Post by The Big Daddy C-Master on Dec 7, 2015 14:37:27 GMT -5
www.investopedia.com/articles/investing/111715/could-saudi-arabia-really-go-bankrupt.asp
In October 2015, the International Monetary Fund (IMF) warned Saudi Arabia that the country may run out of the financial assets needed to support spending within five years if planned expenditures are not curbed. Saudi’s fiscal condition has deteriorated rapidly in 2015 because of the roughly 50% drop in the average price for a barrel of oil.
According to the Wall Street Journal, in the summer of 2015 the IMF stated that Saudi Arabia is likely to run a fiscal deficit of about 20% of its gross domestic product, or about $150 billion this year. Oil and gas together account for about 80% of the country’s fiscal revenues. The price drop of this key export commodity is beginning to take its toll on the country’s fiscal condition, leaving some wondering if Saudi Arabia could actually go broke.
The sharp deterioration in the government’s fiscal condition, among other factors, prompted Standard and Poor’s (S&P) to downgrade the country’s credit rating to ‘A+’ from ‘AA-‘ on October 30th,2015. It also prompted the Saudi government to terminate its rating agreement with S&P, as reported in S&P’s press release at the time of the downgrade. (For more information see, Saudi Arabia Disputes S&P Downgrade.)
Oil Glut Until 2020
One primary concern is that Saudi’s key export–oil could be selling cheaply for several years to come. The International Energy Agency (IEA) recently published its 2015 annual outlook where it says the oil market will remain oversupplied by one million barrels per day until the end of the decade. The IEA states that oil demand will increase by less than 1% per year between now and 2020. This is a much slower pace than is necessary to take current excess oil supplies off the market (For more information see, The Economics of U.S Crude Oil Storage Capacity). Worse still, the IEA believes that after 2020, oil demand growth will increase just 5% over the next 20 years (or roughly 0.25% per year). This supply glut could be made worse depending on the timing of Iranian barrels returning to the market, which could keep the price close to $50 per barrel. (For more information see, How Cheap Oil Will Hurt the Saudi Economy).
S&P Downgrade
At the end of October, S&P downgraded Saudi Arabia’s credit rating to A+ from AA-. According to S&P, “An obligor rated 'A' has strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.” Whereas “an obligor rated 'AA' has very strong capacity to meet its financial commitments. It differs from the highest-rated obligors [i.e. AAA or risk-free] only to a small degree.” In other words, when Saudi Arabia was rated AA-, S&P believed it was practically certain Saudi would pay its debts on time and in full, whereas now with a rating of A+, this is less certain because of the current “circumstances and economic conditions” facing Saudi Arabia.
the factor that seems to have played a large role in the downgrade decision is the rapid deterioration of the country’s fiscal condition. The table below shows the change from a fiscal surplus of 7% of GDP in 2013 to a deficit of 16% expected in 2015. S&P gradually expects the deficit to decline but does not foresee any surplus.
Saudi Arabia’s Fiscal Surplus/(Deficit) - % GDP
2013
+7%
2014
-1.5%
2015
-16%
2016
-10%
2017
-8%
2018
-5%
Source: Standard and Poor’s
Further, S&P says that over the next three years, they expect Saudi Arabia to finance its deficits by evenly drawing down fiscal assets and issuing new debt. Doing so implies an average 6% of GDP increase in nominal gross general government debt per year.
International Bond Debut
According to the FT, Saudi Arabia decided in November 2015 to tap international bond markets for the first time. Saudi officials say the kingdom could increase debt levels to as much as 50% of GDP within five years, up from an expected 6.7% in 2015. This almost certainly means more credit rating downgrades are coming. Saudi issued 20 billion riyals ($5.33 billion) in August 2015, as reported in the Wall Street Journal in an attempt to maintain its current spending plans. The FT reports that according to Abu Dhabi Commercial Bank’s chief economist, “tapping international debt markets will be an important way to fund spending without absorbing liquidity from domestic banks.” Domestic bank lending is needed to support the country’s private sector.
FX Devaluation
Another issue facing the Saudi government is the possibility of an increase in interest rates by the U.S. Federal Reserve Bank. This is particularly relevant for Saudi Arabia because its currency is pegged to the U.S. dollar, which basically means that if the U.S. dollar strengthens with rising interest rates, then the Saudi currency will strengthen too. This is not necessarily what the country needs when the economy is struggling. Instead, Saudi could solve some of its problems by devaluing its currency. This is a move other oil exporting countries like Russia, Kazakhstan and Nigeria have all taken to ease the pain of declining oil prices. The idea is an oil exporter may sell its barrel of oil for fewer dollars, but the dollars they are getting in fact buy more local currency, which is needed for domestic spending.
The Bottom Line
Saudi Arabia is doing what it can to get its fiscal house in order, but it remains to be seen if they are doing enough to deal with the current economic reality facing the country. Bloomberg reports that the government is creating a project management office that will report to the Committee of Economic Development, chaired by Deputy Crown Price, Mohammed Bin Salman to tighten oversight of government spending. This will be sorely needed to prevent the IMF’s warning from coming true. Bloomberg reports that Saudi’s 2015 total budgeted spending is $229.3 billion, and the FT says foreign reserves as of September 2015 are $647 billion. So at the current rate of spending, current reserves are exhausted in a little less than three years.
