Saudi Arabia is planning on operating a fiscal deficit of approximately $35 billion (just over five percent of GDP) for the year 2019. Once it has issued the debt required for funding this deficit, Saudi Arabia’s public debt should rise to around 22 percent of GDP. This low figure means that the government has the option of running an even larger fiscal deficit. Conversely, it could choose to tighten its belt aggressively and balance its budget well in advance of its 2023 target. Which option is best?
Saudi Arabia is not alone in running a budget deficit. Advanced economies such as France, Japan, and the United States all intend to spend significantly more than their income for 2019, though their deficits are expected to be closer to three percent of GDP. However, virtually every advanced economy has a public debt that far exceeds that of Saudi Arabia, with Japan’s equaling over 200 percent of its GDP—and still growing (most have something in the range 80-100 percent).
But mimicking these economies should not be a policy target for Saudi Arabia, because it has a fundamentally different set of goals and circumstances.
Fiscal deficits represent efforts to redistribute income from the future to the present, as it is future generations that will have to settle the debt issued to fund the deficit. There are many reasons why governments choose to run deficits, but most of the time, it is because the economy is undergoing a recession and is expected to organically resume its normal growth path in the near future. Under these circumstances, the deficit is a way of soothing the pain of the recession—it is the economic equivalent of taking sick leave rather than trying to work while ill.
Sometimes, if recessions are protracted (such as Japan’s) or frequent (such as Italy’s), governments assess that there is a need for structural economic reforms. Under these circumstances, a budget deficit switches from being a painkiller to being an investment in the future, as it partially reflects financing for some of the deeper reforms that the economy needs to resume normal service. This often applies to economies recovering from war, such as those of European countries in the late 1940s, due to extensive infrastructure damage suffered during a conflict.
Saudi Arabia has two goals that differ significantly from those mentioned above.
The first goal is effecting a massive transformation in the structure of its economy. This revamp requires huge levels of investment, both in physical infrastructure, and in human capital. Traditionally, oil and its downstream sectors accounted for the lion’s share of value created in the Saudi Arabian economy, with the private sector being uncompetitive globally and making negligible contribution to innovation and technology. The main goal of Vision 2030 is to cultivate a globally competitive private sector that can grow to become a source of technological dynamism.
For example, Saudi Arabia wants to expand the size of key sectors such as arms manufacturing and tourism. Both require purchasing new machines, upgrading facilities, building new infrastructure, and training young Saudis.
Saudi Arabia’s second goal is to convince global investors that it has made sustainable fiscal adjustments to the oil-price crash that started in 2014. This goal relates to the first: the investments that the Saudi economy needs most are foreign ones that feature cutting-edge technology, as they lay the foundation for accelerated growth in the private sector via knowledge transfer. However, foreign investors are reluctant to invest in a country that has unsustainable finances, because they fear either default or expropriation of assets, as seen in several Latin American countries during the last 40 years. A key ingredient to securing the trust of foreign investors is balancing the books, and keeping deficits small when the need to run them arises.
On the surface, these goals appear conflicting: The first calls for loosening the purse strings, while the second calls for tightening them. However, thanks to Saudi Arabia’s fiscal prudence during the last two decades of oil prices, they are in fact closely aligned.
The second goal of sustainable finances requires much more than simply raising taxes and cutting spending. Oil revenues have historically accounted for around 80 percent of government income, meaning that state finances are highly exposed to changes in oil prices, which are almost completely beyond the control of the Saudi government. The only way to make its finances truly sustainable is for the contribution of oil to shrink massively, which requires a fundamental restructuring of the economy—the first goal.
For the alignment to be complete, the fiscal deficit has to be driven by investments in the future of the Saudi economy, rather than politically popular but financially imprudent wage increases for public sector salaries. Fortunately, Saudi Arabia’s large and diverse investments are in fact a key cause of the deficit. This is why the decision to increase the deficit and delay balancing the budget to 2023 was actually lauded by the IMF, an organization that is almost always seen instructing governments to tighten their fiscal belts.
What does this have to do with Saudi Arabia’s previous fiscal prudence? If Saudi Arabia were in a position similar to Portugal or Greece, both of which have public debts that exceed 120 percent of GDP, and tried to run a large deficit, then investors would rightly ask questions about the government’s ability to settle its debts, even if the reforms turn out to be moderately successful. However, by having a public debt that is currently less than 20 percent of GDP, external lenders do not fear default, and this is reflected in the classification of Saudi Arabia’s sovereign debt as “upper medium grade” according to all three major global credit rating agencies (Fitch, Moody’s, S&P).
Saudi Arabia, therefore, is right to run a government deficit, and a significant one, too. The focus for the next four years will be on ensuring that the investments financed by the deficit are successful, sowing the seeds of the new Saudi economy.