Fitch: Saudi 1Q Deficit Narrows, Some Allowance Cuts Reversed

Saudi Arabia's sharply narrower first quarter deficit highlights the positive fiscal impact of higher oil prices. But the partial reversal of a cut in public sector allowances shows reforms are not yet well entrenched, Fitch Ratings says.

Saudi Arabia's Ministry of Finance published the government's first-ever quarterly budget performance update on 11 May as part of its efforts to improve fiscal transparency. At SAR26 billion (USD6.9 billion), the 1Q17 deficit decreased by 71% from a year earlier. The major contribution came from higher oil prices, which saw oil revenues more than double to SAR112 billion.

The strong 1Q17 outturn supports our view that the budget deficit will fall substantially this year, although the fall for the full year will be less dramatic than for the first quarter. Oil prices reached their trough in 1Q16, and the year-on-year comparison in oil revenues will be less favourable for the remainder of the year.

The budget update highlights the continuing importance of oil prices to fiscal performance. Non-oil revenues were little changed, while expenditure fell 3% from 1Q16, helped by a 5% fall in spending on wages (the largest single expense) and lower spending on subsidies, grants, and social benefits.

The government has not stated any intention to deviate from its reform path, and 1Q expenditure figures show no signs that the overall 2017 expenditure target will be breached. However, the reversal of about a third of a cut in allowances for public sector workers raises questions about the government's ability to implement a more predictable policy process. It suggests the risk of a return to fiscal policy-making where spending is adjusted to short-term revenue fluctuations during the course of the year.

The policy reversal on public sector allowances is worth around SAR9 billion per year or about 0.3% of GDP. While any negative impact on fiscal consolidation this year is likely to be dwarfed by the improvement due to higher oil prices, it weakens efforts to make private sector employment more attractive to Saudis, who are traditionally drawn to highly-paid and stable public sector jobs.

The implementation of planned cuts in energy subsidies, which will be combined with social benefits for the poor, and of increases in expat levies, will be important to gauging the continued commitment to fiscal consolidation.

We assume that the fiscal deficit will continue to fall on the back of higher oil prices and a partial implementation of government reform measures. This should contain the deterioration of Saudi Arabia's balance sheet.

Our downgrade of Saudi Arabia's sovereign rating to 'A+'/Stable in March reflected the continued deterioration of public and external balance sheets, the significantly wider than expected fiscal deficit in 2016 and continued doubts about whether the ambitious reform programme can be implemented.