The Trade-off between dollar value and oil price on Saudi Arabia s economy

Transcription

1 The Trade-off between dollar value and oil price on Saudi Arabia s economy 1

2 Contents Introduction...3 Government expenditure rising steadily despite variation in revenue.. 4 Saudi revenues and expenditure dependent on variation in oil prices than value of dollar...4 Correlation of government revenue and expenditure with dollar index and oil prices...6 Dollar index and oil: A macro dilemma...6 Combining dollar index and oil price: A step-down analysis *...7 Spending data suggests a different trend...7 Factors affecting performance of Saudi stock market...8 Atypical correlation during Normalization of interrelationship between macroeconomic variables and TASI...9 Impact of oil price and currency fluctuations on Saudi trade balance...9 Consistent reduction in debt...11 Substantial foreign reserves to support government expenditure

3 Introduction The Kingdom of Saudi Arabia (KSA) s economy is heavily dependent on oil (the second-largest reserves globally), as income from oil exports account for over 9% of the revenue and forms approximately 5% of its GDP. Government expenditure/investments are driven by income from oil exports. Oil prices, which plummeted in 214, seem to have recovered slightly since January 215. However, it would be difficult for oil prices to touch triple-digits any time soon. This prompted us to examine the effect of oil price and dollar on Saudi Arabia s economy over the past three to four decades. Saudi Arabia has pegged its currency Saudi Riyal (SAR) to the US dollar (USD), as *: Saudi Arabia is a resource-based economy; its foreign exchange receipts and payments are predominantly in US dollars. A stable USD/SAR exchange rate is critical to encourage investments in Saudi Arabia. This would diversify its economy and help plan state budgets. Since, the exchange rate parity has been fixed at SAR 3.75 per USD, and the government has adopted a countercyclical fiscal policy to stabilize growth. During upswings in oil exports, the government runs a fiscal surplus. During downturns, the government utilizes its foreign exchange assets and boosts domestic spending by deficit spending. Saudi Arabian Monetary Agency s (SAMA) policy is aimed at long-term stability rather than short-term solutions. Historically, the relative value of the US dollar and the price of oil have been prominent factors in determining the level of Saudi Arabia s oil exports and public spending. Saudi Arabia s only stock exchange s performance, Tadawul, is relatively dependent on the oil sector and fluctuations in the value of the US dollar. We have attempted to analyze the impact of the fluctuations in oil price and the dollar index on the performance of the stock market and investments in Saudi Arabia. In brief, the study marks international oil prices as the key factor for Saudi government s income and expenditure, as well as demand from the leading industrial countries around the world. China oil imports increased dramatically in the past few years. Since 197 till present, comparing oil prices to the US Dollar strength (Strength Index) against other currencies, we found limited effect of Dollar strength on the Saudi government income and expenditure as compared to the effect of oil prices. Thus, though the inverse correlation between international oil prices and the strength of the US currency, this correlation is neutral to the kingdom on the long run, because the study clearly exhibits oil prices as the main factor for high/low government income and expenditure. AGM - Head of Research Abdullah Alawi a.alawi@aljaziracapital.com.sa * BIS Papers No 57, Monetary policy in Saudi Arabia 3

4 Government expenditure rising steadily despite variation in revenue Analyzing the Saudi government revenue and expenditure data from 197 to 213, we can observe two distinct phases: from 197 to 22, and 23 onwards. During , government expenditure largely moved in tandem with government revenues, which fluctuated with fluctuation in oil prices. Figure 1: Saudi government revenue and expenditure 1,4 Figure 2: Saudi government revenue and expenditure (SAR bn) from 197 to ,2 35 1, SAR bn Government rev. Government exp. Government rev. Government exp. After 23, oil prices started rising and peaked (c.usd 145/bbl) by mid-28. However, the global debt meltdown thereafter led to a stupendous fall in oil prices, which touched a low of c.usd 3/bbl by January 29. From February 29, oil prices started recovering steadily. Despite volatile oil prices during 23 13, KSA s government expenditure has risen steadily. During the period of high oil prices, the government accumulated significant amount of foreign reserves. Government would be utilizing these reserves to manage its expenditure while revenues are expected to remain low due to low oil prices. Figure 3: Saudi government revenue and expenditure (SAR bn) 23 onwards 1,4 1,2 1, Saudi revenues and expenditure dependent on variation in oil prices than value of dollar To analyse the impact of oil prices and dollar value on Saudi Arabia s revenues and expenditure, we went through data Government rev. Government exp. starting from 197. Since, change in oil revenues is primarily driven by three key variables i.e. change in oil price, volumes and dollar index, we have provided a graphical representation of % change in oil revenues impacted by % change in the above mentioned variables. Our analysis for data between 197 and 213 suggest that of the three variables dollar index has the least impact on the oil revenues. Thus, we can infer that change in government revenues and expenditure is primarily driven by oil prices and volumes. Low oil prices are expected to prevail in near to medium term which, according to the historical data, suggests that government expenditure henceforth would be driven by oil revenues. 4

