May 218 Summary The total Saudi gross public debt stood at SAR 443.3bn by the end of 217, and has been raised to SAR 483.7bn during 1Q218. Accordingly, total public debt is expected to rise to at least SAR 57bn by the end of 218 representing almost 21% of GDP; in-line with the government target for 218. The Ministry of Finance is targeting debt to GDP ratio not to exceed 3% by 22, while the debt/gdp ratio is expected to reach 21% by the end of 218, leaving ample room for the Kingdom to raise further debt. Although Saudi Arabia has repeatedly resorted to public financing to bridge its state budget deficit; the Kingdom has to restrict itself to a disciplined gross debt levels. Moreover, a heavy public sector foreign currency debt burden may affect consolidated expenditure in the public sector. Thus, authorities plan to change the current debt composition to 65% domestic debt and 35% international debt financing from 57.35% domestic and 42.65% foreign currently. Additionally, the introduction of the trading of government bonds on Tadawul is certainly a big step toward deepening the capital market. Since the Saudi riyal is pegged to the US dollar, Saudi monetary policymakers are faced with limited choices. Thus, it is important for the authority to maintain the gap between SAIBOR and LIBOR. The recent move by SAMA to trench surplus liquidity from the banking system is reflective of the same strategy. In the current scenario, KSA s debt landscape is enviable. Furthermore, declining fiscal deficit, backed by growth in oil prices, is adding to the optimism. However, the government and central bank are required to regularly monitor their funding proceeds, as this would have a waterfall effect on the entire economy. AJC Research Ajc_research@AlJaziracapital.com.sa +966 11 225625 1
May 218 Kingdom s international bond sale Amid declining oil prices in 216, KSA issued its first dollar debt to resolve certain major shortcomings in the economy. The Kingdom aimed to bridge the fiscal gap created by declining oil prices, control current account deficit, and support foreign exchange reserves for a longer duration. The Kingdom made its first dollar bond sale in April 216 worth USD 17.5bn, which was recorded as the largest ever emerging market bond sale. It surpassed Argentina, which raised USD 16.5bn during the same year. In the following year, Saudi raised international debt in two phases: USD 9.bn worth of Islamic bonds in April 217, followed by USD 12.5bn worth of dollar debt in September 217. Saudi Arabia concluded its fourth international bond sale worth USD 11.bn recently in April 218. The government sold USD 4.5bn worth of bonds due in 225 at 14bps over similar maturity US Treasuries, USD 3.bn worth of notes maturing in 23 at 175 bps over a similar benchmark, and USD 3.5bn worth of bonds due in 249 at 21 bps. The total gross public debt stood at SAR 443.3bn by the end of 217, and had been raised to SAR 483.7bn during 1Q218. For 2Q218, the government issued international bonds of SAR 41.3bn (USD 11.bn) and SAR 5.bn domestic sukuk; which increased the total public debt to SAR 53bn. Since the beginning of 218; the Kingdom borrowed SAR 18bn (USD 4.8bn) from the domestic market and plans to raise about SAR 6-7bn in total during 218, through the issuance of monthly Riyal denominated instruments. Accordingly, this is expected to raise the total public debt to at least SAR 57bn by the end of 218 representing almost 21% of GDP; in-line with the government target for 218. Fiscal deficit still remains a major concern in spite of rising oil prices amid tending to more expansionary budget until 223 and the re-introduction of austerity measures. Over the years, the reasons for international bond sale have largely remained the same. The budget deficit came in at an alarming USD 98.bn (15% of the GDP) in 215. However, a mammoth dollar bond sale was a major factor (apart from recovery in oil prices) that helped bridge the fiscal deficit of USD 79.bn (13% of the GDP) during 216. With a cumulative USD 21.5bn international bond sale in 217, the Kingdom managed to partially reduce the impact on government s current account after the budget deficit of USD 61.bn (8.9% of the GDP). It further aims to reduce the impact on the government reserve after the target of USD 52.bn (7.3% of GDP) fiscal deficit in 218; the Kingdom again taps the international debt market to raise funds. International bond issuance vs Fiscal deficit 25 21.5 12 2 17.5 9 USD Bn 15 1 11. 6 USD Bn 5. 215 216 217 218 International bond sale - LHS Fiscal deficit - RHS 3 Source: Bloomberg, Ministry of Finance, KSA Debt Management office 2
