Saudi Arabia: Selected Issues


Saudi Arabia: Selected Issues

Financing the Fiscal Deficit – Possible Options and their Potential Implications1

To meet large financing needs over the coming years, Saudi Arabia has multiple financing options. It can draw down the large stock of government deposits held at the central bank, sell other financial assets, or borrow domestically or abroad. This paper uses an asset-liability management framework to discuss the benefits and risks as well as the macroeconomic implications of each of these options, and illustrates some of these aspects through a simulation analysis. It also reviews a number of policies that will help expand the investor base and reduce financing costs, while having broader positive implications for the economy. In particular, establishing a benchmark yield curve will encourage the development of the domestic debt market. Moreover, the fiscal and debt management frameworks and policies need to be strengthened in order to mobilize domestic savings and attract foreign financing.

A. Introduction

1. The large and sustained decline in oil prices since the second half of 2014 has turned Saudi Arabia’s fiscal surpluses of more than a decade into deficits and increased the need for financing. Current staff projections suggest that large financing needs will continue over the medium-term. Initially, the government used its deposits at the central bank to finance the fiscal deficit, and since June 2015, it has started to issue domestic government securities. The government signed a syndicated loan with international banks for $10 billion in the second quarter of 2016.

2. Saudi Arabia is starting from a strong asset-liability situation. At end 2015, government deposits at SAMA stood at SAR 1050 billion (about $280 billion) and government debt was low at SAR 121 billion ($32 billion). The gross reserves position at SAMA, even after declining by $115 billion in 2015, remains strong, at $609 billion (about 32 months of import coverage). In addition, the government asset portfolio in the form of equity participation in SOEs and/or strategic investment projects increased over the last decade. The value of the government’s ownership of listed domestic companies held through the Public Investment Fund (PIF) was estimated at $130 billion at end-2015. It also owns many non-listed companies including the very large oil company ARAMCO, which even if a small portion of it is privatized, the reinvested proceeds could generate sizable investment income for the budget.

3. The government is working to develop a comprehensive strategy to meet its budget financing needs. It is working to strengthen the regulatory and institutional framework, particularly the debt management framework, and to better integrate the two sides of the government balance sheet to efficiently meet the financing needs of the budget—both domestically and in the international financial markets. The government has extensive experience in managing its asset portfolio—including through the PIF (at home) and SAMA (for gross reserves). However, debt management capacity has declined over the years, with the dwindling need for budget financing. With the emerging need for borrowing, it will be necessary to integrate the management of both sides of the government balance sheet.

4. This paper discusses the options for financing the government fiscal deficit and the supporting institutional reforms that are needed. In particular, the paper discusses the main trade-offs between drawing down assets and various borrowing options and related risks and benefits, including the benefits of domestic market development and the role that could be played by Islamic finance. It also looks into the macroeconomic implications of the different financing options. The paper is organized as follows. Following a brief history of government assets and liabilities in Saudi Arabia, Section B discusses the investment-financing tradeoffs and the different budget financing options available to the country as well as their relative costs and benefits. Section C studies the economic and financial implications of a menu of financing options through simulations. Developing the domestic debt market and broadening the investor base are the focus of section D. Section E concludes.

B. Financing the Fiscal Deficit: The Past, the Present, and the Future

A brief history of government assets and liabilities in Saudi Arabia

5. The Saudi government’s assets and liabilities structure has evolved over the past three and a half decades. Its evolution can be separated in four periods, reflecting in part oil price developments.

  • A buildup in government assets (deposits at SAMA) which started in the 1970s continued through the early 1980s and peaked at over SAR 400 billion in 1983. However, estimated in percent of GDP, government assets exceeded 100 percent in the mid-1970s and declined to about 93 percent of GDP in 1983 as GDP grew larger over the period (Figure 1).

  • During the 1990s, the government’s “net debt” increased.2 The stock of government assets declined to close to SAR 30 billion (about 5 percent of GDP) in 1999 and the stock of debt securities rose to about SAR 700 billion or 100 percent of GDP in the late 1990s.

  • From the early 2000s to 2014, the government reduced its net debt into negative territory. The stock of government securities fell to about SAR 40 billion or less than 2 percent of GDP in 2014. Meanwhile, government deposits at SAMA rose to SAR 1.5 trillion or 54 percent of GDP in 2013, benefitting from high oil prices and prudent policies.

  • However, the trend has reversed since mid-2015. The stock of debt securities is estimated to have risen again reaching close to 5 percent of GDP by end year as the government re-started bond financing in June while government deposits at SAMA fell. However, the Saudi Arabian government is still one of only a handful of countries with a net asset position (Figure 2). Estimates for 2015 show that the Saudi government held net financial assets equal to 38 percent of GDP.

Figure 1.
Figure 1.

Saudi Arabia Government Gross Debt and Assets, 1975–2015

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Sources: IMF WEO, October 2015, Saudi Arabian Monetary Agency, and IMF staff calculations.Note: Assets are implied by gross and net debt.
Figure 2.
Figure 2.

General Government Gross Debt and Assets, 2015

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Sources: IMF WEO, October 2015; and IMF staff calculations.

6. Government issuance of debt instruments over the past 40 years has been intermittent. The government issued for the first time its own borrowing instrument (Government Development Bonds) in 1988, and in 1991, it started to issue Treasury bills (T-bills) to finance the fiscal deficit (Table 1, and Appendix II). However, issuance of these debt securities was stopped when the fiscal situation improved. To help promote the development of domestic debt markets and conduct monetary policy, SAMA issued its own instruments—including those that are Sharia-compliant to cater to the needs of Islamic banks. However, the secondary market has never fully developed, market liquidity remained low, and no benchmark yield curve developed. More recently, the government resumed issuance of debt securities to fund the fiscal deficit.

Table 1.

Debt Securities and Facilities

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Source: Saudi Arabian Monetary Agency.