5 Figure 4: Saudi government revenue and expenditure between 1971 and 1979 Figure 5: Saudi government revenue and expenditure between 198 and 3% 2% Yom Kippur war oil embargo % 1% 4 32 Iranian 5% Revolution 1% 1 % % 5-5% Iraq/Iraq War -1% -1% % Chg. in oil rev. % Chg. in oil prod. % Chg. in oil price % Chg. in oil rev. % Chg. in oil prod. % Chg. in oil price % Chg. in dollar index Government rev. (SAR bn) Government exp. (SAR bn) % Chg. in dollar index Government rev. (SAR bn) Government exp. (SAR bn) Figure 6: Saudi government revenue and expenditure between 199 and Figure 7: Saudi government revenue and expenditure between 2 and 29 1% 7% Gulf war A ian nan ial i i OPEC 1% quota increase % 11% US 9/ 11 attack Iraq war US debt meltdown % 18 7% 6 1% 12 3% 4-2% % % % Chg. in oil rev. % Chg. in oil prod. % Chg. in oil price % Chg. in dollar index Government rev. (SAR bn) Government exp. (SAR bn) Figure 8: Saudi government revenue and expenditure between 21 and 213 8% Arab spring 15 6% 12 4% 9 2% 6 % % % Chg. in oil rev. % Chg. in oil prod. % Chg. in oil price % Chg. in dollar index Government rev. (SAR bn) Government exp. (SAR bn) -2% % Chg. in oil rev. % Chg. in oil prod. % Chg. in oil price % Chg. in dollar index Government rev. (SAR bn) Government exp. (SAR bn) 5

6 Correlation of government revenue and expenditure with dollar index and oil prices To calculate the correlation between government revenue and expenditure with the dollar index and oil prices, we have considered data since 197. Correlation analysis * reveals that government revenue and expenditure are positively correlated with oil prices, while government revenue and expenditure are negatively correlated with the value of the dollar index. Thus, it can be inferred that high oil prices lead to higher government revenue and expenditure, while lower oil prices curb revenue and expense. Negative correlation with the dollar implies that a strong dollar has an adverse effect on government revenues and expenditure. Table 1: Correlation between government revenue with dollar index and oil price Government revenue Dollar index Oil price Government revenues 1. Dollar index Crude price Table 2: Correlation between government expenditure with dollar index and oil price Government expenditure Dollar index Oil price Government expenditure 1. Dollar index Oil price Figure 9: Movement of government revenue and expenditure with oil price and production (Indexed at 1 as of ) 18,1 16,1 14,1 12,1 1,1 Figure 1: Historical trend in GDP growth & inflation 25.% 2.% 15.% 1.% 1.% 8.% 6.% 4.% 8,1 6,1 4,1 2, %.% -5.% -1.% %.% -2.% -4.% Government rev. ( SAR bn) Oil production (bn barrels) Government exp. ( SAR bn) Oil price (USD/bbl) -15.% GDP growth (%) Annual inflation (%) -6.% 6 *Correlation is computed into what is known as the correlation coefficient, which ranges between -1 and +1. Perfect positive correlation (a correlation coefficient of +1) implies that as one variable moves, either up or down, the other variable would move in lockstep, in the same direction. Alternatively, perfect negative correlation means that if one variable moves in either direction, the variable that is negatively correlated would move in the opposite direction. If the correlation is, the movements of the variables are said to have no correlation; they are random. Between 197 and 213, Saudi Arabis s revenue and expenditure increased due to growth in oil exports from 1.2 bn barrels (bbls) to 2.8 bn bbls, and a rise in oil prices from USD 2/ bbl to USD 97/bbl. Saudi Arabia s average GDP growth during the period, thus stood at about 5%. After analyzing the inflation and GDP growth rate since 197, it can be inferred that inflation and GDP growth have been countercyclical to each other. This validates the official fiscal policy of the government, which aims to boost domestic consumption during periods of low oil revenue, which weighed on GDP growth. Dollar index and oil: A macro dilemma Oil accounts for c.5% of Saudi Arabia s GDP and c.9% of revenues. Thus, Saudi Arabia s revenues and GDP growth are directly driven by oil prices. Additionally, as Saudi Arabia s currency is pegged with the US dollar, the country s revenues are dependent on the dollar movement. Our analysis (for the period from to 213) suggests a correlation of -.56 between oil prices and the dollar index, indicating a relatively weak negative correlation.

