OREANDA-NEWS. September 14, 2015.

Tim Callen, Mission Chief, IMF
Wafa Amr, Senior Communications Officer

MS. AMR: Good morning everybody. Thank you for joining us today for the Conference Call on the Conclusion of the Article IV Consultations for Saudi Arabia. Tim Callen, Mission Chief for Saudi Arabia, will be making a presentation and then take your questions.

MR. CALLEN: Thank you, Wafa, and good morning from Washington, and thank you everybody for joining us. I want to start by just briefly highlighting five important messages from the 2015 Saudi Arabia Article IV Report that we are releasing today, and after that I'm then available to answer any questions that you have.

And the first message from the report is that growth in Saudi Arabia remains favorable. We do expect growth to slow this year compared to 2014, but we expect it to remain robust at 2.8 percent. And the recent set of the GDP Outcome, which clearly came out after our report was finalized, and the increase in oil production, mainly in that growth turns out to be somewhat stronger than we had projected in the report. So the Saudi economy is continuing to do quite well despite the oil price drop.

The second message is that banking system is well placed to cope with lower oil prices and slower growth. While the banks will certainly face a more challenging operating environment in the period ahead, profits are strong, capital ratios and provisioning levels are high, nonperforming loans are low, and banks are very liquid.

Additionally, Saudi will continue to strengthen its supervision and regulation of the banking sector, all these factors mean that banks are in a strong position, in our view, to weather a period of lower oil prices and weaker growth.

The third message is that the drop in oil prices means that the government needs to adjust its fiscal policy. Our estimates are that the government's fiscal deficit will be around 20 percent of GDP this year.

The good news is that over the past decade the government has built up substantial bank deposits and reduced its debt to very low levels. These deposits can be run down and new debt issued to avoid the sharp adjustment in government spending that could hurt growth.

Nevertheless it's substantial and sustained fiscal adjustment will be needed over the next few years. If this doesn’t happen the fiscal buffers will be quickly eroded, and fiscal risks over time will rise. The buffers buy time, but they do not mean that adjustment can be avoided.

The needed fiscal adjustment, in our view, should include an expansion of non-oil revenues, improved efficiency of public investment, energy price reform and firm control of the public sector wage bills. The latter means limiting the growth in government employment, and decides the future salary increases, but it doesn’t mean cutting salaries.

The fourth message is that the exchange rate peg continues to serve Saudi Arabia well. While there has been some speculation about the exchange rate in recent weeks, our message is that no change is needed. The peg is helping to deliver monetary policy credibility and low inflation, and in our view, a more flexible exchange rate regime would have few benefits given the structure of the Saudi Arabian economy particularly the currently heavy reliance on oil.

SAMA continues to have very large foreign exchange reserve to support the peg as well, therefore we believe the exchange rate peg remains appropriate to Saudi Arabia. The second final message is that the decline in oil prices puts an even greater emphasis on labor market and other reforms, to switch the focus of growth away from the public sector and towards the private sector.

While the employment of nationals in the private sector has been increasing in recent years, more needs to be done to encourage nationals to work in the private sector, continued efforts are needed to strengthen education and training, as well as to make it clear that further increases in public sector employment are not going to be an option going forward.

More also needs to be done to diversify the economy away from oil and create high productivity, high-paying jobs in the non-oil trade sector. An increase focus on attracting foreign investments, and encouraging exports could help here.

So, with those brief remarks, I'm now happy to take any questions that you have on the report. Thank you.

QUESTIONER: Good afternoon. I have two questions to Mr. Callen. The first question, before one week, to the visit of the King Salman Abdulaziz to USA, he made declaration that Saudi Arabia is ready to open widely the investment for the foreigner companies to invest with Saudi Arabia. I want Mr. Callen to comment on this. The second question, how the situation of the Saudi economic, after the decline in oil prices in the international markets? Thank you.

MR. CALLEN: Thank you for those two questions. Let me take them in order. I think first of all, the opening up for foreign investment is very important for Saudi Arabia. I think it's one of the ways that the economy can benefit from international technology, and international financial flows coming in over time, and we would expect that, I think, to improve productivity in the domestic economy, and should also improve employment prospects as well. So, I think foreign investment is something that they are opening up further as foreign investment is something we would -- we very much welcome.

