Originally published on December 22, 2017 on The Irrational Observer.
On December 19, the Saudi government published its record fiscal budget of SR 978 billion for 2018 while revenues were at SR 783 billion. This has left the deficit at SR 195 billion for this year.
Four years ago, the fall of oil prices has put immense pressure on the Kingdom to reform itself. The figure below illustrates oil price fluctuations, the vertical lines are structural breaks. A structural break is when a time series abruptly changes at a point in time. The last break occurred in September 2014. The government has previously taken different fiscal strategies to mitigate the shock of continuously low oil prices.
In late 2016, the government resorted to austerity measures that saw a cut in ministries salaries, halted projects, planned to remove price support for energy prices, and removed many perks for employees who work governmental jobs. The figure below is the inflation rate of Saudi Arabia, we can see a large surge in mid-2015 and a plummet in 2016. The austerity measures can be seen and reflected in the inflation rate. First we see a rapid disinflation followed by negative inflation (deflation). Deflation indicates that prices of goods and services fall because supply exceeds demands. Usually because of a reduction in consumer spending or reduction in money supply. Nonetheless, the introduction of VAT and removal of energy price subsidies are ought to bring back inflation to more comfortable levels.
In a country like Saudi Arabia, where most Saudis are employed in governmental jobs and the private sector is overwhelmed with foreigners. The reduction in spending is usually trickled down to locals. What I mean is that people often mimic the government’s actions. As a result, people’s sentiment was, hold on to money and brace for impact. Yet this contagion can be toxic to an economy that is in trouble.
In economics, this behavior has a term. It was popularized by John Maynard Keynes and is called the Paradox of Thrift. It essentially means that individuals try to save more money during an economic recession (downturn), and that leads to a fall in demand and low economic growth. This is true if government spending and investments is not increasing. In other words, if everyone is saving no one is spending, and if no one is spending then no one is earning.
In theory, the increase in spending is a good thing. It is often the norm that governments intervene heavily during economic downturns to stimulate demand. The 2018 budget is a testament to this form of strategy. In other words, spend now as non-oil income grows and captures a larger share of economic output. Subsequently, the economy would be strong enough to sustain itself in the future. Already the Saudi economy has seen a whopping 38 percent increase in non-oil revenue year on year in 2017 (see figure below).
Nicholas Gregory Mankiw is best known in academia for his work on the New Keynesian economics. The figure below explains a theoretical approach to what we should expect to happen in the next few years in Saudi Arabia. This graph shows us that an increase in government spending shifts the planned budget upward which increases national income. In other words, things are going to get better economically and socially.
Despite these strategic budgeting, for many Saudis national debt is a cause of worry. They perceive that borrowing from others adds more problems to the economy than solutions.
However, debt issuance is not a terrible thing especially for Saudi. Debt issuance is source of funding that is used globally by almost all governments and institutions through a sophisticated and technical fashion. The presence of debt can be a signal of faith in the governments ability to honor these debts and lender confidence. Additionally, it is a sign that the government has faith in its people to be able to grow and prosper to pay these debts.
Thus, there is no logical justification for fearing debt. When you hear the debt to GDP is at 20 or 30% remember that the USA has 106% debt to GDP ratio, and in Japan, the debt ratio reached 245% and both of these countries are among the richest in the world.
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