## _cr15286

## Source details

**Canonical URL:** [_cr15286](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15286.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15286.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15286.pdf.json)

---

### Summary findings: oil and interest-rate shocks
- Oil prices have fallen by over 40 percent since mid-2014.
- Oil revenues account for around 90 percent of central government fiscal revenues and around 85 percent of export revenues.
- The oil sector comprises over 40 percent of overall GDP.
- Government deposits in the banking system were equivalent to 56 percent of GDP at end-2014.
- Exchange rate peg: the riyal has been pegged to the U.S. dollar at a parity of 3.75 since 1986.
- SAMA moves its policy rates closely with the fed funds rate; an expected increase in U.S. policy rates will see SAMA also raise its policy rate.
- High liquidity levels in the banking system may slow pass-through of policy rate changes.
- The riyal’s nominal and real effective appreciations over the past year left the currency “at its highest level in real terms since 2003” despite the large terms of trade decline.
- Main takeaway: oil prices have typically played a bigger role than interest rates in affecting economic and financial outcomes in Saudi Arabia.

### Historical evidence: major oil-revenue decline episodes
- Three periods with oil revenues falling by 50 percent peak-to-trough: 1982–86, 1998–99, and 2008–09.
- Common responses across episodes:
  - Money and credit growth slowed.
  - Export receipts and government revenues fell.
  - Despite declines in imports and government spending, fiscal and external balances moved into deficit (or surpluses narrowed considerably).
  - Real GDP declined, driven by a substantial drop in real oil GDP as Saudi Arabia cut production.
  - Real non-oil GDP generally proved more resilient.
  - Equity prices declined and, with a lag, non-performing loans in the banking sector rose during the latter two periods.
- Episode-specific figures:
  - 1982–86:
    - Saudi oil production declined from 10.4 mb/d in 1981 to 3.5 mb/d in 1983.
    - Nominal oil revenues only returned to their 1982 level in 2004.
    - Real GDP dropped by a cumulative 25 percent from 1981–85.
    - Starting position: net financial assets tentatively estimated around 60 percent of GDP in 1980–81.
  - 1998–99:
    - Starting fiscal position: deficit of around 3 percent of GDP and outstanding debt of around 70 percent of GDP.
  - 2008–09:
    - Starting fiscal position: surplus of close to 30 percent of GDP and government net financial assets of around 45 percent of GDP.
    - Non-oil GDP growth remained around 5 percent in 2009.

### Transmission channels and empirical evidence
- Main transmission channels:
  - Lower oil revenues reduce fiscal space, transmitting to non-oil activity via fiscal policy, banking-sector channels, and confidence effects.
  - Key determinants: starting fiscal position and persistence of oil price decline.
- Empirical findings from cited studies:
  - Government size and fiscal policy are primary in determining oil price impact (Husain, Tazhibayeva, and Ter-Martirosyan (2008)).
  - Oil prices affect the economy strongly through government spending in Saudi Arabia (Alghaith et al (2014)).
  - Interest rate channel has a less significant impact; monetary policy effects are limited when tighter policy coincides with strong oil-driven growth (Sheehan and Russer (1995)).
- Historical Fed tightening episodes with flat oil prices (examples):
  - Feb. 1988: Fed Funds Rate 6.5 percent → Feb. 1989: 9.75 percent. Change of +3.25%.
  - Jan. 1994: Fed Funds Rate 3.0 percent → Feb. 1995: 6.0 percent. Change of +3.00%.

### Econometric VAR results and macro-financial links
- VAR frameworks:
  - Quarterly VAR (1995Q1–2014Q4) including global real oil price, U.S. Fed Funds rate, and Saudi variables (real equity prices, real private sector credit, real government spending, CPI inflation, real non-oil GDP).
  - Annual panel VAR (bank-by-bank, 1999–2014) examining NPL ratios, credit and deposit growth alongside real oil price growth and non-oil GDP growth.
- Oil price shock (one standard deviation = 14 percent drop) reduces:
  - equity prices, credit, government spending, inflation, real non-oil GDP growth.
  - Impulse response peaks (after a 1–5 quarter lag): 5 percent, 1.1 percent, 0.8 percent, 0.2 percent, and 0.1 percent, respectively.
- Fed Funds rate shock (one standard deviation = rise of 35 basis points) produces:
  - reduction in equity price growth by 0.5 percent in the first quarter,
  - reduction in real non-oil GDP by 0.1 percent in the first quarter,
  - reduction in CPI inflation by 0.1 percent for three quarters.
- Banking panel VAR quantifications:
  - A 1 percent decline in oil prices leads to:
    - a 0.3-0.4 percent decline in credit growth,
    - a 0.1-0.2 percent decline in deposit growth,
    - and higher NPLs (NPL responses measured in percentage point changes).
  - Feedback loop: higher NPLs → lower deposit growth → reduced credit growth → further strain.

### Model simulations (G20MOD) and fiscal-response scenarios
- Shock design:
  - Simulated initial shock: a 40 percent decline in oil prices with one-half of this decline subsequently reversed (i.e., 40 percent initial decline with a 20 percent partial recovery).
- Two fiscal-response scenarios:
  - Maintain nominal government spending using buffers → initial real GDP impact more limited.
  - Upfront fiscal adjustment → larger short-term fall in real GDP but smaller widening of the deficit and reduced use of buffers.
- Composition of fiscal adjustment ranking (least to most adverse on real GDP):
  - Cuts in transfers → reductions in current expenditure and increases in distortionary taxes → cuts in infrastructure spending (greatest adverse effect).
- Other model outcomes:
  - Imports contract, partly offsetting current account impact.
  - Domestic inflation eases because domestic energy prices are fixed (no feed-through from global oil price changes to CPI).
  - Under the exchange rate peg, policy rate follows U.S. rates; no domestic policy easing → higher real interest rate → further weakness in private consumption and investment.
  - Partial rebound in oil prices reverses some impacts; upfront fiscal adjustment allows expenditure to return closer to original levels over time.

### Banking sector starting position, projections, and scenarios
- Starting banking metrics (averages):
  - NPLs: 1.1 percent of gross loans (2014).
  - Capital adequacy ratio: 17.8 percent (2014).
  - Provisions: 183 percent of NPLs (2014).
- Baseline projections / Scenario I (central IMF staff path) — selected series (2014–2019):
  - Nonoil private sector growth (percent): 5.6 (2014), 3.4 (2015), 3.8 (2016), 4.7 (2017), 5.0 (2018), 5.0 (2019).
  - Oil prices (US dollars): 96 (2014), 59 (2015), 64 (2016), 67 (2017), 70 (2018), 71 (2019).
  - Nonperforming loans (percent of total loans): 1.1 (2014), 1.3 (2015), 2.5 (2016), 2.7 (2017), 2.8 (2018), 2.8 (2019).
  - Provisions (percent of NPLs): 182.9 (2014), 173.2 (2015), 148.4 (2016), 146.2 (2017), 145.3 (2018), 145.2 (2019).
  - Capital adequacy ratio: 17.8 (2014) rising to 18.6 (2019).
  - Bank counts by CAR category (2019): CAR > 12 percent: 12 banks; 8 percent < CAR < 12 percent: 0 banks; CAR < 8 percent: 0 banks.
- Scenario II (sharper and sustained oil price decline) — selected series (2014–2019):
  - Oil prices (US dollars): 96 (2014), 44 (2015), 43 (2016), 44 (2017), 44 (2018), 44 (2019).
  - Nonoil private sector growth (percent): 5.6 (2014), 0.8 (2015), 1.3 (2016), 2.1 (2017), 2.5 (2018), 2.5 (2019).
  - Nonperforming loans (percent of total loans): 1.1 (2014), 1.3 (2015), 3.7 (2016), 5.2 (2017), 6.2 (2018), 7.0 (2019).
  - Provisions (percent of NPLs): 182.9 (2014), 170.1 (2015), 125.3 (2016), 117.8 (2017), 114.9 (2018), 113.2 (2019).
  - Capital adequacy ratio: 17.8 (2014), 18.4 (2015), 18.0 (2016), 17.8 (2017), 17.4 (2018), 16.9 (2019).
  - Bank counts by CAR category (2019): CAR > 12 percent: 11 banks; 8 percent < CAR < 12 percent: 1 bank; CAR < 8 percent: 0 banks.
- Scenario III (extreme GDP slowdown to hit CAR = 12 percent) — design and selected outcomes:
  - Same as Scenario II except nonoil private sector GDP: contract by 2.6 percent in 2015 and remain flat on average between 2016–19.
  - Nonperforming loans (percent of total loans): 1.1 (2014), 1.3 (2015), 5.1 (2016), 8.7 (2017), 11.6 (2018), 14.1 (2019).
  - Provisions (percent of NPLs): 182.9 (2014), 170.1 (2015), 118.3 (2016), 110.7 (2017), 108.0 (2018), 106.5 (2019).
  - Capital adequacy ratio: 17.8 (2014), 18.4 (2015), 17.1 (2016), 15.4 (2017), 13.8 (2018), 12.0 (2019).
  - Bank counts by CAR category (2019): CAR > 12 percent: 4 banks; 8 percent < CAR < 12 percent: 7 banks; CAR < 8 percent: 1 bank.
- Interpretation:
  - Scenario I: aggregate NPL ratio rises to 2.8 percent by 2019; average capital ratio remains above 18 percent.
  - Scenario II: NPLs to 7.0 percent by 2019; provisions cover about 1.1 times NPLs; aggregate capital ratio declines modestly to around 17 percent with one bank below 12 percent but above 8 percent.
  - Scenario III: NPL ratio to 14.1 percent by 2019; average capital ratio reaches 12.0 percent; bank-level capital shortfalls concentrated in several banks.
- Uncertainty:
  - Parameter uncertainty implies aggregate NPL ratio in 2019 could be between 1.3–5.2 percent under Scenario I autoregressive coefficient range.

### Deposits, liquidity risk, and Box 1 findings
- Deposit sensitivity:
  - Real deposit growth slows by 0.1–0.2 percent in response to a one percent decrease in real oil prices.
  - Real deposit growth slows by 1-2 percent in response to a one percentage point increase in the NPL ratio.
  - A 40 percent decline in oil prices, if sustained for one year, would lead to a 4-8 percentage point reduction in deposit growth, everything else constant.
- Box 1 stress-test scenarios (30-day window split into five 6-day periods):
  - Scenario A:
    - Demand deposits decline by 2 percent per period; time deposits decline by 1 percent per period → average decline 8 percent over 30 days.
    - Asset availability: 95 percent liquid, 2 percent illiquid; haircuts 1 percent liquid, 15 percent illiquid; encumbrance 10 percent liquid, 25 percent illiquid.
    - Result: no liquidity shortfall system-wide; no individual bank shortfall.
  - Scenario B:
    - Deposits decline by >10 percent during 30 days (context: 11 percent reduction within a week in 1990).
    - Asset availability: 85 percent liquid, 1 percent illiquid; haircuts 5 percent liquid, 30 percent illiquid; encumbrance 20 percent liquid, 50 percent illiquid.
    - Result: aggregate system remains liquid; five banks experience liquidity shortages of 1–2 percent of initial assets.
- Conclusion: banking sector generally resilient to deposit withdrawals considered, though some liquidity shortfalls emerge under severe stress.

