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The Impact of the Oil Price Decline on Saudi Arabia Economy Case Study

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Updated: Aug 7th, 2020

The Saudi Arabian economy is particularly susceptible to changes in oil prices since it is primarily oil-based and the country is the largest petroleum exporter in the world (“Saudi Arabia” par. 1). Hence, a significant and prolonged decline in oil prices will hurt multiple macroeconomic and socioeconomic indicators.

Fiscal Sector

A decline in the price of oil will result in a budget deficit, which, supported by the imbalance between state revenues and expenditures, will lead to an increase in national debt. When revenues are lower than expenditures, the fiscal balance becomes negative—in other words, a deficit occurs. During a financial recession, budget revenues decrease because business activity decreases. As a result, the deficit increases as the country loses its sources of revenue. When the main sources of revenue include governmental enterprises’ profits, taxes on foreign investments, and privatization profits, the country needs to increase the levels of oil production to balance the budget.

Currently, Saudi Arabia adheres to a low oil price policy to maintain its firm position in the market. However, if the country decides not to utilize its reserves, its adherence to low oil prices will lead to an increase in the national debt and will interfere with plans for further economic development and the creation of new sources of profit.

Inflation: Domestic Prices and Unemployment

Low oil prices can provoke a greater reduction of budget expenditures. Recently, the government cut fuel subsidies which equaled $107 billion in 2014 (Newton par. 1). As a result, gasoline prices increased nearly twofold compared to the previous year (Newton par. 2).

The increased prices result in a decrease in demand. When the potential production output is smaller than the actual output, a decrease in production supply takes place. Income reduction leads to a decline in production demand, and as a result, production volumes and quality of life decrease as well. To increase organizational cost-efficiency in the given circumstances, employers may reduce workplaces. In this way, the unemployment rate will grow due to the cyclic economic decline.

Domestic Prices Increase, Product Production, and Demand Decrease Ratio.
Figure 1: Domestic Prices Increase, Product Production, and Demand Decrease Ratio

Monetary Sector

As stated in the World Economic and Financial Surveys, low oil prices may provoke the devastation of the Saudi Arabian treasury within five years (77). As a result, the country’s monetary supply will be significantly decreased. As has been previously observed, a reduced monetary supply is related to changes in national production volumes, employment rates, domestic prices, and inflation.

The decrease in money supply is also interrelated with the growth of interest rates and a credit squeeze (World Economic and Financial Surveys 91). While the demand for money remains the same, the low supply of money makes bank loans less available to the population. The increased interest rates will affect entrepreneurs and organizations, while the inability to invest in the expansion of business operations will interfere with financial growth in both the public and private sectors. Moreover, high-interest rates are associated with the depreciation of assets’ values, as well as decreases in stocks and real estate prices (World Economic and Financial Surveys 26).

Correlation Between Monetary Supply, Interest Rate, and Credit Availability.
Figure 2: Correlation Between Monetary Supply, Interest Rate, and Credit Availability

External Sector

Currently, Saudi Arabia struggles with external payment balancing due to a decline in prices of oil when the total oil sales comprised over 70% of national revenue (Newton par. 1). The current state budget deficit is over $90 billion, and a big negative balance brings on the risk of external debt increase (“Saudi Arabia Reveals Cuts Plan” par. 1). To develop a positive payment balance, the country should utilize its accumulated financial reserves and significantly reduce governmental expenditures. Moreover, budget-balancing may require foreign investments. As a result, Saudi Arabia’s budget deficit may significantly increase by 2021.

The predicted payment balance position associated with the adherence to low oil prices may be regarded as a temporary deviation, but, at the same time, it entails the risks of developing a prolonged structural deficit. A significant budget deficit can also provoke a decline in the exchange rate. However, even if Saudi Arabia will ultimately balance its budgets, the country will have to pay off its huge external debt.

Exchange Rates

Saudi Arabia supports the adherence of its currency to the dollar, and in the circumstances of an oil price decline, the country is obliged to spend financial reserves not only on the reduction of the budget deficit but on the maintenance of adequate currency exchange rates.

A further reduction in Saudi Arabia’s currency reserves may occur by 2021. In 2004, the price of $25 per barrel was required to balance the state budget, but today this indicator sits at $105 (Holodny par. 1). It is important to reduce expenditures, but even doing so, it will be hard to bring back the country’s previous financial state. The scenario of the devastation of reserves seems more realistic. Such a prediction is not surprising, as even now it is possible to observe a significant decline in Saudi Arabia’s volume of currency reserves.

Fiscal Breakeven Price ($/ bbl) per Production (mmb/d).
Figure 3: Fiscal Breakeven Price ($/ bbl) per Production (mmb/d)

Social Sector

Saudi Arabia’s major governmental expenditures are meant to cover the needs of public administration, infrastructure support, public health and social support, budget support provision, education, military, and security. A drastic reduction of expenditures related to social support and subsidies is correlated with the risk of a deterioration in the general population’s quality of life. Hence, public discontent may arise. However, expressions of public discontent may be held back until the government invests in national security given the region’s ongoing international conflicts and the risks of political and military destabilization.

Works Cited

.” The Guardian.

.” Forbes, 2015.

Holodny, Elena. “Here are the Break-Even Oil Prices for 13 of the World’s Biggest Producers.” Business Insider, 2015.

Newton, Jennifer. “Petrol prices to go up by FIFTY PER CENT in Saudi Arabia after the nation suffers record $98 billion budget deficit for 2015 – but it still only costs 16p per liter!” MailOnline, 2015.

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IvyPanda. "The Impact of the Oil Price Decline on Saudi Arabia Economy." August 7, 2020. https://ivypanda.com/essays/the-impact-of-the-oil-price-decline-on-saudi-arabia-economy/.

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IvyPanda. 2020. "The Impact of the Oil Price Decline on Saudi Arabia Economy." August 7, 2020. https://ivypanda.com/essays/the-impact-of-the-oil-price-decline-on-saudi-arabia-economy/.

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IvyPanda. (2020) 'The Impact of the Oil Price Decline on Saudi Arabia Economy'. 7 August.

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