In 2015 we witnessed OPEC lose 500 billion dollars in revenue due to uncharacteristically low oil prices. For years, gulf economies have been sustained by a steady flow of black gold but falling oil prices now pose a real threat to economic prosperity and stability in the region. It's safe to say that oil is the commodity that that will dictate the fortune of many economies this year as oil prices plummet to below $30 dollars a barrel.
So, naturally Saudi Arabia, the world's largest producer and exporter of oil, must brace itself for 2016. In 2015, the nation flooded the market with cheap oil in an attempt to drive high cost competitors out of business and retain market share. And I'm sure you are acquainted with the drill- supply exceeds demand, and oil prices drop. Unfortunately for Saudi Arabia, shale producers proved to be much more resilient than expected and the Saudi's were left with a ballooning deficit. The deficit is now 15% of GDP and the Saudi Arabian economy is expected to contract by 6% this year alone as the price of oil is expected to decrease to $20, partly due to the Iranians flooding the market as well after sanctions were recently lifted against them so that they could gain greater access to this market.
To reduce the deficit, the Saudi's are also considering the feasibility of partly privatizing a range of public sectors and creating a sovereign wealth fund to attract greater capital flows by focusing on fostering greater transparency and a vigorous private sector, both of which will help the Kingdom diversify its sources of revenue. But the most controversial policy they have planned is totally out of character for Saudi Arabia.
So how will austerity work then? The key is the devaluation of the riyal. One of my favorite columnists/economists of all time, Paul Krugman, has diagnosed the nation with the ' St Augustine Problem' and says it needs "fiscal chastity and continence" but with a cheaper currency. As other oil-dependent countries such as Kazakhstan and Azerbaijan have ceased to peg their respective currencies to the US dollar, the Saudi's will need to follow suit. In the past year, Saudi Arabia's real effective exchange rate is 15 percent against a basket of other currencies, so it really is relatively overvalued. Through devaluation, The price of the riyal would then decrease against oil and other goods and services so the Saudi's wont have to execute such extreme budget cuts because inflation would take over, and effectively play austerity's role in curbing domestic spending whilst preventing a radical deviation from it's growth trajectory.
A big year for Saudi Arabia ahead, amidst mounting tension with regional rival Iran and trying to save its economy but I guess we'll have to patiently wait and observe. For now, the Saudi's face a crude predicament indeed as their love affair with oil and opulence comes to a close. ( I enjoy the occasional pun or two).
- Nehmat
Further Reading:
http://www.theguardian.com/business/ng-interactive/2015/apr/29/the-austerity-delusion
http://foreignpolicy.com/2015/10/09/the-promise-and-peril-of-cheap-oil-us-exports-shale/http://cje.oxfordjournals.org/content/36/1/283.full.pdf+html
So, naturally Saudi Arabia, the world's largest producer and exporter of oil, must brace itself for 2016. In 2015, the nation flooded the market with cheap oil in an attempt to drive high cost competitors out of business and retain market share. And I'm sure you are acquainted with the drill- supply exceeds demand, and oil prices drop. Unfortunately for Saudi Arabia, shale producers proved to be much more resilient than expected and the Saudi's were left with a ballooning deficit. The deficit is now 15% of GDP and the Saudi Arabian economy is expected to contract by 6% this year alone as the price of oil is expected to decrease to $20, partly due to the Iranians flooding the market as well after sanctions were recently lifted against them so that they could gain greater access to this market.
To reduce the deficit, the Saudi's are also considering the feasibility of partly privatizing a range of public sectors and creating a sovereign wealth fund to attract greater capital flows by focusing on fostering greater transparency and a vigorous private sector, both of which will help the Kingdom diversify its sources of revenue. But the most controversial policy they have planned is totally out of character for Saudi Arabia.
Ever heard of Saudi Arabia and austerity in the same sentence? Don't worry, neither have I.
But it seems the time has arrived for Saudi Arabia to curb it's profligate government spending because it can't just continue borrowing and relying on its foreign reserves to finance it's deficit any longer. Austerity measures will include the reduction of fuel subsidies, increased electricity tariffs and increased indirect taxation such as the introduction of a sales tax. Austerity however needs to be implemented in tandem with monetary policy; the Saudi's are unwilling to cut interest rates so it is unlikely that austerity will prove to be successful; Greece serves as a prime cautionary tale. On another front, austerity will also cause domestic instability as tensions are bound to intensify. The Saudi's combat most of their problems by throwing money at them, and have done so repeatedly to buy loyalty, ensure acquiescence and curb domestic tension, especially in the eastern regions of the country. Not a strategy I'm fond of. Anyways, with the costly intervention in Yemen and other activities, Saudi Arabia will be forced to decrease spending by a much larger extent than originally planned and it will be hard to digest for citizens. So how will austerity work then? The key is the devaluation of the riyal. One of my favorite columnists/economists of all time, Paul Krugman, has diagnosed the nation with the ' St Augustine Problem' and says it needs "fiscal chastity and continence" but with a cheaper currency. As other oil-dependent countries such as Kazakhstan and Azerbaijan have ceased to peg their respective currencies to the US dollar, the Saudi's will need to follow suit. In the past year, Saudi Arabia's real effective exchange rate is 15 percent against a basket of other currencies, so it really is relatively overvalued. Through devaluation, The price of the riyal would then decrease against oil and other goods and services so the Saudi's wont have to execute such extreme budget cuts because inflation would take over, and effectively play austerity's role in curbing domestic spending whilst preventing a radical deviation from it's growth trajectory.
A big year for Saudi Arabia ahead, amidst mounting tension with regional rival Iran and trying to save its economy but I guess we'll have to patiently wait and observe. For now, the Saudi's face a crude predicament indeed as their love affair with oil and opulence comes to a close. ( I enjoy the occasional pun or two).
- Nehmat
Further Reading:
http://www.theguardian.com/business/ng-interactive/2015/apr/29/the-austerity-delusion
http://foreignpolicy.com/2015/10/09/the-promise-and-peril-of-cheap-oil-us-exports-shale/http://cje.oxfordjournals.org/content/36/1/283.full.pdf+html
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