DUBAI - Saudi Arabia's economy is likely to contract by 0.5% this year following its decision on Sunday to cut oil output, Capital Economics forecasts.

The research firm had previously forecast Saudi gross domestic product (GDP) growth of 1% this year.

The kingdom's energy ministry said on Sunday the country would cut its oil output to 9 million barrels per day (bpd) in July from around 10 million bpd in May, the biggest reduction in years as the country and other producers seek to shore up flagging oil prices.

Despite the production cut, Capital Economics still expects the kingdom to run a budget surplus this year. It sees the kingdom's breakeven oil price at $80 a barrel. Brent crude was trading at about $76.8 a barrel on Monday.

"And we have left our end-year Brent crude price forecast unchanged at $90pb for end 2023, just that prices may be a little more elevated in the interim than we had envisaged," James Swanston, emerging market economist at Capital Economics, said.

Besides the global financial crisis and COVID-19 pandemic, the GDP contraction "would be the weakest pace of growth in the last 20 years," Capital Economics said in its research note.

Monica Malik, chief economist at Abu Dhabi Commercial Bank, said if the production cuts are maintained from July to end-2023, it would result in a GDP contraction.

"We estimate that if the 1.0 million b/d oil production cut is only maintained for July, it will reduce Saudi Arabia real headline GDP growth by c.0.3 percentage points. However, if it is extended for the remainder of the year (i.e. July to December), we estimate it will lower Saudi Arabia's headline GDP growth by 2.0 percentage points," she said.

Malik had previously forecast GDP growth of 1% for Saudi Arabia in 2023 and a fiscal breakeven price of $86.3 a barrel.

(Reporting by Yousef Saba; Editing by Susan Fenton)