Saudi Arabia could suffer from an economic downturn and a massive fiscal deficit after years of strong performance in case oil prices dip to as low as $40 a barrel, according to a top Saudi bank.

At current prices, the Kingdom will still record a budget surplus and its economy will grow in 2008 but the performance of both sectors will be far below that in 2007, the Saudi American Bank (Samba) said.

What could aggravate the situation in the next two years if oil prices remain at around $40 is that the Kingdom's crude output will be lower and private investment could be stifled by dollar funding constraints.

But Samba said it believed Riyadh could still deal with such a pessimistic scenario given its massive foreign assets and low public debt, which has been slashed to nearly a fifth of its level nine years ago.

"The economy's likely resilience in the face of global turbulence is amply demonstrated through a simulated oil shock. In this exercise, an average price for WTI of $40 a barrel is projected for 2009 and 2010… though unlikely, this could conceivably arise if the seizing up of global capital markets intensifies, and if asset prices continue to fall, forcing further retrenchment among OECD consumers," it said in its monthly bulletin.

"In this environment we anticipate that the country's economic growth would slow rapidly as public spending is trimmed and private confidence is undermined by the new realities. A fiscal deficit of an average 22 per cent of GDP in 2009-2010 would also be in prospect." According to the report, such a scenario is ostensibly alarming, adding that those deficits could be comfortably financed by either a drawdown in foreign assets or fresh domestic debt issues.

"The aggregate projected deficit for both years is $140 billion (Dh514bn), while official foreign assets currently exceed $400bn," it said. "Moreover, such a drawdown would probably be unnecessary… domestic debt is equivalent to around only 18 per cent of GDP. There is also considerable pent-up demand for fresh issues: in the late 1990s, domestic debt exceeded $170bn, or over 100 per cent of GDP."