Tight spending and oil revenues drove Saudi Arabia’s fiscal improvement in the first half of the year, said a report published by Bank of America Merrill Lynch (BofAML).

The fiscal deficit in the second quarter of 2017 (2Q17) stood at SR46.5 billion ($12.5 billion), with 1H17 deficit standing at SR73 billion annualizing SR145 billion ($39 billion). The financing for the budget deficit was taken from the government's reserves account at Sama (SR15 billion) as well as external borrowing (international sukuk of SR33.7 billion; $9 billion). Simplistically, the fiscal deficit target of the authorities (SR198 billion; 7.8 per cent of GDP) could be within reach for 2017 at the current pace excluding any off-budget spending and seasonality.

The increase in fiscal oil revenues over 1H17 appears due to a mix of higher oil prices and a higher payout ratio from Saudi Aramco. Oil revenues are c70 per cent yoy higher in 1H17 despite the Opec production cuts thanks to higher oil prices as well as a higher fiscal transfer ratio from Saudi Aramco, the report said.

The fiscal transfer ratio has been pro-cyclical to oil prices and is broadly in line in 1H17 with the ratios achieved at similar levels of oil prices. While Saudi crude oil exports are down by 0.4mn bpd in 1H17 compared to 1H16, oil prices are $12/bbl higher over the same period. The additional export revenues (SR58.6 billion) represent c70 per cent of the year-on-year increase in fiscal oil revenues (SR82 billion), suggesting a higher payout ratio from Saudi Aramco as oil prices recovered.

As 1H17 fiscal oil revenues have reached roughly 44 per cent of the budget target, this suggests that the budgeted proceeds of domestic energy subsidy reform for 2017 could be relatively minor, or that the first phase of energy pricing reform program could take place late in the year.

As anticipated, the retroactive (to 1 January) fiscal regime change for Saudi Aramco in late 1Q17 has not changed the government fiscal intake. As the tax rate in the oil sector was brought down from 85 per cent to 50 per cent, fiscal oil revenues would likely have benefited from higher dividends instead. According to the press, authorities are considering a proposal to replace the current fixed royalty system (20 per cent) on the oil sector with a more flexible system that would increase it automatically if oil prices rise significantly.

Non-oil revenues are somewhat lower year-on-year in 1H17 but should increase materially starting from 2018 onwards as fiscal reforms kick in. 1H17 non-oil revenues stood at c45 per cent of the budget target. In the meantime, the excise tax on soft drinks, tobacco and energy drinks as well as the fee on dependents of expatriate workers could add in SR7.5 billion of non-oil revenues in 2H17. The introduction of VAT, the introduction of an expatriate worker levy, the possible introduction of tariffs on luxury products and the increase in fees on dependents of expatriate workers could add SR80 billion ($21.3 billion; 3.0 per cent of GDP) to non-oil revenues in 2018.

Authorities appear to have underspent the budgeted target, helping improve fiscal accounts. Compared to the targeted budget spending of SR890 billion, spending stood at only SR381 billion (43 per cent of target).

All of the budget sectors saw realized spending come below the 50 per cent mark versus the targeted level. Underspending was most pronounced in infrastructure and transportation, and economic resources. Military, security and regional administration stood at a combined 44 per cent of budgeted spending although it is unclear if this can be sustained going forward.

Reported fiscal spending may exclude cSR20 billion of arrears to contractors repaid over 1Q17. The larger drawdown of government deposits in Sama in 2H17 compared to the reported financing suggests some off-budget spending of around SR20 billion.

Spending discipline may be tested in 2H17 due to seasonality as well as the reversal of public sector allowance cuts on a retroactive basis (cSR7 billion). The reintroduction of the public sector allowances (SR7 billion) and the introduction of military personnel one-off bonus (SR4 billion) in April 2017 should have started to be included in 2Q17 data. However, this may have been accommodated within the budget envelop. The introduction of the Household Allowance Program (at a cost of SR25 billion) as well as linkage of gasoline and diesel to reference prices (with potential revenue of SR22 billion) appears to have been both delayed. Nevertheless, the delay is fiscally neutral for now.

Tight spending suggests non-oil economic activity is likely to remain fragile. The non-hydrocarbon real GDP growth stood at 0.6 per cent yoy in 1Q17 (private non-oil sector: 0.9 per cent yoy; public non-oil sector: -0.1 per cent yoy). This suggests that the economy may not avoid a headline recession this year as the Opec-mandated oil production cuts drive real GDP growth to negative territory.

“Although political developments and seasonal increase in domestic energy consumption may have delayed the next leg of fiscal reforms, we still expect the latter to take place by year-end,” the BofAML report said.

Positively, the imposition of the expatriate dependent fee (part of the planned fiscal reforms) went ahead on schedule on 1 July. The weak economy complicates the government's plans to implement further fiscal reforms. This may suggest a more back-loaded path for fiscal consolidation or the concurrent introduction of a private sector support package alongside fiscal reforms. – TradeArabia News Service