7 Figure 11: Negative correlation between the dollar Index and WTI crude prices Figure 12: Step down correlation between government revenue and oil prices & dollar index % % % % Jan-14 Jan-14 Feb-14 Mar-14 Mar-14 Apr-14 May-14 May-14 Jun-14 Jul-14 Jul-14 Aug-14 Sep-14 Oct-14 Oct-14 Nov-14 Dec-14 Dec-14 Jan-15 Feb-15 Feb-15 Mar-15 Apr-15 Apr-15 May-15 Dollar Index (LHS) WTI oil price (USD/ bbl) (RHS) Source: SAMA, Aljazira Capital -4% -8% Net impact of oil price and dollar index YoY (LHS) Correlation (RHS) % Chg. in govt. rev. YoY (LHS) Source: SAMA, Aljazira Capital Combining dollar index and oil price: A stepdown analysis * We have analyzed the correlation between government revenues and oil prices/dollar index independently. As oil prices and the dollar are in turn correlated, it is pertinent to analyze the combined impact of these two variables on government revenues (over a period of three decades). We have calculated the yearly combined net impact as the sum of YoY change in average crude prices and YoY change in average value of dollar index. We have formulated a step-down correlation between YoY change in government revenues and YoY change in net impact of dollar index and oil prices. Our analysis suggests that a strong correlation of.84 exists between the two variables. This is different than the earlier independently calculated positive correlation of.98 between government revenues and oil prices and negative correlation of.55 between government revenues and the dollar index. It can be inferred that revenues are more affected by fluctuation in oil prices than fluctuation in the dollar index. Spending data suggests a different trend Generally, government expenditure is correlated with revenue dynamics. Despite volatile and commodity-cycle driven nature of revenues in Saudi Arabia, fiscal initiatives have played a significant role in keeping government expenditure relatively stable. In our step-down analysis, we have tried to find a correlation between the change in government revenues and expenditure. Our data suggests a positive correlation of.63, indicating a relatively weaker correlation compared with our earlier correlation between revenues and combined macro variables (dollar index and oil prices). 7 * By step-down correlation, we mean a correlation between the combined effect of two variables (dollar value and oil price together) and government revenues. We have called it a step-down correlation because rather than using actual unit values of the variables, we have used the combined effect of YoY % change in both the variables (dollar value and oil price). Combined effect is calculated by taking a sum of 1) YoY % change in average crude prices, and 2) YoY % change in average value of dollar index. This derived combined value is then used against YoY % change in government revenue to determine the correlation.

