Complex Made Simple

Saudi Arabia: Political succession preserves reform programme

Last month, MSCI Inc, a leading provider of global equity indexes, announced the inclusion Saudi Arabia to the upcoming (June 2017-June 2018) review cycle for potential inclusion of Saudi Arabia in MSCI Emerging Markets.

If successful, this could mean Saudi Arabia will be added to MSCI Emerging Markets at end-May 2019, in time for the Saudi Aramco’s initial public offering (IPO).

The kingdom has made significant progress in market reforms in the recent years along a host of fiscal reforms that has attracted global investor attention to Saudi asset classes.

Smooth political succession to bring back focus on reform

A relatively smooth political succession is expected despite the unprecedented political change. Priority will go toward domestic politics near term. As such, the next phase of economic reforms is likely to be delayed.

Should the start of the Household Allowance programme be delayed simultaneously with the next phase of energy pricing reforms, then the net fiscal impact is likely marginal.

The retroactive application of the reinstatement of the public sector allowances only adds 0.25 per cent of GDP to spending. However, the key risk is that it reduces policy-making room to maneuver in response to low oil prices.

Shifting gears

The reforms ushered in by the Fiscal Balance 2020 Program are likely to fundamentally transform the economy’s structure and growth model. Here are four key takeaways from these measures:

1. Reforms are credible, robust, and generally there is a strong government commitment to the reform process

2. Growth environment is likely to be muted, and the main losers from reforms will be non-strategic corporates and expatriate workers

3. Reform effort is enough to support the USD peg but more will be needed if we are stuck in an environment of $40/bbl

4. Energy policy is likely to stay the course as higher oil prices are needed to fill the gap

Q1 2017 budget deficit data mixed

The recently released quarterly fiscal data suggest spending is tightly controlled, while the revenue increase is due to higher oil prices and likely a higher transfer ratio from Saudi Aramco. However, the larger drawdown from government deposits at SAMA (SAR50bn in Q1 2017; $13.3bn or 1.9 per cent of GDP) suggests underreporting in the deficit.

This is due to the ongoing repayment of government arrears (SAR30bn). The larger drop in FX reserves than implied by the fiscal imbalance suggests that capital outflows (partly linked to FX demand following repayment of government arrears) have continued.

FX reserves assets decline markedly in April

Saudi Arabia Monetary Agency (SAMA) total reserve assets declined by $8.4bn in April to stand at $500.3bn. This is a large decline and worse than expected as the Saudi government issued a $5.9bn international sukuk during that month.

One reason could be that the sukuk proceeds are still being held in a government account and will only reflect in FX reserves when they are transferred into the domestic account, perhaps in May.

If this benign interpretation is not correct, we think that the decline is likely due to capital outflows, potentially partially linked to off-balance sheet government spending (arrears/military spending) and a $1bn uptick in private sector dollarization, rather than fiscal policy per se, in our view.

Market commentary

Here are the key highlights from Saudi Arabia’s financial markets this week:

1. Tadawul All Share Index (TASI) gained 90.85 points or 1.24 per cent to close at 7,425.72. Fifteen of the twenty sector indices closed higher. The advance decline ratio was 122/50. Trading turnover was around SAR7.5bn.

2. BUPA Insurance announces it has been awarded as the health insurance provider for the Saudi Basic industries corporation (SABIC): Bupa Arabia for Cooperative Insurance announces it has received the confirmation to renew its contract as the health insurance provider for the Saudi Basic Industries Corporation (SABIC) to provide health insurance for its employees and their families for one year starting 4 July 2017. (Tadawul)

3. Aramco cuts July propane price: Saudi Aramco lowered propane and butane prices for July. The company set its July contract price for propane at $345 a tonne, a decline by $40 from its current price. Aramco cut its July contract price for butane by $25 to $365 a tonne. (Mubasher)

Editor’s note: This article contains inputs from the Bank of America Merrill Lynch’s GEMs Macro Monthly report