### Macroprudential framework, tools, and recommendations (Annex III highlights)
- Rationale:
  - Oil price shocks create feedback loops between asset prices, government spending, credit, and non-oil GDP; fiscal policy remains the main tool to manage aggregate demand.
  - Countercyclical macroprudential and fiscal policies can reduce buildup of systemic risks during upswings and cushion financial services during downswings.
- Suggested tools and operational guidance:
  - Broad-based capital tools: Countercyclical Buffer (CCB) — BCBS suggests maximum of 2.5 percent of risk-weighted assets; preannounce increases 12 months ahead; restrict dividends when released.
  - Dynamic Loan Loss Provisioning Requirements (DPR) — formula-based, trigger-based, loan-level, or hybrid approaches; restrict dividends upon release.
  - Sectoral tools: sectoral capital requirements, LTV limits, DTI limits, exposure caps; sequence: capital requirements → LTV/DTI on new loans → caps on sectoral credit growth as fallback.
  - Liquidity tools: liquidity buffer requirements, LCR, NSFR, LTD ratio, reserve requirement adjustments, liquidity charges on non-core funding.
  - Nonbank sector tools: data collection, leverage ratios, liquidity buffers, margin lending regulations.
- Practical recommendations for Saudi Arabia:
  - Develop a formal macroprudential policy framework assigning roles among SAMA, the Capital Markets Authority, and the Ministry of Finance.
  - Calibrate CCB and DPR using stress tests and early warning indicators (credit gap, asset price deviations, volatility measures, leverage ratios).
  - Expand perimeter of MPIs to nonbanks and foreign branches to contain leakages; consider extending DTI to include all debt service and LTV limits to CRE loans and corporate loans secured by real estate.
  - Strengthen data compilation, information sharing, and coordination across regulators; monitor high-frequency granular indicators.
  - Guidance on relaxing tools: relax reserve requirements first for liquidity pressures; relax DPR before CCB if asset quality stress; require banks to raise capital/liquidity if buffers remain inadequate.

### Key regulatory ratios and sectoral requirements (Annex I excerpts)
- Capital Adequacy Ratio: Basel requirement minimum 8 percent.
- Provisioning: General 1 percent of total loans; Specific minimum 100 percent of NPLs.
- Leverage Ratio: Deposits/(Capital + Reserves) ≤ 15 times.
- Reserve Requirement: 7 percent for Demand Deposits; 4 percent for Time & Saving Deposits.
- LTV: Mortgage loans ≤ 70 percent of home value.
- DTI: Monthly repayments ≤ 33 percent of employed salary and 25 percent of retired pension.
- Loan-to-deposit (LTD) ratio: 85 percent.
- Liquidity: Liquid Assets/deposits ≥ 20 percent; LCR (Basel III) 100 percent by 2019 (already fulfilled); NSFR 100 percent by 2019 (already fulfilled).
- Counterparty Exposure: Individual Exposure/total capital ≤ 25 percent.

### Energy implicit costs, electricity sector, and reform guidance
- Implicit cost estimates (2014):
  - Implied cost of low petroleum products and natural gas: $83 billion (11.1 percent of GDP) in 2014.
  - After accounting for a 16 to 35 percent drop in international prices since 2014, implicit cost estimated to fall to $65.9 billion (10.2 percent of GDP).
  - Petroleum products account for 85.9 percent of total oil and gas implicit cost (gasoline 22.1 percent, diesel 39.4 percent).
  - Natural gas accounts for 14.1 percent of the total implicit cost.
  - Electricity implied cost: $11,348 million or 1.5 percent of GDP (2014).
- Table 2 highlighted items (selected):
  - Gasoline (Premium): 18,333 (22.1% share of petroleum products implied cost).
  - Diesel (Gas oil): 32,736 (39.4%).
  - Total oil and gas: 82,987 (100.0%); % of GDP: 11.1%.
  - Electricity: 11,348; % of GDP: 1.5%.
- Electricity sector specifics:
  - SEC supplies 77 percent of total energy supplied; residential share 49 percent, industrial 20 percent, commercial 15 percent, government 11 percent, other 5 percent.
  - Fuel mix for electricity generation (2013): crude oil 28 percent, diesel 15 percent, heavy fuel oil 10 percent, natural gas 47 percent.
  - ECRA estimated average cost of electricity production and transmission: SR 0.152 per kwh.
  - Capital requirement to fund electricity expansion projects: estimated about SR 526 billion over the next 5 years.
  - Tiered residential rates range from SR 0.05 per kwh to SR 0.26 per kwh; SEC levies additional monthly charge averaging to SR 0.2 / $ 0.05 per kwh.
- Domestic energy prices (2014 examples):
  - Saudi Arabia gasoline 0.14 (US$ per liter), diesel 0.06.
  - Domestic price for natural gas: $0.75 per mmbtu (2014), which was 7.3 times below international prices (Henry hub).
- Consumption trends and risks:
  - Domestic consumption of refined oil: 2.5 mbd in 2014 (~19 percent of total crude oil production).
  - Oil consumption growth average annual rate: 6.3 percent since 2011.
  - At 6.3 percent annual growth, additional domestic demand would crowd out 1 mbd of refined exports by 2022; by 2042 all of the 8.1 mbd exports in 2014 would be required for domestic needs.
  - Natural gas consumption grew by 5 percent annually between 2011 and 2014; Saudi produced about 1.95 million barrels of oil equivalent per day of natural gas in 2014, all consumed domestically.
- Environmental and distributional consequences:
  - CO2 emissions in Saudi Arabia recorded at three times the world average of 5 metric tons (IMF, 2014).
  - CO2 intensity around 1.0 (tons/$1,000 of GDP).
  - Distributional incidence: low energy price benefits likely concentrate with the better off; household survey indicators suggest transport fuel incidence lower for low income segments.
- Policy implications and reform guidance:
  - Comprehensive energy price reform plan needed to gradually phase out low energy prices, with mitigating measures to protect vulnerable populations and help industry adjust.
  - Phasing, communication, targeted cash transfers (or vouchers), and temporary mitigation to households and energy-intensive industries recommended.
  - Complementary measures: expand refining, electricity generation and renewables, energy efficiency programs, and public transportation development.
  - Long-term price elasticity of energy demand estimated between -0.3 and -0.5.

### Labor market reform, public employment, and demographic pressures
- Labor market metrics and challenges:
  - Overall unemployment rate for nationals: 11.7 percent; female unemployment about 33 percent in 2014; male unemployment less than 6 percent.
  - Total number of unemployed Saudis in 2014: 650,000.
  - Public employment has continued to rise; government wage bill reached about 12 percent of GDP in 2014.
- Recent initiatives and instruments:
  - Nitaqat program (quota and color-coding system), de facto minimum wage SR 3,000 for Nitaqat credit, Hafiz jobseekers’ allowance SR 2,000 monthly (max one year), fees SAR 200 per month per foreign worker.
  - Evidence: under Nitaqat 96,000 nationals employed in private sector (Peck (2014)), but overall impact on private-sector job creation was negative in that study.
- Projections and scenarios (2015–20):
  - Private sector projected to create around 1.7 million jobs for nationals and expatriates based on non-oil growth and employment–growth elasticity.
  - Employment of nationals in private sector would increase by between 380,000–450,000 depending on share of new jobs to nationals (21% baseline to 23%).
  - If government hires nationals at 3.7 percent annually, 800,000 Saudis absorbed into public sector → 450,000–700,000 Saudis unemployed by 2020; unemployment rate between 14.9 and 16.4 percent.
  - Wage bill projections: baseline implies wage bill close to 14 percent of GDP by 2020; keeping unemployment at 2014 level requires public employment growth of 5.2 percent annually → wage bill about 15 percent of GDP by 2020.
- Reform scenarios:
  - Raising nationals’ private-sector share by 10 percentage points to 32 percent by 2020 → 1.2 million jobs to nationals out of 1.7 million private-sector jobs → unemployment declines to 5.1 percent (assuming baseline government hiring).
  - If public hiring reduced to <2 percent annually, wage bill and unemployment remain around 2014 levels.
- Tradeoffs and macro implications:
  - Replacing expatriates with nationals raises average wages and operating costs (operating costs could rise up to 3 percent under certain scenarios).
  - Gradual substitution recommended; skill gaps require long-term education and training reforms.
  - Under the peg, fiscal policy must smooth expenditures and build buffers during oil booms; over time, greater exchange rate flexibility could help manage cycles.

### Public employment and civil service reform guidance
- Recommendations:
  - Signal that public sector cannot remain employer of first and last resort; combine firm control of public employment and compensation with a civil service review.
  - Implement gradual substitution of foreign workers, aligned with skills development and vocational training expansion.
  - Narrow wage gaps while improving productivity and skills; consider targeted wage subsidies and measures to increase expatriate mobility where appropriate.
  - Fiscal approaches: smooth expenditures, strengthen medium-term fiscal framework, and reduce wage and subsidy rigidities to free resources for productive spending.

*July 14, 2015 — International Monetary Fund (Saudi Arabia staff report).*

### References _______________________________________________________________________________ 23

### _cr15286 - References _______________________________________________________________________________ 23

### Summary findings: oil and interest-rate shocks
- Oil prices have fallen by over 40 percent since mid-2014.
- Oil revenues account for around 90 percent of central government fiscal revenues and around 85 percent of export revenues.
- The oil sector comprises over 40 percent of overall GDP.
- Government deposits in the banking system were equivalent to 56 percent of GDP at end-2014.
- Exchange rate peg: the riyal has been pegged to the U.S. dollar at a parity of 3.75 since 1986.
- SAMA moves its policy rates closely with the fed funds rate; an expected increase in U.S. policy rates will see SAMA also raise its policy rate.
- High liquidity levels in the banking system may slow pass-through of policy rate changes.
- The riyal’s nominal and real effective appreciations over the past year left the currency “at its highest level in real terms since 2003” despite the large terms of trade decline.
- Main takeaway: oil prices have typically played a bigger role than interest rates in affecting economic and financial outcomes in Saudi Arabia.

### Historical evidence: three major oil-revenue decline episodes
- Three periods identified where oil revenues fell by 50 percent peak-to-trough: 1982–86, 1998–99, and 2008–09.
- Common responses across episodes:
  - Money and credit growth slowed.
  - Export receipts and government revenues fell.
  - Despite declines in imports and government spending, fiscal and external balances moved into deficit (or surpluses narrowed considerably).
  - Real GDP declined, driven by a substantial drop in real oil GDP as Saudi Arabia cut production.
  - Real non-oil GDP generally proved more resilient.
  - Equity prices declined and, with a lag, non-performing loans in the banking sector rose during the latter two periods.
- Episode-specific notes:
  - 1982–86:
    - Saudi oil production declined from 10.4 mb/d in 1981 to 3.5 mb/d in 1983.
    - Nominal oil revenues only returned to their 1982 level in 2004.
    - Real GDP dropped by a cumulative 25 percent from 1981–85.
    - Starting position: large surplus in 1980–81 and net financial assets tentatively estimated around 60 percent of GDP; assets were run down by the early 1990s.
  - 1998–99:
    - Triggered by the Asian financial crisis and reduced global oil demand.
    - Saudi Arabia reduced production in late 1998 and early 1999.
    - Starting fiscal position: weak—a deficit of around 3 percent of GDP and outstanding debt of around 70 percent of GDP.
    - Broad money growth slowed in 1998; credit growth slowed the following year.
  - 2008–09:
    - Triggered by the global financial crisis and a sharp oil price drop.
    - Export and fiscal revenues dropped sharply in 2009; government spending growth continued.
    - Non-oil GDP growth remained around 5 percent despite slowing.
    - Starting fiscal position: surplus of close to 30 percent of GDP and government net financial assets of around 45 percent of GDP.

### Transmission channels and comparative importance
- Empirical studies cited:
  - Husain, Tazhibayeva, and Ter-Martirosyan (2008) — the size of government and fiscal policy play a primary role in determining how oil prices impact the economy.
  - Alghaith et al (2014) — a positive and strong impact of oil prices on the economy through government spending in Saudi Arabia.
  - Eltony and Al-Awadi (2001) — oil price shocks transmitted mainly through government expenditure in Kuwait.
  - Studies on stock markets (e.g., Park and Ratti (2008); Bjørnland (2009); Wang et al. (2013)) find a positive association between oil prices and stock markets in oil-exporting countries.
- Interest rate channel:
  - Interest rate changes have a less significant impact on economic outcomes in Saudi Arabia.
  - Sheehan and Russer (1995) — monetary policy channel has limited impact because tighter policy is usually associated with periods of strong growth driven by higher oil revenues.
  - Alghaith et al (2014) — an increase in the U.S. federal funds rate has a small and statistically insignificant impact on Saudi Arabia's non-oil output, though a significant negative impact on inflation; higher U.S. interest rates are unlikely to have an adverse impact on the Saudi economy if the increase is driven by an improving U.S. economy.

