The Saudi budget has been under financial pressure in the wake of the decline of oil prices in mid-2014. This has prompted the Kingdom to use its currency reserves and issue bonds to finance its deficit. In this context, the Saudi authorities began negotiations recently with potential investors to (or “intending to”) issuing international bonds denominated in dollars. This would be the first time Riyadh has to borrow from the international market, with the bonds expected to raise between $10-15 billion.

Why raise finance abroad?

States usually resort to borrowing when their public revenues fall, and they become unable to fund their public spending. In exchange for the money they lend, governments issue sovereign bonds to lenders that are a key method used to finance public budgets. Saudi Arabia had several options for covering the budget deficit it has faced in recent years, including borrowing domestically and internationally and tapping into the currency reserves it accumulated during the prosperous years of high oil prices.

Riyadh began by withdrawing from its vast currency reserves, its first line of defense against the fall in oil prices over the past two years, in order to sustain public spending on its development projects and cover the budget deficit. Next, the Saudi authorities resorted to other means to avoid chipping away at its currency reserves and threatening its credit rating, which has already been downgraded.

Taking into account its rising domestic debt, the Saudi government opted to issue sovereign bonds to achieve several goals set by the country’s leadership, through which it aims to achieve its vision of economic reform. By issuing foreign bonds, the Kingdom seeks to address its financial problems, which are rooted in economic over-reliance on oil, and its lack of success in sufficiently diversifying its economy during periods of plentiful revenues and financial surplus. The current crisis is reflected in the following:

1. Falling oil prices. Global prices for a barrel of crude oil dropped from $115 to less than $30 over the course of 2014. Despite a slight gradual recovery in prices more recently, Saudi oil income has not recovered enough to cover the budget deficit.
2. Declining public revenue. As a result of the Kingdom’s reliance on crude oil sales, which account for 85 per cent of state revenues, the state’s income has fallen dramatically, giving a harsh blow to the Saudi economy.
3. A growing budget deficit. The Kingdom suffered a budget deficit of $38.61 billion in 2015, which rose in 2016 to $87 billion. The deficit is expected to hit $107 billion this year as a result of oil prices that are currently lower than revenue estimates on which the budget was set, while the Kingdom has continued spending on development projects.
4. Falling foreign currency reserves. Saudi Arabia’s foreign currency reserves decreased markedly during the last three years, from $732 billion in 2014 to $611.6 billion in 2015 and finally to $562 billion in August 2016, as the state made withdrawals to cover its budget deficit.
5. Growing government debt. Saudi government debt has increased from $11.8 billion dollars in 2014 to $37.9 billion in 2015. Between December 2014 and the end of August 2016, the size of the government’s direct debt rose to $73 billion, including $63 billion of local debt and the remaining $10 billion of foreign debt.
6. Rising energy costs. Government energy subsidies in Saudi Arabia reached $61 billion in 2015, achieving the threshold of 10% of GDP. The state bears the cost of $23 billion annually just for petrol, the biggest single energy cost in the Kingdom representing the highest demand within Saudi Arabia.
7. Downgrading of the Kingdom’s credit rating in 2016. The world’s major credit ratings agencies - Moody’s, Fitch, and Standard and Poor’s - have downgraded Saudi’s credit rating. Moody’s lowered its rating from AA3 to A1; Fitch downgraded it from AA to AA-, and S&P’s lowered it two grades from A+ to A-. The main reason for this downgrade was the decline in oil revenue. However, the agencies continue to perceive Saudi Arabia as “stable”, particularly given the reforms being carried out under “Vision 2030”, which supports the view of the Kingdom as an economy that will continue to be stable in the future.

Sovereign bonds and Vision 2030

Saudi Arabia’s issuing of sovereign bonds fits within its plan for economic reform, halting its economic reliance on oil exports, and turning itself into a global investment power by 2030 by achieving several major goals:

1. Increasing the country’s non-oil revenues and attracting foreign direct investment (FDI) to the Saudi economy.
2. Resetting and restoring the government’s budget by limiting public expenditure and cutting unnecessary spending, while rationalizing subsidies, notably for energy.
3. Diversifying the national economy through broadening its productive base to generate revenues, developing new income streams by imposing a VAT, and increasing non-oil revenues.
4. Diversifying the Kingdom’s investment holdings to generate income beyond petrochemical revenues, which create volatility in revenue forecasts, due to price fluctuations.
5. Creating more job opportunities for Saudi citizens, and continuing to shoulder the cost of massive state-funded development projects.

These aims are consistent with a decree issued by the Saudi Council of Ministers, based on a royal decision, to remove/ cut some of the privileges for state employees through repealing some allowances and bonuses, lowering the salaries of ministers and senior civil servants at the ministerial level by 20 per cent. In addition, the annual bonus for the Hijri year of 1438 (October 2016 to September 2017) was halted for all the employees in the public sector. On top of that, the state will pay salaries based on the Gregorian calendar, which is 11 days longer than the Hijri calendar. This adds up to a saving of one-month worth of wages saved every three years.

Likely impacts of Saudi sovereign borrowing

The loans that the Saudi government is striving to obtain by issuing sovereign bonds is expected to achieve a number of aims for the state, including: 

1. Proving and affirming the merit of Saudi Arabia’s credit ratings. After the recent downgrading of its credit ratings, Riyadh is working to obtain loans to show that it is capable of borrowing large sums of money from international markets, as its foreign debt is extremely low, affirming its creditworthiness.
2. A net increase in the resources available to the public. Foreign loans will transfer financial income in foreign currencies into the Saudi economy, strengthening the purchasing power of local economic actors.
3. Easing the pressure on local liquidity by avoiding - at least temporarily - domestic borrowing. This will stabilize the local debt.
4. Increasing investment and creating new jobs by giving every opportunity to the private sector to borrow locally, broaden its activities and investments. Such incentives will lead to the creation of local jobs and unemployment reduction. The Kingdom is investing its loans in development projects and holding back on public spending.
5. Avoiding the cost of the alternative, i.e. withdrawing from foreign currency reserves. The cost of borrowing from abroad should be less, in the long run, than the income created by Saudi reserve assets overseas. Thus, the Kingdom will be able to keep hold of its reserves by borrowing cheaply while maintaining assets that will bear greater returns in the future.

Such positives do not imply the absence of potential negative aspects to borrowing from overseas. These outcomes could result from any of the following:

1. A growing budget deficit due to a deduction in Saudi GDP in order to service its debts, could lead to increase its public expenditure vis-a-vis its revenues, prolonging its deficit.
2. The loans could become a burden if the deficit continued and the debt accumulated. The costs of servicing its debts could widen the gap in the Saudi budget and prolong the deficit, hindering economic growth.
3. The loans could be used for current expenditure, prompting more borrowing; if no money is found for repayments, the size of the debt could grow.

In conclusion, the Saudi state’s decision to resort to sovereign debt is not a bad decision in general, as sovereign bonds are a fundamental element of the development planning and reviving of any major economy. Such policies are common in international transactions, as long as the state has reserves of foreign currencies to cover its repayments and the costs of its foreign debts, and is unlikely to default.

For the policy to succeed, it must be managed within certain guidelines, including the use of money borrowed from abroad within the framework of Vision 2030 for the reform and diversification of the Saudi economy. The money must be directed into productive enterprises that can service their debts without creating a burden on the national economy. Expenditure on current costs must be avoided and efforts towards financial reform, to close the growing budget deficit, must resume. The country’s tax policies and tax collection efficiency must be reviewed to control any growth in the country’s public debt.