1. Oil price and production developments remain critical to Saudi Arabia’s fiscal position. Despite efforts to diversify the economy, oil still accounted for about 40 percent of real GDP in the last few years, down from about 45 percent 10 years ago. The share of the oil economy in nominal GDP varies significantly with oil prices and was about 30 percent in 2021 but is projected to increase to about 40 percent in 2022. The importance of oil for the economy is also reflected in its large share of fiscal revenues. Oil revenues averaged 75 percent of total budget revenues since 2010 with large variations, peaking at 93 percent in 2011 and falling to 53 percent in 2020 as the COVID-19 crises pushed global oil demand down. As a result, fiscal balances have also varied with oil prices, with large surpluses during booms and deficits during times of depressed oil prices.


1. Oil price and production developments remain critical to Saudi Arabia’s fiscal position. Despite efforts to diversify the economy, oil still accounted for about 40 percent of real GDP in the last few years, down from about 45 percent 10 years ago. The share of the oil economy in nominal GDP varies significantly with oil prices and was about 30 percent in 2021 but is projected to increase to about 40 percent in 2022. The importance of oil for the economy is also reflected in its large share of fiscal revenues. Oil revenues averaged 75 percent of total budget revenues since 2010 with large variations, peaking at 93 percent in 2011 and falling to 53 percent in 2020 as the COVID-19 crises pushed global oil demand down. As a result, fiscal balances have also varied with oil prices, with large surpluses during booms and deficits during times of depressed oil prices.

The Need for a Fiscal Anchor and Potential Fiscal Rules in Saudi Arabia1

1. Oil price and production developments remain critical to Saudi Arabia’s fiscal position. Despite efforts to diversify the economy, oil still accounted for about 40 percent of real GDP in the last few years, down from about 45 percent 10 years ago. The share of the oil economy in nominal GDP varies significantly with oil prices and was about 30 percent in 2021 but is projected to increase to about 40 percent in 2022. The importance of oil for the economy is also reflected in its large share of fiscal revenues. Oil revenues averaged 75 percent of total budget revenues since 2010 with large variations, peaking at 93 percent in 2011 and falling to 53 percent in 2020 as the COVID-19 crises pushed global oil demand down. As a result, fiscal balances have also varied with oil prices, with large surpluses during booms and deficits during times of depressed oil prices.

2. In the past, government spending tended to be procyclical, as it followed the swing in oil prices. Government revenues as well as expenditures are positively correlated with the oil price. Looking back, during the period of higher oil prices of 2003–14, annual expenditure grew by more than 14 percent on average, which compares to less than 1 percent average annual growth during the period of lower oil prices 1991–99. Similarly, it grew by 1½ percent on average during 2015–19 in the period following the sharp oil price drop in 2014 (which includes a 28 percent increase in 2018 as the oil price rebounded).2 Fiscal balances have varied, with persistent deficits during 1991 through 1999, followed by a period of mostly surpluses, peaking at almost 30 percent of GDP in 2008, and then a sharp deterioration to a deficit of almost 16 percent in 2015.

3. Most recently, government spending did not increase with higher oil prices. Expenditures declined by almost 3½ percent in 2021 even as the oil price increased by more than 66 percent. This was all due to lower capital expenditure and current expenditure essentially staying flat with continued expenditure control in 2022 critical. The 2022 budget does envisage a substantial reduction in expenditure for 2022 and continued restraint for 2023 and 2024 and the authorities have expressed a clear commitment to break past patterns of increasing expenditures as oil revenues rise.

4. This development is the result of an intentional effort to improve fiscal management and reduce the sensitivity to–and dependence on–oil prices. The Saudi authorities have implemented broad fiscal reform in the last several years as part of Vision 2030 with a view to improve fiscal management and reduce oil dependency. Important progress includes (i) non-oil revenue mobilization, in particular the introduction and subsequent increase of VAT rates and revenue administration reforms; (iii) energy price reforms, although gasoline prices were capped in mid-2021; (iii) broad based expenditure rationalization and procurement reform; (iv) a move towards a Treasury Single Account; (v) more systematic fiscal risk assessment; (vi) improved budget disclosure; and (vi) strengthened debt management.

5. These efforts need to continue to ensure fiscal sustainability and should be combined with a comprehensive grasp of the fiscal stance and a clearly defined fiscal anchor. The institutional coverage needs to be expanded beyond the central government, including the Public Investment Fund (PIF) and the National Development Fund (NDF) to allow proper assessment of the fiscal position. Fiscal policy should furthermore continue to be guided by a medium-term fiscal framework (MTFF) that enhances expenditure prioritization. The authorities have made important progress in this area, and there are also advanced plans for the introduction of a fiscal rule to set expenditure targets, manage surpluses and finance deficits. However, to complement the existing level of debt to GDP ceiling an anchor for fiscal policy would be beneficial to set adequate policy goals.

