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King Salman Banks On Welfare Spending In Gloomy Oil Era

King Salman Banks On Welfare Spending In Gloomy Oil Era

Saudi Arabia recently announced a new round of bonuses for government employees, a direction that experts believe is opposite to what it should be doing in this time of cheap oil.

Only two months after he ascended the throne of the Kingdom of Saudi Arabia, King Salman issued a surprise decree that saw several of Saudi Arabia’s state-owned companies paying out hundreds of millions of dollars as two-month bonuses to their employees.

For the state employee, some largesse from the new king was expected, but not many expected it to be a full two- month bonus.

Saudi Electricity, the region’s biggest utility company, for example, distributed SAR545 million (Dhs533 million) among its Saudi employees, capping the per person bonus at SAR50,000.

This move came barely a week after King Salman issued another decree to pay a two-month bonus to civil servants and pension to retired government workers, a move seen by many as acknowledging the country’s bureaucracy after his accession to power.

These payments are not an exception – in the past, many emirs and kings in the Middle East have marketed the start of their reign with such lavishness.

THE TIMING

However, the circumstances in which King Salman took the throne can be anything but enviable in the context of the current economic scenario.

The price of crude oil has almost halved since the later half of last year. In June 2014, a barrel of oil was trading at $115 before it sank to a six-year low of around $45. Although it has since partially recovered to $60, a further fall is not unexpected.

The fall, which was a combination of multiple factors including slowing demand, was ostensibly further precipitated by the OPEC meeting in November, where the cartel decided to maintain their supply quota of 30 million barrels a day.

Saudi Arabia, as the swing producer in the cartel, has always had the final voice in OPEC’s decisions and many experts theorised that the oil-rich country made this decision with an eye to cramp US shale oil producers – who produce oilat a much higher cost than that of Saudi Arabia.

The most accepted theory behind OPEC’s November decision is that Saudi Arabia in particular wants to let the price fall and put the high-cost shale producers out of business – in turn decreasing supply and increasing prices.

Suhail Al Mazroui, UAE’s Energy Minister, reiterated this stand of OPEC at a recent energy event in the UAE.

“[OPEC] cannot continue protecting a certain price. That is not the only aim of OPEC,” he said. “We are concerned about the balance of the market but we cannot be the only party that is responsible to balance the market.”

According to IHS, a research firm, the cost of production for shale oil is anywhere between $57 and $70, but decreasing gradually as frackers have learnt to drill wells faster and more efficiently.

Saudi Arabia in contrast has a cost of production that, according to various estimates, ranges between $10 to $12.

In addition, it is reported that the country has up to $750 billion in foreign exchange reserves and therefore can easily absorb the lower price of oil – revenues which form the backbone of its welfare economy – for a sustained period and outlast more expensive producers of oil.

THE KING’S LARGESSE

King Salman’s latest gifts to the country’s population can also be therefore seen as a statement of intent along with the latest budget announcement that the country will be able to outlast this spell of cheap oil.

In December, Saudi Arabia’s finance ministry said that it planned to raise government spending 0.6 per cent to a record high in its 2015 budget.

Spending in the 2015 budget is projected at SAR860 billion ($230 billion), up from SAR855 billion in the 2014 budget plan even as revenues were projected to drop to SAR715 billion in 2015 from SAR855 billion in the 2014 plan, leaving a deficit of SAR45 billion.

But according to Dr. Marie Owns Thomsen, chief economist at Credit Agricole Private Banking, these moves may not reflect the ground realities and Saudi Arabia,in fact, may have a shorter rope than imagined with its subsidy-heavy economy.

“The Saudi Arabian policy of injecting stimulus or giving handouts is not the right way to go. It is not the right policy is the current scenario,” she told Gulf Business in February.

“In fact, we have estimated that the budget break-even price of oil production is close to $95 per barrel. The cost of production in Saudi Arabia is low. It is the break-even on the fiscal side, which is the issue.

“If oil prices remain to be this low and the burden on the fiscal side keeps increasing, then it is clearly not the sustainable path to take,” she added.

According to Thomsen, such a situation may not provoke an economic crisis for maybe three years, but at some point Saudi Arabia will have to face up to a harsh economic situation.

“Governments must realise that if there is a drop in one line of production, oil in this instance, then they must reroute investment into other lines of production,” she said, adding that the best positive for Saudi Arabia would be to attract foreign investment or re-route domestic investment towards areas other than the energy sector.

Instead of freebies, Saudi Arabia must look at free enterprise, according to Thomsen, who pointed to its neighbour the UAE as a Gulf state that has diversified its economy and will be able to better withstand the oil shock.

“If you look at the ease of doing business, the UAE, according to the World Bank, has done very well. It is going down the right route…diversifying its economy, increasing transparency, reducing bureaucracy… and it is really showing results.

“For investors to be attracted to countries in the GCC, you need strong open clear institutions, a high level of education, skilled labour etc. Though not isolated from neighbours, UAE has been a shining light,” she said, adding that she expected the UAE economy to grow at a lesser rate in 2015 than expected but above four per cent.

Saudi Arabia is expected to grow at 2.6 per cent, according to a report by Samba Financial Group.

MUST REFORM NOW

Agreeing that we may never (or not for a long time) see $100 oil again, Thomsen said that countries in the Middle East that do not engage in serious structural reforms could find themselves in a confrontational state at a later stage. “If Saudi Arabia manages to liberalise the economy now rather than later, it can avoid that.”

Some with a stake in the Saudi Arabian economy are cognisant of that. Hatem A. Samman, chief economist
at Saudi Arabian General Investment Authority, told Gulf Business that while the oil drop might have fastened the process, the Kingdom is already pushing ahead with its diversification agenda.

“The drop in oil prices has asked us to look more closely…but Saudi Arabia is inviting investment in all major sectors… we want diversification…we are investing in our labour markets and doing more
in education…there are people looking at subsidies,” he told Gulf Business at an event recently in Dubai.

Though there is no clear estimate of the amount of hand-outs given out after King Salman ascended, some experts are believing it could around SAR 70 billion.

Would the new king continue this trend or will he re-look at the Saudi economy in the context of cheap oil it remains to be seen.

Economic experts are hoping that at some point we will see the Saudi government work towards the pledge it made to rationalise spending on public salaries when announcing the 2015 budget.

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