Saudi Arabia's big welfare spending faces the oil abyss

Saudi Arabia forecast an annual budget deficit for the first time since 2011.

Here's why Saudi Arabia is burning through cash
Here's why Saudi Arabia is burning through cash   

If Saudi Arabia maintains oil production at current levels amid the oil price crash, then it's going to have to cut its budget — or it will likely be bankrupt by the end of the decade. The big issue is Saudi Arabia's big spending ways, especially increased government spending on social welfare programs.

According to the IMF, government expenditures in Saudi Arabia are expected to reach 50.4 percent of GDP in 2015, up from 40.8 percent in 2014. That increase can be attributed to two things: falling oil prices (it's bringing in less revenue) and an inflated budget (it's spending more money).

It's no secret that a large portion of Saudi Arabia's roughly 30 million people rely on the government for economic support. In February, the newly crowned King Salman doled out a reported $32 billion to the Saudi people in bonuses and subsidies to celebrate his ascension to the throne.

"We are a welfare society, so the population depends a lot on government subsidies, directly and indirectly," Abdullah Al-Alami, a Saudi writer and economist, recently told The New York Times. "But one day we are going to run out of oil, and I don't believe it is wise to be pampered and subsidized."

Street scene in Jeddah, Saudi Arabia.
Omar Salem | AFP | Getty Images
Street scene in Jeddah, Saudi Arabia.

Saudi Arabia is expected to run a deficit of more than 20 percent of GDP in 2015, according to the IMF.

The Saudi kingdom itself projected a 6 percent deficit in its 2015 forecast, but more importantly, this year marked the first time Saudi Arabia predicted a budget deficit since 2011.

Saudi Arabia budgeted at the beginning of the year for expenditures of $229 billion, a record level, but also the lowest level of spending growth since 2002. That figure is likely to be higher as actual spending typically outpaces the estimated number by, on average, 25 percent over the past decade. Last year the actual spend reached $293 billion. The 2015 forecast was based on a predicted $79-per-barrel price for Brent crude.

Budget woes across the OPEC nations
Low oil prices are creating budgetary and GDP pressures across many OPEC nations.

Gulf Producers (UAE, Kuwait, Qatar)

Oil production is at near record highs among the Gulf producers, and they may be able to keep it up. These countries still have fairly hefty reserves, which would enable them to run deficits over the next couple of years. According to World Bank data, the UAE had $78.4 billion in reserves at the end of 2014, Kuwait had $35.2 billion, and Qatar had $43.2 billion. The Economist reported that, in a bold move last summer, the UAE cut fuel subsidies, bringing fuel prices closer to market value. Since then, rumors have been swirling that some of its fellow GCC countries, like Kuwait and Qatar, will follow suit. According to the IMF, all of these countries are expected to post GDP growth in 2015.

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Of the budgeted total for 2015, 25 percent was allocated for education, 19 percent for health and social affairs, 7 percent for transportation and infrastructure, 7 percent for water and agriculture and 5 percent for municipal services. Meanwhile, 36 percent of expenditures were unspecified in the Saudi budget.

Saudi Arabia noted in its 2015 budget that while the forecast represented "almost flat growth, it nonetheless sends an important message to the private sector that the fall in oil prices will not prevent the government from implementing and expanding on its investment plans. High fiscal spending remains psychologically important for the private sector, in our view," it said.

Saudi reserves were approximately $736 billion coming into the year.

"Saudi Arabia can afford its oil regime and the economic status-quo in the near-term," Jean-Michel Saliba, an economist at Bank of America Merrill Lynch, wrote in a report in August. "However, the domestic macro costs of its unchanged policy choices are likely to become more acute and apparent."

Part of the problem is Saudi Arabia's growing population. The kingdom supported roughly 4 million people in 1960, and since then, its population has grown rapidly, to the 30 million population level it's at today. Although far-off population boom highs hit in the 1980s, Saudi Arabia's population growth rate is still positive, with the overall population increasing at around 2 percent per annum.

The House of Saud provides its citizens with housing, education, health care — even electricity tariffs tend to be low.

In addition to bonuses, Saudi citizens are not subject to a personal income tax and enjoy perks like subsidized gasoline. According to the International Energy Agency, gasoline prices in Saudi Arabia are less than 10 percent of average prices in Europe. And the IMF estimates that the kingdom spends about $60 billion subsidizing gasoline and other energy resources.

With a growing population and oil hovering around $40 a barrel, how long will it be able to sustain the status quo?

According to the IMF, Saudi Arabia's fiscal breakeven — the price per barrel of oil that it needs to balance its budget — was about $106 in 2014, and it is estimated to remain at about that level for this year as well.

"The simple truth is more people means more expense," said Simon Henderson, director of the Gulf and Energy Policy Program at the Washington Institute.

'Saudi may cut production a bit, but don't hold your breath'
'Saudi may cut production a bit, but don't hold your breath'   

To compensate, Saudi Arabia has turned to the bond market, issuing $5.33 billion in new debt, while tapping into its vast reserves. Domestic debt was only 1.6 percent of GDP at year-end 2014. Budget cuts seem like an obvious option, and the Saudi government has taken steps to pull back on infrastructure spending. But for a regime that had front row seats to the Arab Spring, scaling back benefits to its citizens probably doesn't seem too attractive — even if it means burning through its cash.

"There's an implicit contract," Henderson said. "In Saudi Arabia, it's you will respect our power, and we will provide for you."

The Saudi cabinet is stepping up efforts to cooperate with other oil-producing countries in order to stabilize the oil market, with this Friday's big meeting of OPEC nations likely to provide a key read on Saudi oil policy.

Ali bin Ibrahim Al-Naimi, the Saudi minister for petroleum and mineral resources, said in a recent statement, "Perhaps it would be fitting here to mention the role of the Kingdom of Saudi Arabia in the stability of the oil market, and its continued willingness and prompt, assiduous efforts to cooperate with all oil producing and exporting countries, both from within and outside OPEC, in order to maintain market and price stability."

"Saudi Arabia hasn't said they won't cut, but that doesn't mean they are going to increase production either," SEB analyst Bjarne Schieldrop recently told CNBC.

The Saudis and the Persian Gulf nations had indicated that they were willing to cut production if Iran, Iraq and non-OPEC countries participated too, evidencing a rift among OPEC nations that has existed for some time. On Friday, press reports indicated that OPEC would maintain its current production policy and no cuts would be mandated. Crude oil dipped below $40 a barrel. Iran specifically stated it would not consider any cuts until it returned to production levels from years before Western economic sanctions, and could add as many as one million barrels of production when sanctions are lifted.

By Kate Drew, special to CNBC.com