In terms of the impact of the decline in oil prices, I think to date we've clearly seen some impact in terms of slowing credit growth, slowing deposit growth, decline in equity prices, but the impact on growth itself has been, so far, relatively limited. We've seen some slowing, clearly relative to early 2014, but as I said in my opening remarks the economy is still growing at a fairly robust pace.

I think the biggest impact has clearly been on the fiscal side where we are expecting a very large fiscal deficit of around 20 percent of GDP. So, in our view, the government will need to start adjusting its expenditure, and we do think that that will result in a slower growth environment particularly next year.

QUESTIONER: Thank you very much.

MR. CALLEN: Thank you.

QUESTIONER: Hi, Tim. Two questions, the first is, you spoke about the need to adjust the fiscal position, and particularly in terms of the government wage bill, realistically, and I'm sure you’ve been speaking to the Saudi Authorities about this, realistically how long do you think it might take to introduce such adjustments in ways that would start to be meaningful?

And secondly, you talked about domestic energy prices, I think, is that a conversation that you’ve had with the government in terms of subsidy reform, and what kind of advice have you been giving them?

MR. CALLEN: Okay. Very good. Thank you for two very good questions. So, let me take the public wage bill to start with. And I think the first point I want to make here is that we are not calling for any cuts in public sector wages. I know that, particularly in social media that there were a lot of stories on that side when the press release came out, but that is simply not the case.

What we've been saying is that now is a good time to take a -- to undertake a review of the whole civil service in Saudi Arabia, and to look at those, you know, positions that are really needed for, you know, sort of implementation and provision of public services, and the government economic and social programs.

And then to try and identify those positions that may not be so essential, and then over time reducing those positions as people retire from the civil service. One of the things we've highlighted in recent years is that the public sector wage bill in Saudi Arabia, as a percent of GDP, is quite high compared to other oil exporting countries. So, we do think there is some scope, over time, to reducing the wage bill.

On energy prices, I think the government is certainly looking at this area, clearly a number of other countries within the GCC have already moved with energy price reform, and I think the Saudi Government itself is looking at this issue.

I think our position on this is it’s very important to have a comprehensive program for energy price reforms that would basically set out, you know, sort of what is the current cost of the energy -- the low energy prices at the moment? What would be the benefits to reform? Look at how the reforms would impact both your households and businesses. Identify those households and business who would be most affected, and then look for ways of helping those people to adjust.

So, on the household side clearly, you are looking at strengthening the safety nets for low and middle-income households. And on the corporate side, it can be those energy-intensive industries, you know, sort of supporting them as they look to improve productivity, and reduce their energy consumption.

The message, if I sum it up in one sentence, if we think higher energy prices are needed, there will be, you know, benefits to that group on both the fiscal side, and also in terms of reducing the growth of energy consumption, but it needs to be done as a complete package, and well communicated to the public. Thank you.

QUESTIONER: Thanks very much for doing this call. Tim. I just wanted to get some context from you. This fiscal deficit of almost 20 percent, how does that fit in historically? Have the Saudis been in this position before? And secondly, how big are these buffers you are talking about, the deposits that they can use? How long might they be able to finance the deficit of 20 percent of GDP?

MR. CALLEN: All right. So, on the first question, yes, clearly the Saudis have been in this position before. I mean, if you go back to the -- you know, the period of the drop in the oil prices in the first half of the 1980s, deficit of over 20 percent of GDP were recorded in a couple of years. A couple of years those were, but there certainly have been deficits of this sort of size.

And I think one of the -- you know the thing, as well, to note is that there was, in the report we are clearly talking about a very large fiscal adjustment that the Saudis did achieve a fiscal adjustment of similar size during this period. So, they have been there before, and they have, sort of managed to make these adjustments.

