Exchange rate and price stability
Saudi Arabia has a fixed exchange rate system, with the Saudi riyal (SAR) pegged to the US dollar at SAR3.75:USD1. Despite pressures on the currency during the low oil price period in 2015-2017, the peg held – thanks to the huge foreign exchange reserves held at the SAMA – and we expect this to continue over the next few years. Progress towards a full Gulf monetary union has been limited and we do not envisage the introduction of an effective GCC single currency in the next five years or so.
The peg has ensured relative price stability in the past. In 2017, Saudi Arabia experienced deflation (-0.9% on average) amid a recession and weak domestic demand. The introduction of a 5% VAT in 2018 lifted inflation to an average +2.5% in that year. In 2019, the country was again mired in deflation (-1.2% on average) amid the renewed recession, and in particular as a result of falling housing prices and waning effects from the VAT introduction. But at the turn of the year, consumer price growth moved back into positive territory, to +0.3% y/y in December 2019 and +0.4% y/y in January 2020. Looking ahead, the expected gradual economic recovery, along with hikes to local fuel prices, should push up headline inflation to an average +1.4% or so in 2020.
SWFs provide buffers for fiscal and current accounts
Since mid-2014, sharply lower oil prices led to a substantial drop in fiscal revenues. The annual fiscal balance swung into a moderate deficit in 2014, which surged to around -17% of GDP in 2015-2016. Fiscal austerity measures narrowed the shortfall to -5.9% in 2018. Meanwhile, since 2019, the Saudi government has embarked on heavy fiscal stimulus measures, so we expect the fiscal deficit to widen again to more than -7% of GDP in 2019-2021.
Initially the fiscal deficits were financed almost entirely by a drawdown of foreign exchange (FX) reserves held at SAMA, which fell from a peak of USD745bn in August 2014 to a temporary low of USD485bn in September 2017 (these reserves include financial assets held by the SAMA Foreign Holdings sovereign wealth fund). Since then reserves have stabilized and hovered around USD500bn until end-2019. Current reserves are sufficient to cover around 30 months of imports, a very comfortable ratio. Since 2016, Saudi Arabia has successfully turned to the international bond market in order to cover its external financing requirements. As a consequence, public debt has risen from just 2% of GDP in 2014 to an estimated 30% currently. While at this level it is still relatively low compared to peers, the trajectory is somewhat worrisome and needs to be monitored closely.
However, another SWF, the Public Investment Fund, currently holds around USD360bn, providing further cushion, if needed. Overall, Saudi Arabia remains a net creditor.
The country’s annual current account balance also shifted to substantial deficits in 2015-2016 in the wake of the oil price slump, after 15 years of very high surpluses. Meanwhile, the partial oil price recovery since mid-2016 and the reduced Saudi import demand against the background of a lower economic growth regime have shifted the current account back into surplus: +1.5% of GDP in 2017 and +9.2% in 2018. As a result of reduced oil output and lower oil prices the surplus is likely to have narrowed to about +6.5% of GDP in 2019. It is forecast to decline further to around +5% in 2020-2021 as oil production and prices will not change much on average while fiscal stimulus should accelerate nominal import growth to some extent.
Gross external debt has increased from 12% of GDP in 2014 to around 25% currently but this is still a relatively low level in comparison to peers.