Sunday, 3 January 2016

Why are markets negative about the Saudi budget?

Saudi Arabia may succeed in reducing its deficit, but it will probably experience anaemic growth in 2016.

The announcement of the Saudi budget on 28 December created a contradiction. On the one hand, the announced budget deficits, while large, were much smaller than expected. The Saudis’ preliminary estimates suggest a deficit of 367bn riyal in 2015, lower than the International Monetary Fund’s (IMF) forecast of 511bn riyal. Similarly, the Saudi budget points to a deficit of “only” 326bn riyal in 2016, compared with the IMF’s expectation of 468bn. On the other hand, the market reaction to the smaller deficit numbers was negative. The Saudi stock market fell sharply after the announcement. Why is there such a contrast between the positive deficit data and the negative market reaction? I believe two reasons are behind this.

First, markets fear that the large spending cuts will lead to slower growth in 2016. The budget slashes spending by 13.8% between 2015 and 2016. This is much larger than the IMF’s expectations of cuts around 5.7%. We can adjust the IMF’s forecast for Saudi growth in 2016 by taking into account the new, smaller spending figures. The result is growth of 1.4% in 2016 instead of 2.2% previously forecast—a significant deceleration from the 3.4% growth recorded in 2015.

Second, markets interpreted the news about subsidy cuts, which accompanied the budget, rather negatively. Saudi Arabia removed some of the subsidies on water, fuel and electricity, leading to significant price increases almost overnight. There is no question that the subsidy system is inefficient and wasteful. But markets might have interpreted the measures as an act of desperation in response to low oil prices. In addition, these measures are likely to lead to even lower growth, as the resulting price inflation will leave the population with less income to spend on other items.

Are markets concerns overstated? Concerns about the ability of Saudi Arabia to run large deficits or maintain the value of the currency are exaggerated: Saudi Arabia still possesses very large reserves at its disposal. But markets concerns about the impact of spending cuts on growth are legitimate. Saudi Arabia may succeed in reducing its deficit, but it will probably experience anaemic growth in 2016.

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