According to OPEC’s 2017 Annual Statistical Bulletin, the Kingdom possessed the world’s second largest proven oil reserves (around 17.8% of global oil reserves) and stood as the largest oil producer (around 13.9% of global oil production) at year-end 2016. Furthermore, the oil sector accounted for 44% of Saudi Arabia’s real GDP at year-end 2016. Consequently, the Kingdom’s public finances were significantly tainted by the crash in the oil price, suffering from large twin deficits, rapid erosion of a considerable amount of reserves, fading banking system liquidity and weakening growth partly due to fiscal consolidation measures. Consequently, the Government announced its ambitious Vision 2030 and related National Transformation Program (NTP) 2020, aimed at reducing excessive dependence on oil and diversify its economic base. The Government also started tapping international debt markets late last year, as an additional tool to fund its fiscal deficits. Another major threat to internal stability may arise from demographic pressures. The Saudi population stands at 32 million people, is relatively young and growing fast.
Founded in 1932, the Kingdom of Saudi Arabia (KSA) is an absolute monarchy governed by House of Saud on the basis of Islamic law. Decision-making is subject to consultations between the ruling family and the religious establishment. The Kingdom is located in the Arabian Peninsula and its geographical location makes it prone to regional event risk. It is a long-standing ally of the United States and has been fighting the regional influence of both Iran and the Islamic State, namely in Yemen, Syria, Libya and Iraq which are currently subject to armed conflicts and sociopolitical unrest. On 5 June 2017, Saudi Arabia (along with UAE, Bahrain, Egypt and Yemen) severed diplomatic ties with Qatar, cut trade and transport links and imposed sanctions on Qatar. The stated rationale for such actions was Qatar’s alleged support of terrorist and extremist organizations and its interference in other countries’ internal affairs.
We see recovering oil prices and the Government’s effort to lessen dependence on hydrocarbon prices as positives for the Kingdoms economy going forward.
The Saudi real GDP stood at SAR2, 589.6 billion ($690.5 billion) at year-end 2016, up only 1.7% from the previous year, after growing at an average rate of 3.5% over the previous 3 years. We expect real growth to be flat in 2017, mainly due to OPEC related oil production curbs and weak non-oil activity following sharp public spending cuts.
On the fiscal front, reforms undertaken by the Government are aimed at boosting non-oil fiscal revenue and reigning in fiscal expenditures among other things. Yet, Government finances currently remain highly sensitive to hydrocarbon prices, as oil revenues accounted for 64% of total fiscal revenue in 2016 (down from 73% in 2015). Over the first half of 2017, despite a deceiving drop in non-oil revenues and the reinstatement of public sector benefits and bonus payments, the Government reported an overall improvement in its fiscal balances driven by higher oil revenues, a gradual phase out of subsidies and lower capital expenditures. The budget deficit dropped by more than half year-on-year to SAR72.7 billion ($19.4 billion) for the first half of the year, and we expect it to stand at around 10.0% of GDP for fiscal year 2017. The Government ambitiously aims at reaching a balanced budget by 2019.
As it recorded budget deficits, the Government has been issuing SAR denominated bonds and Sukuks to government agencies and local banks (which are highly capitalized and well regulated) in the domestic market, since 2015. It also tapped external sources of liquidity, first through a $10 billion 5yr syndicated loan from commercial banks in May 2016, before issuing an aggregate $17.5 billion of conventional bonds 5 months later, and an aggregate of $9 billion of Sukuk issuance in April 2017. As of August 2017, Saudi Arabia’s total outstanding direct indebtedness amounted to SAR369.2 billion ($98.4 billion), comprising SAR232.3 billion ($62.0 billion) of domestic debt and SAR136.9 billion ($36.5 billion) of external debt. We expect Total Debt to GDP at around 20% of GDP by year-end 2017, edging closer to the Government’s 2020 cap of 30% of GDP.
On the external front, the current account balance also fell into negative territory over the last 2 years, mainly due to the weight of hydrocarbon exports within Saudi Arabia’s total export earnings. Indeed, oil exports accounted for 86% of Saudi Arabia’s total export earnings on average between 2011 and 2014 and 74% between 2015 and 2016. Due to the sharp drop in the value of hydrocarbon exports, the current account balance fell into a deficit of 8.7% of GDP (2015) and 4.3% of GDP (2016). As oil price recovers, we expect minor current account deficits over the next two years.
As at July 2017, the Government’s reserve assets amounted to SAR1,854.5 billion (U.S.$494.5 billion). The overall decline in foreign reserves has been sizable from $732.4 billion reached at December 2014. Yet, the pace of decline is gradually slowing down, as foreign reserves dropped 12.6% over the last 12 months. The Government reports a strong net international investment position estimated at 94% of GDP at year-end 2016.
We are very comfortable with Saudi Arabia’s ability to pay its foreign currency denominated debt given current levels of foreign buffers and authorities’ commitment to fiscal consolidation. We continue to see improvements in oil price dynamics and credit conditions.
Saudi Arabia is expected to issue a total of $10billion to $15 billion in 3 conventional bond tranches with maturities of 5.5-year, 10.5-year and 30-year. Initial pricing guidance is T+130bps, T+165bps and T+200bps respectively, which translate approximately to yields of 3.15%, 3.89% and 4.78%. We expect demand may be strong enough to tighten spreads by 20bps or more.
We see fair Z-spread for the proposed 5.5-year, 10.5-year and 30-year tranches at 102bps, 137bps and 226bps respectively, which translate into respective fair yield to maturity of 2.95%, 3.55% and 4.65%. Hence, we recommend a Buy on the new tranches, should their respective yield to maturity stand above the computed levels, at issuance.
We maintain very positive on our outlook for the Kingdom’s economy and their ability to repay its foreign currency denominated debt.