Considerations in financing the current and future fiscal deficits3

7. As a resource rich country, Saudi Arabia needs to approach budget financing from an integrated balance sheet standpoint. Over the past decade, the government has built-up significant liquid assets in the form of deposits in the banking system and holdings of equity stakes in a large number of companies in Saudi Arabia (an estimate of the value of the stakes in the listed companies is 20 percent of GDP which excludes Aramco). These could be rundown or sold to investors. The government also has considerable opportunities for borrowing in domestic and international markets given outstanding debt is very low.

8. Against this background, the question is how much the government should borrow versus how much should it draw down/use its assets to finance the budget deficit. Indeed, the government could also consider borrowing more than it needs to finance the deficit and increase its asset holding (this issue is not discussed further in this paper). Ultimately, the government needs to balance the costs and risks of each option to arrive at an appropriate financing mix. In the 1990s, Saudi Arabia relied exclusively on drawing down its financial assets and domestic borrowing to finance the deficit. However, this time around, encouraged by a strong balance sheet and a low interest rate environment, the government is using a broader financing mix that includes borrowing in the international financial market.

9. There is merit to the government maintaining a stock of financial assets even in a situation of emerging financing needs. Financial assets are most useful during shocks when other financing resources become either scarce or very expensive and are therefore an important buffer against risks, particularly when the fiscal position is exposed to the volatility of the oil market. They also help reduce borrowing costs to the extent they serve as collateral for the lender.4 The optimal size of such precautionary asset holding is difficult to know, but could perhaps be considered as what would be needed to finance the fiscal deficit for a one or two year period in an adverse oil price scenario.

10. Returns on government financial assets vary across countries and time. Little information is directly available about the returns on the Saudi government’s financial asset holdings. The Public Investment Fund (PIF), which holds most of the government’s equity stakes in Saudi companies, does not publish data on returns, but holdings include very profitable companies such as SABIC and a number of banks.5 Also, returns of SAMA’s foreign reserves are not published, although the implied rate of return on the external assets of Saudi Arabia was estimated at about 2.7 percent in 2015 (Table 2). By comparison, Norway’s sovereign wealth fund reports it earned a nominal return of 2.7 percent in 2015. Clearly, returns depend on the types of assets held in the portfolio, while past returns do not provide a guide to the future.

11. Borrowing domestically has the primary advantage of avoiding exchange rate risk and encouraging the development of the domestic debt market (see later). Issuance of domestic government debt facilitates the development of domestic financial markets, benefits that should be factored into the financing decision. Establishing a risk free government yield curve also helps develop the private debt market. This in turn would help strengthen private sector development, economic diversification, growth, and the resilience of the economy to shocks. SAMA and the Ministry of Finance (MoF) have relied on a range of domestic debt securities and facilities (Table 1). Over the past year, the government has issued bonds of 5-, 7-, and 10-year maturities. The yields on 7- and 10-year domestic bonds were less than 3 percent, below the yields on comparable international debt securities.

Table 2.

Indicators of Funding Cost and Asset Returns


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Sources: Saudi Arabian Monetary Agency, JPMorgan, Internet sources, and IMF staff estimates.

The US dollar Libor-based funding cost reported by media swapped into a fixed rate.

Average maturity is 5 to 7 years. In May 2016, Saudi Arabia was rated AA- by Fitch, A+ equivalent by Moody’s, and A- by S&P.


12. External borrowing could alleviate pressure on the domestic market, but creates new risks. Reliance on foreign investors may help further enhance transparency. Foreign investors’ demand for diversification could also allow the Saudi government to enjoy attractive yields. However, foreigners could constitute a less stable investor base than local counterparts.6 In addition, external debt risks relating to the currency composition of debt and the foreign exchange rate are more complicated to manage. For Saudi Arabia, exchange rate risk appears limited owing to the fact that a significant portion of government revenue is denominated in foreign currency and the country has a well-established peg. Exchange rate risk could further be reduced through careful management of its assets and liabilities, including matching its asset currency composition with its external debt. However, external borrowing is characterized by high (debt) rollover risk or what is known as risk of sudden stops (or reversal of private capital flows). The government has recently arranged a 5-year loan with international investors. Looking forward, foreign investors’ demand for oil exporters’ credit exposure could become constrained as many countries try to borrow at the same time after being affected by a common adverse shock (Table 3).

13. The relative cost of domestic versus foreign borrowing and the returns on government assets are likely to depend on market circumstances. Looking back on the 1990s and 2000s, yields on the Saudi Arabian government’s domestic bonds were estimated to have remained below those on comparable international bonds. However, domestic liquidity conditions have tightened. More generally, emerging and low-income countries often face higher borrowing costs in local currency than in foreign currency. Domestic market tends to lack depth and domestic borrowing instruments are typically less liquid and have lower credibility than international instruments (IMF 2004). This may be also true of Saudi Arabia despite the relatively large domestic investor base, which extends beyond the banking system to include the Autonomous Government Institutions (AGIs) and the high net wealth individuals. Thus, over time, there is likely to be a net cost to holding financial assets (for emerging market countries like Saudi Arabia) because the cost of borrowing is likely to exceed the return on the investment portfolio, particularly if it is invested largely in safe assets like U.S. treasuries. A riskier investment portfolio could generate higher returns, but at the cost of taking on additional risks which the government would need to carefully consider as part of its asset/liability management strategy.

14. In sum, there are advantages and disadvantages of all three options (asset run-down, and domestic and external borrowing). In terms of liquid financial asset holdings, the net cost (of investing) could be considered as the insurance premium against shocks, and the balancing act for the government is how much coverage to buy given the potential risks ahead relative to the cost for the insurance premium. For debt issuance, the costs and benefits of domestic versus foreign borrowing will need to be weighed carefully. Overall, while difficult to be specific, some combination of all three options is likely to be optimal.

Table 3.

GCC—Sovereign Bond Issuance, 2015–161/

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Sources: Bloomberg; and IMF staff estimates.

Abu Dhabi. Dubai is not rated.

Figure 3.
Figure 3.