6. The authorities have been preparing a Fiscal Sustainability Program (FSP), seeking to avoid excessive deficits, while supporting long-term objectives through dedicated public spending (infrastructure to support diversification and broader growth objectives). This paper offers options to support the goals of the FSP. In particular, it argues that an expenditure rule, based on a permanent income hypothesis (PIH) anchor, may best serve the county in reconciling its stabilization and growth objectives in the longer term.

A. Developing and Assessing a Long-Term Fiscal Anchor

Using the PIH as a Fiscal Anchor: Some Considerations

7. Resource-rich countries can use their resource revenue to accumulate a financial wealth that can in turn finance a sustainable non-resource primary fiscal deficit. Since these assets earn a positive rate of return, this allows current and future generations to run primary deficits equivalent to the rate of return on their level of assets. There are several frameworks that can provide anchors, based on policymakers’ aversion to risk and/or social preferences (Box 1). For Saudi Arabia, with both significant resources in the ground and a need to diversify away from oil over time, the permanent income hypothesis (PIH) as an anchor for the design of fiscal policy deserves the most focus. In essence, the PIH ’s design helps(i) achieve intergenerational equity by leaving future generations a financial wealth to sustain fiscal deficits, (ii) create flexibility throughout the medium-term, by making the adjustment to the long-term anchor gradual, and (iii) develop a prudent fiscal stance, as Saudi Arabia would save resource revenue to accumulate buffers that can be used in “bad” times.3

Alternative Fiscal Anchors in Resource-Rich Countries (RRC)1

A generally accepted principle is that future generations should also derive a benefit from resource wealth as well as the generation(s) living during the period of extraction. Alternatives to an intergenerational wealth sharing approach are possible, however, both more prudent (such as “bird-in-hand”) and more profligate (such as “spend-as-you-go”), though both of these have drawbacks.

In the Bird-in-hand (BIH) approach, all resource revenues are invested in financial assets with consumption out of resource wealth equivalent only to the interest earned on accumulated financial wealth (i.e., not based on permanent income concepts). The approach is prudent, since it does not permit bringing forward consumption of (uncertain) future resource revenue and may be an appropriate anchor for some countries for example, if there is high degree of uncertainty about future resource revenues, borrowing constraints, either due to high cost or debt sustainability issues. This is also the case when absorption capacity issues prevent an efficient scale-up in spending. The drawbacks of the BiH are that future generations benefit more than the current and that it introduces some inflexibility to borrow for the financing of productive investment opportunities when they arise. This highly risk-averse approach might be appropriate for countries in an advanced stage of development and with a short resource horizon. Norway is implementing a type of BIH framework by setting a floor on the non-oil primary deficit not to exceed 4 percent of the accumulated financial wealth, which corresponds to the expected long-run real rate of return of its sovereign wealth fund. This model notably helps Norway produce the necessary savings to prepare for the rising costs of its pension system as the population ages.

The Spend-as-you-go (SAYG), on the other hand, is a highly procyclical approach, where the government automatically spends all resource revenues on receipt, to buy goods and services and to make capital investments. As a result, when natural resource revenue increases, the government increases its expenditures; when it decreases the government is forced to cut its expenditures.

The permanent Income Hypothesis (PIH) provides a more flexible anchor than the BIH, while bringing a better guiding instrument for the long run than the SAYG. Under the PIH, the total financial wealth (current wealth and the net present value of future oil revenue) is used to finance either a constant flow of revenue in real term or in real term per capita. Few countries have attempted to apply the PIH framework through a non-resource fiscal balance rule, and often deviated from it. Azerbaijan targeted a non-oil balance consistent with constant consumption out of oil wealth, but eventually moved to an ad-hoc balanced budget. Similarly, Timor-Leste set a floor on non-oil deficit in line with an estimated sustainable income, but subsequently the scaling up public investment led to deviations from the PIH.

If the current fiscal stance differs significantly from the stance consistent with the long-term fiscal anchor from the PIH, the gap will need to be closed with a fiscal adjustment or “transition.” In designing the transition, countries can thus deviate for some time from the PIH to reach the long-term anchor after a few years (the so-called modified PIH, or mPIH, outlined in IMF, 2012). These deviations can also enable countries to factor the positive growth impact of the transition, if, for example, it is used to scale up investment to buttress growth prospects (the so-called fiscal sustainability framework, or FSF, see IMF 2012). The analysis of this report is primarily predicated on the mPIH.

1 This box draws heavily on Basdevant, Hooley and Imamoglu, (2021).

8. The level of economically extractable reserves and oil prices matters greatly in defining the sustainable fiscal space in the long term. As shown in Table 1 and Figure 1 below, it is a critical parameter (the larger the reserves the higher the deficit). Any assumption would need to be based not only on the total reserves available, but also on the share that would be economically feasible to extract. In the case of Saudi Arabia, assuming long-term prospects for the oil market in the context of competition from other producers, including through alternative fuels would be essential. We have assumed that the assessed reserves of about 260 billion of barrels of oil as of 2021 are exploited (baseline). We have also explored two alternative scenarios (see below). Given that the differences can be quite important, including for the fiscal strategy leading to the long term, it would be essential for the authorities to undertake this type of analysis regularly and to stress test their assumptions to ensure that their fiscal plans remain sustainable under a broad set of assumptions.

