Saudi Arabia’s 2010 budget sends a clear signal to private investors that the country is committed to continuing its stimulatory state-spending program without resorting to debt financing. The budget, released on Monday, projects a 14 percent increase in state expenditures next year to a record level of SR540 billion ($144 billion). The government has stepped up to the plate in terms of generating momentum behind an economic recovery in hopes the private sector will reciprocate.

Oil prices, now ranging around $70 a barrel, enable Saudi Arabia to comfortably push ahead, with little fiscal strain, its plan to invest in the oil and gas sectors in the medium term, improve education, as well as develop and maintain the infrastructure necessary to support the growing population. The 2010 budget includes allocations of SR260 billion for investment projects, up 16 percent from last year, underpinning the state’s commitment to keep spending high even as if forecasts a second straight deficit. These steps are ultimately expected to draw in the private sector and create additional employment opportunities.

The 2010 budget anticipates a deficit of SR70 billion — steeper than the deficit projection for 2009 — on state revenues of SR470 billion. This indicates the Saudi government is using a conservative oil price of $44 per barrel of Saudi crude ($48 per barrel for WTI) on production of 8.5 million barrels per day to determine its budget, according to our estimates. Government expenditure plans envision significant increases in funds allocated to key sectors. The education budget grew 13 percent, health and social budget rose 51 percent, allocations for transport and communications surged 63 percent, and the budget for water, agriculture and infrastructure increased 30 percent.

Over all, Saudi Arabia has plenty of room to maneuver its budget in the next decade, but there are certain risks associated with continuous high spending which we highlight in this report by developing scenarios of what the budget could look like in 2015 and 2020. These scenarios underpin the importance of economic diversification and private sector job creation to the future success of the Saudi economy.

2009 slightly better than expected

The Saudi government, which had anticipated its first budget deficit since 2002 of SR65 billion, emerged from 2009 with a smaller deficit of SR45 billion owing to a rise in oil prices during the latter part of the year. When the Kingdom released its 2009 budget last December, oil prices were fluctuating near a trough below $35 a barrel.

Oil prices recovered in the second half of the year and we expect them to average $62 a barrel this year. The price recovery enabled Saudi Arabia to bring in revenues of SR505 billion, 23 percent above its earlier projection of SR410 billion. For 2010, we take a conservative view on oil prices, forecasting WTI to average $75 a barrel, without discounting for geopolitical upside risks.

The deficit came below our forecast of a SR2.3 billion surplus, mainly due to our higher revenue projection of SR581 billion — a 15 percent discrepancy. Fiscal outlays were also 5 percent below our expectations. The Kingdom spent SR550 in 2009 against its budget target of SR475 billion. We were expecting government expenditures to reach SR579 billion in 2009 as the government shelled out billions of riyals to support its economy through the financial crisis and avoid recession.

The government had been drawing on foreign assets for most of the year to support spending in various sectors of the economy, although this tendency leveled off later in the year, and in October, net foreign assets of the Saudi Arabian Monetary Agency (SAMA) rose 2.26 percent, but were still down 11.2 percent from their level in December last year.

Saudi Arabia’s spending plans have prioritized qualitative improvements to education, social and physical infrastructure in recent years. In 2009, the education budget rose almost 17 percent to SR121.9 billion as more than two schools a day were built, with many more planned for next year.

Saudi Arabia has succeeded at reducing domestic debt to very manageable levels this year. Saudi Arabia’s outstanding domestic debt stands at SR225 billion, down 5 percent from 2008 and about 60 percent less than levels in 2002 — the start of an oil price rally that continued to mid-2008. Saudi Arabia’s debt to GDP level — at 16.3 percent this year — is among the lowest for members of the G20. We project domestic debt will fall to 13.8 percent of GDP in 2010 even as debt-to-GDP ratios soar in developed markets in the fallout of the global financial crisis. This decline will stem from the outright increase in GDP as well as a small net decline in public debt. IMF estimates show debt-to-GDP in the United States will rise to 70 percent in 2010 from 62 percent this year. Meanwhile, other Gulf countries are facing steeper debt-to-GDP levels than Saudi Arabia’s.

High levels of government debt are not healthy for the fiscal situation, underpinning the need for long-dated government bonds, which can act as an important tool to develop credit and financial markets. Government bonds maturing in seven to 10 years would create the necessary reference price to develop a viable corporate bond market — something that is necessary as state and private investors embark on long- term infrastructure and utilities projects.

The reference price helps to create a swap curve, and would enable Saudi issuers to move away from benchmarking prices against US T-bills at a premium. Several countries have issued sovereign bonds to stimulate their bond markets, even if they don’t have a specific need for the funds. Once a benchmark is created, companies and banks are able to raise credit more efficiently, capital markets are deepened and a strong ratings culture emerges. Banks further gain access to more liquidity management tools. While this culture will take time to develop there is a need to start somewhere.

Strong economic fundamentals

The current account also looked strong last year against the backdrop of global recessionary conditions. The Kingdom posted a current account surplus of SR76.7 billion — which was higher than our forecast of SR12.8 billion.

While down drastically from a record surplus of SR496 billion in 2008, Saudi Arabia managed to avoid turning a current account deficit due to strong end-year oil export receipts and a smaller import bill resulting from weaker demand and prices. Total exports amounted to SR691.6 billion, according to the finance ministry — down 41 percent from 2008 levels. Imports also declined 21 percent to SR301.3 billion — slightly lower than our forecast of SR333.8 billion, and the biggest annual decline in 15 years. We are not worried about the decline in imports as the ratio to exports remains positive.

The Saudi economy grew 0.15 percent in 2009, according to the estimate released in the budget, above our forecast for a 0.9 percent contraction. The discrepancy was due to a lower- than-expected contraction of oil GDP, likely the result of huge investments in the oil and gas sector as part of the state’s commitment to invest $130 billion to expand energy output over five years.

Non-oil GDP growth came in line with our forecasts. The non- oil sector grew 3 percent in real terms, including a 4 percent expansion of the government sector (versus our forecast of 3.8 percent) and 2.5 percent growth of the private sector (on par with our forecast). The transport and communications sector witnessed the fastest growth at 6 percent, followed by construction at 3.9 percent. The industrial sector grew by a slower 2.2 percent, while finance, insurance and real estate expanded 1.8 percent. Electricity, gas and water sector grew by 3.4 percent, and wholesale, retail, restaurants and hotels expanded by only 2 percent, not surprising given it was tough year for consumers and sellers alike. The private sector contributed 47.8 percent to GDP in 2009, up from 46 percent in 2008.

In our view, the Saudi economy will grow 4 percent in 2010 as private sector loan growth recovers and state fiscal outlays stimulate the economy. Although private sector lending is still not picking up pace fast, the signs are there that credit allocation to private business is on a positive track and no longer contracting as earlier in the year. Inflation levels also fell off the radar screen in 2009, with average inflation of 4.4 percent much below the record 9.9 percent witnessed in 2008. Still, prices stemming from domestic housing shortages as well as rising import costs, particularly foodstuffs, are likely to keep inflation levels historically high in 2010. The 2009 inflation level was below our 5.1 percent annual forecast. We expect inflation of 4.6 percent next year.

(To be continued)

(John Sfakianakis is group general manager and chief economist at Banque Saudi Fransi, Riyadh)