the retirement replacement ratio are also comfortable. Although the ratio is projected to decrease over the next two decades, the projected ratio of workers to retirees remains comparatively high. The indicator for pensions, which measures the projected change in expenditures over thirty years, is slightly above the risk threshold. Currently, Saudi pension expenditures are low at around 2 percent of GDP, reflecting a relatively young population. Pension expenditures are projected to increase to 4 percent of GDP within the next two decades. This increase is large relative to the peer group of countries. However, it should also be noted that the Saudi pensions system has considerable assets to mitigate the fiscal risks in this area. Furthermore, the favorable demographics will contribute to a further build up of assets that should in part offset the projected increase in pension expenditure. Finally, the indicator for future health expenditures is also below the risk threshold.

E. Managing Future Fiscal Policy

17. If oil prices were to moderate over the medium-term, this would have implications for Saudi fiscal policy and could weigh on growth. In this scenario, the authorities would have to consider whether to slow real expenditure growth while continuing to smooth expenditures to account for ongoing revenue volatility. Over the forecast horizon (2013–18), assuming the authorities continue to spend in line with structural revenues, real expenditures would be broadly flat on average. This is in contrast to the annual growth in real expenditure of over 11 percent in recent years (Figure 9).

Figure 9.
Figure 9.

Path of Real Government Spending, 2003–18

(Index, 2010=100)

Citation: IMF Staff Country Reports 2013, 230; 10.5089/9781484362419.002.A003

Source: IMF staff estimates.

18. Slower expenditure growth will have implications for the broader economy. Estimated short-run fiscal multipliers of about 0.2 would indicate a downward drag on non-oil GDP growth of almost 1¾ percent in the near-term; a long-run multiplier of 0.5 indicates a downward drag of 4½ percent over three years (Espinoza and Senhadji, 2011).

19. Looking beyond smoothing oil price volatility, the authorities will need to consider issues of intergenerational equity. Fiscal buffers, while large, are consistent with what would be needed for precautionary reasons to smooth oil price volatility. Saving for future generations would likely require additional accumulation of assets, although this could be partly offset by returns from public investment.

F. Conclusion

20. Oil price volatility has long been the key risk factor for fiscal policy in Saudi Arabia. As recently as 2009, a sharp fall in prices pushed the overall balance into a deficit of just over 5 percent of GDP compared to a surplus of almost 30 percent of GDP recorded in the previous year. Notwithstanding the large revenue shock in 2009, Saudi Arabia has enjoyed a period of strong oil revenue growth. This has permitted a sizable increase in real public expenditures, the accumulation of public savings and international reserves, and the near elimination of the public debt that was built up during the 1980s and 1990s when the oil price was low. Government deposits in the banking system increased to approximately SAR 1.5 trillion at end-2012, equivalent to nearly 20 months of expenditure. As a consequence, the fiscal position has strengthened enormously and the authorities are in a position to smooth a temporary decline in oil prices.

21. An assessment of risks that extends beyond oil price volatility confirms Saudi Arabia’s strong fiscal position. The public sector debt-to-GDP ratio is low relative to a peer group of emerging economies; short term public debt has been retired, and long term demographics indicate very limited risk vulnerabilities. Nevertheless, the authorities’ strategy of using conservative oil price assumptions in the budget to contain fiscal risks has come at the expense of weaker medium expenditure planning.

22. In principle, oil price volatility could be managed within the budget planning process, by setting the expenditure envelope in line with an estimate of “structural” oil revenues. This would provide the basis of a more explicit medium term expenditure strategy which could enhance expenditure efficiency.

References

  • Baldacci, E., J. McHugh and I. Petrova, 2011, “Indicators of Fiscal Vulnerability and Fiscal Stress,” IMF Working Paper 11/94 (Washington, DC: International Monetary Fund).

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  • Baldacci, E., Petrova, I., Belhocine, N., Dobrescu, G., and S. Mazraani, (2011) “Assessing Fiscal Stress,” (Washington: International Monetary Fund).

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  • Cottarelli, C. (2011) “The Risk Octagon: A Comprehensive Framework for Assessing Sovereign Risks” presented in University of Rome “La Sapienza,” January. Available via the Internet: www.imf.org/external/np/fad/news/2011/docs/Cottarelli1.pdf

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  • Espinoza R., and A. Senhadji, 2011, “How Strong are Fiscal Multipliers in the GCC? An Empirical Investigation”, IMF Working Paper WP/11/61 (Washington: International Monetary Fund).

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1

Prepared by Cornelius Fleischhaker, Padamja Khandelwal, Malin Hu, and Jimmy McHugh.

2

Non-oil revenues had increased from 9.3 percent of non-oil GDP in 2003 to 16 percent in 2008. More recently, the ratio has fallen to 10.2 percent in 2012.

3

State Revenue Law, Royal Decree No. M/68, dated 18/11/1431H.

4

This experience, when oil revenues were subdued for an extended period, underscores the magnitude of fiscal buffers available to the authorities. Should lower oil revenues result in a depletion of the current stock of foreign exchange reserves, the authorities could in principle return to capital markets.

5

This approach computes “structural oil revenues” on the basis of a “long-term oil price” and “long-term oil output”. Revenues that are in excess (below) the structural revenues are considered to be the cyclical or non-structural component of revenues. A structural balance of zero, which matches expenditures to structural revenues, builds up precautionary saving buffers in years when prices are above the long term price. For additional details, see “Macroeconomic Policy Frameworks for Resource-Rich Developing Countries”, IMF Policy Paper, 2012.

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Cover IMF Staff Country Reports
Saudi Arabia: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.
Volume/Issue:
Volume 2013: Issue 230
Publisher:
International Monetary Fund
ISBN:
9781484362419
ISSN:
1934-7685
Pages:
46
DOI:
https://doi.org/10.5089/9781484362419.002

Central Government Revenues, 2012

(Percent)

Oil Spot Prices, 1997–2013

(US$ per barrel)

Saudi Arabia Expenditures, 2006–12

(SAR billion)

Oil Prices and Additional Within-year Expenditures

(Percent)

Saudi Structural Revenue and Spending Decomposition, 2003–131

(Percent of non-oil GDP)

Projected and Sustainable Non-oil Primary Deficit, 2010–18

(Percent of non-oil GDP)

Saudi Arabia: Fiscal Risk Indicators, 2012

(Z-scores)

Saudi Arabia: Fiscal Risk Indicators, 2012

Path of Real Government Spending, 2003–18

(Index, 2010=100)