### Implications for fiscal and financial resilience
- Given the economy’s strong dependence on oil, dealing with oil price volatility and uncertainty is a key challenge.
- It is important that strong fiscal buffers are built up in periods of high oil prices to cushion government spending when oil prices are low.
- Historical experience illustrates that the duration of an oil shock and the starting fiscal/financial position materially affect macroeconomic and financial outcomes.
- While a temporary drop in oil prices would likely have little effect on the economy and banks given the financial cushions built up, a longer-lasting period of low oil prices would have a more significant impact.

*July 14, 2015 — International Monetary Fund (Saudi Arabia staff report).*

### 8.      These episodes emphasize the common channels of transmission of the decline in oil

### _cr15286 - 8.      These episodes emphasize the common channels of transmission of the decline in oil

### Transmission of oil revenue declines to the Saudi economy
- Common channels: lower oil revenues reduce government fiscal space, which transmits to non-oil activity via fiscal policy, banking-sector channels, and confidence effects.
- Key determinants of macroeconomic and financial impact:
  - Starting fiscal position: a stronger starting fiscal position allows cushioning via buffers; a weaker starting position forces expenditure cuts that hurt non-oil growth.
  - Persistence of oil price decline: a long-lasting decline uses up buffers and produces a larger economic impact.

### Episodes of increasing U.S. interest rates and interaction with oil prices
- Historical observation: Periods of rising U.S. interest rates have often coincided with increasing oil prices; two episodes when the Fed tightened while oil prices remained broadly flat are highlighted:
  - Feb. 1988: Fed Funds Rate 6.5 percent → Feb. 1989: 9.75 percent. Change of +3.25%.
  - Jan. 1994: Fed Funds Rate 3.0 percent → Feb. 1995: 6.0 percent. Change of +3.00%.
- Empirical takeaways from those episodes:
  - Higher U.S. interest rates are associated with slowing in deposit and credit growth.
  - The behavior of non-oil GDP differs across episodes; the impact on inflation is not clear-cut.
  - These episodes are not particularly informative about current higher-rate consequences because they often coincided with rising oil prices.

### Econometric analysis — VAR approaches
- Two VAR frameworks used:
  - Quarterly VAR (1995Q1–2014Q4, with interpolated annual series for real non-oil GDP and real government spending) including global real oil price, U.S. Fed Funds rate, and Saudi variables: real equity prices, real private sector credit, real government spending (all deflated by the CPI), CPI inflation, and real non-oil GDP.
  - Annual panel VAR (bank-by-bank data for 12 banks, 1999–2014) examining NPL ratios, and growth rates of credit and deposits alongside real oil price growth and non-oil private sector GDP growth.

### Macro-financial links — main VAR results
- Oil price shock effects:
  - A one standard deviation negative shock to oil prices (equivalent to a 14 percent drop in oil prices) reduces:
    - equity prices,
    - credit,
    - government spending,
    - inflation,
    - real non-oil GDP growth.
  - Impulse response peaks (after a 1–5 quarter lag) are: 5 percent, 1.1 percent, 0.8 percent, 0.2 percent, and 0.1 percent, respectively.
  - Some impacts are sustained for several quarters.
- Fed Funds rate shock effects:
  - A one standard deviation positive shock to the Fed Funds rate (a rise of 35 basis points) produces:
    - a reduction in equity price growth by 0.5 percent in the first quarter,
    - a reduction in real non-oil GDP by 0.1 percent in the first quarter,
    - a reduction in CPI inflation by 0.1 percent for three quarters.
  - The immediate impact on non-oil GDP in the VAR may be affected by interpolated quarterly data for some series.

### Banking sector — panel VAR and feedback loops
- Evidence of macro-financial feedback loops:
  - NPL ratios rise after declines in the growth rates of oil prices and non-oil GDP (the latter via lower credit growth).
  - Deposit growth declines alongside declines in non-oil GDP and credit growth.
  - Quantified responses: a 1 percent decline in oil prices leads to:
    - a 0.3-0.4 percent decline in credit growth,
    - a 0.1-0.2 percent decline in deposit growth,
    - and higher NPLs (NPL responses are measured in percentage point changes).
  - Within bank balance sheets, solvency risk and liquidity risk reinforce each other (higher NPLs → lower deposit growth → reduced credit growth → further strain).

### Model simulations (G20MOD) of a lower oil price scenario
- Shock design:
  - Simulated initial shock: a 40 percent decline in oil prices with one-half of this decline subsequently reversed (i.e., a 40 percent initial decline with a 20 percent partial recovery thereafter).
- Broad model outcomes and role of fiscal response:
  - As oil prices decline, export and fiscal revenues decline relative to baseline; fiscal balance and current account weaken.
  - Two fiscal-response scenarios:
    - Government maintains spending in nominal terms and uses buffers to finance the deficit → initial impact on real GDP is more limited.
    - Government undertakes an upfront fiscal adjustment → larger short-term fall in real GDP but smaller widening of the deficit and reduced use of buffers.
  - Real GDP dynamics: falls below baseline as consumption and investment decline in response to lower government spending and national wealth.
  - Composition of fiscal adjustment matters for real GDP impact:
    - Cuts in transfers have the least adverse effect,
    - followed by reductions in current expenditure and increases in distortionary taxes,
    - cuts in infrastructure spending have the greatest adverse effect.
  - Other modeled outcomes:
    - Imports contract, partly offsetting the current account impact.
    - Domestic inflation eases because domestic energy prices are fixed (no feed-through from global oil price changes to CPI in Saudi Arabia).
    - With the nominal exchange rate pegged to the U.S. dollar, policy rate does not respond to the weakening domestic economy, raising the real interest rate and further weakening private consumption and investment.
    - Partial rebound in oil prices reverses some initial impacts over time; with upfront fiscal adjustment, expenditure can return closer to original levels and offset some real GDP loss.

### Conclusions and policy implications
- Key conclusions:
  - Oil prices are a primary determinant of macroeconomic and financial outcomes in Saudi Arabia.
  - The impact of higher U.S. interest rates is less clear but is likely to have some effect on the Saudi economy.
  - The duration of the oil price decline is critical: short-term smoothing is possible with substantial fiscal and financial buffers, but a prolonged decline necessitates fiscal adjustment that will affect growth and the banking sector.
- Policy recommendations:
  - No knee-jerk reduction in fiscal spending given substantial buffers, but establish a medium-term fiscal consolidation plan and begin gradual adjustment.
  - Prioritize continuation of key development priorities while reducing medium-term fiscal risks by aligning spending with lower oil revenues.
  - Intensify careful monitoring of the banking and broader financial system to identify emerging stresses early for prompt policy action.
  - Accelerate structural reforms to diversify the economy away from oil to boost non-oil growth and offset weaker government spending.

### Annex I — Summary of G20MOD features relevant to Saudi Arabia
- G20MOD general characteristics:
  - Annual, multi-economy, forward-looking model combining micro-founded and reduced-form sectors.
  - 25-bloc global general equilibrium structure (G-20 countries plus 5 additional regions).
- Country-model features (and Saudi-specific notes):
  1. Consumption and investment: overlapping-generations and liquidity-constrained households; firms’ investment via Tobin’s Q; firm risk premia respond to output gap.
  2. Trade: reduced-form equations dependent on competitiveness and demand; competitiveness improves one-for-one with domestic prices; for Saudi Arabia, exports are mostly oil so competitiveness plays a small role.
  3. Potential output: endogenous via Cobb-Douglas with exogenous trend TFP and endogenous capital and labor; for Saudi Arabia, potential output moves one-for-one with long-run average oil production.
  4. Inflation: reduced-form Phillips curves with lags/leads and output gap; consumer price inflation includes real effective exchange rate effects and second-round food/oil effects; no feed-through from global oil price changes to CPI in Saudi Arabia (domestic energy prices fixed); expatriate labor effects approximated by a low weight on the output gap.
  5. Monetary policy: interest rate reaction function; for Saudi Arabia the rule defends the fixed nominal exchange rate to the U.S. dollar, implying domestic policy rates follow U.S. rates via uncovered interest parity.
  6. Commodities: three commodities modeled—oil, metals, food—allowing headline/core CPI distinction; commodity prices driven by global demand, short-run price inelasticity in supply and demand; global real prices determined by global output gap, global demand, and global commodity production.

*Source: IMF staff analysis and G20MOD simulations as presented in the original content.*

### 8.      Commodities can function as a moderator of business cycle fluctuations. In times of

### _cr15286 - 8.      Commodities can function as a moderator of business cycle fluctuations. In times of 

### Commodities as a macroeconomic moderator
- Commodities moderate business cycle fluctuations by:
  - Putting downward pressure on demand when excess aggregate demand raises commodity prices due to sluggish supply adjustment.
  - Ameliorating deterioration when excess supply leads to falling commodity prices.

### Model assumptions and calibration for Saudi Arabia
- Oil is the only commodity produced and exported; it dominates the model.
- Exports of oil respond largely to Saudi production decisions.
- Oil revenue allocation:
  - Eighty-five percent of oil revenues accrue to the government.
  - The remainder accrues to Aramco, the state oil company.
- Implications:
  - Oil price fluctuations affect government revenues but have little effect on household wealth because households have no direct ownership stake in the oil sector.
  - Domestic oil prices are held fixed, so oil prices have little effect on households’ and firms’ decisions.
- Fiscal policy:
  - The government has a large stock of financial assets and is assumed to set long-run fiscal policy aiming to maintain this asset stock.
  - Short-run fiscal policy can result in significant deviations from this target.
- G20MOD model structure:
  - Economies are structurally identical except for commodities and are distinguished by unique parameterizations (different steady-state ratios and behavioral parameters).
  - Saudi Arabia’s parameterization is strongly determined by oil dominance.

### Banking system: starting position and risks
- Banking sector metrics (averages / starting values):
  - NPLs: 1.1 percent of gross loans.
  - Capital adequacy ratio: 17.8 percent.
  - Provisions: 183 percent of NPLs.
- Regulatory environment:
  - SAMA has strengthened regulation and supervision, including early adoption of Basel III capital and liquidity standards.
- Historical drivers of NPLs:
  - Influenced by oil prices, government spending, and non-oil sector growth.
  - Deposits historically correlated with oil prices; lower oil prices reduce deposit inflows or trigger drawdowns, particularly by affected companies.
- External factors:
  - Higher interest rates from U.S. monetary tightening would raise borrowing costs and could pressure asset quality.

### Econometric findings on NPL determinants
- Panel GMM estimates (bank-level NPL logit as dependent variable) identify key determinants:
  - Real oil prices, % change (L1): coefficients around -0.011 to -0.009, significant at 1% in most specifications.
  - Nonoil private sector GDP growth, % (L1): coefficients vary (e.g., -0.132***, -0.127***, -0.113***, -0.098**), significance varies by specification.
  - Lagged logit NPL ratio (L1): coefficients around 0.845–0.964, all significant.
  - 2008/09 dummy: positive and significant across specifications (e.g., 0.434**, 1.045***).
- Model diagnostics (selected p-values across specifications):
  - AR(1): values between 0.012 and 0.029.
  - AR(2): values between 0.317 and 0.850.
  - Hansen: values between 0.041 and 1.000.

### Baseline projections and Scenario I (central IMF staff path)
- Assumptions (2014–2019, historical and scenario I baseline):
  - Nonoil private sector growth (percent): 5.6 (2014), 3.4 (2015), 3.8 (2016), 4.7 (2017), 5.0 (2018), 5.0 (2019).
  - Oil prices (US dollars): 96 (2014), 59 (2015), 64 (2016), 67 (2017), 70 (2018), 71 (2019).
- Projected impacts:
  - Nonperforming loans (percent of total loans): 1.1 (2014), 1.3 (2015), 2.5 (2016), 2.7 (2017), 2.8 (2018), 2.8 (2019).
  - Provisions (percent of NPLs): 182.9 (2014), 173.2 (2015), 148.4 (2016), 146.2 (2017), 145.3 (2018), 145.2 (2019).
  - Capital adequacy ratio: 17.8 (2014) rising to 18.6 (2019).
  - Bank counts by CAR category (2019): CAR > 12 percent: 12 banks; 8 percent < CAR < 12 percent: 0 banks; CAR < 8 percent: 0 banks.
- Interpretation:
  - Under Scenario I, average capital ratio remains above 18 percent despite provisioning at 120 percent of new NPLs.
  - Aggregate NPL ratio rises gradually to 2.8 percent by 2019, with bank-level NPLs ranging between 2.2–3.2 percent.
  - Parameter uncertainty (autoregressive coefficient range) implies aggregate NPL ratio in 2019 could be between 1.3–5.2 percent.