8 Referring to figure 8, the government spending pattern, particularly after 22, has largely stabilized despite significant change in revenue due to fluctuation in oil prices. However, if we analyze the data between and 2, we understand that government spending was directly correlated to government revenues, which were followed by changes in oil price. Government spending before 2 was cyclical, while after 2 it became countercyclical. This can be witnessed from figure 8, where government revenue has changed significantly due to variation in oil prices; however, government spending has remained largely stable. This provides confidence that in the future government spending would not be impacted significantly due to variation in oil price. Saudi Arabia has consistently resorted to countercyclical fiscal measures such as utilizing its foreign currency reserves or issuing debt to sustain public expenditure whenever oil prices have fallen, thereby impacting revenues. Particularly after 2, government spending has consistently increased despite a sharp drop in oil prices after the 28 global debt meltdown. Figure 13: Countercyclical fiscal measures helped maintain public spending Figure 14: Correlation of TASI with Government revenue positive correlation (Indexed at 1 as of June ) 12% 1. 1,4 1,2 8%.8 1, 4% %.4 4-4% %. Jun-94 Jun-95 Jun-96 Jun-97 Jun-98 Jun-99 Jun- Jun-1 Jun-2 Jun-3 Jun-4 Jun-5 Jun-6 Jun-7 Jun-8 Jun-9 Jun-1 Jun-11 Jun-12 Jun-13 % Chg.in govt. exp. YoY (LHS) % Chg. in govt. rev. YoY (LHS) Correlation (RHS) Source: SAMA, Aljazira Capital Factors affecting performance of Saudi stock market The Tadawul All Stock Index (TASI) comprises 169 stocks across 15 sectors. It was incorporated in. We have tried to identify the impact of government revenue, oil prices, and dollar index on the performance of the TASI index. TASI Government rev. ( SAR bn) Figure 15: Correlation of TASI with dollar index negative correlation (Indexed at 1 as of June ) 1,4 1,2 1, Figure 16: Correlation of TASI with oil price positive correlation (Indexed at 1 as of June ) 1,4 1,2 1, Jun-94 Jun-95 Jun-96 Jun-97 Jun-98 Jun-99 Jun- Jun-1 Jun-2 Jun-3 Jun-4 Jun-5 Jun-6 Jun-7 Jun-8 Jun-9 Jun-1 Jun-11 Jun-12 Jun-13 Jun-94 Jun-95 Jun-96 Jun-97 Jun-98 Jun-99 Jun- Jun-1 Jun-2 Jun-3 Jun-4 Jun-5 Jun-6 Jun-7 Jun-8 Jun-9 Jun-1 Jun-11 Jun-12 Jun-13 TASI Dollar index TASI Oil price (USD/bbl) Data analyzed from 23 reveals that the performance of the TASI index is positively correlated with the government s revenue and oil price, whereas it is negatively correlated with the dollar index. Thus, it can be inferred that strong government revenue, supported by high oil prices, positively impacts the TASI performance. 8

9 Atypical correlation during 23 6 Charts above indicate that the correlation of TASI with government revenue, dollar index, and oil prices during 23 6 was significantly low. We understand that all GCC markets reacted similarly during 23 6 and experienced a stock market bubble that collapsed subsequently. TASI gained over 8x between March 23 and February 26, while losing c.7% (from its peak) by the beginning of 27. Data suggests that over USD 48bn value was eroded during the collapse, which was equivalent to 14% of Saudi Arabia s GDP in 26. Relatively less mature market participants and extremely liquid monetary environment were the two key reasons behind the stock market bubble. Private sector investment (up from average of c.1% in 22 4 to c.39% in 25) in Saudi Arabia surged during This fuelled the liquidity-driven bubble. Normalization of interrelationship between macroeconomic variables and TASI Analyzing the correlation of TASI with the dollar index and oil price, and considering the historical trade balance data, it is evident that TASI s performance is positively correlated to oil prices and negatively correlated to the dollar index. Oil prices (WTI) increased from c.usd 46/ bbl since early January 215 to c.usd 56/bbl by the end of April (jump of c.22%), and oil is currently trading at c.usd 6/ bbl. The performance of TASI too has improved in tandem with the surge in crude prices. TASI rose from c.8,4 in early January to c.9,8 by the end of April (17% during January April 215). TASI s recent performance reiterates our hypothesis that its performance is positively correlated to oil prices. Impact of oil price and currency fluctuations on Saudi trade balance Saudi Arabia exports oil and imports base metals, machineries, mechanical equipment, and transport equipment. These constitute over 5% of its imports. Data analyzed between 197 and 213 reveals that the kingdom has never witnessed a trade deficit. However, trade surplus during the period widened or narrowed based on fluctuations in oil prices and exchange rates. Here, we analyze Saudi Arabia s trade balance with its major partners. We believe that oil prices and currency fluctuations had an impact on the trade balance between and 213. Figure 17: Saudi trade balance with the US (SAR bn) Figure 18: Saudi trade balance with Japan (SAR bn) % fall in oil price and 6% SAR depreciation against USD 231% rise in oil price 2% rise in oil price 35% fall in oil price Except for the initial couple of years starting, Saudi Arabia always had trade surplus with the US. The trade balance increased and decreased with changes in oil price. Currency fluctuations did not impact trade balance as the SAR was pegged against the USD since % fall in oil price & 46% 3% rise in oil price SAR depreciation & 6% SAR against JPY depreciation against JPY 383% rise in oil price & 14% SAR depreciation against JPY 35% fall in oil price & 1% SAR depreciation against JPY The Saudi Arabia always had trade surplus with Japan. However, during some periods, sudden appreciation of the Japanese Yen impacted trade balance. 9

