FUELLING THE DEBT Saudi Arabia’s plan to pay for 132 planes with oil has been hit by the slump in the price of crude.
Oil barter agreements have long been the resort of cash-hungry Opec nations such as Nigeria or Gabon. But Saudi Arabia’s deal with the UK Defence Ministry to pay for military aircraft with oil opened a new era. And it raised the question of when will the desert kingdom come to the Euromarkets to borrow?
Saudi Arabia signed a $7.5 billion contract with the MoD for 132 aircraft, including 72 Tornado jet fighter/bombers made by the UK-West German-Italian consortium Panavia. The payment is to be effected through the supply of 300,000 barrels of oil a day to British Petroleum and Shell. Proceeds from the sale of the oil are paid into a London account of Lloyds Bank. But Riyadh’s hopes of paying off the debt in two years have been dashed by the fall in the price of oil. It has more than halved since the deal was agreed in September 1985.
Saudi Arabia may need an overdraft facility of $1.5 billion to cover the shortfall if it wants the plane deliveries made on time.
But a similar credit arranged by Lloyds for the Mod’s prime contractor, British Aerospace, fell through in mid-1986 when Riydah refused to guarantee it.
This leaves Saudi Arabia in a dilemma. It wants the aircraft badly as a front line defence against any incursion into its territory by the Gulf war. But it is reluctant to draw down its reserves — estimated at close to $100 billion — and would be loath to increase the amount of oil being bartered because of the delicate state of the oil market. Shell and BP are in any case understood not to want to lift any more oil under the deal.
Bankers in Saudi Arabia doubt that the government will borrow domestically, although there is plenty of liquidity available. Its reluctance is more to do with a deep dislike of being in debt than with religious concerns.
To combat a fall in revenue, oil production was aggressively raised to 5.4 million barrels a day (b/d) in June, the highest level since 1982, signalling Saudi Arabia’s determination to defend its interests after five years of declining fortunes. Riyadh has watched its revenues dwindle to about one-quarter of the $100 billion peak in 1981.
True to its deeply conservative nature, Saudi Arabia has not been rushed into formulating its oil policy. From mid-1983 to the end of 1985, it had absorbed the brunt of falling demand for Opec oil, consistently producing less than the 4.35 million b/d quota allocated to the organisation’s “swing producer”. It was an uncomfortable period for a country that had been pumping close to 10 million b/d in 1981.
The alarm bells which sounded when output fell to a 10-year low of 2 million b/d in mid-1985 was followed towards the end of the year by a concerted effort to win back a “fair share” of the world oil market, abandoning the previous policy of defending oil prices. The price of Saudi Arabian light, Opec’s benchmark crude, has fallen to less than half the $28 a barrel being charged a year ago. The blame for the turmoil was masterfully laid at the door of non-Opec producers such as the UK and Norway, for failing to co-operate in dividing up the market.
King Fahd recently said he believed oil prices would stabilize at about $20 a barrel. As the owner of about one-quarter of the world’s oil reserves, Saudi Arabia has a vested interest in seeing a price settle in line with market forces. Its long-term interests are best served if demand for oil remains strong and steady, and it can avoid a repeat of the past few years, when the $40 a barrel price led to a fall in demand.
The uncertainty in the world oil market has had a deep effect on the Saudi economy. On March 10 in an eve-of-budget television address, King Fahd took most people by surprise by announcing that the 1986/87 budget would be postponed for five months.
He cited “the present oil market situation and the implications of the current world economic crisis” as the reasons for the deferral. He reminded the 10 million population of “the spectacular progress achieved by the kingdom in such a short span of time”, adding: “We are still enjoying abundant welfare and decent living” as the rest of the world passes through “an acute economic crisis”.
Business reaction was mixed. Some saw it as a desperate act that would undermine confidence in the economy and possibly lead to a flight of capital. Others saw it as a part of the government’s strategy to regain control of the oil market and gradually to revive the economy.
Mohammad Ali Abalkhail, the Finance and National Economy Minister, explained: “When you do not know what will happen [in the oil market] in the coming few months, you cannot make appropriate decisions on some matters.” The kingdom was playing its cards close to its chest; it was not going to give away any clues about its oil policy by publishing revenue targets for the 12 months ahead.
The new budget is scheduled to be announced to run from the beginning of the Muslim hijra year 1407, in the first week of September. Since March ministries have been under strict instructions to keep monthly spending at or below their average monthly allocation in the 1985/86 budget.
Total expenditure in 1985/86 was about $53 billion, 9% less than the year before, and divided more or less equally between capital and current. Given the precarious state of the oil market, a further decline of as much as 25% cannot be ruled out for the 1986/87 actual budget. (Official Saudi budget projections are traditionally inflated and usually fall short of target.)
Despite attempts to rein in expenditure, lower oil revenues have produced current account deficits since 1982. The 1985 deficit is estimated to have shrunk to less than $17 billion from $24 billion in 1984.
There has been success in curtailing imports, which dropped 28% from 1984 to about $23 billion in 1985. Further downward pressure on the import bill was exerted on June 1 with a 2.7% devaluation of the Saudi riyal, the biggest adjustment ever made by the central bank authority, the Saudi Arabian Monetary Agency.
The new rate, fixed at SR3.75/$1, will make imports such as vehicles and electronic goods more expensive, encouraging frugality, but the government is expected to maintain the price of subsidized foods and other basic goods at, or near, their previous level. Bankers believe there is still enough pressure on the riyal for a further devaluation later this year.
The turnabout in the kingdom’s fortunes has coincided conveniently with a fundamental change in the economy. The past few years have seen the completion of most of the large infrastructure projects in the transport, utilities, communications, education and health sectors. A heavy industrial base has been established with the oil refineries, steel mill and petrochemical plants of the twin industrial cities. Jubail on the Gulf, and Yambu on the Red Sea.
To some extent this has enabled the government to ease off capital expenditure. The $266 billion five-year development plan (1985-90) makes it clear that the government feels it is the private sector’s turn to step up investment in the free market economy of Saudi Arabia and it is expecting Saudi manpower to replace 600,000 guest workers by the end of the plan.
The change in the economy has seen the demise of the construction sector and the growth of contractors specializing in the operation and maintenance of hospitals, airports, power plants and most of the rest of the Saudi infrastructure. This market is said to be worth about $50 billion during the 1985-90 plan.
Foreign companies are still welcome in Saudi Arabia as joint venture partners in industrial projects, helping to transfer much sought after technology. But increasingly, the more basic contractual tasks are being reserved for wholly Saudi companies and there is a growing mood in favour of protectionism among the beleaguered local business community.
The results of the kingdom’s 11 commercial banks have mirrored the slowdown of the past four years. The privately-owned Jeddah-based National Commercial Bank (NCB), by far the biggest, with assets totalling $14.8 billion at the end of 1985, reported an 80% drop in profits to $27 million in 1985.
As with the other banks, the main reason for the dramatic fall in profitability was a hefty increase in provisions for bad loans. The inability, or refusal, of creditors to meet their obligations, citing Islam’s prohibition of usury, has become a major problem, with up to 40% of many institutions’ loan portfolios now considered non-performing.