In terms of the size of the buffers, I think that depends, you know partly, clearly, on how you measure the buffers. I mean, if you start at the beginning of this year the government had deposits in the banking system of around 55 percent of GDP, and its government debt was paid down to about at 1.5 percent of GDP. So, if I look at how long it would take me to run through the deposit in the banking system, I would probably be looking at, you know, sort of four or five years using the deficit parts that we have in report.

Of course, you know, they also then, and already beginning to, you know, tap ability to borrow as well, given their very low, you know, debt levels at the moment. So, it seems they could borrow to, you know, 60, 70 percent of GDP, then that will clearly extend the horizon which they would last; but I should also point out of course, you know, that we do in the report already assume some degree of fiscal consolidation happens over the medium term. If that doesn’t happen in the deficit phase around this year's level of, say, 20 percent of GDP, then those buffers are going to be exhausted much more quickly than that. Thank you.

QUESTIONER: I just wanted to ask you, if you can say a bit more about what the impact of the study, the military operations in Yemen, how do you see it impacting the economy? I saw a couple of references to it in the document, but I wanted to hear a little bit more what -- you know, what you think of both where it's going, and how much it's cost to date? And what the impact is?

MR. CALLEN: Yeah. I mean, I don’t have the information on that to be able to, you know, to give you a definite or clear answer. I mean, I think it's, you know, clear that the operations are going to have a fiscal cost, it's going to be one of areas of pressure on the budget as we move forward while the operations continue, but I have nothing more specific I can give you on that.

QUESTIONER: Okay. And I mean, also do you think, when the operation ends that there will be continued costs? Are there -- they’ve already made some humanitarian commitments, but I don’t know if we can trust it. Things like, a large part of Yemen has been destroyed, so I just wonder, is that part of your analysis or not?

MR. CALLEN: No. We haven't -- we haven't looked at that angle of it. No.

QUESTIONER: Okay. All right. Thanks a lot.

QUESTIONER: Hi. I just wanted to clarify something from your previous answer.

MR. CALLEN: Sure.

QUESTIONER: Is this the first time we see a deficit like this since the 1980s? Thanks.

MR. CALLEN: Yes. That’s right. I mean, I think if you -- you know, if you -- there was a large deficit in the -- a large fiscal deficit in the -- you know, basically the second half of the 1980s and into the very early '90s, and then the deficit, you know, declined and moved into a surplus in the 2000s, and now moved back into deficit, yet.

QUESTIONER: Okay. Thank you.

QUESTIONER: I just wonder whether you heard, or seen Abraham and Assaf Declaration on Sunday about spending cuts, and whether you felt that they showed that Saudi Arabia was already starting to rationalize state spending in the way that you think is necessary? And whether they’ve had conversations with you about, you know, ways that that might happen? And then, another question on -- You talked about labor reform, and I just wondered whether there were any other areas of reforms that you’ve been talking to them about, aimed at strengthening the private sector? Thank you.

MR. CALLEN: Yeah, sure. So, on the first question, you know, clearly the Mr. Minister has suggested that the assets already being made in terms of trimming expenditure, we think that's, you know, in line with our overall recommendations, although we don't have details of exactly what has been looked at. But maybe let me take the opportunity here to say, well, I mean, one of the recommendations in the report is in terms of strengthening the fiscal framework in Saudi Arabia.

So I think, particularly, putting the budget in the medium-term context, and being clear about what the objectives the fiscal policy are, and I think this is one area where, you know, strengthening that and giving guidance on how the government is intending, you know, to tackle the currency fiscal deficit, is going to be very important in terms of setting expectations both for domestic businesses, who are obviously, you know, quite reliant on government spending, but also for financial markets.

In terms of other areas of reform, I mean, clearly we talk a lot about other areas of reform. I mean, I think the labor market reforms are probably, you know, in my view, are probably the most important on the structural side, but we've also been speaking about the housing market reforms. And also reforms in terms of strengthening the financial sector, and particularly one area would be the financing provided to small or medium-sized enterprises, which I think is an area the government is very set on addressing, and realizing that the SME sector is one area where, you know, in terms of greater private sector involvement, and greater employment of Saudis in the private sector, this is one area that needs to be expanded in the coming years.

MR. CALLEN: Thank you, all.