10 Figure 19: Saudi trade balance with UK (SAR bn) Figure 2: Saudi trade balance with China (SAR bn) % fall in oil price and 9% SAR depreciation against CNY % rise in oil price and 16% SAR depreciation against CNY % fall in oil price & 24% SAR depreciation against GBP 5% rise in oil price & 9% SAR 22% rise in oil appreciation price & 13% against GBP SAR depreciation against GBP % rise in oil price and 26% SAR appreciation against CNY Particularly with the UK, Saudi Arabia always had trade deficit. Due to lower exports, oil prices did not affect trade balance with the UK. Saudi Arabia s trade with China picked up only after 2 due to rising energy consumption in China leading to higher oil requirement. Trade surplus benefitted due to rising oil exports to China, increasing oil prices, and lower impact from currency fluctuations. Figure 21: Saudi trade balance with India (SAR bn) Figure 22: Saudi trade balance with South Korea (SAR bn) % fall in oil price and 4% SAR appreciation against INR % rise in oil price and 1% SAR depreciation against KRW % rise in oil price and 4% SAR depreciation against INR % fall in oil price and 3% SAR appreciation against KRW 17% rise in oil price and 4% SAR appreciation against KRW Trade with India picked up since 2. Rising oil demand and prices increased the trade surplus. Trade with South Korea picked up since 199. Trade benefitted from rising oil price and appreciation of the SAR. 1

11 Figure 23: Saudi trade surplus supported by high oil prices with consistent reduction in debt 15% 8 Figure 24: Consistently rising government expenditure 1,5 12% 6 1,2 9% % 2 3 3% % Trade surplus (SAR bn) (RHS) Gross debt/ GDP % (LHS) -2 KSA expenditure (SAR bn) KSA revenue (SAR bn) Source: SAMA, Aljazira Capital Substantial foreign reserves to support government expenditure Rising oil prices from 2 led to a substantial growth in government revenues. However, the global debt meltdown in 28 and the subsequent fall in oil price led to a major revenue decline. Nonetheless, government spending was not impacted due to cushion from foreign reserves. In the current oil price scenario, Saudi Arabia s revenues are expected to be lower; however, foreign reserves would support government spending. 11

12 RESEARCH DIVISION AGM - Head of Research Abdullah Alawi a.alawi@aljaziracapital.com.sa Analyst Jassim Al-Jubran j.aljabran@aljaziracapital.com.sa Senior Analyst Talha Nazar t.nazar@aljaziracapital.com.sa Analyst Sultan Al Kadi s.alkadi@aljaziracapital.com.sa BROKERAGE AND INVESTMENT CENTERS DIVISION General manager - brokerage services and sales Ala a Al-Yousef a.yousef@aljaziracapital.com.sa AGM-Head of Sales And Investment Centers Central Region Sultan Ibrahim AL-Mutawa s.almutawa@aljaziracapital.com.sa AGM-Head of international and institutional brokerage Luay Jawad Al-Motawa lalmutawa@aljaziracapital.com.sa AGM-Head of Qassim & Eastern Province Abdullah Al-Rahit aalrahit@aljaziracapital.com.sa AGM- Head of Western and Southern Region Investment Centers & ADC Brokerage Abdullah Q. Al-Misbani a.almisbahi@aljaziracapital.com.sa AGM - Head of Institutional Brokerage Samer Al- Joauni s.aljoauni@aljaziracapital.com.sa RESEARCH DIVISION AlJazira Capital, the investment arm of Bank AlJazira, is a Shariaa Compliant Saudi Closed Joint Stock company and operating under the regulatory supervision of the Capital Market Authority. AlJazira Capital is licensed to conduct securities business in all securities business as authorized by CMA, including dealing, managing, arranging, advisory, and custody. AlJazira Capital is the continuation of a long success story in the Saudi Tadawul market, having occupied the market leadership position for several years. With an objective to maintain its market leadership position, AlJazira Capital is expanding its brokerage capabilities to offer further value-added services, brokerage across MENA and International markets, as well as offering a full suite of securities business. RATING TERMINOLOGY 1. 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