Saudi Arabia Economic Update

If investors were looking for a sign that Saudi Arabia is doing more than just pumping oil at a record pace to shore up its finances, they may have just got it.

The world’s biggest crude exporter is seeking advice on how to cut billions of dollars from next year’s budget because of the slump in crude prices, two people familiar with the matter said on Tuesday. The cost of insuring Saudi bonds against default fell for the first time in six days after the report.

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“Saudi Arabia is moving in the right direction at this point,” Steven Hess, senior vice president at Moody’s Investors Service, said by phone from New York on Tuesday. “We think that’s positive. We’ll have to see how that pans out over the next year or two.”

The kingdom is eating into 664bn of reserves as plunging oil prices and fighting in Yemen threatens to saddle the country with its biggest budget deficit in almost three decades. Brent oil is near a six-year low just as Saudi Arabia starts to tap the domestic bond market for the first time in eight years. Fitch Ratings Ltd cut its credit outlook on the country to negative last week, citing falling oil prices and lack of spending cuts.

Saudi credit-default swaps retreated to 100 basis points after the report that the government is studying spending cuts. The measure of how much investors must pay to insure against a Saudi default had doubled over five days to August 24, according to prices compiled by CMA. That compares with an average 43 basis-point gain for government debt in the six-member Gulf Cooperation Council, which includes Saudi Arabia.

The Arab world’s largest economy is expected to post a budget deficit of 97bn in 2015, Fitch estimates. Last year, the gap was 17.5bn, according to data compiled by Bloomberg. The country sold at least 35bn riyals (9.3bn) of bonds on local markets this year, turning to the capital markets for the first time since 2007.

Oil prices have dropped 58% in the past year as the 12-country Organisation of Petroleum Exporting Countries exceeded its production target at a time when the US hasn’t cut back. Saudi Arabia will probably keep output close to current levels to support government income, Fitch said in an August 24 report.

The country pumped a record 10.48mn bpd in June.

Moody’s rates Saudi debt Aa3, the fifth-highest investment grade, and has a stable outlook for the country. It can rely on government reserves and bond sales for a year or two before risking a downgrade, Hess said. That assumes oil prices stay at the current level of about 45 a barrel. Spending cuts could support the credit rating, he said.

Fitch on August 21 revised the outlook for the country to negative for the first time, from stable. Jan Friederich, a senior director at the ratings company, said he needed more details on the possible spending cuts to comment if it changes the outlook.

“In the situation of a declining oil price, a challenge for the government is can they make a significant effort to address that by cutting expenditures,” Friederich said. “So that’s what we are quite focused on. Are there going to be more substantial reactions in terms of expenditure adjustment over the next year?”

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