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Analysis: State investors help plug Saudi's yawning deficit

Davide Barbuscia and Yousef Saba
·5-min read
FILE PHOTO: The spread of the coronavirus disease (COVID-19), in Riyadh

Analysis: State investors help plug Saudi's yawning deficit

FILE PHOTO: The spread of the coronavirus disease (COVID-19), in Riyadh

By Davide Barbuscia and Yousef Saba

DUBAI (Reuters) - Saudi Arabia is increasingly relying on state-owned investors to finance itself amid the coronavirus pandemic, a strategy that raises questions about how exposed ordinary Saudis could be to a sovereign shock.

The government-backed institutions - namely the pension fund and insurance agency - have seen their domestic debt holdings nearly double in the first six months of this year as Riyadh finances a yawning budget deficit through bond sales.

Their ultimate exposure to Saudi Arabia Inc, however, remains under wraps because the government does not provide comprehensive and up-to-date breakdowns of their investment holdings or their returns.

"In normal times the funding of the government from its own related entities may cause concern over transparency of the ultimate debt figure and over the autonomy of those related entities," said Hasnain Malik, head of equity strategy at Tellimer.

"However, this concern over the total liabilities of all government entities has existed for some time in other parts of the GCC (Gulf Cooperation Council) and funding very large fiscal deficits probably requires some unorthodox tactics."

Using local debt to finance deficits and having state funds investing in it is quite common across emerging and developed economies, and it has some benefits, such as reducing currency mismatch risks, investors and analysts say.

In Saudi Arabia, the move also has the advantage of not soaking up banks' liquidity, which happened after the 2015 oil price crash, when government debt issuance pressured Saudi banks.

At the same time, it could make Saudis who are reliant on the Public Pension Agency (PPA) and the General Organization for Social Insurance (GOSI) "over-exposed to Saudi sovereign risk, which would become problematic if Saudi government securities underperform other domestic or international investments," said Krisjanis Krustins, a director in Fitch's sovereign team.

The Saudi government, asked whether authorities encouraged state institutions to increase their exposure to government debt, told Reuters demand for local sovereign debt increased this year across investor types due to market volatility in other asset classes.

It said indebtedness is updated on a quarterly basis to reinforce market transparency, and that demand for local debt helped it manage supply levels in the foreign markets, therefore protecting credit spreads. It did not respond to questions on GOSI and PPA's investment portfolios.

RISING DEBT

The coronavirus pandemic has led central banks across the world to add local assets to their portfolios and, more generally, to a greater state involvement in the economy.

Saudi Arabia, the world's largest crude exporter, was hit especially hard by the economic fallout from COVID-19. Lower oil revenues blew out the government deficit, more than doubling Saudi Arabia's funding needs this year to $85 billion, according to Moody's.

In the early phases of the crisis, Riyadh raised its public debt ceiling to 50% of GDP from 30% to have more fiscal leeway. It also transferred $40 billion from central bank foreign reserves to fund investments by sovereign wealth fund Public Investment Fund.

A chunk of the new funding was covered by institutions such as the PPA and the GOSI, which fund state employees' retirement income and social welfare benefits for ordinary Saudis respectively.

PPA and GOSI, which did not respond to Reuters requests for comment about their investments, do not provide a detailed breakdown of their finances. This is not unusual in the Gulf but when compared to similar agencies across developed and emerging markets, Saudi disclosures lag.

Government institutions' holdings of domestic debt increased to 166.9 billion riyals ($44.50 billion) by the end of June from 92 billion riyals at the end of last year, while Saudi commercial banks' exposure to government domestic debt rose by just over 20 billion riyals in the same period.

STATE LINKS

Riyadh has increasingly used debt to fill state coffers since oil prices crashed in 2014-2015 but debt levels, expected to hover around 32-33% of GDP in the coming three years, are considered still relatively low.

The finance ministry has said it expects the government deficit to spike to 12% of GDP this year from 4.5% last year.

According to Garbis Iradian, chief economist for the Middle East and North Africa at the Institute of International Finance, some $25 billion of this year's fiscal deficit - which he estimates at around $72 billion, or 10.2% of GDP - will be financed from domestic banks and institutions such as the national pension and insurance agencies.

The rest will be covered by tapping official reserves for an amount of $32 billion, and with $15 billion in external funding, he said.

"The strategy of developing the local debt market to reduce dependency on external instruments is good. It's encouraging and doing all the right kind of things," said Tim Ash, senior emerging market sovereign strategist, BlueBay Asset Management.

But he said his fund had not invested in the domestic market because of wider concerns over the stability of regional currency pegs. The Saudi riyal is pegged at 3.75 to the dollar in the spot market, but the currency saw some volatility in the forwards market this year as oil prices dropped.

For Rachel Ziemba, adjunct senior fellow at the Center for a New American Security, a Washington think tank, the active involvement of domestic pools of capital in financing the deficit is a "source of resilience," and similar moves in other emerging markets have helped offset the impact of capital flow volatility.

"My big concern is less the deployment of state stockpiles, which are there for a rainy day, and more a concern about whether transparency about government spending and links between state-linked entities will be worse," she said.

($1 = 3.7504 riyals)

(Reporting by Davide Barbuscia and Yousef Saba; additional reporting by Tom Arnold in London; Editing by Carmel Crimmins)