### Scenario II (sharper and sustained oil price decline)
- Assumptions for Scenario II:
  - Oil prices (US dollars): 96 (2014), 44 (2015), 43 (2016), 44 (2017), 44 (2018), 44 (2019).
  - Nonoil private sector growth (percent): 5.6 (2014), 0.8 (2015), 1.3 (2016), 2.1 (2017), 2.5 (2018), 2.5 (2019).
- Projected impacts:
  - Nonperforming loans (percent of total loans): 1.1 (2014), 1.3 (2015), 3.7 (2016), 5.2 (2017), 6.2 (2018), 7.0 (2019).
  - Provisions (percent of NPLs): 182.9 (2014), 170.1 (2015), 125.3 (2016), 117.8 (2017), 114.9 (2018), 113.2 (2019).
  - Capital adequacy ratio: 17.8 (2014), 18.4 (2015), 18.0 (2016), 17.8 (2017), 17.4 (2018), 16.9 (2019).
  - Bank counts by CAR category (2019): CAR > 12 percent: 11 banks; 8 percent < CAR < 12 percent: 1 bank; CAR < 8 percent: 0 banks.
- Interpretation:
  - NPLs rise to 7.0 percent and provisions cover about 1.1 times the stock of NPLs by 2019.
  - Aggregate capital ratio declines modestly to around 17 percent; one bank’s capital ratio falls below 12 percent but remains above the 8 percent international regulatory minimum.
  - SAMA implicitly sets regulatory capital minima equal to 12 percent (4 percentage points above Basel requirements).

### Scenario III (extreme GDP slowdown to hit CAR = 12 percent)
- Scenario design:
  - All assumptions unchanged from Scenario II except trajectory of nonoil private sector GDP growth.
  - To bring average capital ratio to 12 percent in 2019, nonoil private sector GDP would need to:
    - Contract by 2.6 percent in 2015.
    - Then remain flat on average between 2016–19.
  - Historical note: The last time private nonoil growth contracted was in 1987.
- Projected impacts:
  - Nonperforming loans (percent of total loans): 1.1 (2014), 1.3 (2015), 5.1 (2016), 8.7 (2017), 11.6 (2018), 14.1 (2019).
  - Provisions (percent of NPLs): 182.9 (2014), 170.1 (2015), 118.3 (2016), 110.7 (2017), 108.0 (2018), 106.5 (2019).
  - Capital adequacy ratio: 17.8 (2014), 18.4 (2015), 17.1 (2016), 15.4 (2017), 13.8 (2018), 12.0 (2019).
  - Bank counts by CAR category (2019): CAR > 12 percent: 4 banks; 8 percent < CAR < 12 percent: 7 banks; CAR < 8 percent: 1 bank.
- Interpretation:
  - NPL ratio would increase to 14.1 percent in 2019.
  - Bank-level capital ratios fall below 12 percent for 8 banks; 5 of those 8 would maintain capital ratios above 8 percent.
  - Resources required to restore the 8 banks’ capital ratios back to 12 percent are characterized as small.

### Deposits and liquidity risk
- Empirical deposit sensitivity:
  - Real deposit growth slows by 0.1–0.2 percent in response to a one percent decrease in real oil prices.
  - Real deposit growth slows by 1-2 percent in response to a one percentage point increase in the NPL ratio.
- Implication of recent oil price shock:
  - A 40 percent decline in oil prices, if sustained for one year, would lead to a 4-8 percentage point reduction in deposit growth, everything else constant.
- Overall liquidity finding:
  - The impact of the decline in oil prices on bank deposits is likely to be manageable.
  - The ability of Saudi banks to manage much larger deposit withdrawals is discussed separately (Box 1 in the source).

### Methodological and caveat notes
- The analysis uses publicly available bank-by-bank data (1999–2014), regression analysis, and scenarios; it is not a replacement for detailed FSAP stress tests.
- Caveats highlighted:
  - Publicly available data are limited relative to regulatory data used in FSAPs.
  - Historical-data-based analysis may not capture effects of recent policy changes.
  - The sample period may not cover sufficient oil price and financial cycles.
  - Considerable parameter uncertainty exists around estimated relationships between macro shocks and NPLs.

*Source: IMF staff analysis as presented in the provided document content.*

### Box 1. The Resilience of Saudi Banks to Deposit Withdrawals

### Box 1. The Resilience of Saudi Banks to Deposit Withdrawals

### Overview
- Liquidity positions in the Saudi banking system are well managed. Banks hold sufficient high-quality liquid assets to already bring both the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) above the regulatory minimum requirements proposed by Basel III (see SAMA (2015)).
- The analysis investigates banks’ capacity to accommodate deposit reductions by selling liquid (and to some extent illiquid) assets within a 30-day window divided into five periods of six days each.
- Withdrawal rates vary by deposit type, with demand deposits suffering higher runoff rates. During market stress, not all liquid assets can be converted at face value and some assets become encumbered for margin calls.

### Stress-test scenarios and assumptions
- Two scenarios (A and B) are parameterized, guided by Saudi historical experience and Schmieder et al. (2012).
- Scenario A:
  - Demand deposits decline by 2 percent per period; time deposits decline by 1 percent per period.
  - Average decline over the 30-day period: 8 percent.
  - Context: This 8 percent is higher than the largest monthly reduction observed since 1993, which was 6 percent.
  - Asset availability: 95 percent of liquid assets available for sale in each 5-day period; 2 percent for illiquid assets.
  - Haircuts: 1 percent for liquid assets; 15 percent for illiquid assets.
  - Encumbrance: 10 percent of liquid assets; 25 percent of illiquid assets.
- Scenario B:
  - Deposits decline by more than 10 percent during a 30 day window.
  - Context: This rate is similar to the 11 percent reduction within a week suffered in 1990.
  - Asset availability: 85 percent for liquid assets; 1 percent for illiquid assets.
  - Haircuts: 5 percent for liquid assets; 30 percent for illiquid assets.
  - Encumbrance: 20 percent of liquid assets; 50 percent of illiquid assets.
- Note: The analysis assumes lower rates of deposit runoff, haircut and encumbrance than those suggested in Schmieder et al. (2012).

### Results
- Scenario A:
  - No liquidity shortfall for the banking sector as a whole.
  - No individual bank experiences a liquidity shortfall.
- Scenario B:
  - Aggregate banking system remains liquid.
  - Five banks suffer liquidity shortages of 1–2 percent of initial assets (banks #3,4,7,8,10).
- Overall conclusion: The banking sector is generally resilient to the deposit withdrawals considered, although some liquidity shortfall emerges under the more severe Scenario B.

### Interpretation and caveats
- The assessment needs to be interpreted with the range of assumptions in mind, including assumed availabilities, haircuts, and encumbrance rates.
- Historical comparators cited: largest monthly reduction since 1993 was 6 percent; the 1990 run entailed an 11 percent reduction within a week (triggered by a military conflict).

### Policy implications (as described in the source)
- Maintaining high-quality liquid asset buffers has placed LCR and NSFR above proposed Basel III minimums.
- Banks’ ability to withstand deposit runs depends on market liquidity conditions, asset encumbrance, and the composition of available assets.
- Vigilance is warranted given potential stress from oil-price-driven economic and fiscal adjustments (discussed elsewhere in the chapter), which could increase nonperforming loans and induce banks to sell assets or reduce lending.

*Source: _cr15286 - Box 1. The Resilience of Saudi Banks to Deposit Withdrawals*

### 11.      An important lesson from the international experience is that multiple early warning

### _cr15286 - 11.      An important lesson from the international experience is that multiple early warning

### Early warning indicators and systemic risk
- Multiple early warning indicators can help assess the evolving nature of systemic risk and the need for tightening or relaxation of measures.
- Early warning indicators can help signal when policy adjustments are appropriate, and support clear communication of policy intentions (IMF, 2014).
- When multiple indicators point to a build-up of risks, there is a stronger case for policy action.
- Over time, assessing the reliability of signals provided by early warning indicators and addressing data gaps can help improve the policy response.

### Leakages and perimeter of macroprudential policy
- Leakages occur when the provision of credit migrates outside of the scope of application of macroprudential tools (e.g., to non-banks, off-balance sheet vehicles, foreign financial institutions).
- Domestic leakages can be addressed by extending regulations to all financial products, including by non-bank financial institutions, and enforcing these through high standards for consolidated supervision (example: in Canada and Malaysia, DTI limits are supported by caps on loan repayment periods, LTV and DTI limits are extended to banks and nonbanks).
- Cross border leakages of capital tools may be addressed by reciprocity arrangements, or greater host control over foreign branches (example: Norway).
- Economies with a larger nonbank sector or more open financial sector may find it challenging to implement macroprudential policies effectively.
- Expanding the perimeter of macroprudential action can face legal and operational challenges, including the need for greater cooperation among supervisory agencies.

### Evidence on effectiveness of macroprudential policies
- Evidence is preliminary given recent introduction of many macroprudential policies.
- Some studies find macroprudential tools effective in reducing buildup of systemic risks during booms, but less so during busts.
- Cerutti et al (2015) finds evidence of asymmetric effects on effectiveness between booms and busts.
- Kuttner and Shim (2013): tightening of the DTI ratio is associated with a significant deceleration in housing credit; housing-related taxes are associated with a decline in house price growth. Loosening of the DTI ratio has a comparable (but statistically insignificant) effect in the opposite direction.
- McDonald (2015) finds somewhat stronger results for the LTV and DTI limits during downturns.
- Literature notes challenges: few instances of policy loosening and difficulty isolating effects from other policies.

### Role of countercyclical macroprudential and fiscal policy for Saudi Arabia
- Oil price shocks create feedback loops between asset prices, government spending, credit, and non-oil GDP.
- Fiscal policy remains the main tool to protect against fluctuations in oil prices and manage aggregate demand.
- A more countercyclical fiscal policy could help dampen both the economic and financial cycle.
- Countercyclical macroprudential policies can:
  - reduce the buildup of systemic risks in the financial sector during oil price upswings, and
  - cushion against disruptions to financial services during oil price downswings.

### SAMA's current toolkit and possible enhancements
- SAMA has implemented a wide range of macroprudential instruments to build resilience in the banking sector.
- Banks encouraged to build capital buffers and provision for NPLs in a countercyclical way; reserve requirements were adjusted during the global financial crisis.
- Saudi banking sector is described as well-capitalized and profitable and compares well with many other commodity exporting countries.
- Some instruments have been introduced to limit risk buildup but have not been adjusted over time.
- A framework for countercyclical buffers is being developed in line with Basel guidelines.
- Countercyclical buffers are considered more effective in building resilience than in moderating credit cycles (IMF, 2014).
- Possible scope to expand countercyclical use of existing time-invariant macroprudential instruments given feedback loops from oil prices to equity prices, credit, and non-oil GDP.
- Sectoral concentration limits (e.g., on margin lending for equities or on construction sector) may be useful to address emerging sector-specific risks.

### Need for a formal macroprudential framework
- A well-defined macroprudential policy framework would:
  - assign roles and responsibilities among SAMA, the Capital Markets Authority, and the Ministry of Finance;
  - help strengthen macroprudential policy formulation and implementation within and across institutions;
  - assess reliability of early warning indicators to identify triggers guiding countercyclical use of a broad set of macroprudential policies.
- The framework should provide clear guidance on implementation to maintain financial stability and manage systemic risks over the financial cycle.
- The framework should identify minimum regulatory capital requirements and set countercyclical buffers in line with Basel III capital requirements; regulatory minima should also be set for other tools used countercyclically.
- Policymakers will need to monitor a number of high-frequency and granular indicators closely to assess financial stress (see Annex III referenced in source for list of indicators).
- Decision to relax macroprudential policies will rely substantially on judgment drawing on market intelligence, supervisory assessments and stress tests.
- Microprudential norms should consider structural risks from lack of economic diversification and concentration risks (corporate, financial, public sector interconnectedness).
- Data gaps with respect to real estate prices imply staff analysis may not capture an important transmission channel to the financial sector; regulatory minima and assessment of policy space should be calibrated to reflect these risks.

