SAUDI ARABIA IS now delivering the reforms and sound economic management that will enable it to attract the investment required to modernize. Ministers face the challenge of ensuring that they use this opportunity to create the private-sector driven growth that will generate employment for a rapidly growing population.
Success with these reforms will also provide a much-needed positive message to the west at a time when Saudi Arabia's traditional alliances with the US and UK are under greater pressure than ever before.
As the country was receiving the news of a positive rating from Standard & Poor's, its foreign minister, Prince Saud Al-Faisal, was in an increasingly acrimonious dispute over the US decision to suppress a 28-page section of a congressional report on the September 11 2001 terrorist attacks.
Saud demanded the publication of the section linking the kingdom to the hijackers, arguing that Saudi Arabia can only defend itself against the charges if they are published in full. Relations between the two countries are at their worst for many years, with Saudi Arabia insisting that it is doing all it can to counter terrorism and pointing to the attacks in Riyadh earlier this year.
Despite this, the US is gradually reducing its dependence on the kingdom as its primary ally in the region. In this context the continued ability of the reformers, headed by Saudi Arabia's de facto ruler, Crown Prince Abdullah, to modernize the economy is critical as it indicates that they still hold the initiative.
Liberalization back on track
A series of announcements in recent months have confirmed that, despite frustrating delays, the liberalization strategy is back on track. It will be given added momentum following a cabinet reshuffle that has created a more reform-minded and dynamic ministerial team. Particularly significant was the creation of a ministry of water and electricity, under Ghazi Al-Qusaibi, the former Saudi ambassador to the UK. He has a mandate to revitalize these sectors and ensure that proper investment is made to meet rapidly increasing demand. The reshuffle is also expected to give new momentum to what was previously seen as a rather conservative-minded commerce ministry.
Local bankers also believe that these positive developments will more than outweigh concerns felt by international investors in the aftermath of the Iraq war and the terrorist attacks in Riyadh in May. The strongest evidence for this came in July with the revival of the initiative to explore and exploit the country's natural gas reserves.
Among other important recent steps taken by the government are measures to modernize the capital market and the insurance industry. It is also reaping the rewards for prudent economic management in recent years; this and high oil prices have put the budget on course for a surplus for only the second time in 20 years.
The government's strategy is also starting to receive international recognition. Standard & Poor's has given an A+ grade to Saudi Arabia's long-term local currency rating in its first official assessment of the sovereign.
The country is now well placed to build on the successes of its foreign investment law, which is one of the most liberal in the Middle East. And its privatization strategy received a big boost with the sale earlier this year of a 30% stake in Saudi Telecom (STC).
This demonstrated that there is a healthy appetite for investment in the right projects, that state-owned companies can deliver the necessary levels of commercial transparency and efficiency savings and that the government can find investors for privatization.
Damage limitation on gas project
Even the failure, after five years of negotiations, to reach an agreement with the world's leading oil companies for the showcase $15 billion project to develop the country's gas sector, a crucial driver of foreign investment, has had a favourable outcome.
This initiative comprised three core ventures, ranging from upstream exploration and production to downstream use of the gas to power desalination plants, generate electricity and feed petrochemicals production.
The initial negotiations with the foreign companies, headed by Exxon Mobil, fell down, apparently over rates of return for the companies and access to the gas fields. However, the rapid restructuring of the project and the award of the first contracts ensured that any damage was kept to a minimum.
The speed with which a new announcement was made was important as it will have restored the faith of foreign investors, says Said Al-Shaikh, chief economist at National Commercial Bank. "The rapid relaunch of the initiative has ensured that there been no damage to the concept of attracting foreign direct investment into Saudi Arabia. Investors could have been deterred if the replacement plan had not been announced," he says.
The new structure of the plan has also been welcomed. Instead of trying to award vertically integrated mega-projects covering everything from exploration to downstream businesses, the government has broken the contracts into smaller elements.
"It is a less complex plan than the one initially devised by the government, which means that it should be easier to meet the requirement of both the Saudi government and the independent oil contractors. It makes sense to start by focusing on exploration without tying in any of the other infrastructure projects," says Al-Shaikh.
The first deal has already been struck with three oil companies. Anglo-Dutch group Royal Dutch/Shell (the lead partner with 40%) and France's TotalFinaElf (30%) will undertake a scaled-down version of the $5 billion contract that Shell had originally been negotiating. These foreign companies will work in partnership with Saudi Aramco, the kingdom's state-owned oil company, which will take a 30% stake, to search for natural gas in 200,000 square kilometres of the Rub Al-Khali desert. However, there are still complex negotiations ahead before this deal can be finalized.
The award of this contract was followed up by a roadshow in London at which Saudi ministers made clear that there was no change in their overall strategy of pressing ahead with the opening up of the gas sector and doing so by involving international oil companies for the first time since nationalization in the 1970s.