Yields on Domestic Saudi and International EM Government Bonds


Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Sources: Bloomberg, JPMorgan, and IMF staff calculations.Note: The Saudi domestic government yield index is estimated by interpolating individual issuance and broadly matching the average maturity of international EM government yield index. International EM government yield index is estimated to broadly match the Saudi government’s credit ratings, assuming a BB rating before Moody’s rated the government’s credit for the first time in late-2001 at BB+ equivalent.

Additional Considerations for Debt Issuance

15. When issuing new debt, there are other important considerations, which are the maturity of issuance, the coupon type, borrowing domestically or internationally, and whether to issue traditional or Islamic instruments. Each type of borrowing will have its own costs and benefits and will appeal to different types of investor. These issues are discussed below.


16. Maturity of debt securities affects funding costs and rollover risks. Shorter maturity instruments entail a lower cost of funding assuming the yield curve is upward sloping. They also help anchor the shorter end of the yield curve and deepen money markets, which is often considered a precondition for developing the yield curve for longer maturities. Longer-dated bonds reduce rollover needs but yields are higher, and because of the greater duration risk, they have more appeal to institutional investors (insurance, pension funds) than banks.

17. During its peak issuing years in the 1990s, the Saudi government generally issued debt at medium to long-term maturities. The average remaining maturity of Saudi government bonds was 6–7 years during times of active issuance. This is comparable to the median of 6.6 years for major advanced and emerging economies (Table 4). The average remaining maturity of the stock of Saudi government debt securities fell to about 3 years in 2014 as the amount outstanding declined in the absence of new issuance (Figure 4). Over the past year, the government has issued in five-, seven- and 10-year maturities.

Table 4.

Central Government Debt Securities Characteristics, 2014 or Latest

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Source: BIS
Figure 4.
Figure 4.

Saudi Arabia Central Government Bonds

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Sources: BIS; Bloomberg; and IMF staff calculationsNote: In right panel, the number of issuance every month is multiplied by the maturity of the individual bond or T bill issuance. Data on issue amount not available.
Coupon type

18. The coupon type affects funding costs and interest rate risk. Fixed rate bonds are typically more expensive than floating rate bonds at longer tenors, because of a premium that investors demand to make up for potential “time inconsistency”, or risk that the government may seek to reduce debt service costs in real terms by increasing inflation. However, fixed rate bonds are attractive because they reduce interest rate risk for the issuer and are a plain vanilla instrument that is easy to value and trade. Two other key coupon bond types are inflation linked and FX linked. During the period up to 2007 when the government was issuing actively domestic bonds to meet its financing needs, fixed-coupon government development bonds (GDB) dominated issuance. Floating-coupon Treasury bills were mainly issued during 2001–04.7

Domestic versus international borrowing

19. Borrowing could be domestic or international. Domestic bonds would typically target resident investors and mobilize domestic savings and international bonds target foreign savings. Investors in domestic bonds tend to be residents, but non-resident investors in some countries hold major shares of total domestic bonds outstanding. Investors can also be classified by institutions such as banks and non-banks. Non-banks include financial and non-financial institutions. Retail investors are part of the latter. Over the past decade, governments have generally shifted their funding to domestic sources, particularly in emerging economies (Figure 5). However, non-resident investors hold important shares of domestic bonds in many advanced economies, such as the United States, and some emerging markets—including Hungary, Indonesia, Mexico, and Poland. In some regions, governments have also relied on international borrowing. In EMEA and Latin America for example, governments issue more in foreign markets, and this could probably be attributed to their more open capital accounts. Until lately, Saudi Arabia has relied solely on domestic bonds, and in April 2016, it reached an agreement with a consortium of international banks on its first international loan for amount of $10 billion.

Figure 5.
Figure 5.

General Government Domestic Bonds

(Percent share of total, 2015)

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Sources: BIS; and IMF staff calculations.
Traditional or Islamic instruments

20. The introduction of Islamic borrowing instruments has been relatively recent in Saudi Arabia as in the rest of the world. The first Sharia compliant instruments were introduced in the late 1990s-early 2000s. The Ministry of Finance led this effort with the issuance of Floating Rate Notes (FRNs) in 1997, and later, the short-term Murabaha securities in 2002. Long-term Murabaha securities were issued for the first time in January 2016 (Table 1 and Appendix I).

C. Economic and Financial Implications of Fiscal Financing

21. How should Saudi Arabia finance the projected fiscal deficits? Unlike in the 1990s, the country is entering this period of fiscal deficits with strong financial buffers. Therefore, the government will be able to combine a drawdown of its financial assets with domestic and external borrowing to finance the deficits. To this end, five different financing scenarios are considered to help assess key implications (Table 5). The cumulative budget financing needs for 2016–21 are estimated at around SAR 1460 billion ($389 billion)is the staff’s baseline scenario in the staff report. In Scenario I, domestic banks absorb a large share of government domestic borrowing, crowding out private sector credit and tightening domestic liquidity conditions. Scenario II assumes domestic non-banks absorb a larger share of domestic borrowing by shedding other assets (including deposits placed in the domestic banking system). Scenarios III–V considers ways to mitigate potential crowding out of domestic assets held by both banks and non-banks. Scenario III considers a case where a large amount of external bonds are issued to non-resident investors. Scenario IV assumes a larger drawdown of government deposits at SAMA, thus reducing financial buffers. Finally, Scenario V illustrates the benefits of greater financial deepening, which translates into higher growth of customer deposits in the banking system and credit to the private sector (while assuming the same financing mix as in Scenario I).

Table 5.

Summary Assumptions: Scenarios 1–5

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Source: IMF staff calculations.

Maintain government deposits of SAR500-600 billion in 2021, equivalent to estimated one-year fiscal deficits under a two standard deviation drop in oil prices from the WEO baseline.

Maintain government deposits of SAR 250-300 billion in 2021.

Some $10 to $20 billion per year relying on average of major EM sovereign international bond issuance and recent Saudi experience.

