The rally in oil prices coupled with a mere increase in oil production brought revenues up by 44.2 percent to reach SR735 billion in 2010, turning the fiscal balance into a surplus of SR108.5 billion (or 6.7 percent of GDP) compared to a deficit of SR87 billion (or -6.1 percent of GDP) in 2009. Expenditures hit a new record as the government continued its commitment to increase economic capacity through spending on social and physical infrastructure projects, according to the National Commercial Bank's (NCB's) special budget report "Fiscal Policy: Toward Sustainable Growth" released here on Tuesday.

The Arabian light average spot prices have reached $76.4 a barrel in 2010, a 29.5 percent increase compared to 2009 average prices. In addition, the increase in oil production, albeit benign, has supported revenues, with Saudi oil production averaging 8.3 million barrels a day this year, around 0.2 million barrels higher than last year's 8.1 million barrels.

Consequently, the published pre-closing figures for the current fiscal year ending December, showed total revenues of SR735 billion, of which SR669 billion represented direct oil revenues, a 56.4 percent above 2010 budgeted revenues.

The government has continued its expansionary fiscal policy to stimulate the economy and mitigate the effects of the financial crisis, on one hand, and to improve infrastructure, on the other. Actual expenditures are estimated to reach SR626.5 billion, representing 16.0 percent increase above budget. This is also the highest spending level on record and about 5.0 percent higher than actual expenditures in 2009. Although capital expenditures have trended upward since 2004, their contribution to total expenditures has remained around an average of 23.0 percent, in addition to falling short by 20 percent of whatever had been budgeted for during the past three years. Meanwhile, additional expenditure amounting to SR18.5 billion have been financed from excess surpluses of the period 2004-2006.

The current account increased to reach $69.6 billion (or 16 percent of GDP), compared to $21 billion last year, registering 231.4 percent increase due to higher oil export earnings. Imports also increased 0.7 percent to reach SR326.2 billion, compared to a drop of 17 percent last year. Over the first ten months of this year, net foreign assets with SAMA (Saudi Arabian Monetary Agency) have increased to $429 billion from $405 billion at the end of 2009, leaving official foreign reserves at a very healthy position covering more than 59 months of imports.

These assets will continue to provide an important buffer to protect the Saudi economy from volatility of oil prices or external financing difficulties.

Even though the government has more than enough reserves to pay off the entire debt, it opted out from such direction, especially that the cost of servicing the debt is currently low. "We do still believe that the government, justifiably, prefers rather to spend this money to finance expenditure plans at home or to diversify investments abroad. Evidently, it is important to keep a level of sovereign debt as a monetary tool to manage money supply and as a benchmark for pricing private corporate bonds and sukuk. Notably, SAMA undertook a proactive strategy this year and increased the issuance of treasury bills by SR21.4 billion in 2010 to replace matured government bonds, which amounted to SR12.5 billion, to avoid a surge in liquidity," NCB Group Chief Economist Said Al-Shaikh said.

The 2010-2014 ninth five-year development plan allocation of SR1.44 trillion to capital expenditures, 67 percent more than the previous plan, have underscored the government's commitment to prop up outlays to all sectors. The 2011's budget, in this context, continues to reflect the government's focus on long-term sustainable development that requires investment in infrastructure, health care, and social and economic development projects. As expected, human development (education and health) continued to be central to the aforementioned strategy, receiving 38 percent of total allocations.

The 2011 budget release estimates revenues and expenditures at SR540 billion and SR580 billion, respectively, projecting a budget deficit of SR40 billion.

Although the budget press release does not provide oil price and production level assumptions, we believe that both revenues and expenditures are understated. With our forecast of $80 per barrel for the average Arabian light spot prices and an 8.5 million barrels per day for average oil production in 2011, we project revenues and expenditures at SR753 billion and SR677 billion, respectively. This would lead in turn to a budget surplus of SR77 billion, or 4.2 percent of estimated GDP in 2011, the NCB report said.

The budget still focuses on capital expenditures; however, we believe current expenditures will increase as the government extends the 15 percent cost-of-living allowance for the year 2011. Out of SR580 billion, around SR324 billion or 55.9 percent is allocated to current expenditures, largely to pay for wages and salaries. The remaining SR256 billion is allocated to capital expenditures, representing around 1.5 percent decline compared to 2010. The budget prioritizes spending on physical and social infrastructure development, namely education and health. However, as reiterated earlier, and based on historical evidence actual capital expenditures will end up well below budgeted figures. Therefore, we project capital expenditures at SR203 billion in 2011, while current expenditures will be SR474 billion, the NCB report added.

The fiscal policy stance remains highly expansionary in the 2011 budget in both nominal and real terms. The impact of the fiscal stimulus will be even higher if we take in account funds allocated to specialized credit institutions. This reflects the government's commitment to expand the economic capacity and to enhance physical and social infrastructure to meet the burgeoning demand and employment needs by a youthful population.

"The robust fiscal and external positions and the elevated oil prices will allow the government to simultaneously sustain its capital spending plans and amass foreign reserves. Even if oil prices decline, the significant net foreign reserves coupled with a low level public debt will comfortably make it possible for the government to achieve its budgeted expenditures, " Al-Shaikh said.

The NCB report said "government will continue its endeavor to diversity the economy and reduce its dependence on oil. The flurry of project finance sponsored by the government from petrochemicals to power and water projects, indicating adamancy to shift to value-added industries. Going forward, We project real GDP growth of 4.0 percent for 2011, mainly driven by nonoil GDP as the private sector regain confidence and Saudi banks resume lending at pre-crisis levels."