Table 1.

Saudi Arabia: Key Assumptions Underpinning Resource Revenue Projection

article image
Sources: IEA; and IMF staff projections.

End of period data.

Figure 1.
Figure 1.

Resource Revenue Projections and Financial Wealth

Citation: IMF Staff Country Reports 2022, 275; 10.5089/9798400217548.002.A001

Source: IEA; and IMF staff estimates and projections.

9. Uncertainty regarding PIH estimates calls for basing it on prudent assumptions. Moreover, it would be important to also: (i) keep flexibility over the short and medium term so as to not overly constrain fiscal policy, and (ii) revising regularly PIH estimates - either in the context of the preparation of medium-term fiscal framework or in case of large and persistent shocks to oil prices that would warrant a revision of the PIH and the corresponding fiscal framework. For our analysis, we assumed two initial scenarios:

  • A combination of demand/supply shocks. The oil market would be affected by a demand shock (i.e., declining demand due to climate change reforms) as well as supply shocks (as producers would get knocked out of the market), resulting in higher oil prices. This would, overall, benefit Saudi Arabia, being a country with the lowest production cost. In this scenario, oil revenue, and more generally Saudi Arabia financial wealth, would be considerably higher.

  • Demand shock only. In this more pessimistic scenario, we assumed only the impact of a demand shock, which would translate into collapsing oil prices. This scenario has to be viewed as a low likelihood illustration of broader cases, as declining oil exports (due to reserves being no longer economically worthwhile to exploit) could generate a similar impact.

Properties of the Baseline Assumptions for the PIH

The permanent income hypothesis, based on assumptions presented above, could serve as a guiding principle (Table 2). Based on our assumptions, the main findings of using the PIH as a fiscal anchor under the baseline are as follows.

Table 2.

Saudi Arabia: Key Assumptions for the Computation of the Fiscal Anchor

article image
Sources: IMF staff estimates.

Assumptions common to both alternative scenarios

The transition period is greater in both alternative scenarios than in the baseline. In the baseline, the duration of the transition is 6 years, which corresponds to the horizon of staff’s baseline projections for the Article IV and incorporate the fiscal consolidation efforts under way since 2016. As such, during this period the potential ceiling given by the PIH would not be constraining, as the authorities would have time to gradually adjust to a level of the non-oil deficit broadly consistent with the PIH norm. In the case of the two alternative scenarios, the transition is much longer (15 years). In the demand shock scenario it simply reflects the fact that the adjustment to reach the PIH would be much larger, and, as a result, would require more time. In the supply and demand shock scenario, it would reflect that the authorities would have a lot more time to adjust, and thus could run higher deficits and support diversification needs further, and start their fiscal adjustment to the PIH later than in the baseline.

10. With a PIH anchor defined as constant in real terms, and with a transition period, the country would have ample room to meet public spending needs to support growth and diversification objectives. Under this assumption, the non-oil primary balance would decline from about 29 percent of non-resource GDP in 2022, to about 21 percent by 2028. This would be obtained at the cost of a slightly reduced fiscal space in the very long term, but with the benefit of a higher growth potential, and thus a higher GDP level that would benefit all future generations.4 In contrast the PIH defined as a constant share of non-resource GDP would likely impose a too sharp adjustment, especially in light of the very large resources available, and the longer-lasting nature of Saudi Arabia’s oil revenue (Box 2). Another option, should the authorities find it more in line with their own objectives, is to target a constant annuity per capita. However, reaching this norm would likely require a longer transition period than the one considered under the baseline (6 years, corresponding to the horizon of the IMF baseline projections and incorporating the fiscal consolidation efforts ongoing since 2016 and well in train for those years) as it would also imply a much larger adjustment than the one considered under our baseline.

Alternatives Measures of the PIH1

How to compute the permanent income hypothesis? The total financial wealth of the country, W, earn a return given by the nominal interest rate r, which can be used to finance a primary deficit (PD, the permanent income).

There are typically three alternative approaches to the PIH:

PDt = (r − γ)Wt

With the following three alternatives for the parameter γ:

  • γ = π, where π is the inflation rate. In this case the government only consumes the fraction (rπ)Wt of the return, and leaves the residual, πWt, to accumulate more wealth: Wt+1 = (1 + π)Wt. As a result, financial wealth grows with the inflation rate and is constant in real terms, and, by extension, so does the primary deficit.

    γ = g, where g is the growth rate of the non-resource GDP. Like the mechanism described above, this option leaves both wealth and the primary balance constant in percent of non-resource GDP.