22. To start the simulation exercise, the balance sheets of banks and nonbanks are projected as follows (Figure 6):

  • Banks: The overall size of the balance sheets is assumed to grow in line with customer deposits, which represent the majority of liabilities. Customer deposits grow at annual rates of 2–5 percent. No distinction is made between conventional and Islamic banks deposits and between bonds and Sukuk financing. Foreign liabilities are assumed constant. The capital ratio remains 18 percent of risk-weighted assets (comfortably above the 12 percent implicit threshold). Other domestic liabilities grow moderately. On the asset side, excess liquidity (cash, current deposits, other deposits, and SAMA bills) is assumed to fall gradually and be exhausted by 2021. With the reserve requirements kept constant, statutory deposits with SAMA reflect the level of customer deposits on the liabilities side. Foreign assets decline moderately as banks allocate more funds to domestic assets. Other assets represent a small share of total assets and are calculated as residuals.

  • Nonbanks: They include two pension funds, PPA and GOSI, and other nonbanks. The two pension funds absorb 80 percent of total non-bank purchases. Their balance sheet growth is projected by accumulating their net income, which in turn grows in line with non-oil private sector activity. Other non-banks absorb 20 percent of total non-bank purchases.

Figure 6.
Figure 6.

Bank and Pension Fund Assets (SAR Billions)

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Source: IMF staff calculations.

Simulation results

The five sets of simulations yield the following results (Figures 7 and 8, and Table 6). Appendix I shows the sectoral allocation of fiscal financing:

  • Scenario I: Banks absorb 36 percent of total government financing needs during 2016–21. Bank holdings of government bonds rise to 22 percent of total bank assets by 2021, remaining below historical highs of close to 30 percent (Figure 7, middle left panel, red line). The loan-to-deposit (LTD) ratio remains at around 0.87 (Figure 7, top left panel, red line). Historically, it was below 0.7 when the share of government bonds on bank balance sheets was around 25–30 percent. Bank credit growth is 4 percent year-on-year on average (Figure 7, top right panel, red line). Non-banks are expected to absorb about 15 percent of total financing needs. PPA and GOSI holdings of government bonds reach 15 percent of their projected total assets in 2021 (bottom left panel, red line). Pension fund holdings of other domestic assets decline moderately as a share of total assets (bottom right panel, red line), leading to a moderate increase in holdings of total domestic assets (middle right panel, red line). Non-resident investors absorb 21 percent of total. The remaining 28 percent of total financing needs is funded by a drawdown of government deposits which is consistent with keeping government deposits large enough to finance the fiscal deficits even if oil prices remained two standard deviations below the baseline projections for one year.

Scenario II: Nonbank absorption of bonds rises to 36 percent of total government financing needs. Pension fund holdings of government bonds are expected to represent nearly 30 percent of their projected assets in 2021 (bottom left panel, blue broken line). Pension fund holdings of other domestic assets, such as equity and bank deposits, decline, reducing corporate capitalization and banking system liquidity (bank deposits decline by the equivalent of 1/3 of additional bond purchases by pension funds each year). By contrast, bank absorption of government bonds declines to 15 percent of total financing needs. The share of government bonds held by banks rises by less, reaching 12 percent of total bank assets (middle left panel, blue broken line). As banks lend more, the loan-to-deposit ratio rises to 1.0, much above the 0.87 in Scenario I (top left panel, blue broken line) and the average growth rate of private sector credit increases to 6 percent (top right panel, blue broken line). As in Scenario I, non-resident investors absorb 21 percent of new issuance. The remaining 28 percent of total financing needs is funded by a drawdown of government deposits.

Scenario III: Non-resident investors absorb 50 percent more debt than under Scenarios I and II during 2016–21, or 31 percent of government financing needs. With 28 percent of the total financing needs still being funded by a drawdown of government deposits, bank absorption of government bonds declines to 26 percent of total budget financing needs from 36 percent under Scenario I. This reduces pressure on domestic liquidity, lifting the loan-to-deposit ratio and average growth of private sector credit to 0.95 and 5.6 percent, respectively (Figure 8, black lines). They are however lower than under Scenario II (1.0 and 6.2, respectively). Non-banks are assumed to continue absorbing 15 percent of total fiscal financing needs, similar to under Scenario I.

Scenario IV: The government maintains a smaller amount of deposits with SAMA as an insurance against future negative shocks. In this case, the drawdown of government deposits accounts for 52 percent of total financing needs, or nearly twice that in Scenarios I–III. Starting from the allocation in Scenario I, banks, nonbanks, and nonresidents each reduces lending to the budget by 1/3 of the additional financing provided through a drawdown of government deposit at SAMA. Bank holdings of government bonds rise to 18 percent of total assets. Compared to Scenario I, the loan to deposit ratio increases by 0.06 to 0.93 and the average credit growth by 1 percentage point to 5.2 percent (Figure 8, orange broken lines).

Scenario V: Financial deepening progresses and the investor base widens. As a result, deposit growth accelerates by about 1.5 percentage points every year during 2016-21. Starting from the allocation under Scenario I, greater customer deposit funding allows banks to extend more credit (5.8 percent yoy on average, right panel, green broken line) even as they absorb government bonds while maintaining the loan to deposit ratio broadly unchanged at 0.88 (Figure 8, left panel, green broken line).

Figure 7.
Figure 7.

Key Indicators: Scenarios I & II

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Source: IMF staff calculations.
Figure 8.
Figure 8.

Key Indicators: Scenarios I, III, IV, V

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Source: IMF staff calculations.

23. Domestic bond issuance to finance the projected fiscal deficits would lead to a crowding out of other assets. As commercial banks and non-banks increase holdings of domestic government bonds, domestic real interest rates would rise and other assets would be crowded out. Bank credit to the private sector would slow, eventually leading to slower private sector activity. Holdings of equities, bank deposits, and real assets by PPA and GOSI will be crowded out. The simulation results (Figures 7 and 8) show that, during 2016–21, as banks reduce the pace of accumulating government bonds on their balance sheets from 3 percentage points of total assets every year in Scenario I to an average of 1 percentage points in Scenario II, credit growth increases by 2 percentage points, from 4.1 percent year-on-year on average to 6.2 percent. Similarly, the loan-to-deposit ratio increases from 0.87 on average to 1.0. An econometric result presented in Box 1 of the staff report also suggests that as banks accumulated less government bonds, bank credit growth increases.