### Guidance on relaxing tools and sequencing
- Only those tools should be relaxed where policy space is assessed to be available.
- If liquidity pressures are the source of banking sector stress:
  - easing reserve requirements first would be appropriate;
  - if insufficient, loan-to-deposit ratio can be relaxed.
- If stress is on asset quality leading to loan losses and declines in bank capital:
  - dynamic provisioning ratios may be allowed to decline first to absorb losses;
  - relaxation of the CCB should be considered only after dynamic provisions have been used, to limit adverse impact on investor confidence.
- Strong financial supervision remains essential to ensure adequacy of remaining capital and liquidity buffers.
- If buffers after release would be inadequate, banks should be required to raise capital and liquidity instead.

### Containing leakages and expanding scope of MPIs in Saudi Arabia
- Current DTI limits apply only to personal and consumer loans and exclude debt service on residential mortgages.
- Consideration under way: expand scope of DTI limits to include all debt service to be paid by an individual borrower.
- Consider extending LTV limits to CRE loans (currently applied on residential mortgages) or other corporate loans secured by real estate as collateral.
- MPIs should be extended to nonbanks and foreign branches to increase effectiveness and contain leakages.

### Data gaps, coordination, and adaptability
- Action needed to address data gaps and improve coordination across regulators:
  - Financial information is limited in several areas, hindering macroprudential framework building and systemic risk identification.
  - The data compilation process needs to incorporate both macro- and micro-prudential aspects.
  - Information sharing and policy coordination between different regulators is essential to prevent macroprudential policy gaps and leakages.
- Macroprudential policies must remain adaptable as the financial sector deepens:
  - Financial deepening (e.g., promoting SME financing, opening capital markets to foreign investment) may increase risk taking and vulnerabilities from capital flows.
  - Over time, the macroprudential framework and toolkit will need to adapt to an evolving set of systemic risks.

### Key statistics and regulatory requirements (Annex I excerpts)
- Capital Adequacy Ratio: Basel requirement of a minimum of 8 percent
- Provisioning:
  - General: 1 percent of total loans
  - Specific: Minimum of 100 percent of NPLs
- Leverage Ratio: Deposits/(Capital + Reserves) ≤ 15 times
- Reserve Requirement:
  - 7 percent for Demand Deposits
  - 4 percent for Time & Saving Deposits
- Loan-To-Value (LTV): Mortgage loans ≤ 70 percent of home value
- Debt Service – To – Income (DTI): Monthly repayments ≤ 33 percent of employed salary and 25 percent of retired pension
- Loan-to-deposit (LTD) ratio: 85 percent
- Liquidity:
  - Liquid Assets/deposits ≥ 20 percent
  - LCR (Basel III): 100 percent by 2019 (already fulfilled)
  - NSFR (Basel III): 100 percent by 2019 (already fulfilled)
- Counterparty Exposure: Individual Exposure/total capital ≤ 25 percent
- Foreign Exposure: SAMA approval needed before foreign lending (a qualitative measure)

Insurance sector highlights (Annex I excerpts)
- Solvency Margin / Admissible Assets = 100 percent
- Statutory Deposit (at SAMA): 10 percent of Paid Capital (Subject to additional 5 percent based on company profile)
- GWP-to-Capital ratio: GWP/(Paid Capital + Reserve) ≤ 10 times
- Reinsurance: 30 percent must be reinsured within the Kingdom; Reinsurers must be rated at least BBB
- Retained Insurance Premium: 30 percent of total Insurance Premium (SAMA exemption may apply)
- Foreign investments/Total Investments ≤ 20 percent
- 50 percent of Investment portfolio should be in Saudi Riyal
- Off-Balance sheet investments are not allowed
- SAMA approval required for mergers and acquisitions and for foreign risk sharing

*Source: IMF staff compilation from the provided chapter content.*

### Annex III. Issues in the Implementation of Macroprudential

### Annex III. Issues in the Implementation of Macroprudential Policies

### Broad-Based (Capital) Tools — Countercyclical Buffer (CCB)
- Basel III framework: time-varying capital buffer on top of minimum capital requirement and a time-invariant conservation buffer.
- CCB implementation timing: expected to be phased in gradually from 2016 to 2019.
- Objective: make banks more resilient to imbalances in credit markets and enhance medium-term prospects by increasing loss-absorption capacity in good times.
- Operational considerations and guidance:
  - The Basel committee recommends that the CCB be set at a maximum of 2.5 percent of risk-weighted assets, although it can be set higher based on broader macroprudential considerations.
  - Stress tests can help calibrate the appropriate size of the CCB to reflect both a capital shortfall in a stress scenario and extra capital needed to maintain investor confidence in a downturn.
  - Reciprocity for foreign banks: under Basel II reciprocity, home supervisors must ensure supervised banks apply the CCB on exposures in host jurisdictions that have imposed the CCB while the buffer does not exceed 2.5 percent; reciprocity above 2.5 percent is voluntary or requires further bilateral/regional agreements.
  - Timing and announcement: because it may take time for banks to raise capital, the process of increasing the CCB should begin early in the financial cycle; increases in the buffers should be preannounced for 12 months to give banks time to meet the additional requirements.
  - Release in stress: at times of financial stress, reductions in the buffer could take effect immediately to help reduce the risk of a credit crunch.
  - Triggers to tighten: BCBS suggests using estimates of the credit gap (deviation of credit-to-GDP ratio from trend) and other early warning indicators such as credit growth, deviation of real estate and equity prices from long term trends, measures of market volatility and spreads, debt service and leverage ratios, reliance on wholesale funding, and current account balances; performance of indicators should be monitored over time.
  - Triggers to ease: high-frequency market-based indicators of banking sector distress such as asset prices, credit spreads, and measures of market volatility in equity and foreign exchange markets; additional indicators: growth rate and leverage on new loans, credit conditions, increases in nonperforming loans.
  - When CCB is released, restrict dividend payments to ensure released capital is used to absorb losses.

### Dynamic Loan Loss Provisioning Requirements (DPR)
- Purpose: smooth provisioning costs over the financial cycle and insulate bank income and lending in bad times by building a pool of provisions in good times to cover realized losses in bad times.
- Four main DPR approaches:
  - (i) through the cycle accumulation (formula-based approach): builds up general provisions in line with expected losses on new and existing loans, net of specific provisions on losses incurred during the period.
  - (ii) trigger-based systems: use thresholds of indicators to increase or release DPR buffers.
  - (iii) loan-by-loan provisioning: based on expected losses and probability of default data.
  - (iv) hybrid approach: combines (i) and (ii) with a trigger for allowing banks to access DPR reserves.
- Operational tradeoffs:
  - Formula-based approach is the least data intensive (examples: Spain, Uruguay) and accumulates/releases DPR buffers automatically and gradually.
  - Trigger-based systems require estimating indicator thresholds and can allow reserves to be saved for rapid deployment during stress.
  - Hybrid approach example: accumulation formula plus a trigger rule for release based on the same indicators used for CCB release; banks would not access DPR reserves unless indicators signal a downturn.
  - When DPRs are released, dividend payments should be restricted.

### Sectoral Tools — Household and Corporate Sectors
- Household sector vulnerabilities addressed by: sectoral capital requirements, loan-to-value (LTV) limits, and debt-service-to-income (DTI) limits.
  - LTV limits cap loan size relative to appraised property value; DTI limits cap debt service as share of borrower income.
- Corporate sector vulnerabilities addressed by: sectoral capital requirements and exposure caps (e.g., higher risk weights for foreign currency credit, caps on growth of corporate credit and in foreign currency); LTV limits for CRE lending.
- Operational considerations:
  - Capital requirements and risk weights build resilience and can be calibrated using stress test results.
  - Caps on credit growth slow supply; LTV and DTI limits reduce demand. LTV and DTI limits reinforce each other— as asset prices rise relative to income, LTV limits become less constraining while DTI limits become more binding.
  - Tools can be differentiated by borrower type, region, currency, and loan type.
  - No fixed thresholds for early warning indicators; calibration should reflect country-specific risks.
  - Application sequencing:
    - Sectoral capital requirements are less distortionary and can be applied to the entire stock of loans or to new lending first.
    - Tightening on the entire stock requires significant adjustment and should be announced well ahead of enforcement.
    - LTV and DTI limits can be imposed on the flow of new loans if capital requirements fail to slow credit growth.
    - A cap on sectoral credit growth is more distortive, has little direct effect on resilience, and should be a fallback if other measures prove inadequate.
  - When multiple indicators signal elevated systemic risk, policy tightening should be gradual; stepped up communication and supervisory guidance prior to introducing measures can reduce burden on borrowers and lenders.
  - Loosening decisions may need to be taken more rapidly than tightening decisions.
- Indicators for household-sector tightening:
  - Joint signals: household loan growth and house price growth.
  - Additional indicators: mortgage loan growth, house price to income, house price to rent ratios, share of households in total credit in local and foreign currency, house prices by region, average risk-weights on household loans and capital buffers above minimum, distribution of LTV and DSTI ratios across income groups, share of foreign currency–denominated or interest-only loans.
- Fast-moving indicators for timely easing or stress detection: transaction volumes, spreads on household loans, CDS spreads of financial institutions.
- Indicators for corporate-sector tightening:
  - Growth rate of corporate credit, share of corporate credit in total credit in local and foreign currency (stocks and flows).
  - Additional indicators: leverage on new and old loans, debt service ratio (debt service as a share of operating surplus), corporate credit/operating surplus (share and growth rate), corporate credit gap, lending standards.
  - Fast-moving indicators for corporate stress: spikes in corporate CDS spreads.

### Liquidity Tools
- Types of liquidity tools and objectives:
  - Liquidity buffer requirements (e.g., liquid asset ratio).
  - Liquidity Coverage Ratio (LCR) to fund net cash outflows over a 30 day period.
  - Stable funding requirement ratios (e.g., Net Stable Funding Ratio (NSFR), loan-to-deposit (LTD) ratio, core funding ratio (CFR)) to ensure banks hold stable liabilities for illiquid assets.
  - Liquidity charges on non-core funding, differentiable by currency, possibly accumulated for the budget or a dedicated fund to provide liquidity during stress.
  - Reserve requirements on short-term liabilities adjustable for financial stability purposes.
  - Constraints on open FX positions and on FX funding, and tools to manage risks in nonbank financial institutions.
- Operational considerations:
  - Tightening liquidity tools boosts resilience but slows credit growth by making funding costlier; gradual tightening is recommended given limited countercyclical experience.
  - When tightening reserve requirements, open market operations may need adjustment to sterilize impacts and keep interbank rates close to policy targets.
  - Indicators useful for tightening: LTD ratio and CFR; general credit condition indicators (surveys, interest rate movements, short-term capital inflows, gross open FX positions).
  - No fixed thresholds for indicators; stress testing can calibrate responses. Sharp movements in indicators can signal need for action.
  - During liquidity stress, relax liquidity tools and release liquidity buffers promptly. Authorities can allow temporary declines in liquidity buffers without changing formal requirements. If insufficient, relax stable funding ratios temporarily; in extreme stress provide central bank liquidity support.
  - Indicators of liquidity stress: increased usage of central bank overnight or emergency facilities, increases in unsecured interbank rate spreads, margins and haircuts on repo collateral, FX swap rates, bid-ask spreads in FX, and CDS-bond spreads.
  - International context: minimum standards for LCR and NSFR are being negotiated under Basel III.

### Tools for the Nonbank Sector
- Nonbanks can be significant sources of systemic liquidity risks.
- First steps: data collection and basic oversight of nonbank institutions and markets.
- Macroprudential extensions for nonbanks: leverage ratios, liquidity buffers, stable funding requirements, sectoral concentration limits, regulations on margin lending.
- Objective: manage systemic risks in the nonbank financial sector and ensure a level playing field with banks.