  • γ = π + n, where π is the inflation rate and n the population growth rate. This option would leave wealth and the primary balance constant in real terms per capita.


Primary Balance

(Percent of non-resource GDP)

Citation: IMF Staff Country Reports 2022, 275; 10.5089/9798400217548.002.A001

Sources: IMF staff estimates and projections.

Applying these alternative approaches to the PIH from 2022 to Saudi Arabia would give the following outcomes:

1See Basdevant, Hooley, and Imamoglu, (2021).

11. The implementation of a fiscal rule can still be possible during that period of transition and would still be consistent with the transition to a PIH norm. In the case of the alternative scenarios, there are two motivations for the transition period to be different. In the demand shock one, the main reason is to preserve–to the extent possible–a gradual adjustment. The much-reduced fiscal space in this scenario would equally imply a much larger fiscal adjustment down the road. However, Saudi Arabia would still be expected to have ample resources to adjust gradually and avoid a very large annual adjustment that would be detrimental to growth. In the supply and demand scenario, the rationale for a longer adjustment period would be quite different: the fiscal space available would be so much larger that the government would have ample room to run larger deficits in the short- and medium-term, which could be helpful to meet spending needs for growth and diversification. Thus, the adjustment to the PIH norm would start only after that period of “scaled up” spending, which, consequently, would lead to a longer transition period than in the baseline.

12. While the PIH norm of a constant annuity in real term would imply a long-lasting fiscal prudence, most of the adjustment effort could be delivered by efforts already planned by the authorities through 2028. Beyond the medium-term, the constant annuity would imply a continued and gradual adjustment, of about ½ percentage point of non-resource GDP annually, slowly converging asymptotically towards 0. The advantage of a PIH norm with a deficit constant in real terms (vs. constant in percent of non-resource GDP), is that it allows for a much higher deficit during the transition period, thus potentially enabling the financing of development and diversification spending. The cost of such an approach though is that the deficit would need to be reduced after the transition period. Beyond 2028, i.e., beyond the horizon of fiscal adjustment plans discussed in the Staff Report, the adjustment could largely come from spending restraint and/or continued efforts in mobilizing domestic revenue. As such, while a sustained effort would be needed, it could be achievable without jeopardizing growth prospects.

Stress-Testing the Baseline Assumptions

The underpinning methodology and assumptions on parameters are critical to guide the authorities in assessing their fiscal space throughout the long term. Overall, risks on assumptions underpinning the PIH, including growth and the implied fiscal adjustment, require careful analysis. In the context of their medium-term fiscal planning, the authorities would need to regularly assess how the underpinning PIH may have changed, and if potential changes would warrant a revision to the PIH.

13. Risks on the fiscal adjustment should also be factored in, as Saudi Arabia would still contemplate a large fiscal adjustment, albeit gradual. Thus, any fiscal rule would need to be crafted to accommodate both a transition period and a steady state once the transition has ended. In the examples of Figure 2, a transition of 6 years is assumed (15 in the two alternative scenarios), to create space for a gradual fiscal adjustment of about 1 percent of non-resource GDP annually (for achieving a PIH anchor of a constant deficit in percent of non-resource GDP) or of only ½ percent to achieve a PIH anchor that would keep the deficit constant in real terms (and thus declining in percent of non-resource GDP). Making the adjustment gradual would leave ample fiscal space to support public investment in the short and medium term and would also leave time to design supporting fiscal reforms (e.g., non-resource revenue mobilization or expenditure rationalization) to reduce the non-resource deficit. However, one may also want to factor scenarios where the adjustment would either not be fully implemented or be implemented as intended but not delivering the expected savings.

Figure 2.
Figure 2.

A Modified PIH with a Transition Period

Citation: IMF Staff Country Reports 2022, 275; 10.5089/9798400217548.002.A001

Source: IMF staff estimates and projections.

14. Uncertainty about the long-term warrant regular re-assessments of the PIH. As shown in Figure 2, different assumptions regarding the long term may lead to very different policy recommendations. When designing a medium-term fiscal strategy, this uncertainty would need to be factored in. First, underpinning parameters (e.g., long-term oil prices) could be based on prudent assumptions. By erring on the cautious side, the government would help reduce the risk building-up deficits that could later-on be assessed as excessive. Second, any fiscal strategy, especially when supported by a fiscal rule, would need to allow for the use of buffers, and, consequently, outlining what would be the fiscal response to sudden shocks. In particular, when shocks are deemed temporary and/or mild, the use of buffers (either as liquid assets or a low public debt that would allow rapid and low-cost market access), would help the government smooth the shock and maintain its spending plans. Third, while buffers can help, they would not be the best option for large and persistent shocks. In that case, the proper strategy would be to reassess the PIH. This is particularly true if following the pre-shock fiscal strategy would imply a fiscal stance inconsistent with the authorities’ sustainability objectives.