Table 6.

Allocation of Fiscal Financing and Key Indicators

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Source: IMF staff calculations.

24. Alternative financing options could mitigate the crowding out effects of domestic borrowing but create new risks. Larger foreign financing (Scenario III) can mitigate crowding out of domestic assets, leveraging on the strong appetite for the Saudi sovereign credit from foreign investors, evidenced by the recent $10 billion syndicated lending deal with foreign banks. However, the cost of funding would likely rise over time, particularly if other oil and commodities producing countries turn to the international market for additional financing. With higher international borrowing, external debt rollover needs increase, and with it, the country’s vulnerability to global financial market volatility. However, a greater drawdown of government deposits (Scenario IV) can also help, but also reduces financial buffers, exposing the country in a different way to adverse domestic/external shocks.

25. Financial deepening could help reduce crowding out of domestic assets (as illustrated in Scenario V). Greater financial deepening would help attract more customer deposits to the banking system. This moderates crowding out of private sector credit for a given increase in bank holdings of domestic government bonds. Financial deepening can be facilitated by institutional reforms and higher transparency. The following section discusses in more detail reforms and the priority measures that can be implemented to take advantage of the fiscal financing need.

D. Developing the Domestic Debt Market and Broadening the Investor Base

26. Broadening the investor base and ensuring the government’s debt issuance supports the development of the private debt market could help alleviate some of the negative economic and financial effects of higher government debt. In case higher financing from non-bank sources can be mobilized, this would reduce pressures on bank balance sheets. Further, the development of a private debt market would provide companies with alternate financing sources to those currently available through banks and nonbanks.

Investor base

27. The investor base for government debt is not very diversified. Banks and pension funds are the main investors in the Saudi Arabian market holding more than 90 percent of government issued debt. Domestic bank holdings of government bonds peaked in 2003 at SAR 160 billion; close to 30 percent of total bank assets and 20–25 percent of the total amount outstanding (Figure 9). In 2015, the government issued just over $26 billion worth of bonds starting in June. Banks bought one-third, or $8.6 billion. Other local institutions absorbed the other two-thirds, or $17.5 billion. Foreign investors and domestic high net-worth investors did not participate.

Figure 9.
Figure 9.

Domestic Bank Claims on Government (Excluding SAMA) (1993–2015)

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Sources: Haver and IMF staff calculations

28. Banks’ demand for government bonds will likely remain high, including because of Basel III requirements. Bank capital regulations typically require institutions to hold a specific amount of capital compared to their risk-weighted assets. The zero percent risk weights make highly rated foreign government bonds or any domestic government bond relatively more attractive as banks do not need to hold capital for holdings these bonds. Basel liquidity regulations require banks to hold sufficient amounts of high quality liquid assets to cover their net cash outflows for a window of period in a stress scenario. Saudi banks already meet the Basel III capital, liquidity and leverage standards that international banks are expected to meet by 2019. However, greater supply of Saudi government bonds would increase the options for banks to manage their balance sheets in compliance with regulatory requirements. Meanwhile, banks may shy away from bonds with long duration as these would increase market risk.

29. Reforms to broaden the investor base would help with absorbing future government debt issuance. In particular, encouraging the further development of the insurance and mutual fund industries will help mobilize national saving. Consideration should also be given to the potential role of domestic high net worth individuals and foreign investors in the domestic securities market. International investors may find Saudi government bonds attractive from diversification perspectives, and the recent discussion to allow foreign investors to purchase listed domestic bonds is a step in the right direction.

30. Islamic finance in general, and Sukuk markets, in particular has great potential in Saudi Arabia and an important role to play in financing the budget.8 Demand for Islamic financial instruments is growing very strongly, and this growth has the potential to support the implementation of fiscal and monetary policies and enhance financial sector development. The authorities have already expressed interest in tapping the abundant Islamic finance market liquidity by debuting sovereign Sukuk in 2016 with the intent to expand the investor base beyond what could be otherwise tapped through conventional finance.

31. The investor base for Shari’a-compliant instruments is growing strongly. Currently, out of 12 domestic commercial banks in Saudi Arabia, four are full-fledged Islamic banks and a fifth, the biggest conventional bank, is in transition to become Shari’a-compliant. The four Islamic banks (Al Rajhi, Alinma, AlBilad, Al Jazira) together hold about 25 percent of the domestic banking system assets. The rest of the banks are conventional banks who offer a mix of Islamic and conventional banking services.9 As of end-2015, the Islamic banking (IB) sector asset base in Saudi Arabia reached about SAR 1,151 billion, representing about 21.4 percent of global IB assets, with a growth rate of 8 percent in 2014. Furthermore, IB deposits exceeded SAR 1,250 billion with year-on-year growth of 10 percent. The market share of assets in the overall banking industry exceeded 50 percent in 2015. These banks provide a strong investor base for government Islamic instruments, although Sukuk securities would appeal to a wider investor base (both conventional and Islamic) and their issuance could eventually lead to a price competition on government securities across the board.

32. Important reforms are needed to encourage the development of the Sukuk market. In particular, for Sukuks to gain broader acceptance, there is need to promote greater instrument liquidity, accompanying risk management tools, and a more robust regulatory regime. The convolution of the instruments and sometimes limited understanding of the principles governing their structure expose investors to a number of risks, including credit risk, mispricing, legal uncertainty, and Shari’a compliance risk and related reputational risk. Issuing government Sukuk securities for funding development and/or capital spending against future underlying assets with plain vanilla structure could be the most suitable financing approach. Related government agencies should develop new budget measures for early planning and asset allocation in case of Sukuk issuance. Building consensus and institutionalizing the Shari’a ruling would help develop a broader investor base, necessary for the deepening and expansion of the Sukuk market.

