The budget for 2006 the Saudi Arabian government released on September 13 contained a "number of superlatives" as highlighted in Riyad Bank's Weekly Economic Briefing: "..highest government budget surplus ever, highest private sector growth in the last twenty years, one of the highest economic growth for the overall economy, record current account surplus, and record non-oil exports."

The new budget as well as a review of performance of the Saudi Arabian economy in 2005 was the subject of a special report issued September 13 by Samba's Office of the Chief Economist, Mr. Brad Bourland. Today we provide that report for your consideration. Complete issues of the Riyad Bank Weekly Economic Brief and the Samba "2006 Budget, 2005 Performance" report, including a number of helpful graphs, can be viewed on-line.

Summary

On Monday, December 12, 2005 the Council of Ministers endorsed the government's budget for fiscal year 2006 (31 Dec. 2005-30 Dec. 2006) and announced economic and fiscal results for 2005. The central theme is the use of exceptional oil revenues for debt reduction and spending on education, healthcare, and basic infrastructure. The highlights are:

• Actual 2005 government spending of SR 341 billion ($90.9 billion) and revenues of SR 555 billion ($148 billion), with a resulting surplus of SR 214 ($57.1 billion). The budget was projected to be in balance with both revenues and expenditures of SR 280 billion ($75 billion). Both revenues and spending exceeded the budget, with revenues more than 90 percent over budget expectations and spending nearly 22 percent above the budget. The government reduced its debt by a Samba-estimated SR 139 billion ($37 billion) to stand currently at SR 475 ($126.7 billion), or a manageable 41 percent of GDP.

• 2006 budget spending of SR 335 billion ($89.3 billion) and revenues of SR 390 billion ($109 billion) for a projected surplus of SR 55 billion ($14.6 billion). Expenditures are 20 percent higher than in the 2005 budget, but in line with actual 2005 spending. Our preliminary forecast is that actual spending and revenues will again exceed the budget for 2006, but still allow for a sizeable budget surplus.

• Preliminary data show that the economy grew strongly in 2005, with real GDP growth of 6.5 percent. Inflation, at 0.4 percent, was insignificant.

Following past practice, the budget appears based on conservative oil price and revenue projections. A Samba-estimated average price for Saudi oil of $35 per barrel at an average 2006 production of 9.5 million barrels per day (b/d) (current production is 9.5 million b/d) would meet the 2006 budget projection. The stimulative 2006 budget -- the largest in the Kingdom's history -- combined with private sector growth across the board, the healthy levels of business spending, all point to the strength of the 2005 economy building in 2006.

[This is a brief spot commentary on the new budget for 2006 and preliminary economic performance for 2005. A complete report reviewing fiscal and economic developments and forecasting 2006 performance will be released in early February 2006.

2005 FISCAL PERFORMANCE

We expected 2005 to be a year of exceptional fiscal performance as total oil exports have been the highest in the country's history at $157 billion, some $52 billion more than last year, which was also a strong year. The government used its anticipated revenues to increase spending over the budget while maintaining its largest surplus ever of SR 214 billion ($57 billion). The second largest surplus was recorded in 1980 at SR 111 billion ($29.6 billion). While growing foreign assets at the central bank (SAMA), the government also spent on both current and capital projects as well as reducing its debt.

• Actual spending over the budget by about 15 percent is the historical pattern, but in 2005 revenues so far exceeded the budget forecast, by 98 percent, that the extra spending of 22 percent over the budget was easily covered. The SR 341 billion ($90.9 billion in actual spending represented growth of 16 percent over actual 2004 spending.

• SAMA increased its foreign assets between December 2004 and October 2005 (latest data) by more than 53 percent or $46.6 billion. Foreign assets have been growing over the past two years but not at the rate we are witnessing at present. From December 2003 to December 2004 foreign assets grew by $28 billion. Foreign assets now stand at 36 months of import cover. These assets provide substantial financial depth to protect the currency's peg to the US dollar and budgetary cushion against future downturns in oil revenues.

• The government announced that it reduced its debt to SR 475 billion ($126.7 billion), which, by our estimate, is a reduction of SR 139 billion ($37 billion) from year-end 2004 levels. Government debt now stands at 41 percent of GDP, down from a peak of 119 percent of GDP in 1999. The combination of debt reduction and strong GDP growth over the past few years has resulted in marked improvement in the government's debt profile.

The combination of a large surplus, debt reduction, and the build-up of foreign assets represented the best year in the past 20 of fiscal performance in the Kingdom. The foreign asset position of the government is strong and debt is now declining quickly in both absolute terms and as a percentage of GDP.

2006 BUDGET

The 2006 budget projects spending of SR 335 billion ($89.3 billion). This represents an increase of 20 percent over the 2005 budget, laying the groundwork for strong fiscal stimulus to the economy in 2006. The growth in the 2006 budget follows a year of similar budgetary growth in 2005.

Infrastructure spending is a focus of the 2006 budget. The budget earmarks SR 126 billion for capital projects. The statement from the Ministry of Finance refers to the budget's "special emphasis on capital expenditures that will enhance economic growth and job creation." Another aspect of the infrastructure spending is that it is geographically diverse, highlighting an emphasis on building in rural areas. For example, the budget announcement notes plans to build universities in Jizan, Hail and al-Jouf, 2,700 new schools across the Kingdom, and 440 primary healthcare centers in all 13 regions of the country.