15. A critical assumption made is on the interest rate-growth differential, the so-called r–g. The principle is fairly simple: the higher the interest rate, the higher the permanent deficit that can be financed by the returns on accumulated financial wealth. Conversely, the higher the GDP growth rate, the lower the deficit. In principle, engineering a higher growth rate in the long term could require a boost in public investment (infrastructure and human capital). In turn, this investment would translate into a higher income for future generations. In terms of risk and stress-testing, it would be critical as the authorities’ fiscal strategy is implemented, to regularly check to what extent public spending is efficient in supporting growth and diversification. A significant risk would be where public spending efficiency would not meet these goals, which could conversely affect the assessment of the sustainable deficit, in a context where non-resource growth could be lower than expected. There could be some upsides risks as well whereby high-quality spending would not only improve the economy’s growth potential but would also serve as a catalyst for private investment, including foreign, which could further enhance Saudi Arabia’s growth potential.

16. While the current medium-term framework is broadly consistent with the PIH norm under the baseline scenario, it also underscores the need for fiscal planning beyond the medium-term. Under the “unchanged policies” scenario (Figure 2), we assumed that beyond the medium term, policies would remain unchanged, and, as a result, the deficit would remain constant. This scenario would imply a steady deviation from the PIH, which would eventually threaten fiscal sustainability. Thus, while there are commendable measures already planned for the medium term, care should be given to build on these efforts to maintain the momentum of gradually adjusting to a more sustainable fiscal stance per the PIH guidance.

B. Fiscal Rules to Support the Long-Term Anchor

General Considerations When Designing Fiscal Rules, Notably for Resource-Rich Countries

Key lessons in this section:

  • Fiscal sustainability and rules need to be articulated around an objective set in terms of net financial wealth of the public sector.

  • Rules need to be flexible: preserve counter-cyclical space; define escape clauses.

  • Sovereign wealth funds need to be part of the design of the fiscal rules.

  • Supporting institutions are essential: fiscal transparency, independent oversight.

17. Fiscal rules have a potential to prevent excessive deficits, smooth shocks, and address intergenerational equity challenges (Box 2). All resource-rich countries face the difficult challenge of balancing the need for spending now high levels of resource revenue against saving it for later i.e., for future generations and to deal with commodity price shocks. This balancing act is further complicated by potential political economy pressures translating into spending pressures (in bad times the pressure may come from a desire to support the economy, but in good times also where the population may feel unfair that the government decides to save some revenue at a time where there is no perceived need to save). These challenges could be addressed in multiple ways, and fiscal rules have often been considered/used, because of the fiscal discipline they bring, even though the early experience appears to be mixed (see IMF. 2015). To be successful, fiscal rules often need to rely on a broader set of fiscal institutions. Indeed, numerical fiscal rules can help achieve fiscal discipline and a desired goal of how much to save/spend from resource revenue, when they are supported by strong institutions, notably adequate budget planning and monitoring, strong public financial management, and broad political and social support for their ultimate objectives (IMF, 2012, 2015).

Elements for Effective Fiscal Rules1

Fiscal rules constraint discretionary options for policymakers, to foster fiscal responsibility. Fiscal rules are usually numerical, in the sense that they set limits on budgetary aggregates (e.g., debt and/or deficit levels). These constraints are designed to be of a permanent nature.

Rules ought to be simple to provide political support, and need to avoid undue constraints, thus preserving flexibility for counter-cyclical policies. While numerical rules can foster fiscal discipline, they have also been criticized for unduly constraining other fiscal objectives (e.g., achieving growth objectives through increases in public investment). Following the global financial crisis of 2008, countries have established new rules or overhauled existing ones leading to the so-called second-generation fiscal rules, which typically include expenditure rules and/or fiscal effort rules. These rules are crafted to target objectives that are more under the control of fiscal authorities (for example, by focusing on cyclically adjusted fiscal balances).

Buffers and escape clauses reinforce rules’ effectiveness and credibility, as the likelihood of triggering them is much higher in resource-rich countries. Care could be given to developing buffers to caution tail risks (i.e., very large oil revenue shocks) and avoid abrupt adjustment that could otherwise be unnecessarily disruptive. However, most escape clauses are primarily about triggers that would warrant the suspension of the rules, and the process to return to their application. Equally important is to have a clear strategy for reinstating the rule after its suspension. Additionally, escape clauses could include provisions to clarify the use of buffers, as well as to rebuild them after an adjustment period following a negative oil price shock.

Fiscal rules can benefit from transparency and independent oversight (IMF, 2013) and adequate public financial management systems. Engagement with the civil society can enhance fiscal transparency and encourage compliance with fiscal rules. The objectives of the fiscal rules must be widely understood and accepted by the public so that a political and social consensus can be reached. The publication of fiscal reports on rules implementation would encourage compliance, as it helps raise public awareness of how fiscal policy adjusts towards meeting the goals underpinning the rules.