33. Whether traditional or Islamic, clearly articulated and transparent fiscal and debt management strategies are likely to support higher financing availability at lower cost. Other things being equal, financing is likely to be available on more favorable terms if there is: (i) a well-articulated macroeconomic framework that lays out a clear government reform strategy and a clear path to fiscal and external sustainability; (ii) a Asset-Liability Management (ALM) strategy with clear targets and objectives, including, at least, an annual issuance plan; (iii) a clear legal and regulatory framework, a strong institutional capacity, and a communication strategy that articulates clearly the government macroeconomic objectives and its debt strategy.

Development of the domestic private debt market

34. The lack of an established government debt market and benchmark yield curve has inhibited the development of the corporate bond market. The size of the corporate bond market is small, but not negligible. It is estimated that the total size of Saudi corporate debt market is around SAR 175 billion (7 percent of GDP) and there is hardly any liquidity as most investors are of the buy and hold nature. Corporate issuances in Saudi Arabia are roughly split between private placement (equivalent to SAR 78 billion) and public offering (equivalent to SAR 98 billion). The preference for issuers to opt for private placements is mainly driven by the fact that it has a shorter timeframe to the market and requires less disclosure.

35. The limited corporate bond market means that companies are very reliant on bank financing (and in some cases financing from specialized credit institutions). Only large companies such as ARAMCO and SABIC are able to access international markets, and most companies would be adversely affected by the crowding-out discussed in the previous section given the absence of alternate financing options. Ensuring that government debt issuance is done in a way that supports the development of private debt markets is one way that some of the negative effects of this issuance could be alleviated.

36. The increased funding needs going forward provides a good opportunity for Saudi Arabia to implement measures to strengthen its debt management capacity and to jumpstart the deepening of local bond markets (Box 1). Efforts have already been made in the past to create a more liquid secondary market through reforms including the relaxation of tax laws and the creation of market makers. Nevertheless, these efforts were not complemented by a regular issuance policy in the absence of funding needs.

Strengthening Debt Management Practices in Saudi Arabia

Saudi Arabia is borrowing domestically and internationally to finance the fiscal deficit. To this end, there is a need to strengthen the regulatory and institutional frameworks for debt management to help reduce borrowing costs and related risks.

Debt management capacity

Saudi Arabia is moving quickly to strengthen the debt management framework, including strengthening the institutional capacity. The government has recently established a Debt Management Office (DMO) and appointed a new head to consolidate the DMO functions in one single agency with an operational autonomy. In this regard, the new office function will be organized along industry’s best practice, including (front, middle, and back-offices) with direct reporting to the minister/vice minister, who will help establish and maintain the agency’s operational independence while enhancing its accountability and transparency. SAMA has been executing the debt management functions as an agent for the government. It has acted as the fiscal agent for the government and has conducted the debt management decisions regarding the instruments to issue, volumes, and rates.

Debt management strategy

The Ministry of Finance is leading the effort to define the debt management policy and its objectives and incorporate them in the legal framework. This would improve clarity for the debt manager and facilitate the accountability process. It would also be an important input when formulating the debt management strategy. Lately, the government has been relying mostly on SAMA to decide on the instruments to be issued at each moment of time, and their specific amount. The issuance decisions have followed an ad-hoc approach basically led by market demand close to the issuance date.

Legal framework

There is currently no comprehensive debt law or specific regulations related to debt management. At present, the Council of Ministers authorizes the Ministry of Finance (MOF) to issue debt on an annual basis, but no piece of legislation permeates a longer period. This should be addressed to allow for a more efficient management of the government liabilities.

Going forward, Saudi Arabia should consider developing a robust legal framework for debt management. A proper legal structure would provide confidence to DMO in executing its tasks. It should also be instrumental as a marketing tool to signal to foreign and domestic investors that Saudi Arabia is moving towards a modern debt management framework.

Comprehensive debt management legislation would regulate all aspects of government borrowing and issuance of guarantees. Debt legislation should ensure that the legal framework clearly sets out the authority to borrow (both domestically and externally), to undertake debt-related transactions (such as currency and interest rate swaps), and to issue loan guarantees.

Special considerations for Sukuk

As the Islamic finance industry expands, the need for a standalone legal and regulatory framework increases. Best practice requires producing a high-quality legal and operational infrastructure framework. The progress achieved by a stable government Sukuk market can be assessed in terms of the extent to which market efficiency, systemic transparency, and governance arrangements comply with international Islamic finance standards. Revamping the legal and regulatory framework to address Sukuk contractual aspects (to fund trade or production of tangible assets and add value to the real economy rather than providing finance through purchase of financial securities) would incentivize a wider market participation base. In this regard, establishing a clear mandate to securitize existing or new assets within financing vehicles is warranted. Furthermore, adopting the industry’s standard-setters guidelines (e.g., AAOIFI and IFSB) for best practices and institutional adherence to broad Shari’a principals would ensure standardization of contracts and market harmonization.

37. Against this backdrop, Saudi Arabia is reviewing its debt management objectives, and this should include in particular reforms to support the development of the private debt market. Debt management objectives provide broad guidance on what the debt management activity should achieve. In most countries, debt management objectives refer to minimizing costs over the medium term, subject to a certain degree of risk.

38. In addition, the government’s debt issuance policy and instrument mix should reflect a decision to develop local debt markets over the medium to long term, instead of purely being geared towards raising resources. The Debt Management Office (DMO) will formulate a medium-term debt strategy (MTDS) in which the choice of funding instruments optimizes the cost-risk trade-offs, as well as its impact on promoting market development. The MTDS should provide medium-term guidance on the share of domestic and external borrowing, and on conventional and Sukuk to be issued. This would take into consideration the investor base and market appetite for each type of instrument. The instrument mix should facilitate the creation of a yield curve in local currency. This will require the issuance of fixed rate instruments in meaningful amounts. Floating rate instruments could also be used to minimize costs, but the share of each should reflect this broader policy decision. Finally, the maturity mix needs to be carefully decided in a way that balances the cost of extending the curve against the lower refinancing risks of longer-term debt.

