Wage cut reversal to support Saudi non-oil sector growth

Dubai: Saudi Arabia’s non-oil economy is expected to benefit from recent government decision to reverse the wage/benefit cuts that were introduced in September 2016 and impacted the allowances, financial benefits and bonuses of civil and military personnel.

“We do expect limited support to private consumption from May on the back of the reversal of the salary cuts. However, the indicators of non-oil activity remained lacklustre in the first quarter of 2017,” said Monica Malik, Chief Economist of Abu Dhabi Commercial Bank (ADCB).

The impact of the decision is expected to be modest on the economy with no material impact on GDP growth rates.

In the past two years, the Saudi authorities have responded to the sharp deterioration in fiscal accounts and low oil prices by launching fiscal reforms, with a focus on reducing government investment and fuel and electricity subsidies. Last September, fiscal adjustment measures were supplemented by cancelling bonus payments and cut in allowances for public employees.

Government spending, which was the main driver of growth in 2003-2014, was cut by a cumulative 20 per cent in the past two years.

“Such spending cuts were aimed at mitigating the impact of the sharp fall in oil revenue and avoiding further increase in the fiscal deficit, which reached $107 billion (Dh392.6 billion), or 16.8 per cent of GDP in 2016. However, large segments of the Saudi society, who were accustomed to generous public welfare, criticized the harsh fiscal measures. In this respect, the recent reversal of some fiscal measures signals the limits to further fiscal consolidation and that the monarchy is sensitive to public complaints,” said Garbis Iradian, Chief Economist, Mena, Institute of International Finance.

Limited boost

Fiscal adjustment and the sharp deterioration in consumer confidence have been taking toll on the nonoil economic activity. Nonoil real GDP growth decelerated from about 5 per cent in 2014 to -0.3 per cent in 2016, and continued to remain anemic in the first quarter of this year.

Economists see only limited boost to the nonoil sector from more money in the hands of consumers. “We now see some of the forecasted gradual strengthening in non-oil economic activity being provided by the reinstating of wages to the original levels. Thus, we maintain our real non-oil GDP growth forecast of 1.4 per cent in 2017, up from 0.4 per cent in 2016,” said Malik.

None of the drivers of domestic demand – private consumption, investment and government spending – have shown any indication of strengthening so far this year. Proxy indicators of household spending such as ATM withdrawals and point of sales transactions (PoST) together were up just 0.1 per cent year on year in the first two months of 2017 despite the higher oil price and absence of further announcements of fiscal reforms.

The wage cuts have been central to the flat spending backdrop. The weak consumer demand is also being reflected in the inflation data, with price discounting resulting in deflation in a number of inflation sub-components, including food, clothing and transportation. Meanwhile, project activity in 1Q remained lacklustre; the value of project awards falling by 0.5per cent year on year.

With the domestic demand remaining structurally soft, economists do not expect to see any big impact on domestic demand from the reinstating of wages.

“The impact will likely be limited, both in duration and magnitude. This is partly as a result of expectations of further fiscal reforms, which will likely temper the rise in positive sentiment,” said Shailesh Jha, and economist at ADCB.

Factbox: Fiscal reforms to remain on track

Saudi government’s decision to reverse the wage/benefit cuts that were introduced in September 2016 is unlikely to impact the fiscal reform package introduced by the Kingdom over the past two years.

“The sizeable fiscal consolidation efforts with more emphasis on nonoil revenue in 2017 and beyond should put the fiscal stance on a more sustainable footing in the medium term if oil prices recover gradually to about $60/bbl by 2020,” said Garbis Iradian, Chief Economist, Mena, Institute of International Finance (IIF).

The IIF expects the impact of the restoration of allowances and bonuses for public employees, which would add about $15 billion to the wage bill, is likely to be compensated by lower spending on infrastructure, further adjustment in fuel and electricity prices and higher oil revenues. Consequently, the fiscal deficit is expected to narrow to 10.5 per cent of GDP in 2017 and 5 per cent by 2020.

Economists expect one-third of the fiscal financing need to be met by tapping official reserves and the rest from external and domestic bank borrowings. While government debt will increase significantly, it will remain below 50 per cent of GDP by 2025, well below the peak of 97 per cent of GDP in 2002.