1 See Eyraud et al. (2018), and IMF (2009, 2012, and 2013).

18. Many RRCs have had experiences of fiscal rules being short-lived. One key lesson from these experiences is that fiscal rules ought to be set in a broader fiscal strategy context (IMF, 2009). In particular, the functioning of fiscal rules need to be robust to shocks (both in good times by limiting excessive deficits, and in bad times to avoid undesirable spending cuts or abrupt revenue measures). To do so, rules would typically need to build on well-defined escape clauses, which would clarify when a rule can be suspended, and under which procedure would it be reinstated.5 This is particularly important in resource-rich countries, which, by nature, are subject to large swings in their commodity revenue. Often, rules would be either abandoned or significantly revised following a large commodity price shock (Russia in 2014, Ecuador following the global financial crisis).

19. Fiscal rules in RRC need to focus on long-term fiscal sustainability, notably once natural resources are exhausted, in terms of net financial assets. While a debt rule can achieve the goal of fiscal sustainability, RRC would need to have a more comprehensive approach by anchoring fiscal policy on net financial assets (IMF, 2012). This is essential to reconcile the objectives of fiscal sustainability with that of intergenerational equity. Furthermore, assessing the net financial assets positions would enable a design in the rule that would be fully consistent with the overall fiscal strategy, which would typically target, inter alia, the non-resource primary balance.

20. Sovereign Wealth Funds (SWF) should be used for stabilization and intergeneration equity.6 While not necessarily part of fiscal rules per say, SWF are an integral part of the rules guiding budgets, especially in terms of resource-revenue sharing between the funds and the budget. In the aftermath of recent oil price collapses, commodity exporters that had buffers in their SWF used them to smooth the adjustment and avoid exchange rate pressures (Algeria, Azerbaijan, Iran, Kazakhstan, Kuwait, Saudi Arabia, UAE – World Bank, 2015). However, the ad-hoc use of SWF, have, in some cases created conflicts between the stabilization need and the intended investment for future generations. Overall, SWF are most helpful when they are set up as financing instruments funding the budget either for stabilization or long-term financing purposes (IMF, 2015), and have no spending authorities (to avoid the creation of extra-budgetary funds that would perform quasi-fiscal operations without proper oversight from fiscal authorities).

Options for Saudi Arabia Fiscal Rules

Key lessons in this section:

  • A price smoothing rule may not be effective in achieving both objectives of preserving excessive volatility while creating adequate space for spending needs to meet diversification and growth objectives.

  • An expenditure rule could provide adequate guidance, provided that it is anchored on a well-defined long-term anchor provided by the PIH.

  • Under the baseline scenario a cap on real expenditure growth could be set to 1 ½ percent annually (after 2028) without further revenue measures, and about 2 percent annually with revenue measures.

21. The implementation of the PIH might be further strengthened with a price smoothing rule, though such a rule may also exacerbate procyclicality in some circumstances. In case of a sudden and persistent drop in oil prices, a revenue smoothing rule based on past prices would imply maintaining the previous level of spending - when starting an adjustment to gradually reduce spending could be more appropriate. Price smoothing rules are not well suited—on their own—for commodity exporters given the highly uncertain behavior of oil prices (IMF, 2015). These are subject to large and persistent shocks that create significant challenges (adjustment for downturn, resisting excessive spending during upturns). The procyclicality of a price-smoothing rule could also be mitigated by a companion rule e.g., defining a floor on net financial assets, to prevent excessive deficits during downturns.

22. An expenditure rule, anchored on a non-resource primary balance goal, should serve Saudi Arabia stabilization and growth objectives. To delink spending from resource revenue, the implementation of the PIH norm after a transition period, supported by two main numerical rules (i) a ceiling on expenditure growth and (ii) a target on net financial assets, which could be strengthened through a debt brake, would be the most relevant option. Such an expenditure rule would not only achieve the goal of providing counter-cyclical support and flexibility but would also support the joint objective of strengthening the PFM system through the development of a medium-term fiscal/expenditure frameworks (MTFF/MTEF). In a comparison of counter-factual exercises shows how an expenditure rule could help smooth spending throughout a prolonged period (Figure 3). While a revenue smoothing rule would have still induced relatively large swings, an expenditure growth rule (cap at 4 percent which is what was achieved over that period) would have better stabilized spending with a similar outcome.7 In this counter-factual exercise, we assumed that an expenditure rule could have capped real expenditure growth at 4 percent, which is, roughly, the average observed over the period considered (2003-21). The property of such a spending rule is illustrated below, providing a smoother path of spending - with a similar outcome in terms of level of spending achieved towards the end of the sample. Note however, that by construction this exercise is purely counter-factual. As such, the recommendation of capping expenditure growth at 4 percent cannot be seen as a recommendation for the future, as it would heavily depend on projections of future parameters and would warrant caution in determining the ceiling.

Figure 3.
Figure 3.

