Is Saudi Arabia’s debt strategy sustainable?

Headline numbers looked better in the second quarter, but not all analysts are reading that as evidence that the Kingdom’s harder questions have been answered. “Saudi Arabia’s increasing reliance on debt extends well before the war, reflecting the extensive costs of diversification and desire to leverage assets to meet economic goals,” Geo-economic risk analyst Rachel Ziemba, founder of Ziemba Insights and an adjunct senior fellow at the Center for a New American Security, tells EnterpriseAM. The bigger tests, in Ziemba’s view, sit further out: in borrowing costs, in how long the reserve buffer can be stretched, and in the external accounts that don’t show up in a quarterly budget release.

Borrowing got no cheaper even as numbers looked better. The entire first-half deficit of SAR 160 bn was financed through borrowing, with nothing drawn from government reserves. Public debt climbed to SAR 1.685 tn by the end of June, up from SAR 1.519 tn at the start of the year, while financing expenses, the interest cost of carrying that debt, rose 41% y-o-y in 2Q alone. “With the conflict, the oil revenue piece is down but partly offset by higher prices,” Ziemba says. “But it’s more that spending needs have gone up.” Saudi Arabia is still better placed to absorb the fiscal hit than regional peers like Iraq or Bahrain, though it shares one exposure with every sovereign borrower: “Saudi Arabia faces challenges as US Treasury rates, and thus Saudi spreads, go up.”

Investors are still showing up, for now. Fitch affirmed the Kingdom’s A+ rating on 12 July, pointing to strong fiscal buffers and external finances even amid regional conflict and trade disruptions, while flagging oil dependence and governance as constraints. Moody’s affirmed Aa3 in May. Ziemba’s read on investor sentiment tracks with that calm: “Investors have been relatively upbeat about Saudi risk given the higher oil prices that partly compensate, but the bigger effects may be medium-term in nature.” She flags a structural issue underneath the calm, though: “Attracting FDI into key projects remains difficult,” which means Riyadh’s own government will likely keep functioning as the main investor behind its diversification agenda.

The government is choosing to borrow rather than draw down its cushion. Asked whether a two-front war, Iranian strikes, Houthi attacks on shipping and oil infrastructure, and the prospect of a Yemen ground campaign is the scenario the reserves were built for, Ziemba says yes: “This is one of the reasons why Saudi Arabia saved, and why the PIF was already turning mostly domestic.” She leaves one thought open-ended: how long that strategy holds depends on “whether Saudi Arabia is able to continue diverting supplies through new channels.”

The external accounts are the part that doesn’t show up in a quarterly deficit number. Ziemba argues the “full cost structure” of the war has to be weighed separately from the budget line, including war-risk premiums and the cost of rerouting shipments around Red Sea chokepoints. “I anticipate that the dynamics of the war will reinforce the Kingdom’s interest in import substitution, including construction inputs,” she says. “This will support the mining sector.” She also expects Saudi Arabia to be “looking to attract cargo throughput from other countries,” pulling in regional transshipment as the war reshapes Red Sea and Gulf logistics.

Ratings agencies are drawing a line between fiscally stressed and geopolitically stressed but solvent, and Saudi Arabia sits on the solvent side. “Saudi Arabia faces a structural fiscal weakness, but a manageable one, and additional stresses from the conflict,” Ziemba says. What keeps the agencies calm, she says, is a mix of continued fuel exports, revenue offsets elsewhere in the budget, and rising re-exports through Saudi Arabia “from other neighbors that lack port infrastructure” of their own. Looking further out, she says the agencies “will be considering demand shifts and the return on recent government investments,” a test that hasn’t come yet.