### Key Energy-Price–Related Findings (Saudi Arabia contextual material)
- Saudi Arabia energy context:
  - Proven oil reserves: 75 years of proven reserves.
  - Domestic energy consumption of refined petroleum products and electricity is growing rapidly; low regulated energy prices are a major driver.
- Retail fuel prices (2014; in US$ per liter) — selected entries from Table 1:
  - Bahrain gasoline 0.27, diesel 0.27
  - Kuwait gasoline 0.22, diesel 0.19
  - Oman gasoline 0.31, diesel 0.38
  - Qatar gasoline 0.21, diesel 0.41
  - Saudi Arabia gasoline 0.14, diesel 0.06
  - UAE gasoline 0.47, diesel 0.64
  - GCC average gasoline 0.27, diesel 0.32
  - United States gasoline 0.90, diesel 1.0
- Specific price and implicit cost facts:
  - Domestic price for premium gasoline in Saudi Arabia: $0.14 per liter (2014).
  - Domestic price for natural gas: $0.75 per mmbtu (2014), which was 7.3 times below international prices (Henry hub).
  - Estimated implied cost of low petroleum products and natural gas prices using domestic-to-U.S. price gaps and quantities consumed:
    - $83 billion (11.1 percent of GDP) in 2014.
    - After accounting for a 16 to 35 percent drop in international prices since 2014, implicit cost estimated to fall to $65.9 billion (10.2 percent of GDP).
    - About 86 percent of the implicit cost is accounted for by petroleum products: diesel share 39.4 percent; gasoline share 22.1 percent.
    - Natural gas accounts for 14 percent of the total implicit cost.
  - Implicit cost for the electricity sector (using tariff gap with the U.S., 2014): $11.4 billion or 1.5 percent of GDP.
- Policy implication in energy section: a comprehensive energy price reform plan is needed to gradually phase out low energy prices, put in place mitigating measures to protect vulnerable populations, help industry adjust, and help retain priority investment and social spending during fiscal adjustment.

*Annex III. Issues in the Implementation of Macroprudential Policies — IMF staff summary as presented in the source document.*

### 4.      The implicit cost, computed using

### _cr15286 - 4.      The implicit cost, computed using

### Implicit cost estimates for gasoline and diesel
- Raising domestic prices of only gasoline and diesel products to the average level in the GCC would yield about 2½ percent of GDP (text: "would yield about 2½ percent of GDP").
- Raising domestic prices to the average export price of refined products from Saudi Arabia or to the price level in the U.A.E would yield an estimated 3.8 to 6 percent of GDP in additional revenues in 2015.
- Figure 1 caption: "Implicit Cost Estimates for Gasoline and Diesel: Under Different Reference Price Assumptions (2015; in percent of GDP)."
- Reference prices used include: "GCC average price", "Saudi average export price", "U.A.E. domestic price", "U.S. retail pre-tax price", "U.S. retail post-tax price."
- Table 2: Implied Energy Cost for Saudi Arabia in 2014 (US$ mn percent share)
  - Gasoline (Premium 95): n.a. n.a.
  - Gasoline (Premium): 18,333 22.1%
  - Diesel (Gas oil): 32,736 39.4%
  - LPG — Public: 1,267 1.5%
  - LPG — Oil Industry: 409 0.5%
  - Fuel Oil — Public: 16,823 20.3%
  - Fuel Oil — Oil Industry: 1,693 2.0%
  - Total Petroleum products: 71,261 85.9%
  - Natural Gas — Public: 9,617 11.6%
  - Natural Gas — Oil Industry: 2,109 2.5%
  - Total Natural gas: 11,726 14.1%
  - Total oil and gas: 82,987 100.0%
  - % of GDP: 11.1%
  - Electricity: 11,348
  - % of GDP: 1.5%
- Implied cost definition: "Implied cost is measured by multiplying per unit implied cost with quantities consumed. Implied cost per unit is measured as the difference between the local price and the reference price. The reference price used is the U.S. market price adjusted for taxes."

### The Electricity Sector in Saudi Arabia (Box 1)
- Saudi Electricity Company (SEC) supplies energy shares: residential 49 percent, industrial 20 percent, commercial 15 percent, government 11 percent, other 5 percent.
- SEC produces 77 percent of total energy supplied and purchases electricity to meet the remaining 23 percent of domestic electricity demand.
- Other producers: Saline Water Conversion Corporation (SWCC) — second largest single producer of electricity (6 percent share); privately-owned independent water and power plants account for the rest.
- Fuel mix for electricity generation in 2013 (ECRA, 2013): crude oil 28 percent, diesel 15 percent, heavy fuel oil 10 percent, natural gas 47 percent.
- 2010 tariff change: "average price of electricity sold to non-individual users was increased by over 20 percent, which increased revenues by SR 3.2 billion in 2011."
- Using U.S. tariff gap to compute implied cost: estimate of $11.4 billion or 1.5 percent of GDP in 2014.
- ECRA estimated average cost of electricity production and transmission at SR 0.152 per kwh.
- Capital requirements: "capital requirement to fund electricity expansion projects is estimated at about SR 526 billion over the next 5 years." Financing to date includes government loans and three sukuk issuances "valued at SR 68.6 billion or $18 billion by end 2014."
- Tiered residential rates: range from SR 0.05 per kwh to SR 0.26 per kwh; SEC levies additional monthly charge ranging from SR 0.1 to SR 0.3 per kwh (averages to SR 0.2 / $ 0.05 per kwh).
- Fuel prices paid by electricity producers in 2013 (in USD per million BTU):
  - Heavy fuel oil: 0.43 (Saudi) vs 15.43 (International)
  - Gas: 0.75 vs 9.04
  - Diesel: 0.67 vs 21.67
  - Crude oil: 0.73 vs 19.26
- Electricity tariffs in 2014 (Average - Saudi Arabia): SAR per kwh 0.14, USD per kwh 0.04, million kwh 274.56, US$ million 10.8
- Average - U.S.: 0.13 (table entry)

### Growing energy consumption and implications
- Per capita energy consumption in Saudi Arabia is among the highest in the world, promoted by low domestic energy prices.
- Elasticity of energy consumption to growth over 1980–2011: oil exporters 1.3 compared to 1.1 for the MENA region (IMF 2014).
- Domestic consumption of refined oil: reached 2.5 mbd in 2014 and constituted about 19 percent of total crude oil production.
  - Note: refined oil consumption of 2.5 mbd in 2014 includes 0.04 mbd of LPG, 1.9 mbd of other refined oil products and 0.6 mbd of crude oil consumed as input by electricity and water companies as well as by cement, petrochemical companies among others.
- Oil consumption growth: average annual rate of 6.3 percent since 2011.
  - If oil consumption continues at 6.3 percent annual growth, additional domestic demand would completely crowd out current refined exports of 1 mbd by 2022.
  - By 2042, all of the total oil exports of 8.1 mbd in 2014 would be required to meet domestic oil needs.
- Natural gas consumption grew by an average rate of 5 percent between 2011 and 2014.
  - Saudi Arabia produced about 1.95 million barrels of oil equivalent per day of natural gas in 2014, all consumed domestically.
- Electricity consumption increases (2010–2014):
  - Industrial usage increased cumulatively by 32 percent.
  - Commercial usage increased cumulatively by 41 percent.
  - Number of residential customers increased by over 50 percent.
- Water consumption: per capita consumption of water is 235 liters per day, "which is 91 percent higher than the international average (according to a 2012 report by SWCC)."

### Environmental and distributional consequences
- Low retail fossil fuel prices encourage overconsumption and environmental distortions.
- Carbon dioxide emissions in Saudi Arabia are recorded at three times the world average of 5 metric tons (IMF, 2014).
- CO2 intensity: Saudi Arabia has CO2 intensity of around 1.0 (tons/$1,000 of GDP) among top emitters.
- Smuggling and black market risks: "low domestic prices also create opportunities for smuggling and black market activities."
- Distributional incidence:
  - World Bank survey findings for other countries: poorest quintile in Egypt, Jordan, Mauritania, Morocco, and Yemen receive only about 1–7 percent of total benefits from low diesel prices.
  - In Egypt, poorest 40 percent received only 3 percent of benefit from low gasoline prices, and 7 percent and 10 percent from low natural gas and diesel prices respectively.
  - In Jordan, low energy benefits received by the richest quintile were about 20 percentage points higher than those received by the poorest quintile.
  - Leakage: "richest quintile benefit nearly 6½ (12) times more from low gasoline (diesel) prices than the poorest quintile (IMF 2014)."
- Saudi household patterns (2013 survey):
  - Households with above average spending spend between 10 and 13 percent of total expenses on transport, compared to 1 to 7 percent among low and medium spending households — implying transport fuel price incidence is likely lower for low income segment.
  - Low and medium spending households consume a larger share of utilities (water, gas, electricity) than households with above average expenses — suggesting targeted increases in electricity and water tariffs for high income groups could be considered.

### Fiscal and policy implications
- Reforms to reduce the high implicit cost of low energy prices would allow retaining priority spending during fiscal adjustment.
- Energy price reform could:
  - Increase government revenues.
  - Reduce the support provided to entities such as the electricity company.
- The implicit cost of low energy prices is higher than fiscal expenditure on either education or health; additional revenues could be used to protect priority investments and social spending.
- Energy price reform considerations:
  - A gradual approach or more generous short-term safety nets may be needed because "the loss of consumer welfare as a result of price reform is likely to be larger in the short term than in the long term."
  - Long-term price elasticity of energy demand estimated between -0.3 and -0.5 (Charap and others, 2013) — suggesting strong responsiveness to price changes and significant long-term benefits from reform.

### Current energy initiatives in Saudi Arabia
- Expanding refining capacity:
  - Three new refineries in Satorp, Yasref and Jazan (with 0.4 mbd capacity each) are being developed as part of Aramco’s strategy to expand refining capacity by 57 percent over the medium term.
  - Satorp is fully operational and contributed to the 25 percent increase in refined oil exports in 2014.
  - Yasref expected to start refining by 2015Q4; Jazan expected functional by 2017.
- Electricity generation expansion and renewables:
  - K.A.CARE aims for half of electricity generated from renewable sources by 2032.
  - Forecast electricity demand growth necessitates power generation capacity increase to 120 gigawatts (GW) by 2032 (from 58 GW in 2013).
  - Brookings Institution report: about 70 percent of additional capacity expected to be solar power and 30 percent nuclear power.
  - Newer technologies expected to use natural gas as primary input and target production efficiency increases to international levels over the next 7 years.
- Energy efficiency initiatives:
  - Saudi Energy Efficiency Center (SEEC) established in 2010.
  - Energy efficiency program launched in 2012 focusing on buildings, transportation, and industry.
  - SEEC targets reducing energy intensity by 2030 and aligning energy intensity with G7 countries.
  - Regulations for building codes and appliance energy efficiency standards are being implemented.
- Public transportation development:
  - Riyadh rail metro project expected completion by 2018.
  - High speed rail project connecting Mecca, Medina and Jeddah expected completion by 2017.
  - North-South railroad project expected completion by 2018.
  - Metro rail project in Jeddah and several bus projects planned between 2015 and 2024.
- Barriers and complementarities:
  - Low domestic energy prices create barriers to energy efficiency and lower attractiveness of alternatives.
  - Non-market obstacles include institutional barriers, lack of information about savings, and challenges in aggregating finance for small-scale technologies.
  - Energy efficiency initiatives complement price reform but may not substantially slow consumption without price reform.

*Source: IMF staff report excerpts from the document _cr15286 - 4.      The implicit cost, computed using*

### 19.      In the MENA region, energy price reforms have started, albeit at a varying pace in

### _cr15286 - 19.      In the MENA region, energy price reforms have started, albeit at a varying pace in

### Recent reforms in the MENA region and GCC
- Many GCC countries have started increasing some energy prices and mostly for a small section of users.  
- UAE and Qatar have increased gasoline prices; Bahrain and Saudi Arabia have increased electricity tariffs for industries; Kuwait has increased diesel and kerosene prices and is studying a proposal to increase electricity prices; and more recently Oman has doubled the industrial price for natural gas.  
- The pace and magnitude of energy price reform in the GCC has been slow.  
- Among other energy exporters in the region, Iran and Yemen have initiated energy price reforms.  
- Many oil importers in the region—Egypt, Jordan, Mauritania, Morocco, Sudan, and Tunisia—have also initiated reforms over the last decade.  
- Among energy exporting countries outside the MENA region, Malaysia, Nigeria, Indonesia have initiated energy price reforms.