39. The DMO should gradually upgrade debt management practices towards international practices, which will help with market development. In particular, the DMO should champion the process of introducing auction mechanisms. This can be done gradually, and perhaps start with shorter-term instruments where demand is higher and interest rate risk less of a concern. Currently, instruments are issued through private placements, with insufficient transparency, which impedes market development.10 MOF provides SAMA the yearly funding amounts that are needed, and SAMA decides (sometimes in consultation with MOF) the amounts to be offered in the monthly private placements. Consultations with the market and decisions on interest rates and specific funding instruments are undertaken by SAMA. However, limited information is released both before and after the placements. SAMA provides a yield range for each bond to be offered, but does not announce the size for each instrument allocation ahead of the placement. The lack of an issuance calendar also leaves investors with limited information on the funding intentions.

E. Conclusions

40. Saudi Arabia is starting from a very strong asset-liability position, but its financing needs are significant given projected fiscal deficits. It has a number of options for financing—reducing its deposits with the central bank, selling other financial assets, and borrowing domestically and internationally. Each of these has its own costs and benefits, which are likely to vary depending on market circumstances. While reducing deposits may be the least costly option in terms of relative interest rates, maintaining a stock of very liquid assets has insurance benefits against periods of difficult market conditions. Selling government stakes in companies could raise considerable financing for the fiscal deficit, but also comes at the cost of foregone future revenue streams if the company is profitable. Borrowing domestically and internationally also involves risk/cost tradeoffs. The composition of the domestic investor base will have implications for the effects of domestic borrowing on the domestic economy and financial system. In particular, higher domestic financing will likely crowd out private sector credit and nonbank holdings of other assets. Given the relative costs and benefits of each, some combination of asset drawdown and domestic and external borrowings is likely to be optimal.

41. A number of policies can help support the financing of the fiscal deficit and help mitigate the impact on the broader economy. Issuance of government debt can help develop a domestic yield curve, and a liquid secondary market in government securities would help support the private debt market that is currently underdeveloped in Saudi Arabia. By developing the private debt market, companies will have alternate sources of financing to banks. Broadening the investor base for government debt would support financing, including if foreign investors, other financial institutions, and high net individuals were allowed to participate in the secondary market. The development of the government Sukuk market would also provide valuable additional financing to the government.

42. Improvements in the fiscal and debt management frameworks would help reduce the risks and costs of government borrowing and increase investor interest. The government should announce a clear medium-term fiscal consolidation strategy and supporting reforms. They would reassure investors that the government will continue to act to reduce the fiscal deficit. Likewise, a medium-term debt strategy would give investors clear guidance about the government’s issuance plans and allow them to plan better for the future.

Appendix I. Projected Fiscal Financing Allocations


Allocation of Projected Fiscal Financing (SAR Billions)

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Source: IMF staff calculations.Note: Nonbank-PPA, GOSI, other.

Appendix II. Local Capital Market and Instruments Development

The history of public debt instruments in Saudi Arabia dates back to the 1980’s, when SAMA started issuing securities for monetary policy purposes. Later on, in 1988 the government started to issue its own instruments to fund the fiscal deficits, but issuance was stopped when funding needs were eliminated. Perhaps partly as a consequence of interrupted issuance, the secondary market has never fully developed, and liquidity has been low. More recently, the government has resumed issuance of securities to fund the deficit, and this new issuance could help boost the development of the local markets.

In the absence of government securities, SAMA began in the 1980s experimenting with issuance of Bankers Security Deposit Accounts (BSDAs) for managing its monetary policy more effectively. SAMA created in 1984 the BSDAs (SAMA obligations) as part of domestic money market reform with a view to creating a domestic money market instrument to absorb excess liquidity and provide a domestic alternative to offshore interbank placements (Banafe, 1993). BSDAs aimed to help create a domestic money market to absorb excess liquidity, enhance monetary policy control in terms of influencing system liquidity and short-term interest rates, and offer an alternative investment to offshore interbank placements, thereby mitigating risks associated with foreign exchange outflows. The introduction of BSDAs contributed to the diminishing volatility in spread between the two reference rates (Libor and Sibor).


3-Month SIBOR vs LIBOR

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Source: Saudi Arabian Monetary Agency.

BSDAs issuances were restricted to domestic banks and were repoable. SAMA’s repo window is an instant overnight facility for banks to engage in collateralized borrowing and was created and made operational on the same day as BSDAs. Repoability was an appealing feature of BSDAs as it provided ready means of accessing central bank liquidity for banks facing unexpected reserve shortages. Prior to this facility, banks were forced to keep higher reserves with SAMA in unremunerated accounts to meet unexpected withdrawals or clearing shortages. Repos are essentially meant to cover clearing shortages arising from unexpected withdrawals, returned checks or failure of counterparty payments, and are operated under strict guidelines to avoid abuse. Banks are not expected to finance their US dollar purchases from SAMA using this facility.

Despite the fact that BSDAs were freely transferable among banks, no secondary market activity took place. The lack of secondary market appeared to be due to the banks’ perception of this instrument as a liquidity cushion rather than a trading product, although BSDAs were not substituted for statutory reserves (i.e. minimum reserve requirements), but counted for liquidity ratios purposes.

The government started to issue Government Development Bonds (GDB) to fund its deficits in late 1980s. Successive budget deficits led to the issuance of the first GDBs in 1988. As a fiscal agent to the Ministry of Finance, SAMA engaged in private placement borrowing from Autonomous Government Institutions (AGIs) and subsequently from domestic banks. GDBs were publicly first offered in June 1988, and later the central government broadened its offering to include Treasury Bills (T-bills), replacing SAMA’s BSDAs in November 1991, shifting the liability from SAMA towards the Ministry of Finance. The change of instrument aimed to benefit from the potential wider application of T-bills in terms of their availability to non-banks and for deficit financing.

