Revealed: How Saudi Arabia's deficit could rise to 10% of GDP

Bank of America Merrill Lynch research says $40 per barrel oil would render country's net fiscal proceeds 'insufficient'

Saudi Arabia's fiscal deficit could rise to nearly 10 percent of its gross domestic product with reserves halving to 35 percent of GDP if oil prices drop to $40 per barrel, according to a new report.

Bank of America Merrill Lynch’s latest research paper said the sensitivity of the macroeconomic adjustment to oil prices is large in the Gulf kingdom.

With oil prices currently trading at seven-month lows of below $47 per barrel, the report said that should oil prices average $40, Saudi Arabia's net fiscal proceeds are "insufficient".

It added that there would be "no sign of stablisation" and capital outflow could accelerate, putting further strain on the Middle East's largest economy.

Bank of America Merrill Lynch noted that at $50 oil prices, Saudi reserves are still likely to continue falling albeit at a slower pace.

"Sustaining domestic confidence and enhancing domestic investment opportunities to provide an outlet for repatriation of private sector capital will likely be key going forward," the report said.

"A sustained drop in oil prices is a key risk. Oil prices above $50 per barrel are conducive to helping reforms succeed while oil prices below $40 are likely to endanger macro stability."

It said that within this price band, further reforms or wider imbalances are likely but commitment to reforms may falter, should the impact of reforms be much larger than anticipated.

The report added that in this oil price range the macroeconomic outlook "is in a relatively grey zone" where a$10 swing in prices causes a $20-30 billion move in the fiscal and current account deficit, all else being equal.

On Saudi banking, the research said banks could enjoy a "significant opportunity to grow lending" as penetration remains low, particularly in the retail sector

With Saudi economic growth having slowed sharply since late 2014 when oil prices collapsed, loan growth in the Saudi system has also abated materially.

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