Why Cheap Oil Is A Threat To Saudi Arabia: Fitch Downgrades Credit Rating, Warns Of Geopolitical Risk

The credit rating agency Fitch downgraded Saudi Arabia to AA-minus on Tuesday, citing low oil prices and a widening government deficit. But Fitch’s downgrade also came with more ominous warnings for the kingdom.

The downgrade for Saudi Arabia is not terribly surprising, as the world’s largest oil exporter is heavily dependent on the production and export of crude oil for its revenue and has suffered economically due to the rapid decline in oil prices. The price of petroleum in June 2014 was $114 a barrel, and though prices have rebounded to the current price of around $43 a barrel, oil is still worth less than half of what it was two years ago. It also comes hot on the heels of other downgrades from credit rating agencies in recent months, including Standard & Poor’s.

Seeking Alpha reported that the increasing Saudi deficit and ongoing budget crisis remains concerning as the deficit increased from 2.3 percent of GDP in 2014 to 14.8 percent in 2015.

“Saudi Arabia posted a budget deficit of $98 billion for 2015. Revenues were $162 billion. Spending was $260 billion, 13% higher than budget. Their budget for 2016 projects revenues of $137 billion and spending of $224 billion, resulting in a deficit of $87 billion. But KSA has a history of exceeding its budgeted spending. If there is a similar overrun of 13% this year, the deficit would be $120 billion.”

The decline shows no signs of letting up. The press release by credit analysts at Fitch mentions that the agency’s outlook on the Saudi economy remains negative, which may signal possible further downgrades in the near future. Fitch’s estimate was partially based on its prediction that oil prices will average about $35 per barrel in 2016 and $45 per barrel in 2017.

“The downward revision of our oil price assumptions for 2016 and 2017 to USD35/b and USD45/b, respectively, has major negative implications for Saudi Arabia’s fiscal and external balances,” said the Fitch release.

However, the Fitch downgrade went far beyond oil prices and budget deficit; it also came with foreboding warnings regarding political uncertainty, social unrest, and geopolitical risks for the kingdom, mentioning the rising tension between Saudi Arabia and Iran in particular.

“Tensions have risen between Saudi Arabia and its long-standing regional rival Iran, and are expected to persist, although a direct confrontation is highly unlikely. Saudi Arabia’s military intervention in Yemen and in Syria shows a greater assertiveness in foreign policy,” it wrote, according to CNBC.

Fitch raised concerns about the fact that power over economic policy in the country has been concentrated in the hands of Prince Mohamed bin Salman, the defense minister, chairman of the Council on Economic and Development Affairs, and second in line to the throne. While this has a positive aspect, in that it has streamlined decision-making, it has also made it more unpredictable.

Fitch also noted that “the degree of support for this accumulation of power from other parts of the royal family is uncertain.” CNN echoed these sentiments regarding one of the Prince’s ambitious projects to reduce Saudi economic dependence on oil exports.

“Earlier this month, the deputy crown prince outlined bold plans to build a mega $2 trillion investment fund to help wean his country off its heavy reliance on oil. But Fitch said that it’s not clear whether the deputy crown prince has built a consensus around his initiatives.”

CNN reported that the kingdom has already “introduced deep spending cuts, cut subsidies, and even slashed its foreign scholarship program in an effort to control spending.”

Deficits in countries across the region have gone up due to the lower oil prices, which forces governments to dig deeper into their coffers. The Saudi downgrade also comes ahead of a meeting in Doha, Qatar, this weekend, where major oil-producing countries in attendance will debate a possible production freeze of oil.

Currently, 90 percent of Saudi Arabia’s budget comes from the sale of crude oil.

[Photo by Bruno Vincent/Getty Images]