Dilemmas of diversification

High oil prices and low interest rates allows the Saudi government to press ahead with structural reforms.

HIGH OIL PRICES and low interest rates, the traditional preconditions for a strong performance from the Saudi Arabian economy, have enabled the government to press ahead with structural reforms without having to impose the spending cuts that in recent years would have been needed to keep the budget under control.

With benchmark oil prices likely to remain nearer $30 a barrel than $20, well above the budgeted average figure of $17 a barrel, and production expected to stay at 9.5 million barrels a day, the revenue side of the budget looks certain to be buoyant this year.

"Oil revenue could be up as much as SR100 billion this year, bringing total oil revenue to SR230 billion and overall revenue to SR280 billion [$73.7 billion]," says Said Al-Shaikh, chief economist at National Commercial Bank.

If the government gets anywhere near its spending target of SR209 billion, the country could produce a rare surplus or balanced budget, something it managed in recent years only in 2001.

Ministers are hinting that books will at least balance this year. But economists inject a note of caution, warning that there is a tendency to announce additional unidentified and unanticipated spending when the final budget figures are produced. In 2002, for example, this transformed what looked on course to be a balanced budget into one with a SR45 billion deficit because of extra spending on projects.

"This year, spending on security after the May bombings in Riyadh and as a consequence of the Iraq war may cut into the surplus or eliminate it completely," says an economist. According to another: "It really is a matter of whether they want to report a surplus or add in other factors that will minimize the surplus and enable the finance ministry to maintain pressure on spending departments."

Despite the external financial and political shocks of recent years, the economy's foundations are now strong. In its economic assessment in July, credit rating agency Standard & Poor's points to the kingdom's ability to "maintain stability in its highly open economy, in particular the stable exchange rate, low inflation and a stable banking system".

S&P also says that this economic resilience will be further enhanced by "ambitious reforms to liberalize the economy further, strengthen its institutional capacity and prepare for World Trade Organization membership".

The kingdom also has a substantial cushion of foreign assets. Foreign exchange reserves held by the Saudi Arabian Monetary Agency (Sama), the central bank, stood at $42 billion at the end of 2002 - 10 months-worth of current account payments and four times the short-term debt.

A further strength is that the government has no foreign debt and no plans to raise any. Although central government debt is equivalent to 95% of GDP, S&P points out that 80% of this is medium and long term and held by the pension funds, the Public Investment Fund and other government institutions. "Consequently, on a consolidated basis, the general government's debt is relatively low at about 20% of GDP," concludes S&P.

The dilemma for the government is that many of the preconditions for Saudi Arabia's economic strength are beyond its control. Brad Bourland, chief economist at Saudi American Bank (Samba), notes that the economy grows at times of high oil prices and low interest rates. "These conditions prevail at present," he says. "But Saudi Arabia has limited control over both global oil prices and domestic interest rates [the currency is pegged to the dollar]." He warns that "relying on externally controlled events for growth is a precarious policy".

S&P also draws attention to the "limited fiscal flexibility" resulting from too great a reliance on oil revenue, noting that "there is insufficient private-sector economic growth". It also points out that policymaking "has been slow and timid in the face of adverse short-term economic shocks and long-term demographic challenges".

However the structural reforms of recent years, particularly a foreign investment law introduced in 2000 that transformed Saudi Arabia from among the most restrictive regimes to among the most liberal in the region, are now starting to take effect.

The Saudi Arabian General Investment Authority (Sagia), under the chairmanship of Prince Abdullah bin Faisal bin Turki Al-Abdullah Al-Saud, is now making it much easier for international firms to set up businesses in the kingdom. "We have granted 1,800 licences for investments totalling $13 billion. These include a number of large petrochemical projects," says Abdulrahman bin Zarah, deputy governor, investment promotion and services, at Sagia.

Sagia has played an important role in removing bureaucratic hurdles. It is often quicker for a European or American business traveller to get a Saudi Arabian visa than it is for a Saudi businessman to obtain a visa for many European countries or the US, for example. "We will follow up and help international companies as they deal with ministries. Our next goal is to have an electronic window to all the relevant departments," Bin Zarah says.

Bin Zarah, who says that there is still a strong flow of investors into the country despite the terrorist attacks in Riyadh in May and the setbacks to the natural gas initiative, believes there are unprecedented opportunities for investors. Most recently, US-based firm CMS's joint venture with Saudi National Power Company completed its $170 million project financing to construct the kingdom's first independent power project. "Saudi Arabia is the biggest market in the Middle East," says Bin Zarah. "We have attractive incentives, cheap industrial land and competitive utility prices. There are generous industrial loans and investment credits."

One concern of foreign investors has been the requirement to employ more Saudis as part of a strategy of reducing unemployment, which stands at 8%. Saudi workers are relatively expensive - as much as three times as much as foreigners - and their work has often been of relatively poor quality.

Bin Zarah counters this by pointing out that there is a human resources fund that provides half the wages of Saudi employees for two years, and also generous training grants. "Moreover, the quality of the Saudi workforce has improved considerably and their attitude has also changed. It used to be hard to find a Saudi salesman or cashier. Today they work in manufacturing and as cashiers at supermarkets," he says.