Saudi Arabia 'A-/A-2' Ratings Affirmed; Outlook Remains Stable
- We expect Saudi Arabia will experience modest economic growth from 2018, supported• by rising government investment and, later in our forecast period, a gradual increase in oil production.
- In 2018, oil prices, in addition to other revenue measures, should be supportive• of the government's revenue growth and headline fiscal consolidation, despite substantial expenditure growth.
- We are affirming our 'A-/A-2' long- and short-term sovereign ratings on Saudi• Arabia and maintaining a stable outlook.
Saudi Arabia, April 7, 2018: S&P Global Ratings affirmed its 'A-/A-2' unsolicited long- and short-term foreign and local currency sovereign credit ratings on Saudi Arabia. The outlook is stable.
The stable outlook is based on our expectation that economic growth will accelerate moderately in 2018, supported by rising government investment. At the same time, we expect that the Saudi authorities will continue to take steps to consolidate public finances over the next two years, while maintaining Saudi Arabia's formidable stocks of liquid external assets.
We could lower our ratings if we observed a reversal in the trend of fiscal consolidation, or a sharp deterioration of the sovereign's external position. An unexpected materialization of contingent liabilities or a build-up of arrears could also place additional pressure on expenditures. The ratings could also come under pressure if we observed a significant increase in domestic or regional political instability, which, in our view, would have fiscal consequences.
We could raise the ratings if Saudi Arabia's economic growth prospects improved markedly beyond our current assumptions.
Rationale The ratings on Saudi Arabia are supported by its strong external and fiscal stock positions, which we expect it will maintain despite large central government deficits. The ratings are constrained by limited public-sector transparency and limited monetary policy flexibility.
While decision-making structures are centralized and, in our view, relatively opaque, we do not expect any major deviation from the stated domestic policy course of fiscal consolidation, economic diversification, and gradual socioeconomic liberalization. We understand that authorities are concerned by the notable decline in net direct investment inflows since 2013. In this regard, we also understand that authorities are focused on creating incentives for foreign investment in Saudi's noncommodity sector.
Institutional and Economic Profile: An era of change brings both risks and opportunities
- Saudi Arabia has articulated an ambitious strategy to reduce the economy's dependency on oil and on imported labor, to transform the domestic education and job market, and to consolidate the budget.
- Increasingly centralized decision-making could lead to more uncertain policy• implementation, but we don't expect any major deviation from the stated policy course.
- Saudi's succession process is largely untested.
We expect that the key parameters of Saudi's institutional framework will remain steady through the 2018-2021 forecast period. Saudi Arabia will partly fund its ambitious economic reform program using the large fiscal and external buffers that it amassed during the pre-2015 era of twin balance of payments and budgetary surpluses. The government is implementing a series of reforms that include social measures that aim to increase labor participation (particularly female), to improve educational attainment, and to raise the private sector's role in the economy, while achieving a balanced budget by 2023 (previously 2020).
While the country's decisionmaking process remains highly centralized, we do not expect any major deviation from the goal to broaden the economy beyond its traditional reliance on hydrocarbons. What we consider more complicated to predict is whether the government's other two objectives--to attract more foreign investment and to reduce reliance on foreign expertise including foreign labor--will succeed.
The authorities have decided to push back the target to balance the general government budget from 2020 to 2023. This reflects the decision to increase public investment under a four-year stimulus plan aimed at stabilizing private-sector demand, even as the government moves on other fiscal consolidation measures, such as energy tariff hikes. Overall, we think there are grounds to project a gradual economic recovery, following last year's contraction. Nevertheless, given that oil production makes up a significant portion of Saudi GDP, forecasting growth in Saudi Arabia continues to be highly sensitive to assumptions of OPEC production targets, not least because Saudi Arabia maintains the world's largest installed crude oil production capacity at around 12 million barrels per day, and is the key marginal producer. Our GDP per capita estimate is just shy of $22,000 in 2018, and we expect that, on a trend basis, growth will remain somewhat below peers'.
