Fiscal loosening to fuel Saudi growth
DRAINING OF LIQUIDITY EXPECTED TO MITIGATE PRESSURE ON RIYAL PEG TO THE DOLLAR IN FACE OF FED RATE HIKES
Saudi Arabia is seen readjusting fiscal and monetary policy tools to boost growth in the economy in the context of rising oil prices and excess liquidity in the banking system, according to economists.
“Higher oil prices are allowing the focus of Saudi authorities to shift to growth without a material impact on fiscal balances,” said Jean-Michel Saliba, Mena economist at Bank of America Merrill Lynch.
Analysts believe the recent increase in oil prices has expanded the fiscal space of the kingdom to move on a higher expenditure path while maintaining fiscal deficits within the low single-digit range.
The sustainability of high oil prices and the ability to increase production, alongside a successful gradual exit from the Organisation of Petroleum Exporting Countries (Opec) deal with non-Opec states, remain critical to the new fiscal plans.
“We expect growth to have bottomed out at the expense of looser fiscal policy. The US [dollar] peg is likely to hold on the back of still-high savings and oil prices,” said Saliba.
Analysts expect the government to support economic activity through a more gradual pace of fiscal reforms, the introduction of household/cost of living allowances and private sector support programmes, the introduction of structural reforms, and the launch of mega-projects.
According to forecasts from the International Monetary Fund in its World Economic Outlook, Saudi Arabia’s GDP growth is projected to resume this year, rising to 1.7 per cent from a contraction of 0.7 per cent in 2017.
Growth in 2019 is expected to rise slightly to 1.9 per cent as oil output increases, with the assumed expiration of the Opec+ production cut agreement. For Saudi Arabia, the forecast has been revised up from the October World Economic Outlook (WEO) by 0.6 and 0.3 percentage points for 2018 and 2019, respectively.
Excess liquidity
As the government moves ahead with fiscal easing, the Saudi Arabian Monetary Authority (Sama) has hinted at plans to drain excess liquidity from the banking system to mitigate pressure on the Saudi riyal’s peg to the US dollar as US interest rates rise.
Specifically, Sama will allow some government deposits placed with commercial banks in 2016 to mature without rolling them over, draining off liquidity in the banking system, which will in turn push up the Saudi interbank offered rate (Saibor) which has lagged US dollar the London interbank offered rate (Libor) in recent weeks.
Interbank rates are key to Saudi economy because an yield discount on Saudi assets in the context of higher US rates could drive investors towards higher yielding currencies, bringing pressure on the Saudi riyal.
“We view this decision by Sama as a crucial step to reverse the negative Saibor-US dollar Libor spread, which has widened recently in order to maintain the relative attractiveness of the Saudi riyal in the context of the dollar peg to stem any potential outflows and capital arbitrage,” Ehsan Khoman, head of Research and strategist for Mena at Mitsubishi UFJ Financial Group (MUFG).
Going forward analysts expect Sama to sustain measures to soak up liquidity from the banking system including open market-operations (the buying and selling of securities to influence borrowing costs).
Large quantity sovereign debt issuance in the recent past has given the regulator the option to use open-market operations, if needed.