In October 2015, the International Monetary Fund (IMF) warned Saudi Arabia that the country may run out of the financial assets needed to support spending within five years if planned expenditures are not curbed. Saudi’s fiscal condition has deteriorated rapidly in 2015 because of the roughly 50% drop in the average price for a barrel of oil.
According to the Wall Street Journal, in the summer of 2015 the IMF stated that Saudi Arabia is likely to run a fiscal deficit of about 20% of its gross domestic product, or about $150 billion this year. Oil and gas together account for about 80% of the country’s fiscal revenues. The price drop of this key export commodity is beginning to take its toll on the country’s fiscal condition, leaving some wondering if Saudi Arabia could actually go broke.
The sharp deterioration in the government’s fiscal condition, among other factors, prompted Standard and Poor’s (S&P) to downgrade the country’s credit rating to ‘A+’ from ‘AA-‘ on October 30th,2015. It also prompted the Saudi government to terminate its rating agreement with S&P, as reported in S&P’s press release at the time of the downgrade. (For more information see, Saudi Arabia Disputes S&P Downgrade.)
Oil Glut Until 2020
One primary concern is that Saudi’s key export–oil could be selling cheaply for several years to come. The International Energy Agency (IEA) recently published its 2015 annual outlook where it says the oil market will remain oversupplied by one million barrels per day until the end of the decade. The IEA states that oil demand will increase by less than 1% per year between now and 2020. This is a much slower pace than is necessary to take current excess oil supplies off the market (For more information see, The Economics of U.S Crude Oil Storage Capacity). Worse still, the IEA believes that after 2020, oil demand growth will increase just 5% over the next 20 years (or roughly 0.25% per year). This supply glut could be made worse depending on the timing of Iranian barrels returning to the market, which could keep the price close to $50 per barrel. (For more information see, How Cheap Oil Will Hurt the Saudi Economy).
S&P Downgrade
At the end of October, S&P downgraded Saudi Arabia’s credit rating to A+ from AA-. According to S&P, “An obligor rated 'A' has strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.” Whereas “an obligor rated 'AA' has very strong capacity to meet its financial commitments. It differs from the highest-rated obligors [i.e. AAA or risk-free] only to a small degree.” In other words, when Saudi Arabia was rated AA-, S&P believed it was practically certain Saudi would pay its debts on time and in full, whereas now with a rating of A+, this is less certain because of the current “circumstances and economic conditions” facing Saudi Arabia.
the factor that seems to have played a large role in the downgrade decision is the rapid deterioration of the country’s fiscal condition. The table below shows the change from a fiscal surplus of 7% of GDP in 2013 to a deficit of 16% expected in 2015. S&P gradually expects the deficit to decline but does not foresee any surplus.
Saudi Arabia’s Fiscal Surplus/(Deficit) - % GDP
2013
+7%
2014
-1.5%
2015
-16%
2016
-10%
2017
-8%
2018
-5%
Source: Standard and Poor’s
Further, S&P says that over the next three years, they expect Saudi Arabia to finance its deficits by evenly drawing down fiscal assets and issuing new debt. Doing so implies an average 6% of GDP increase in nominal gross general government debt per year.
International Bond Debut
According to the FT, Saudi Arabia decided in November 2015 to tap international bond markets for the first time. Saudi officials say the kingdom could increase debt levels to as much as 50% of GDP within five years, up from an expected 6.7% in 2015. This almost certainly means more credit rating downgrades are coming. Saudi issued 20 billion riyals ($5.33 billion) in August 2015, as reported in the Wall Street Journal in an attempt to maintain its current spending plans. The FT reports that according to Abu Dhabi Commercial Bank’s chief economist, “tapping international debt markets will be an important way to fund spending without absorbing liquidity from domestic banks.” Domestic bank lending is needed to support the country’s private sector.
FX Devaluation
Another issue facing the Saudi government is the possibility of an increase in interest rates by the U.S. Federal Reserve Bank. This is particularly relevant for Saudi Arabia because its currency is pegged to the U.S. dollar, which basically means that if the U.S. dollar strengthens with rising interest rates, then the Saudi currency will strengthen too. This is not necessarily what the country needs when the economy is struggling. Instead, Saudi could solve some of its problems by devaluing its currency. This is a move other oil exporting countries like Russia, Kazakhstan and Nigeria have all taken to ease the pain of declining oil prices. The idea is an oil exporter may sell its barrel of oil for fewer dollars, but the dollars they are getting in fact buy more local currency, which is needed for domestic spending.
The Bottom Line
Saudi Arabia is doing what it can to get its fiscal house in order, but it remains to be seen if they are doing enough to deal with the current economic reality facing the country. Bloomberg reports that the government is creating a project management office that will report to the Committee of Economic Development, chaired by Deputy Crown Price, Mohammed Bin Salman to tighten oversight of government spending. This will be sorely needed to prevent the IMF’s warning from coming true. Bloomberg reports that Saudi’s 2015 total budgeted spending is $229.3 billion, and the FT says foreign reserves as of September 2015 are $647 billion. So at the current rate of spending, current reserves are exhausted in a little less than three years.
