Last week, in the latest sign of Saudi Arabia’s deteriorating financial condition, S&P downgraded the kingdom to AA- negative citing “lower for longer” crude and the attendant ballooning fiscal deficit.
To be sure, we’ve covered the story extensively and it was almost exactly one year ago that we flagged the quiet death of the petrodollar and explained the significance to a market that hadn’t yet woken up to just what it means when, thanks to plunging crude prices, producing nations cease to be net exporters of capital.
With more than $650 billion in SAMA reserves, Riyadh does have a sizeable cushion. However, there are a number of factors (in addition to low oil prices) that are weighing heavily including, i) financing the war in Yemen, ii) maintaining the lifestyle of everyday Saudis, and iii) preserving the riyal peg. Here's a look at the breakdown of government expenditures:
When you mix heavy outlays with declining revenue, it means dipping into the warchest…
Here's a bit of color from Deutsche Bank which helps to explain what we mean by "the cost of preserving the societal status quo":
The largest energy subsidy beneficiary is the end-consumer in the form of fuel (petrol) subsidies. Bringing up the price of petrol to levels in the UAE, which earlier this year eliminated the petrol subsidy, could provide the government with USD27bn incremental revenues, or 20% of the budget deficit. However, this is a highly unlikely scenario given the demographic differential between KSA and UAE and the socio-economic impact that such an outcome (blended prices rising from USD0.11/l to USD0.5/l) could have within the country.
The Saudi government could look to increase electricity tariffs. This would be a challenge for residential consumption (51% of aggregate consumption) given the political/social impact, though it would present the highest incremental revenue benefit. Bringing up the electricity rates for industrial/commercial consumers to UAE levels could raise incremental revenues of USD3bn, which, while higher than those from the chemical sector feedstock impact, is still only 2.3% of the budget deficit.
Water is another area where the government could raise more revenues. Currently consumers pay only SAR0.1/cu meter for consumption of 50 cu.m per month, which is one of the lowest in the world.
You get the idea. The Saudis are paying a heavy price to pacify the masses and ensure that some type of Arab Spring event doesn't come to Riyadh. This puts enormous pressure on the budget which leads directly to pressure on SAMA reserves when oil prices collapse.
In a sign of the times, the Saudis have also tapped the debt market, setting up a scenario where Riyadh’s debt-to-GDP ratio (which might as well have been zero) is now set to rise at least sevenfold by the end of next year and fifteenfold by 2020.
All of this suggets that S&P may be painting far too rosy a picture. That is, it’s not entirely clear that a 16% fiscal deficit is attainable this year, and we’re not sure it’s looking good for 10% in 2016. Here are Deutsche Bank's estimates:
As for the economy, well, it's set to decelerate meaningfully going forward.
Finally, note that for the first time in decades, the Saudis are actually staring down a current account deficit and speaking of trade, Bloomberg is out today with a particularly interesting assessment of the kingdom's aquifers which have run dry, meaning the country will no longer be able to grow wheat in the harsh desert environment. Here's more:
For decades, only a few features punctuated the vastness of the Saudi desert: oil wells, oases -- and wheat fields.
Despite torrid weather and virtually no rain, the world’s largest oil producer once grew so much of the grain that its exports could feed Kuwait, United Arab Emirates, Qatar, Bahrain, Oman and Yemen. The circular wheat farms, half a mile across with a central sprinkler system, spread across the desert in the 1980s and 1990s, visible in spring to anyone overflying the Arabian peninsula as green spots amid a dun sea of sand.
The oilfields remain, but the last wheat farms have just disappeared to save the aquifers supplying them. For the first time, Saudi Arabia will rely almost completely on wheat imports in 2016, a reversal from its policy of self-sufficiency. It will become a full member of the club of Middle Eastern nations that, according to the commodity-trade adage, "sell hydrocarbons to buy carbohydrates."
"The Saudis are the largest new wheat buyer to emerge," said Swithun Still, director of grain trader Solaris Commodities SA in Morges, Switzerland.
Ahmed bin Abdulaziz Al-Fares, managing director of the Grain Silos and Flour Mills Organization, the state agency in charge of cereal imports, told an industry conference in Riyadh last month that Saudi Arabia will import 3.5 million metric tons in 2016. That’s a 10-fold increase from about 300,000 tons in 2008, the first year local crops were curtailed. An agency presentation says the kingdom will rely on imports for "100 percent" of its wheat in 2016 for the first time.
By 2025, demand is forecast to rise to 4.5 million tons as population growth drives demand for flour, positioning Saudi Arabia as one of the 10 biggest wheat buyers worldwide.
It may not be the last country to turn away from growing its own crops. Aquifers in other key agricultural regions, including northern India and northern China, are also under pressure. The stress is compounded by erratic rains, which some blame on climate change.
Saudi Arabia became a net exporter of wheat in 1984 from producing almost none in the 1970s. The self-sufficiency program became a victim of its own success, however, as it quickly depleted aquifers that haven’t been filled since the last Ice Age. In an unexpected U-turn, the government said in 2008 it was phasing out the policy, reducing purchases of domestic wheat each year by 12.5 percent and bridging the gap progressively with imports.
In short, the Saudis are running out of money, water, and food and although the global deflationary supply glut (thank you ZIRP) means that importing things like wheat will be cheap for the time being ...
...moving away from self sufficiency as you deliberately suppress the price of your most important export while attempting to simultaneously fight two proxy wars and preserve costly subsidies for the oppressed masses is a dangerous cocktail, and with Tehran set to transition from pariah state to regional power broker we ask once again: is the House of Saud about to enter a terminal decline?