Saudi Arabia's Oil Sector: Economic Strength and Vulnerability

The oil sector plays a crucial role in the economic activity in Saudi Arabia. This is no surprise since Saudi Arabia possesses 18 percent of world oil proven reserves. Over the years, the oil sector contributed significantly to its economic activity and has been reflected in strong government expenditure among different sectors in the economy. While high oil revenues are certainly beneficial to oil producing countries (Saudi), it makes the Saudi economy vulnerable to price swings (see graph 1). From instance, oil prices were increasing during the boom years (2003 – 2014) and oil rents increased accordingly; however, the benefits of strong revenues soon faded in the wake of the global financial crisis 08/09 and recently in the crash of oil prices.

In fact, oil exports determines the expenditure, government revenues and foreign earnings, and these in turn are the primary deriver of aggregate demand. The IMF estimates that oil revenues account for about 90 percent of government revenues, 85 percent of export revenues and around 40 percent of overall GDP. Thus, low oil prices will translate sequentially into lower export revenues, lower government revenues, and lower of overall GDP. If the country continues at the same pace of expenditure as before the drop, this indicates that an imbalanced budget (i.e. budget deficit) will occur (see table 1.). To balance the budget, the government could use its fiscal arm to fill in the budget gap by raising taxes, restricting expenditure, cutting subsidies or bit of each. Raising taxes, reducing expenditure or cutting subsidies, the government will face pros and cons for each option. For instance, if the government chose to raise taxes (perhaps imposing taxes since the environment is tax free), consumers will have less disposable income to spend (not applicable under the VAT), inventories will likely increase and investment drops, and unemployment will likely rise. Secondly, if the government restricts expenditure the effect might to be different across sectors. To be specific, reducing expenditure on infrastructure might not be as negative as reducing it on health care. However, because the government expenditure plays a crucial role in the economy, it may not be very good to cut down spending, but instead could allocate the spending on the most needed sectors. Finally, the government could cut subsidies (fuel, electricity..), and this is what actually happened. The subsidies cut was a successful implementation at least on fuel