Given that Middle Eastern capital markets are among the last to open up to international finance, it's unsurprising that analysts' research bulletins on the region often conjure up images of inertia. Consider the headings given to two reports published last year. Robert Fleming entitled a study on Egypt "The Sleeping Beauty". ING Barings chose "The Sleeping Giant" as the title for the section on Saudi Arabia in its Arab Stock Markets Review.
The authorities in Cairo could justifiably take offence. Egypt is wide awake when it comes to opening capital markets, privatizing with gusto and providing international investors with a steady stream of GDRs. Saudi Arabia, by contrast, is still snoozing. Although it has stepped up its encouragement of foreign direct investment, non-GCC (Gulf Cooperation Council) nationals are still excluded from its stock exchange, the region's biggest.
Saudi Arabia might argue that its economy does not need the drastic repairs introduced by president Hosni Mubarak's government over the last few years. The most basic macroeconomic indicators for 1996 do indeed make encouraging reading: GDP, boosted by higher than expected oil prices, is estimated to have risen last year by 8.6% in nominal terms, compared with 4.3% in 1995 and only 1.7% in 1994. In spite of this, inflation last year was kept below 1%, compared with 5% in 1995.
More important, as Kevin Taecker, chief economist at Saudi American Bank (Samba), argues, private-sector activity in the kingdom seems to have picked up over the last year. In an economy that desperately needs to diversify its revenue stream away from crude oil, the private sector - by definition concentrated in the non-oil sector - is an important indicator of industrial diversification. As the Jeddah-based National Commercial Bank (NCB) explains in its latest economic overview, the private sector expanded by 3.5% in 1996, confidence mainly being bolstered by "higher oil prices and the payment of arrears by the government to contractors, farmers and suppliers, to the tune of SR22 billion [$5.9 billion]". As a result, says the report, "several major private sector institutions which stretched their lines at local banks to the limit in 1995 were able to borrow again after receiving payments from the government".
Looking to the future, there is a general recognition that Saudi Arabia needs to introduce widespread reform in its economy and its financial services industry if it is to build on oil revenue.
The NCB report implies that higher oil prices may not have been such a welcome development after all. "Even if oil prices maintain the high level attained in 1996," it warns, "this would not solve any of the fundamental challenges that the country faces, be it overspending, increasing private sector participation, boosting productivity of public sector institutions, upgrading the legal and financial infrastructure, reducing unemployment and downsizing the public sector. It is hoped that the recent rise in oil prices would not lead to the postponement of the reform policies that were introduced in the past two years."
Temptation resisted
To date, this has not been the case. As Samba notes in its spring 1997 Outlook for the Saudi Economy: "Temptations have been resisted to use the oil revenue uptick for quick-fix bail-outs of financially troubled enterprises. Rather, more fundamental solutions are sought where the aim is to bring these quasi-independent entities into the process of economic reform. As with the rest of economic policy - in uniquely Saudi ways - they will be moving to harmonize with IMF, World Bank and WTO prescriptions for economic openness and liberalization."
Pressure from these institutions aside, there are good reasons why economic and financial policy needs to change. First, the western stereotype of a desert kingdom luxuriating in fantastic wealth is a myth. One London-based banker insists change has to come simply because "20 years ago Saudi's per capita income was $15,000; today it is nearer to $5,000. Twenty years ago the kingdom ran no budget deficits; today it has a huge budget deficit to service." The brunt of the decline in living standards has fallen not on the thousands of ruling princes, but on the poorer sections of society.
Alarmingly, Saudi Arabia's social indicators are starting to reflect the free fall in per capita icome. A report last year in the Arab Review pointed to estimates that 30% of children in Saudi Arabia do not go to school and that the literacy rate of about 55% is lower than Jordan's or India's. Although they are rarely expressed publicly, there are concerns - not just in Saudi Arabia but in many of its neighbours - that this environment is starting to show uncomfortable similarities to that in Iran in the mid-to-late 1970s before the Islamic revolution.
Second, Saudi Arabia's increasing need to reform its economy in general and its capital markets in particular is also a simple by-product of trends elsewhere in the region. Five years ago the kingdom could rightly claim that its policy on foreign portfolio investment was roughly in line with that of most of its near neighbours. Today, change is spreading rapidly, most notably in Egypt but also in Bahrain and Oman (which are opening their stock markets to foreigners), Lebanon (which is rejuvenating its capital markets), the UAE and Qatar. With even Kuwait reaching an agreement with Cairo and Beirut on the cross-listing of equities, the Saudi capital market is increasingly looking like the odd one out. None of these developments has been lost on the authorities in Riyadh. "From the Saudi perspective the other markets in the Gulf look pretty small," says Taecker at Samba. "But Egypt is large by Saudi standards and the kingdom is very mindful of the changes which have been brought about there."
Prerequisites of equity
"Historical evidence," says one London banker, "shows that volumes of portfolio investment tend to go hand in hand with volumes of direct industrial investment. Clearly if Egypt is going to win more and more investment from companies building a presence in the Middle East, economies which are reluctant to change are going to suffer in relative terms as a result."