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Shrinking oil sector pushes Saudi Arabia into recession

18 October 2017 Coface

Saudi Arabia’s economy fell back into recession during the second quarter of 2017, with a contracting oil sector and a stagnating private sector. The economy contracted at an annual rate of 1% in the second quarter of 2017, after shrinking 0.5% during the previous three months.

Contracting oil sector: The oil sector, which accounts for 44% of the country’s GDP, shrank by 1.8% in the second quarter of 2017, compared to the second quarter of 2016. In the first half of the year, the oil sector contracted by 2%. The sector was affected predominantly by the OPEC agreement implemented in November 2016, which consists of holding back oil production in a bid to lift ailing oil prices. In May 2017, oil producers agreed to extend the agreement for another nine months. Under this agreement, Saudi Arabia has agreed to keep its crude oil production below 10.1m barrels per day (b/d) compared with 10.5m b/d in 2016. The kingdom’s oil production fell as low as to 9.97m b/d in the second quarter of 20171.

Public sector struggles: The public sector accounts for 16% of GDP, but only expanded by 1.0% in the second quarter of 2017 from a year earlier. Lower energy prices forced the government to implement austerity measures based on a combination of spending controls, and increases in taxes and utility fees. If the government had not decided to remove some of these measures in April and June, public sector growth would have been even weaker.

Ailing non-oil private sector: The non-oil sector (39% of GDP) has struggled to regain traction, expanding by only 0.4% in the second quarter of 2017 from a year earlier. Ongoing government efforts to cut spending on a number of infrastructure projects are putting pressure on non-oil activity.

Risks

Oil sector performance will continue to represent a drag on the kingdom’s economy. The OPEC agreement, planned to end in March 2018, is expected to be extended in a bid to support sluggish oil prices. The Saudi economy is unlikely to receive a boost from its oil sector until the end of the OPEC agreement, which may be extended even further.

Non-oil sectors will continue to remain subdued. Fiscal consolidation and weakened consumer and business sentiment due to lower energy prices will likely continue to weigh on the nonoil sectors. Evidence of this situation has been seen in the construction sector (4.6% of GDP) which contracted by 1.6% year-on-year (YoY) in the second quarter.

During this period, the non-oil manufacturing sector also shrank by 0.2%, after expanding 3.9% YoY in the first quarter of 2017. Contraction of the retail sector by 0.1% YoY in the second quarter also suggests that consumer sentiment remains low, as households have been hit by the government’s austerity measures (although the government has reversed some austerity measures and reinstated benefits to civil servants and military personnel). Without further support from state spending, the private sector will continue to struggle.

This situation will especially impact consumer-driven sectors, such as automotive, retail, consumer electronics, and food. Substantially slower consumer spending will slow down the growth rate of food sales, but said rate would remain positive.

Unfavourable economic conditions will weaken growth performance of clothing, personal care and household goods sales. Automotive sales will also suffer from spending pressures, with declines in both commercial and private car sales. Spending on consumer electronics is also expected to decline due to the impact of austerity measures on the market.

Slow recovery in oil prices will prevent a sharp recovery in the government sector. Saudi Arabia’s fiscal breakeven oil price stands at $83.8 USD per barrel, far below the current market level of around $50 USD2. Pressure on public finances is therefore likely to remain in place, and would mean that the kingdom’s fiscal deficit would narrow to 9.3% of GDP in 2017 from 17.2% in 2016 as per the IMF. However, in these circumstances, it would take until 2022 for the deficit to narrow to less than 1%.

1. OPEC Monthly Oil Market Report, September 2017
2. Regional Economic Outlook: Middle East and Central Asia Update, IMF, April 2017

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