Unlike the BSDAs, T-bills were offered to bank and non-bank institutions to help them manage their short-term investment needs. This expanded the borrowing capacity of the government and allowed for greater flexibility to the Ministry of Finance in managing current fiscal operations. Given banks and non-banks exposure to offshore deposits at the time, T-bills were seen as an attractive instrument for diversification purposes. Moreover, there was a marked growth in bank deposits at that time that was partly attributed to the absence of any short-term alternative instrument.

In May 1992, SAMA introduced the reverse Repo facility in an attempt to stem foreign exchange reserve outflows and encourage banks to hold liquid funds in the system. At the time, banks held about one third of their deposits in US dollars to manage liquidity. At the same time, banks were willing to convert their dollar holdings in domestic investments to reduce their large foreign exchange exposure. Introducing the reverse Repo facility provided the banks with a mechanism for employing their excess liquidity in the domestic market. This also lent a hand to T-bill and GDB subscription activity. Both Repo and reverse Repo facilities helped to stabilize demand for the US dollar in the system and the overall Saudi money market structure.


Net Repo Amount

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Source: Saudi Arabian Monetary Agency.

Murabaha debt securities and Floating Rate Notes (FRNs) were introduced for the first time in January 1997 to cater for sharia-compliant banks. This helped expand the range of available instruments and diversify price risk in the face of increasing funding requirements.1 FRNs attracted banks’ appetite as they suited their balance sheet structure given their reliance on customer deposits and role in mobilizing domestic savings, and the fact that frequent coupon re-fixing minimizes the interest rate risk. While FRNs are deemed attractive in a rising yield environment from an investor’s point of view, they allow the issuer to tap into longer maturities at short-term funding costs.

Benefits and Risks of Fixed vis-à-vis Floating Rate Instruments

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Source: Saudi Arabian Monetary Agency.

Government Murabaha were first offered in April 2002 for up to 3-year maturities. Government Murabaha and FRNs (like traditional liquidity instruments) are also all repoable with SAMA, widening the framework of system liquidity management. Banks can engage in sale and repurchase arrangements with SAMA to raise liquidity up to 100% (currently at 98%) of their gross holdings issued by SAMA, the MoF, or any quasi-government debt that is explicitly guaranteed by the central government (e.g. General Authority of Civil Aviation, GACA). SAMA additionally considered these holdings as eligible assets when calculating banks’ liquidity ratios. Such holdings also carried a zero weighting under the risk-based capital adequacy scheme.

In 2005, SAMA created anew its own short-term security to avail domestic banks with a short-term instrument to park their liquidity. This was triggered by the suspension by the Ministry of Finance of its borrowing activity with T-bills, which limited banks’ ability to manage short-term liquidity.

However, the secondary market never developed although banks were able to act as market makers. They resell SAMA bills and GDBs to government and quasi-government institutions, to resident and non-resident investors, as well as in the interbank market. Still, a secondary market in GDBs never really developed despite government promotion efforts. Tax laws were relaxed so that Saudi banks were able to deduct their GDB holdings from their net assets (net worth) before “Zakat”, a special tax on income and trading assets, was calculated. SAMA also established procedures defining and governing the “market-maker” role for local banks as they acted as investors, distribution agents, secondary market makers and sub-custodians or paying agents.

Banks found it instead more convenient to hold debt instruments until maturity, especially, when the yield curve continued to steepen. Non-resident investors on the other hand were allowed to participate through domestic banks, but their involvement remained negligible. In retrospect, the lack of secondary market development may be attributed to the perception by banks that deficit financing would be temporary, their reluctance to promote secondary market trading because of conflict of interest as it undermines their objective to mobilize non-interest bearing deposits helpful to reducing banks funding costs, the absence of investment banks, the buy and hold culture of AGIs, and the narrow investor base.

In June 2015, the ministry of finance returned to the market following the drop in oil prices, and issued its first borrowing of SAR 15 billion in private placements. Since then, GDBs and FRNs with 5-, 7- and 10-year maturities were issued. In February 2016, the government also issued long-term Murabaha with 5-, 7- and 10-year maturities. The interbank deposit market is up to one year and interest rates are determined by the market.


Outstanding Holdings of SAMA Bills and Murabaha

(In SAR bn)

Citation: IMF Staff Country Reports 2016, 327; 10.5089/9781475544275.002.A001

Source: Saudi Arabian Monetary Agency.


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Prepared by Fahad Alhumaidah, Ryadh Alkhareif (all SAMA), Khalid AlSaeed (MCM), Nabil Ben Ltaifa (MCD), Ken Miyajima, and Guilherme Pedras (all MCM). Research support was provided by Zhe Liu and editorial support by Diana Kargbo-Sical (all MCD).


Net debt is calculated by subtracting the stock of financial assets from debt outstanding.


See IMF (2014) for more detailed analysis on sovereign asset liability management.


Some resource rich countries placed part of their financial surpluses (generated during period of booms) into sovereign wealth funds (SWF) which overtime have grown in size and are generally invested in less liquid-higher return/risk assets that have become a significant alternative source of income to their country.


See accompanying paper on “Privatization and PPPs in Saudi Arabia: Past Experience and the Way Forward”.


A large presence of foreign investors in the domestic market can increase market volatility and abrupt capital outflows.


To assess the relative importance of fixed-coupon bond issuance, the number of monthly bond issuance of fixed- and floating rate bonds or bills is multiplied by maturity.


Sukuk is the plural form of “Sakk” in Arabic, which translates as title deed, as it underscores ownership in the underlying asset.


“Islamic Banking Is Dominant in Saudi Arabia,” Fitch Ratings, February 2016.


See Appendix II for a more detailed analysis and coverage of existing money market instruments.

Saudi Arabia: Selected Issues
Author: International Monetary Fund. Middle East and Central Asia Dept.