- Selected country actions (as reported):
  - Bahrain: Gas price for old industrial costumers was increased 50 percent starting in January 2012, from $1.50 to $2.25 per mmbtu; price for new industrial customers remained at $2.50 per mmbtu (prices for new customers were increased from $1.30 to $2.50 In April 2010). Starting in March 2015 the gas price for industrial users was unified at $2.50 mmbtu. Authorities announced annual increases of $0.25 per mmbtu in the gas price for industrial user starting in April 1, 2015 until the price reaches $4.0 per mmbtu by April 2021. In March 2015 the authorities increased the fuel price in marine stations. Tariffs for electricity and water for non-domestic use were also raised (in October 2013).
  - Kuwait: A study on the impact of a differentiated electricity and water tariff structure was completed in 2014. Subsidies on diesel have been discontinued.
  - Oman: An energy sector study is ongoing, with a view to gradually reducing the overall fuel subsidy. In January 2015, the industrial price for natural gas has doubled.
  - Qatar: Qatar raised the pump prices of gasoline by 25 percent and of diesel by 30 percent in January 2011. Diesel prices were again raised in May 2014, by 50 percent.
  - Saudi Arabia: Saudi Arabia increased the average price of electricity sold to nonindividual users by over 20 percent on July 1, 2010.
  - United Arab Emirates: UAE increased gasoline prices in 2010 to the highest level in the GCC. Abu Dhabi increased tariffs in January 2015 (by 170 percent for water and 40 percent for electricity). Dubai raised water and electricity tariffs by 15 percent in early 2011.

### Elements of successful energy price reform (six elements)
- A comprehensive energy sector reform plan:
  - Should be drawn up in consultation with stakeholders and include clear long-term objectives and an assessment of potential political barriers and impact.
  - Iran (2010 fuel price reform): incorporated clear objectives, compensating measures, and a timetable; preceded by an extensive public relations campaign; bank accounts opened for most citizens prior to the reform and compensating cash transfers deposited into these accounts preceding the implementation of price increases.
  - Electricity price liberalization in the Philippines and Turkey: clear medium-term reform strategy and careful planning cited as major success factors.
  - Ghana (2005): government commissioned an independent poverty and social impact analysis to assess winners and losers and to inform communication and mitigation design.

- A comprehensive communication strategy:
  - A well-planned campaign is essential throughout the reform process to generate broad political and public support.
  - Should inform the public of the cost of current policies and benefits of reform, including budgetary savings to finance education, health care, infrastructure, and social protection.
  - Strengthen transparency in reporting the costs of low energy prices in the budget.
  - Information campaigns supported reforms in Ghana, Iran, Namibia, Philippines, Armenia, and Uganda.
  - Philippines example: a nationwide road-show to inform the public of problems associated with low petroleum prices.

- Appropriately phased and sequenced price increases:
  - Phasing in price increases and sequencing across energy products may be preferable to avoid intense opposition.
  - Phased strategy allows households and enterprises to adjust and gives government time to develop social safety nets.
  - Examples: Morocco raised fuel prices gradually from 2012 to 2014 with partial indexation and gradual elimination of low prices; Jordan increased gasoline, diesel, and electricity tariffs gradually from 2012 and adopted an automatic gasoline price formula.

- Targeted mitigating measures:
  - Well-targeted measures to protect the poor are critical for public support.
  - Targeting approaches: higher prices for products used by the better off, transfers, targeted cash transfers or vouchers (preferred).
  - When cash transfers are not feasible, expand public works programs while administrative capacity is developed.
  - Improving Targeting examples: Morocco and Egypt set higher octane fuel at higher price than diesel used in public transport; Jordan and Egypt provide cheap electricity to households up to a threshold; Iran’s electronic card system (June 2007) created a de facto multi-tier pricing structure.
  - Cash transfers examples: Jordan’s recurrent cash assistance program; Yemen’s poverty alleviation program; Iran deposited cash transfers in new bank accounts financed by revenue from price increases; Indonesia expanded unconditional cash transfer payment and health insurance for poor households and introduced programs covering education, financial assistance, and healthcare with card technologies; Morocco and Mauritania introduced cash transfer programs.
  - Other household measures: Tunisia introduced a new electricity tariff to protect low consuming households, a new social housing program, and increased income tax deduction for the poor; Morocco strengthened existing programs to expand social spending and targeting.
  - Other industry measures: Jordan is developing lower-cost energy generation sources to reduce dependence on imports for energy intensive sectors; Iran proposed using some revenue from end-2010 price increases to support enterprise restructuring and reduce energy intensity.

- Depoliticized price setting:
  - Durable reforms require a depoliticized and rules-based mechanism for setting energy prices to reduce chances of reversal.
  - Adoption of an automatic fuel pricing mechanism should be part of a broader reform strategy; responsibility can be given to an independent body.
  - Over the longer term, reforms for petroleum products should aim to fully liberalize pricing.

- Improved efficiency of state-owned energy producers:
  - Strengthen financial position and operational performance to reduce need for budget transfers.
  - Permit private companies for electricity generation and distribution to address operational inefficiencies.
  - Improved demand management (e.g., higher prices during peak periods) can shift demand to lower marginal cost periods.
  - Revenue-enhancing measures like improved collection and metering could be initiated with large customers then extended to smaller ones.

### Automatic Pricing Mechanism (Box 2)
- Under such a mechanism, international price fluctuations are passed through to the consumer using an explicit fuel price formula. Retail fuel prices are changed at pre-specified regular intervals (e.g., weekly, bi-weekly, or monthly) to fully reflect changes in international prices.
- Price smoothing rules may be used to avoid excessive volatility in domestic prices in the short term. Smoothing mechanisms include price band and moving average mechanisms.
  - Price band mechanism: sets the maximum limit on magnitude of retail price changes.
  - Moving average mechanism: bases retail price adjustment on changes in the history of international prices.
- Objectives: reduce price volatility and avoid political pressures created by large one-off increases or ad-hoc approaches that can lead to long periods of fixed prices.
- Examples of adoption:
  - Jordan resumed a monthly fuel price adjustment mechanism in January 2013.
  - Tunisia re-introduced an automatic price formula for gasoline in January 2014.
  - Mauritania adopted a new automatic diesel price formula in May 2012.
  - Morocco implemented partial indexation in September 2013, eliminated regulated gasoline and industrial fuel prices in January 2014, and introduced bimonthly reviews.
  - Cote d’Ivoire adopted an automatic pricing mechanism with smoothing in 2013.

### Macroeconomic impact of energy price reform
- Cross-country experiences show limited inflationary impact if reform is well planned and gradual.
  - Morocco and Jordan experiences suggest persistent inflation is unlikely if price increases are gradual and well planned.
  - Indonesia: price reforms in 2005 and 2008 caused short-lived inflationary pressures which subsided within a few months. A new round of reforms since January 2015 had no substantial pickup in inflation.
  - Iran: policy measures and comprehensive communication taken several months before December 2010 reform helped keep domestic inflation low for the initial months.
- Saudi Arabia specific points:
  - Energy-related products―utilities (water, gas, electricity) and transport fuels—together constitute about 3.7 percent of the total CPI basket.
  - The impact of the first-round increase in gasoline and diesel prices could be bigger on the middle and high income groups in Saudi Arabia with a bigger share of transport fuel expenses.
  - Middle and low income households would be more impacted by increases in utilities prices, such as cooking gas, electricity and water.
  - Second-round impact on non-fuel components of CPI depends on expectations of future inflation (IMF 2014).
  - Since prices of food and many other consumer basket commodities in Saudi Arabia are imported, some of the impact of fuel price hike could be restricted.
  - Detailed information on the consumption basket across income groups is needed to estimate full incidence impact on inflation.
- Industrial impacts in Saudi Arabia:
  - Energy-intensive industries (plastics, petrochemical and aluminum) would see increased production costs and reduced competitive advantages, potentially slowing export growth.
  - Improving competitiveness and business climate and energy-efficiency measures can help adaptation over time.
  - Higher energy prices create incentives for industries to minimize energy costs, increase efficiency, and strengthen incentives for R&D in energy-saving and alternative technologies.
  - Short-term adjustment costs may be large; temporary measures can mitigate these costs.

### Conclusions and key takeaways for Saudi Arabia
- Costs of low energy prices in Saudi Arabia are substantial though not immediately obvious: rapid growth in energy consumption, potential fiscal revenues forgone, and distributional effects that likely disproportionately benefit the better off.
- A gradual increase in energy prices could reduce these costs and allow retaining priority investment and social spending during fiscal adjustment.
- Additional gains from initiatives to increase energy supply and improve energy efficiency could be achieved by raising domestic energy prices.
- Policy guidance drawn from other countries’ experiences:
  - Develop a comprehensive energy price reform plan with clear long-term objectives and a detailed assessment of impacts on households and the productive sector.
  - Gradually phase out low energy prices and put in place mitigating measures to protect vulnerable populations and help industry adjust.
  - Implement a well-designed communication strategy: calculate and publish the cost of low energy prices, discuss benefits of raising domestic prices, and announce mitigating measures for targeted households and industries.
  - Cash transfers and other targeted mitigating measures may need to be implemented almost simultaneously with price changes.
  - Availability and development of public transportation systems is expected to reduce the impact of fuel price increases on transportation costs of the population.

*Source: SAUDI ARABIA — International Monetary Fund (excerpts from the provided chapter).*

### 27.      The availability of detailed household level data on the consumption basket across

### 27.      The availability of detailed household level data on the consumption basket across

### Household consumption data and policy relevance
- Detailed household level data on the consumption basket across income levels is essential to conduct a thorough analysis on the impact of increase in domestic prices on the low and middle income groups.
- A detailed breakdown of the consumption basket would facilitate planning for cash transfers and other mitigating measures needed to protect the most vulnerable sections of the population, as part of a comprehensive reform strategy.

### Labor market reform overview and objectives
- Recent intensified effort to increase employment of nationals in the private sector through education and training reform and implementation of a quota scheme (Nitaqat).
- Reform strategy components:
  - Active labor policies.
  - Investment in education and training.
  - Wage policy aimed at raising the wage of nationals in the private sector.
  - Enforcement of a more rigorous quota system requiring companies to employ a minimum number of Saudi workers and limiting access to cheap, low-skilled expatriate workers.
- Key tradeoffs noted: replacing low-skilled, low-wage expatriates with nationals will increase wage levels and inflation; improving skill composition of the national workforce could raise productivity and offset adverse impacts on competitiveness.
- Policy emphasis: controlling public employment size and compensation and gradually implementing the quota system to avoid higher costs and disruption to private sector activity.

### Background: employment and structural issues
- Long-run structural outcomes:
  - Reliance on low-wage foreign labor has contributed to distortions: reliance of nationals on public employment and a low productivity growth pattern.
  - Population size has tripled since 1975.
  - Population structure has tilted toward working age groups, with over 35 percent of the population still under the age of 19.
- Employment and growth patterns:
  - Non-oil economy grew on average by over 7 percent a year since 2000 and created more than 3.6 million jobs in the private sector, but only one fifth of these went to nationals.
  - Private sector jobs continue to be largely filled by foreign workers; government remains the largest employer of nationals.
  - Job creation for nationals concentrated in government and community service sectors, which contributed more than 70 percent of total jobs created for nationals, but only 15 percent to GDP growth.
- Labor market segmentation and skills:
  - Wage levels of nationals are about three times those of expatriates, especially for less educated groups.
  - Nationals are concentrated in higher-paid and higher-skilled sectors such as banking and mining.
  - Occupational profile differences: about 30 percent of expatriates are in “basic engineering” while nationals’ share in that category is less than 5 percent; nationals’ largest occupation is “services” at about 33 percent of total.
  - Public sector employs about 70 percent of the Saudi work force.
  - Creation of a public-sector job can crowd out private-sector employment.