May 218 Still room for additional debt The Kingdom is eyeing both the domestic and international bond markets to lower fiscal deficit; with the listing of government debt instruments on Tadawul, raising of debt is expected to be more liquid and transparent. The Ministry of Finance is targeting public debt to GDP not to exceed 3% by 22, while the debt/gdp ratio is expected to reach 21%(as compared to average of 41% in the GCC nations, and 48% for the BRICS) by the end of 218, implying that the there is still ample capacity to raise debt. This direction reflects the kingdom s dependence on financing some of its development projects through public debt, as well as filling the budget deficit that began to increase since 215. Moreover, Saudi Arabia s Debt Management Office (DMO) indicated they may consider debt sales in some other currencies as well in the long run. As per authorities, the Kingdom plans to issue additional debt worth USD 31.bn in 218 (USD 11.bn) has already been issued). However, with oil prices scaling to new highs, Saudi Arabia may have to re-consider its initial debt financing plans. According to a Reuters estimate, a one-dollar increase in average oil prices over a year reduces the Saudi budget deficit by.3.4%. Thus, assuming steady budget spending, a few dollars increase in oil prices would prove attractive for Saudi Arabia. Crude oil prices closed at USD 66.9 per barrel in 217. So far in 218, oil prices (Brent) have averaged at USD 69.6 per barrel, as compared to the expected USD 6 per barrel for 218 budget. According to our calculation if Oil prices average at USD 7. per barrel for 218, this can potentially lower the budget deficit by excess of USD 7.bn ( SAR 26.25bn). Hence, the Kingdom could potentially consider to rationalize its future debt issues, in line with the oil prices. Brent oil vs. Fiscal Deficit 12 98 8 9 79 6 USD per barrel 6 3 61 4 2 USD Bn 215 216 217 Fiscal Deficit - LHS Brent - RHS Source: Bloomberg, KSA Ministry of Finance Public Debt vs. Debt-to-GDP ratio 75 65 55 45 35 25 15 5 26.% 24.% 21.% 17.3% 13.1% 555 673 749 5.8% 142 316 443 215 216 217 E218 E219 E22 Debt (SAR billion) - LHS Debt/GDP - RHS 3.% 25.% 2.% 15.% 1.% 5.% 3 Source: KSA Ministry of Finance (218 Budget)
May 218 Foreign-currency debt has its own impact Tapping the international debt market would certainly provide Saudi Arabia access to a large investor base and help it reduce the crowding-out effect in the domestic market, in most cases at lower yields. Moreover, it would offer the Kingdom access to longer maturities and present the possibility of building up forex reserves, eventually leading to short-term stability in challenging times. However, large-scale foreign issuances could increase the Kingdom s external vulnerability; hence, credit rating agencies may adopt a contrary opinion. Moreover, such a high level of external influence could have a serious impact on the Saudi Arabian Monetary Authority (SAMA) s ability to autonomously determine the desired level of foreign currency reserves. Eventually, authorities plan to change the current debt composition to a more 65% domestic debt and 35% international debt financing from 57.35% domestic and 42.65% foreign currently. Current debt composition (%) Planned debt composition (%) 57.35 42.65 65 35 Domestic Foreign Domestic Foreign Source: AlJazira Research Source: AlJazira Research Debt-to-GDP ratio is expansionary Saudi Arabia in 217 had a debt-to-gdp ratio of 17.3%; while in 1Q218 ratio expanded to 19% and is expected to exceed 2.% by the end of the year. Hence, the government indicated there is still ample capacity to raise debt, not necessarily for funding, but possibly from a market development perspective. Debt-to-GDP ratio (%) 3. 25. 2. 21. 24. 26. 15. 17.3 1. 13.1 5.. 5.8 215 216 217 218 219 22 4 Source: KSA 218 Budget, KSA Ministry of Finance