Counterfactual Illustration of an Expenditure Rule

Citation: IMF Staff Country Reports 2022, 275; 10.5089/9798400217548.002.A001

Sources: IMF staff estimates.

23. An expenditure rule could also adequately support the building of buffers. To be effective, the expenditure rule would need to be supported by adequate financial buffers. In the illustrative example provided above, stabilizing spending would also generate significant buffers (about 50 percent of non-resource GDP in a counter factual exercise), which would subsequently help guard the budget against cyclical fluctuations. This level of buffer was deducted from the difference between the actual spending over the period 2003–21, compared to that of expenditure implemented with a cap of 4 percent growth in real terms (as discussed in the previous paragraph). As such, this illustration of fiscal buffers can only be seen as indicative, and not a projection (or recommendation) of the required level of buffers in the future. The calibration of buffers would still depend on various factors, beginning with social preferences on risk-taking (Basdevant, Hooley, and Imamoglu, 2021). A comprehensive strategy would also need to factor when buffers are used, and when the budget needs to adjust (in case of large and persistent shocks).

Figure 4.
Figure 4.

Accumulated Under an Expenditure Rule: A Counter-Factual Illustration

(Percent of non-ressource GDP)

Citation: IMF Staff Country Reports 2022, 275; 10.5089/9798400217548.002.A001

Sources: IMF staff estimates.

24. Looking forward, the authorities may want to consider a cap on real expenditure growth of 1½ percent annually, to implement the PIH anchor after the transition period. Assuming that, under the baseline, a PIH norm is implemented after a period of 6 years, the corresponding trends for revenue and expenditure would be depicted in Figure 5. Basically, it assumes that non-resource revenue would remain constant as a share of non-resource GDP, while expenditure would gradually decline, also as a share of non-resource GDP. However, this would not necessarily mean complex or painful fiscal measures to implement. It could be achieved primarily expenditure at 1½ percent (Figure 5). With the assumed non-resource GDP growth rate of 2.8 percent (Table 2), the adjustment needed would be achieved. Further, a relative decline in expenditure could also be adequately mitigated by strengthening public expenditure management, to ensure that the quality of public spending increases over time.

Figure 5.
Figure 5.

Expenditure Growth Consistent with the PIH

Citation: IMF Staff Country Reports 2022, 275; 10.5089/9798400217548.002.A001

Sources: IMF staff projections.

25. The cap to get the adjustment necessary would also be lower if accompanied by additional revenue measures (Figure 6). Despite strong revenue measures taken recently (with the VAT rate tripling from 5 to 15 percent), Saudi Arabia is expected throughout the medium term, to have a tax-to-GDP ratio stable at about 14 percent by 2027 under the IMF’s baseline projections. While significant, this would still leave Saudi Arabia way below the levels reached by emerging economies (about 18 percent of GDP) or the G20 (about 22 percent of GDP).8 Thus, there would still be potential for Saudi Arabia to mobilize non-oil tax revenue over the long term. In the simulations below, we assumed that total non-oil revenue would increase gradually, over 10 years, from 18 percent of non-oil GDP in 2027, to 20 percent in 2037, reflecting a mix of tax policy and tax administration measures. The implications for the expenditure rule would be a less constraining path, where real expenditure growth could be roughly capped at 2 percent until the new revenue level is reached (Figure 6).

Figure 6.
Figure 6.

Expenditure Growth with Revenue Measures

Citation: IMF Staff Country Reports 2022, 275; 10.5089/9798400217548.002.A001

Sources: IMF staff projections.

Dealing with Shocks: How to Articulate the Rule Around Unforeseen Events

Key lessons in this section:

  • Escape clauses are essential in dealing with shocks (to have room for counter-cyclical interventions, to revisit the expenditure cap ceiling when needed).

  • The rule needs to be able to accommodate both positive and negative shocks.

26. Dealing with shocks: the principles underlying the cap on expenditure. When dealing with shocks, the rule would face, potentially two different situations. For positive shocks (notably a positive surprise on oil revenue), the recommendation would be fairly straightforward, as the expenditure growth cap would be applied to limit any excessive growth of spending. In case of a negative shock the problem would be potentially more complex. A one-off shock could for example warrant the continuation of the execution of the spending plan (as defined in the medium-term fiscal strategy). The economy may also need further support (beyond automatic fiscal stabilizers) as was the case during the COVID19 pandemic. Such support may lead to an increase in spending contradicting the rule ceiling, which would require having an escape clause defined in the rule.

