RIYADH/DUBAI (Reuters) - Saudi Arabia, its finances hit by low oil prices, announced plans to shrink a record state budget deficit with spending cuts, reforms to energy subsidies and a drive to raise revenues from taxes and privatisation.

Construction labourers work at the site of the development project of King Abdullah Road in Riyadh February 5, 2013. REUTERS/Fahad Shadeed

The 2016 budget, released by the Finance Ministry on Monday, marked the biggest shake-up to economic policy in the world’s top crude exporter for over a decade, and includes politically sensitive reforms from which authorities previously shied away.

The plan suggests the kingdom is not counting on a major recovery of oil prices any time soon but is instead preparing for a multi-year period of cheap oil. The International Monetary Fund warned in October that Riyadh would run out of money within five years if it did not tighten its belt.

“Our economy has the potential to meet challenges,” King Salman said in a speech, adding the 2016 budget launched a phase in which his kingdom would diversify its revenues.

The government ran a deficit of 367 billion riyals ($97.9 billion) or 15 percent of gross domestic product in 2015, officials said. The 2016 budget plan aims to cut that to 326 billion riyals, reducing pressure on Riyadh to pay its bills by liquidating assets held abroad and issuing bonds.

Next year’s budget projects spending of 840 billion riyals, down from 975 billion riyals actually spent this year. The ministry said it would review government projects to make them more efficient and ensure they were necessary and affordable.

Revenues next year are forecast at 514 billion riyals, down from 608 billion riyals in 2015, when oil revenues accounted for 73 percent of the total. The Brent oil price averaged about $54 a barrel this year but is now around $37.

The success or failure of the budget plan will be key to maintaining the confidence of financial markets in Riyadh.

As the deficit has swelled, the riyal has dropped in the forwards market to its lowest since 1999 because of fears Riyadh may eventually have to abandon its peg to the U.S. dollar.

SUBSIDIES

In its budget statement, the ministry said it would adjust subsidies for water, electricity and petroleum products over five years. That is a politically sensitive step since the kingdom has traditionally kept domestic prices at some of the lowest levels in the world as a social welfare measure.

Changes will aim to make energy use more efficient and conserve natural resources, while minimising the negative effects on lower- and middle-income Saudis, the ministry said.

Minutes later, state news agency SPA said the government had raised domestic fuel, water and electricity prices. The price of 95 octane gasoline climbed to 0.90 riyal ($0.24) per litre from 0.60 riyal - though it remained very low by global standards.

The ministry also outlined other reforms including “privatising a range of sectors and economic activities,” although it did not give details.

The government plans to introduce a value-added tax in coordination with other countries in the region and raise taxes on soft drinks and tobacco, the ministry said, without giving a timeline. The United Arab Emirates has said it expects a regional VAT to take about three years to introduce.

Private analysts said markets could react positively to Monday’s budget announcement because the 2015 deficit was lower than the 400-450 billion riyals which many investors had feared.

“It seems the levers of fiscal discipline were put into action in the second half of this year, rather than waiting,” said John Sfakianakis, regional director of asset manager Ashmore Group in Riyadh.

But gross domestic product growth, which was 3.3 percent this year, is expected to suffer as state spending cuts hurt the construction industry and higher fuel and electricity prices dampen consumer spending.

“We see real GDP growth decelerating sharply in 2016, albeit remaining positive,” said Monica Malik, chief economist at Abu Dhabi Commercial Bank.

The Finance Ministry did not disclose the average oil price assumed in its 2016 budget calculations but economists estimated it was about $40 a barrel. The figure is an accounting device and does not necessarily mean Riyadh expects oil at that level.

Figures given by Economy and Planning Minister Adel Fakieh indicated the cost of Saudi Arabia’s military intervention in Yemen, which it launched in March and consists mostly of air strikes, was not a major factor in the budget. He said Saudi Arabia had increased its military and security spending in 2015 by about 20 billion riyals because of the conflict.