May 218 However, a widening debt-to-gdp ratio may not be advisable for an emerging economy. Excessive government borrowing results in rising market interest rates and reduced private investments, a phenomenon commonly known as the crowding-out effect. Conversely, a narrower debt-to-gdp ratio implies lower borrowings by the government, essentially leading to reduced interest rates. Decline in interest rates would encourage private consumption and investments, resulting in an upgrade in the Kingdom s sovereign rating. However, considering Saudi Arabia s new and improved ambitious plan to move away from oil dependence and focus on Vision 23, the ratio still holds capacity to magnify. The GCC recorded large amount of debt financing (USD 5.5bn) in 217, of which Saudi Arabia s share was 42.6%. Despite the highest share, the Kingdom s debt-to-gdp ratio is the lowest vis-à-vis GCC counterparts (45.7% on average) at 17.3%, with Bahrain (highest) and the UAE s (lowest) ratio at 9.3% and 19.5%, respectively. While comparing with emerging markets such as BRICS, Saudi Arabia is amongst the least leveraged nations. Brazil accumulated huge amounts of debt, thus leading to an alarming debt-to-gdp ratio of 84.%. However, the Kingdom is in line with the likes of Russia, which has a debt-to-gdp ratio of 17.4%. Saudi Arabia vs GCC nations (%) Saudi Arabia vs BRICS (%) 1 8 9 1 8 84 7 6 4 54 44 Average 41% 6 4 53 48 Average 48% 2 21 19 17 2 17 17 Bahrain Qatar Oman Kuwait UAE Saudi Arabia Brazil India South Africa China Russia Saudi Arabia Source: IMF Source: IMF Impact on interest rates needs monitoring Selling government securities to finance state budget deficit has a direct impact on interest rates. Government bonds are considered safe investments; thus, the interest rates on such instruments are considered risk-free. Hence, other financial assets must pay a higher interest rate to entice investors. Rising Fed rates: SAMA sells government bonds in the open market to fine-tune SAIBOR within the interest rate corridor. The authority raised the repo rate for the first time since 29 on March 15, 218, led by the expectation of a Fed rate hike. With rising Fed-rates, SAIBOR rose above the central bank s benchmark repurchase rate, which compelled SAMA to raise the repo and reverse repo rates to keep the Saudi riyal attractive for depositors who may otherwise be tempted to shift to dollars. The need for loose monetary conditions has been a key factor driving SAMA to keep repo rates steady thus far. Influence on policy rates: SAIBOR is directly influenced by the reverse repo rate (policy rate). This policy rate is set with reference to the US Fed s target rate. If SAMA s policy would not replicate the movement in the US Fed rate, this would result in potential pressure on the peg due to more likely capital inflows or outflows. 5
May 218 US Fed Rate vs Reverse Repo rate (%) 3. 2. 1.92 1. 1.5 1.75.25. Q1 15 Q2 15 Q3 15 Q4 15 Q1 16 Q2 16 Q3 16 Q4 16 Q1 17 Q2 17 Q3 17 Q4 17 Q1 18 US Fed Rate (%) Reverse Repo rate (%) Source: Bloomberg, SAMA Since the Saudi riyal is pegged to the US dollar, Saudi monetary policymakers are faced with limited choices. Furthermore, if LIBOR would continue to rise, SAMA would have to either raise the repo rate or restrict liquidity and allow SAIBOR to climb above the repo rate. Thus, it is important for the authority to maintain the gap between SAIBOR and LIBOR to a minimum. Moreover, the recent move by SAMA to trench surplus liquidity from the banking system is reflective of the same strategy. The Kingdom witnessed a similar situation during 24 6 when SAIBOR surpassed the repo rate, which lagged behind the US Fed rate, due to concern surrounding economic growth. Saudi SAIBOR 3 months Rate vs. USD dollar Libor 3 months Rate 3.% 2.5% 2.% 1.5% 1.%.5%.% -.5% May-9 May-1 May-11 May-12 May-13 May-14 May-15 May-16 May-17 May-18 Spread - RHS LIBOR 3 Month -LHS SAIBOR 3 Month - LHS Source: Bloomberg, SAMA 6
RESEARCH DIVISION Head of Research Talha Nazar +966 11 225625 t.nazar@aljaziracapital.com.sa Waleed Al-jubayr +966 11 2256146 W.aljubayr@aljaziracapital.com.sa Sultan Al Kadi, CAIA +966 11 2256374 s.alkadi@aljaziracapital.com.sa Muhanad Al-Odan +966 11 2256115 M.alodan@aljaziracapital.com.sa Jassim Al-Jubran +966 11 2256248 j.aljabran@aljaziracapital.com.sa BROKERAGE AND INVESTMENT CENTERS DIVISION General Manager Brokerage Services & sales Alaa Al-Yousef +966 11 22566 a.yousef@aljaziracapital.com.sa AGM-Head of Sales And Investment Centers Central Region Sultan Ibrahim AL-Mutawa +966 11 2256364 s.almutawa@aljaziracapital.com.sa AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa +966 11 2256277 lalmutawa@aljaziracapital.com.sa AGM-Head of Qassim & Eastern Province Abdullah Al-Rahit +966 16 3617547 aalrahit@aljaziracapital.com.sa AGM- Head of Western and Southern Region Investment Centers Mansour Hamad Al-shuaibi +966 12 6618443 m.alshuaibi@aljaziracapital.com.sa RESEARCH DIVISION AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. 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