As Saudi Arabia looks to cut spending, contractors and suppliers face greater competition and eroding profits
Deep beneath Riyadh, seven giant tunnel-boring machines are chewing through hard rock, constructing a mass transit system designed to solve the city’s notorious congestion. Meanwhile, above ground officials are scouring planned capital expenditure and looking for projects to cut, scale back or delay. Saudi Arabia’s finance minister Ibrahim Alassaf confirmed in an interview on 5 September that the government is actively looking to cut capital spending, with projects that have been approved years ago but have not yet started the first to face the chop. Key focus areas will be less affected. “Projects in sectors such as education, health and infrastructure are not only important for the private sector but also for the long-term growth of the Saudi economy,” said Alassaf.
But the official announcement this month may not be news to private contractors in the kingdom, who largely rely on government-tendered contracts. Project awards have been in “pause mode” since the oil price decline in 2014, says Santhosh Balakrishnan, research analyst manager at Riyad Capital, the investment arm of Riyad Bank. Contract awards in 2014 declined by 25 per cent on the previous year, while first quarter awards this year declined seven per cent, says Balakrishnan, quoting figures from MEED.
The steep drop in oil prices has put a sharp focus on Saudi Arabia’s spending habits, and according to an estimate from the IMF the central government faces a fiscal deficit of 19.5 per cent of GDP this year. Jadwa Investment has estimated a shortfall of around $109 billion. While the government is expected to issue up to $26.7 billion of bonds this year—and is drawing on its vast foreign reserves—cuts to spending have been seen as inevitable. Capital spending is the natural target: Not only is it bloated, having grown from $53 billion in 2010 to $94 billion in 2014, but it’s less politically sensitive than cuts to current spending, which includes public sector wages and subsidies. Current spending in the 2015 budget was increased by 18 per cent compared to the level budgeted for the previous year, while capital spending was slashed, according to a note from Jadwa Investments. Actual spending normally exceeds budgeted spending by a significant amount.
The ascension of King Salman to the throne this year makes unpopular cuts even less likely, says Camille Accad, a Kuwait-based economist with Asiya Investments, as the new sovereign looks to consolidate his popularity with measures that have included bonuses for public sector workers and military personnel involved in the campaign in Yemen. Likewise, efforts to boost revenue via new taxes or by cutting subsidies aren’t likely to be implemented within the next 2-3 years, he says. Instead, OPEC’s largest oil producer will look to raise its debt levels, which are among the lowest in the world, and 2016 will likely witness an acceleration of debt issuances if oil prices stay low, Accad says.
In a bid to make capital spending more efficient the new king has implemented a series of reforms including creation of the Council of Economic and Development Affairs (CEDA), headed by defence minister Prince Mohammed bin Salman Abdulaziz Al Saud, a rising star within the administration and son of the king. CEDA is tasked with approving any capital project with value greater than $26.7 million. While entities have their annual budgets set by the central authority, most line items now have to be individually approved as the year progresses, says James Reeve, deputy chief economist at Samba Financial Group. “[There’s] a general recognition that things have been wasted in the past and it’s time to tighten things up,” he says.
With spending in priority areas—infrastructure, healthcare, education and housing—less affected, it will be projects such as football stadiums and other “nice-to-haves” which won’t see the light of day, says Sachin Kerur, head of Middle East for Pinsent Masons. Anticipating a cut of 4-5 per cent in capital spending for 2016, Reeve says the scythe of spending cuts will swing wider, with many of the large economic cities to be “mothballed,” developments in Makkah and Madinah to be “slowed down,” while less important infrastructure such as the east-west landbridge or some of the proposed rail links, will be off the short-term agenda. “It’s those big projects that don’t have an immediate social benefit that are going to suffer.”
Copyright: UMS International Fz LLCTheme