Flexibility and Performance Profile: Strong external and fiscal positions from a stock perspective
Despite the country's rising fiscal expenditures, we expect continued• consolidation as oil prices increase in 2018 and as other revenue-raising items come online. We forecast a continued current account surplus, but surpluses are likely to• moderate in line with our oil price assumptions. Monetary policy effectiveness is limited by the fixed exchange rate, which• requires Saudi Arabia to track movements in the U.S. federal funds rate, even when they may not be appropriate for Saudi Arabian economic conditions.
We expect continued fiscal consolidation through 2021, though at a slower pace than in 2017, which was boosted by higher oil prices. We expect that oil prices will be supportive and offset planned expenditure increases in 2018, as will revenueboosting measures linked to electricity tariff revisions and the introduction of a 5% value-added tax, which came into effect at the start of 2018. Still, the pace of fiscal consolidation will be deliberate. On the expenditure side, the 2018 budget is about 8% higher than last year in nominal terms. We expect actual performance to be in line with the budget as was the case in 2017. In addition to the budget, we understand that a separate plan focusing on domestic capital expenditure will be implemented by the Public Investment Fund and the National Development Fund in 2018, with expenditures totaling some 5% of GDP. Compared with most rated sovereigns, the Saudi authorites spend far more on investment, and this could raise growth potential toward the end of our ratings horizon.
In the medium term, we partly base our more conservative view of the government's fiscal consolidation prospects (versus our last review) on our oil price assumptions, which decline to $55 per barrel in 2019 (from $60 in 2018) and remain flat through 2021 (see 'S&P Global Ratings Raises 2018 Brent And WTI Oil Price Assumptions,' published Jan. 18, 2018, on RatingsDirect). We also base our view on the government's decision to push its balanced budget target date to 2023 from 2020. We factor in our expectation that Saudi Arabia's oil production will remain at around current levels of 10 million barrels per day (bpd) in 2018, in line with OPEC's decision in late 2016. We expect a very gradual increase in production from 2019.
We forecast an average annual increase of net general government debt of about 3% of GDP over 2018-2021 (this is our preferred fiscal metric because in most cases it is more comprehensive than the reported headline deficit), and we expect that the pace of net debt growth will slow over the forecast horizon. In Saudi Arabia's case, the change in net general government debt is lower than the central government deficit, because we have assumed that the deficit is financed 30% by asset draw-downs and 70% by debt issuance. This split implies that Saudi Arabia would report gross liquid financial assets of about 90% of GDP by 2021. These fiscal assets include the central government's deposits and reserves on the liabilities side of the balance sheet of the Saudi Arabia Monetary Authority, government institutions' deposits, and an estimate of investment income. We also include in our calculation an estimate of government pension funds' liquid assets.
We acknowledge both upside potential and downside risk to these forecasts. Upside potential stems principally from oil prices. The downside rests with the scale of the required fiscal consolidation and the broader impact it will have on the economy.
Our general government balance consolidates the central government and the social security system. It also includes our estimate of investment income from sovereign wealth fund assets, which largely accounts for the difference between our central government and general government deficit projections.
Although Saudi Arabia's fiscal profile has weakened on a flow basis in recent years, we believe it has remained strong on a stock basis. We expect net general government assets (the excess of liquid fiscal financial assets over government debt) to remain at about 100% of GDP in 2018, but to fall closer to 90% by 2021.
We continue to view Saudi Arabia's external position as a strength. We expect that Saudi Arabia's liquid external assets, net of external debt, will average about 180% of current account payments over 2018-2021. Gross external financing needs are about 43% of the sum of usable reserves and current account receipts over the same period, suggesting ample external liquidity. That said, usable reserves continue to decline, largely due to fiscal deficit financing. We expect them to reach about $400 billion at end-2018, compared with $536 billion at end-2015. Our calculation of usable reserves subtracts the monetary base from gross foreign currency reserves for sovereigns that have a long-standing fixed peg with another currency (because the reserve coverage of the base is critical to maintaining confidence in the exchangerate link).
Given the Saudi riyal's peg to the U.S. dollar, we view monetary policy flexibility as limited. The long-standing currency peg helps to anchor the population's inflation expectations, but binds Saudi Arabia's monetry policy to that of the U.S. federal reserve. We expect that the peg will be maintained.
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