27. Opting for smoothing temporary shocks (either by keeping spending plans unchanged or providing counter-cyclical stimulus) may still create medium-term financing challenges as it would imply depleting the country’s financial wealth. In other words, maintaining spending plans or going further through the provision of a stimulus, could raise the need for greater adjustment later, with the view of rebuilding the pre-shock financial wealth of the country. We modeled a negative shock on oil prices in 2026 (a 30 percent reduction compared to the baseline), leading to a revenue loss of 6 percent of non-resource GDP (Figure 7). Keeping the spending plan unchanged would lead to a permanent decline in financial wealth of about 6 percent of non-resource GDP. As a result, the total net wealth available to finance future deficit would be reduced by this amount. However, according to staff estimates, Saudi Arabia would still have a total wealth of about 640 percent of non-resource GDP by 2026, so even a shock like this would only have a marginal impact on the long term. Further, negative shocks could also be expected to be counter-balanced by more positive ones in the future, thus helping the rebuilding of the financial wealth as envisaged under the PIH. Nevertheless, this example stresses how shocks would need to be factored in, not just for their immediate impact but also for the long-term fiscal strategy. In other words, this means assessing each time a large shock occurs, even if temporary, if it warrants a revision of the underlying PIH benchmark, and consequently the cap on real expenditure growth, or if it can be fully absorbed by using available buffers.

Figure 7.
Figure 7.

Example of a Temporary Shock

Citation: IMF Staff Country Reports 2022, 275; 10.5089/9798400217548.002.A001

Source: IMF staff estimates and projections.

28. The expenditure rule could thus be strengthened by setting an explicit target on fiscal buffers. As discussed before, any fiscal rule would be challenged by negative and large shocks on oil prices. Some instruments such as debt-brakes can provide adequate flexibility, while also taking into consideration fiscal sustainability. Specifically, the definition of buffers would need to be fully incorporated in the fiscal rule:

  • The equivalent of a debt brake could, for example, set a floor on net financial assets of the government (NFA), so that when it falls below a threshold, automatic adjustment measures kick in to reduce spending and increase NFA. Ultimately it would largely depend on social aversion to risk. However, if we take as a benchmark the volatility of oil revenue in percentage of non-resource GDP, over the past ten years, a standard deviation of about 25 percent of GDP is noted (Table 3). In other words, assuming a medium-term framework of 3 years, adequate buffers to guard against oil revenue fluctuations could amount to 75 percent of non-resource GDP. Following a negative shock and a depletion of net financial assets, a rule on the floor of net financial assets could help further restrain expenditure growth, to ensure that over subsequent years buffers would be rebuilt.

  • Further, buffers would not necessarily need to be kept as accumulated financial assets, especially at a time when the country is still recovering from a large shock. Keeping gross public debt low would preserve a capacity to borrow, thus providing the country with rapid access to financial markets. However, care would need to be given to the rationale of using debt instrument at high interest rates, while financial assets could be used at a lower cost.

Table 3.

Saudi Arabia: Calibration of Fiscal Buffers

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Sources: IMF staff estimates.

29. In case of persistent and large shocks on oil revenue, the parameters of the rule and the underpinning PIH could be revisited. Pending an eventual reassessment of the underlying PIH norm, an escape clause could also be triggered to suspend the application of the rule in case of a large and persistent shock. While a cap on expenditure growth could typically work under “normal” circumstances, it would not be sufficient to deal with shocks on oil prices that are very large and persistent. Unsurprisingly, with an unexpected shock on oil prices of the magnitude envisaged in the “demand” shock scenario, the country would have to implement a large–and relatively front-loaded– fiscal adjustment (Figure 8). Indeed, it would imply (after a transition period of about 6 years) that expenditure growth would need to be capped at -4 percent annually to ensure that the non-resource fiscal balance would adjust to a considerably reduced fiscal space. In short, triggering an escape clause in that case would not only be needed for potential counter-cyclical support, but mostly to ensure that the authorities could (i) reassess the PIH norm, (ii), reassess the transition period needed to achieve the PIH, and (iii) ensure that the cap on expenditure growth would be consistent with fiscal sustainability

Figure 8.
Figure 8.

Example of a Permanent and Large Shock

Citation: IMF Staff Country Reports 2022, 275; 10.5089/9798400217548.002.A001

Source: IMF staff estimates and projections.



Prepared by Olivier Basdevant (FAD).


During 2000-2002 expenditure grew by 28 percent in 2000 as the oil price jumped, followed by a sharp deceleration in expenditure growth in 2001-2002 as the oil price declined somewhat.


See IMF (2012) for a more detailed discussion of PIH options.


As noted in Table 2, the adjustment would imply a transition of 6 years under the baseline and 15 years under the alternative scenarios.


Many RRCs set up SWFs, to achieve objectives in terms of stabilization (Mexico), investment for future generations (Botswana, Iran, Norway, Saudi Arabia), or both (Russia).


Note that in this counter-factual exercise, the real expenditure growth would have been capped at 4 percent during both upward and downward changes in oil prices, except for periods where oil prices were so large that the rule would have been suspended anyway, which we illustrated by keeping spending at its actual level (and not the one recommended by the expenditure or revenue rules).


Sources: IMF Fiscal Affairs Department Assessment of Revenue Tool, 2022.

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