### Unemployment and demographics
- Unemployment statistics and disparities:
  - Overall unemployment rate for nationals: 11.7 percent.
  - Female unemployment: about 33 percent in 2014.
  - Male unemployment: less than 6 percent.
  - Total number of unemployed Saudis in 2014: 650,000, which is one tenth of the total number of jobs held by foreign workers.
  - Regional variation: unemployment as high as 20 percent in some regions.
  - Youth employment note: youth unemployment rate rising; urgency underscored by demographic composition.

### Recent labor reforms and initial impact
- Major reform instruments:
  - Nitaqat program (quota and color-coding system tied to visa renewal and services).
  - De facto minimum wage requirement for Nitaqat credit: SR 3,000.
  - Hafiz jobseekers’ allowance: monthly allowance of SR 2,000 for a maximum period of one year.
  - Fees on companies with a majority of expatriate workers: SAR 200 per month per foreign worker to finance wage subsidies and program expansions.
  - Greater internal mobility and bargaining power for expatriate workers in certain conditions; stricter enforcement of work permits.
  - Targeted measures to increase female employment (e.g., retail).
- Initial outcomes and evidence:
  - Since 2011, employment of nationals in the private sector has increased in manufacturing, transportation, and services; nationals have accounted for an increasing share of new jobs created.
  - Overall employment growth has declined owing to a sharp decline in expatriate employment growth (driven by stricter enforcement of regulations on illegal foreign workers).
  - Unemployment has declined slightly while youth unemployment continued to edge up.
  - Public employment has continued to rise and the government wage bill reached about 12 percent of GDP in 2014.
  - An empirical study by Peck (2014) using firm-level data to 2012 found that under Nitaqat, 96,000 nationals had been employed in the private sector, but its overall impact on total job creation in the private sector was negative.
  - Evidence of firms avoiding the system by hiring Saudi workers on a temporary basis to avoid penalties.
  - Alshanbri et al. (2015) based on HR manager interviews identified barriers: skill profiles and high wage requirements of nationals, and cultural issues.
  - The de facto minimum wage requirement affected over 50 percent of Saudis working in the private sector; wage data from GOSI shows about 700,000 Saudi workers in the lower wage category saw their wage double in 2013.

### Box 1 — Components of recent labor initiatives (high-level)
- Nitaqat program: quota system, color-coded firm classification, incentives and penalties tied to expatriate visa renewal and services.
- De facto minimum wage: SR 3,000 required to be counted as a full Nitaqat credit.
- Hafiz jobseekers’ allowance: SR 2,000 monthly for up to one year, conditional on participation in job search and training.
- Fees on companies with majority expatriate workers: SAR 200 per month per foreign worker to finance wage subsidies and program expansions.
- Reforms to expatriate workers’ mobility and stricter enforcement of work permits.
- Initiatives to increase female employment in targeted sectors and establishment of an unemployment assistance scheme.

### Policy implications and recommended sequencing (from the text)
- Gradual implementation of quota systems is important to avoid abrupt disruption to private sector activity.
- Controlling public employment size and compensation is critical to prevent crowding-out and rising fiscal costs.
- Focus on improving skill composition of the national workforce through education and training to raise productivity and offset wage and inflationary pressures.
- Consider targeted cash transfers and mitigating measures for low and middle income groups informed by detailed household consumption data.

*Source: _cr15286 - 27.      The availability of detailed household level data on the consumption basket across (IMF staff report excerpts).*

### 16.      The availability of low-wage expatriate labor has played an important role in shaping

### 16.      The availability of low-wage expatriate labor has played an important role in shaping

### Labor market dynamics and recent initiatives
- The availability of low-wage expatriate labor removed constraints to private sector growth in early development stages and contained wage and price pressures during oil upswings, but contributed to low productivity and disincentives for nationals to build private-sector skills.
- Recent initiatives with immediate impact include: Nitaqat program, Hafiz program, wage subsidies, and the new de facto minimum wage.
- Returns to education and skills development are expected to take longer to materialize.
- Demographics and participation:
  - Between 1.6 and 1.8 million nationals will enter the labor force over the next 6 years, given current age structure and assuming further increases in participation.
  - The higher number (1.8 million) is derived from estimated working-age population growth and continuation of recent participation increases; the lower number (1.6 million) assumes participation increases continue but at a slower pace.

### Fiscal implications and employment projections (scenarios and key figures)
- Private sector job creation and nationals’ share:
  - Private sector would create around 1.7 million jobs (for nationals and expatriates) based on staff projections for non-oil growth for 2015–20 and past employment–growth elasticity.
  - Employment of nationals in the private sector would increase by between 380,000–450,000 depending on whether the share of new jobs going to nationals stays at its 2014 level of 21 percent or increases to 23 percent by 2020.
- Public sector hiring and unemployment outcomes:
  - If government hires nationals at a growth rate of 3.7 percent annually (baseline), 800,000 Saudis will be absorbed into the public sector.
  - This would leave between 450,000–700,000 Saudis unemployed, with the unemployment rate ranging from 14.9 to 16.4 percent by 2020 (Table 1, scenarios 1 and 2).
- Wage bill projections:
  - Baseline projections imply a wage bill close to 14 percent of GDP by 2020.
  - If the government aims to keep unemployment at its 2014 level, public employment growth would need to be 5.2 percent annually during 2015–20, increasing the wage bill to about 15 percent of GDP by 2020 (Table 1, scenario 3).

### Reform scenarios and fiscal outcomes
- Reform raising nationals’ private-sector share by 10 percentage points (to 32 percent by 2020):
  - Would result in 1.2 million jobs going to nationals out of the 1.7 million projected private-sector jobs by 2020.
  - Unemployment would decline to 5.1 percent, assuming government hiring continues at the baseline rate (Table 2, scenario 4).
- Alternative reform allowing lower public hiring:
  - If reforms permit government to reduce public employment growth to less than 2 percent annually, both the wage bill and unemployment rate would remain around their 2014 levels (Table 2, scenario 5).

### Impact on wages, inflation, and real exchange rate
- Wages and operating costs:
  - Employment of nationals in the private sector is correlated with their wage level; average wages will need to increase to attract more nationals.
  - Worker compensation share of operating costs varies across sectors, from less than 10 percent to over 75 percent in some service sectors.
  - Under a scenario where labor reforms increase the share of nationals in the labor force by 10 percentage points (from 22.4 percent to 32.4 percent), and using current wage gaps, operating costs in the private sector could rise by up to 3 percent.
- Econometric evidence on expatriates and inflation:
  - A VAR using annual data 1980–2014 relating CPI inflation to FP, GDPGR, DNEER, and EXPATGR suggests that a one percent increase in the growth of expatriates in the workforce reduces inflation by about 0.1 percent after one year; the effect fades over time.
  - A gradual decline in expatriate employment growth from the recent average of 3.5 percent annually to 1.5 percent annually over 2015–20 would increase the ratio of nationals in the private sector by 10 percentage points; the impact on inflation would be small each year, around 0.2–0.4 percent.
- Real exchange rate:
  - Replacement of expatriates could lead to real exchange rate appreciation via reduced remittance outflows (leakages) and higher domestically spent income, consistent with empirical findings linking remittance outflows to real effective exchange rate depreciation in comparable countries.

### Productivity and growth
- Recent growth drivers and TFP:
  - Growth has been strong but productivity growth generally slow; non-oil sector growth driven mainly by factor inputs (capital and labor) while total factor productivity (TFP) made a small contribution.
  - TFP improved and became positive in the 2000s compared to the 1990s, but its contribution remained small relative to capital and labor.
- Growth accounting (average contribution to non-oil sector growth):
  - Cost share of capital (α) = 0.4:
    - Growth: 2.9 (1990–99) and 6.8 (2000–2014)
    - TFP: -0.4 (1990–99) and 1.0 (2000–2014)
    - Capital: 2.0 (1990–99) and 3.0 (2000–2014)
    - Labor: 1.3 (1990–99) and 2.8 (2000–2014)
  - Cost share of capital (α) = 0.68:
    - Growth: 2.9 (1990–99) and 6.8 (2000–2014)
    - TFP: -1.2 (1990–99) and 0.3 (2000–2014)
    - Capital: 3.4 (1990–99) and 5.0 (2000–2014)
    - Labor: 0.7 (1990–99) and 1.5 (2000–2014)
- Labor productivity and human capital (average contribution to labor productivity):
  - Cost share of capital (α) = 0.4:
    - Productivity growth: 0.9 (1990–99) and 2.1 (2000–2014)
    - TFP: -1.4 (1990–99) and 0.1 (2000–2014)
    - Capital–labor ratio: 1.1 (1990–99) and 1.0 (2000–2014)
    - Human capital: 1.2 (1990–99) and 1.0 (2000–2014)
  - Cost share of capital (α) = 0.64:
    - Productivity growth: 0.9 (1990–99) and 2.1 (2000–2014)
    - TFP: -1.6 (1990–99) and -0.2 (2000–2014)
    - Capital–labor ratio: 1.8 (1990–99) and 1.7 (2000–2014)
    - Human capital: 0.7 (1990–99) and 0.6 (2000–2014)
- Education and productivity:
  - Expected years of schooling increased from 5.8 to 8.7 between 1990 and 2013.
  - Results suggest education has contributed positively to labor productivity and played a more important role than physical capitalization in some specifications.
  - Continued focus on improving education outcomes, aligning skills with private sector needs, and directing more investment to technical and vocational training is recommended to strengthen productivity over time.

*Italic: Source: IMF staff calculations and authority data as presented in the supplied chapter excerpt.*

### 32.      Firm control of public employment and compensation is needed to encourage people

### 32.      Firm control of public employment and compensation is needed to encourage people to seek employment in the private sector.

### Public employment and civil service reform
- A clear sign from the government that the public sector can no longer be the employer of first and last resort would help set expectations of people entering the workforce.
- Combine firm control of public employment and compensation with a civil service review to identify positions that are essential for the provision of government services and those that are not.

### Gradual substitution of foreign workers
- Gradualism in substituting foreign workers would help limit any potential disruptions to economic activity and pressures on wages and prices.
- Current skill profiles of nationals are not in line with private sector needs, especially for basic technicians and basic supporting engineering skills, and private sector needs will continue to rely on expatriates in the near term.
- Building skills is a slow process and will require continuous efforts to:
  - transform the education and training systems to be demand driven, and
  - encourage more Saudis to pursue vocational and technical programs.
- These factors should be taken into account in the design and enforcement pace of the Nitaqat quotas.
- Other research suggests a need for gradualism in the implementation of employment quotas to preserve the incentives for qualified candidates to invest in skills (Fryer and Loury, 2005).

### Narrowing wage gaps and labor market measures
- Wage gaps will need to narrow to increase the employment of nationals in the private sector, but this must go in tandem with changes in productivity and skill composition.
- Policy tools and measures to narrow wage differentials include:
  - Target high-skilled, high-wage expatriate workers through fees on low skilled labor.
  - Level the playing field in the labor market for nationals and expatriates with regard to regulations and work conditions.
  - Allow more labor mobility to increase productivity and wages of expatriates.
- Evidence: Naidu et al. (2014) find that reforms to increase expatriate mobility in the UAE have increased their earnings and reduced demand to import new immigrants.
- Wage subsidy programs implemented by the government can:
  - Support the acquisition of job skills, and
  - Help narrow wage differentials.
- For more details on ways to reduce wage differentials in the GCC and international experience, see IMF (2014).

### Macroeconomic policy implications
- Macroeconomic policies will need to adapt to a labor market where over time the role of foreign labor may diminish.
- If the labor market becomes less flexible and less able to play its historic role of helping contain overheating pressures, alternative instruments will be needed.
- Under the current exchange rate peg, the main instrument will be fiscal policy.
- Recommended fiscal approaches:
  - Smooth expenditures and build buffers during oil price booms to reduce overheating pressures and keep inflation under control.
  - Strengthen the fiscal framework and adopt a medium term framework to support policy and delink expenditure from oil revenue swings.
  - Reduce rigidities in the budget through lower wage and subsidy bills to facilitate fiscal policy and free resources for more productive spending.
- Over the longer term, greater exchange rate flexibility that would allow a more independent monetary policy could help manage economic cycles and cushion the economy from external shocks.

*Source: SAUDI ARABIA — INTERNATIONAL MONETARY FUND (excerpt paragraphs 32–35).*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15286.pdf_