Saudi Arabia faces years of tough austerity as the worst oil price crash in the modern history forces the Arab country to make radical cuts to government largesse, the International Monetary Fund has warned.
The world's largest producer of crude oil will need to "transform" its economy away from oil revenues, which make up more than 80% of the government's wealth, according to Masood Ahmed, head of the Middle East department at the IMF, Yahoo reported.
The Saudi monarchy has already been forced to unveil the largest program of government austerity in decades as oil prices have collapsed by more than 70% in 18 months.
"This will have to be part of a multi-year adjustment process," Ahmed said. He urged the kingdom to reform its generous system of oil subsidies and introduce a host of new taxes, including consumption levies such as VAT.
"There will have to be a major transformation of the Saudi economy. It is necessary and it is going to be difficult, but it is a challenge which I think the authorities have clearly laid out", said Ahmed.
The warning comes as the world's weakest oil producing nations could buckle under the pressure of the price rout.
IMF officials have been in Azerbaijan this week amid fears Baku will need a $4 billion international rescue package to stave off a debt default.
Currency Peg
During the world's last major oil price crash in 1986, 17 out of 25 of the developing world's major oil producers defaulted on their debts, according to research from Oxford Economics. Debt mountains in producer nations ballooned by 40% of GDP on average.
"The 1980s precedents are alarming; producers that avoided sovereign defaults were the exception rather than the rule", said Gabriel Sterne, head of global research at Oxford Economics.
Azerbaijan was forced to abandon its foreign exchange peg with the dollar in December, after speculators caused the currency to crash.
The Saudis have been burning through their reserves at a record pace to protect the riyal's fixed value against a soaring dollar, and should continue to preserve the peg at all costs, said the IMF.
Ahmed said it was "neither necessary nor appropriate" for Riyadh to move to a floating exchange rate, forcing it to undertake record levels of expenditure cuts instead.
"The currency peg has served Saudi Arabia well. It's appropriate for the structure of the economy", he said.
His comments echo concern that any moves to jettison a stable currency, or embark on massive fiscal austerity, could erode the social fabric of the Persian Gulf Arab oil producing nations (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, UAE) five years on from the Arab Spring.
Need for Change
Saudi Arabia is set to slash subsidies on water and electricity, and must begin to overhaul its generous fuel subsidies for its 30 million people, recommended the fund.
"Energy price reform is key. It has been part of the social contract but that will now need to change," added Ahmed.
IMF calculations suggests Saudi Arabia could be running a deficit of around $140 billion, far above the government's own estimates of around $98 billion, or 15% of GDP.
But the country's relatively large fiscal buffers mean it remains one of the best placed producers to withstand an oil price rout which has been largely driven by its own policy to ramp up supply to punish higher-cost producers such as US shale.
"Commodity slumps are a prolific cause of sovereign distress", said Sterne. "Things could work out very badly this time round if commodity weakness persists."
Meanwhile, Bahrain also plans austerity steps to cut its budget deficit in line with IMF recommendations, its finance minister said on Saturday in comments that could help the island country sell its bonds when it returns to international markets later this year.
Bahrain is one of (P)GCC Arab oil states using the IMF's assistance to plan economic reforms as low crude prices put heavy pressure on state finances. The IMF is also providing valuable political cover for the painful reforms.