Spending priority is given to education and healthcare, in line with the government's policy shift since the late 1990s that focuses more on the social needs of a rapidly growing population. Sectoral appropriations are as follows:

• Education and human resource development received some SR 87.3 billion, an increase of SR 18 billion from last year's budget allocation. The country's primary and secondary schooling system will benefit with the construction of 2,673 new schools, in addition to 3,330 schools currently under constructions and the rehabilitation of 2,000 existing schools. Funds are allocated for the construction of three new technical colleges and 15 vocational training centers.

• Health and social affairs is the second largest category in the 2006 budget, totaling SR 31 billion in expenditures compared to SR 23 billion in 2005. Twenty-four new hospitals will be constructed in addition to the 89 hospitals currently being built. In social affairs, allocation for public housing projects throughout the Kingdom will be increased to SR 10 billion.

• Water, agriculture, and infrastructure is budgeted at SR 22.5 billion. This includes spending for new water, sewage and desalination projects, in addition to infrastructure projects in the industrial cities of Jubail and Yanbu, as well as various agricultural projects.

• Municipal services (urban roads, street lighting, city bridges, and cleaning services) will receive SR 12.4 billion.

• Transportation and telecommunications will receive SR 11.5 billion.

The 2006 budget also project revenues of SR 390 billion ($104 billion), resulting in a projected surplus of SR 55 billion ($14.7 billion). Typically, non-oil revenues provide about 20 percent of budgetary revenues from sources such as investment income, taxes, customs duties and fees. The amount and sources of non-oil revenues have not changed significantly in many years. The expected income from customs duties will shrink in 2006 as Saudi Arabia lowers tariffs due to WTO accession. We expect that the loss in customs duties will be more than offset by higher proceeds from privatizations and higher corporate tax proceeds in 2006. Non-oil revenues will account, we believe, for about SR 50 billion, or 13 percent, of the SR 390 billion total in the budget. 

The rest must come from oil. A 2006 average price for Saudi oil of $34 per barrel (about $41 for WTI) and an average production of 9.5 million b/d, which is currently the level of Saudi oil production, would meet the budget, in our view. As in the past, this represents a conservative outlook on the oil market. We think it likely that the pattern of 2005 will be repeated, wherein both revenues and expenditures exceed the budget, but with the end result being a large surplus. Our current forecast is for the average price of Saudi oil to be $50 per barrel in 2006.

In its December 2005 meeting, Opec decide to adhere to the group's official 28 million b/d ceiling (excluding Iraq), but rein in excess (200,000-300,000 b/d) to keep strictly within that limit, in anticipation of seasonally weakening demand in early 2006. Opec projects first quarter demand at 29.8 million b/d and the second quarter at 27.7 million b/d, hence a lower requirement for its crude. While prices have declined from their August record high of $70.85 per barrel (WTI), today they are at $61 per barrel, and no signs of a significant drop in price are on the horizon.

Of significance in the budget statement is the government's strong commitment to significantly lower government debt. We were surprised by the level of debt reduction. In 2004, debt was reduced by about 9 percent, coming down from SR 660 billion to SR 614 billion, and we expected the same amount of reduction in 2005. Instead, debt was reduced by more than 29 percent in 2005 to SR 475 billion. Banking data shows that government debt held by the commercial banks declined through October by about SR 15 billion, or about 11 percent of the total debt reduction. Thus, the majority of the debt that was retired was held by two large government pension funds -- GOSI and the Retirement Pensions Agency.

2005 ECONOMIC PERFORMANCE

In its mid-December budget announcement, the government also provides preliminary estimates of macroeconomic performance for the year. The government announced the following for 2005. 

• Real GDP growth of 6.5 percent, and nominal GDP growth of 22.7 percent. (The difference is primarily due to the increase in price in Saudi Arabia's oil exports, not domestic inflation.)

• Consumer price inflation of 0.4 percent.

• Broad money (M3) growth of 9.2 percent through October.

• Current account surplus of SR 326.5 billion ($87.1 billion).

This data, combined with the government budget data, portrays an economy experiencing nearly ideal conditions. Growth is robust and accelerating. Rarely does a country experience 23 percent growth in nominal GDP and no domestic inflation. Government finances are healthy with high spending growth but even higher growth budget surpluses. The trade balance is strong, with the Kingdom now enjoying current account surpluses in 9 of the past 10 years. Also evident in 2005 is that economic reform continues to be a central policy theme, even in the context of strong economic performance. The Kingdom became a member of the WTO on 11 December, ending 12 years of negotiations, and made commitments to WTO members of dozens of further actions to improve and liberalize the country's trade profile.

Conditions for 2006 look equally bright. Oil revenues are likely to remain strong. We believe private sector growth will accelerate, business investment, including by foreigners, will grow strongly, consumer confidence and spending will remain high, and the fiscal stimulus of higher government spending will aid the growth.

How did we do in forecasting?   The following table summarizes our most recent forecasts with the actual data. Most data was in line with our forecasts, but we were a bit too optimistic about GDP growth and the trade balance. Higher levels of imports than we expected would account for the difference. What we clearly did not expect was the high level of debt reduction that occurred. We had been watching SAMA foreign assets grow strongly throughout the year, so we did not calculate that as much was going toward debt reduction as was announced.

Check Full Version for graphs and notes. 

Source: Samba

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