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Saudi Arabia - Responding to international crisis

Moin Siddiqi

Sunday, 21 June 2009 19:53

The oil-rich Kingdom amid bleak global outlook is taking concrete steps to defeat the downturn. Whilst not immune from the OECD-wide recession and waning oil prices, the fallout is less severe than elsewhere because the state continues to invest heavily on infrastructure programme to support domestic demand and achieve greater diversification. The future, however, poses
stiff policy challenges in terms of providing new jobs and basic services to a blooming population forecast to reach 33m by 2020.

Saudi Arabia has enjoyed a period of stellar growth, fuelled by petrodollars, buoyant private sector activity and infrastructure spending, as well as prudent macro-policies of recent years. This has provided a platform for vibrant-diversified economy and increased upstream investments, which are essential for a stable global energy market. Riyadh-based SABB, the Saudi British Bank notes: “The Kingdom stands as the most unscathed member of the Group of 20 [major economies].” True, Saudi Arabia [like China] is proving resilient by maintaining spending and imports, thereby acting as a stabilising force during the downturn affecting all major commodity exporters.

Fortunately, direct financial channels of contagion are limited, thanks to low external debt, at 10% of GDP in 2008, a strong capitalised/profitable banking system with good provisioning practice and it does not rely on external funding. The risk of capital outflows is remote since foreign portfolio investment [so far] is small. Automatic stabilizers, such as welfare payments and concessional loans to low-income citizens, as well as support for housing and aid to small & medium sized enterprises (SMEs) will, too, cushion the impact of slowdown.

Real GDP growth is forecast to slow sharply to 1-2% before picking up in 2010. But this should be seen within context of five-year trend. Nominal GDP has swelled by twofold between 2004 and 2008, according to the International Monetary Fund (IMF). Buoyed by oil windfalls, the ‘twin surpluses’ [national budget and external account] reached record highs, despite increased imports and public spending (see Table 1). Energy Information Administration (US) estimated Saudi 2008 oil revenues at $287bn, up from $194bn in 2007.

Fiscal probity observed in boom period and better policy frameworks are helping to ride out the storm. A large chuck of windfalls was used to build-up foreign assets – currently totalling some $500bn – and buy-back public debt, which stands at mere 10% of GDP, compared with over 100% of GDP by end-1999. This year, fiscal laxity and dwindling oil receipts will push government finances into a deficit of SR65bn, the first time since 2002, as revenues plunge from record SR1.1 trillion in 2008 to SR410bn. There still remains probability of a ‘balanced budget’ if oil prices recover during the second-half and average $55 per barrel. It’s important to note unlike Mexico, Hungary and Pakistan, among others, the risk of balance of payments crisis or currency devaluation is negligible. We expect a return to ‘twin surpluses’ by 2010-11.

The Saudi Arabian Monetary Agency (SAMA; the central bank) has remained supportive of private businesses by cutting interest rates from 4% to 2% since November 2008 and offering extra credit to local firms. The Bank also reduced the reserve requirement on bank deposits from 10% to 7% (they had been at 13% in early September 2008) – a move that is estimated to inject $8bn into the interbank lending market. Thus, SAMA has embraced ‘quantitative’ easing by providing more liquidity into the system. While few Saudi banks have received capital injections from the state aimed at boosting their lending capacity.

Gradually, the economy is becoming diversified that augurs well for job creation. Since mid-2000s, non-oil sectors have grown by more than 5%. Projections from finance house Jadwa Investment showed manufacturing as the key driver of output expansion, with 9.4% growth, followed by transport and telecoms (9.3%), financial services (8.1%), and construction (7.8%). According to the Saudi Industrial Property Authority (MODON), the non-oil economy received investments of SR324.94bn ($86.65bn) in recent decades. Booz & Company, the US consultancy, said: “Investments in manufacturing have brought the Kingdom’s industrial activity into line with other emerging markets.”

Ibrahim al-Assaf, Saudi Finance Minister, told Reuters: “There will definitely not be any impact from the oil-price decline on the government’s development programme.” Ihsan Bu-Hulaiga, member of the Majlis Al-Shura (Consultative Council), echoed this view “Slowdown is not an option. We have the money and there is the need. It would not be advisable to slow the economic development programme down – after all, prices are falling and contractors are looking for jobs, so we will be able to execute projects with very competitive pricing.”

To help sustain confidence and underline the government’s commitment to growth, the Kingdom has pledged to spend $400bn over the medium-term,
representing annum fiscal stimulus worth $80bn. Despite some liquidity constraints, most major projects deemed critical to future growth are moving ahead in infrastructure, real estate and industry (including hydrocarbons),
albeit with some delays. The Saudi British Bank commented: “The country has a strong government that is intent on developing infrastructure with revenue from a variety of sources.”

Some examples of projects underway or in pipeline are Saudi Landbridge, a $7bn rail scheme linking Dammam and Jeddah via Riyadh and the $6bn Haramain 450-km high-speed railway between the holy cities of Mecca and Medina, via Jeddah. The former project is based on a 50-year concession whereby contractors will hold 80% of the equity. Meanwhile, civil works have started on North-South minerals railways. The $14bn scheme will link northern bauxite and phosphate mines to Ras al-Zour industrial site, on the Gulf. The
General Authority for Civil Aviation has also approved works on new terminal at King Abdulaziz International Airport, Jeddah, with capacity for 30m visitors. France’s Aeroports de Paris is expected to finish the $20bn project by 2012.

The state-owned Water and Electricity Corporation is due to award projects designed to add 14,560 megawatts (MW) of power capacity and 555m gallons a day (g/d) of water. By 2025, the Kingdom’s power usage is predicted to exceed 60,000 MW and demand for desalinated water could double to 1,600 g/d.
Education is a priority in development plans. Riyadh University for Women is under construction with a capacity of 40,000 students (costing $5bn) – the world’s biggest learning institute for female. Even the Interior Ministry is building a network of rehabilitation facilities for prisoners across the country.

In the upstream segment, Saudi Aramco (world’s No.1 company by proved reserves and production) has recently unveiled a $60bn spending plan for 17 mega oilfields. Also, in partnership with Sumitomo of Japan, it expects to
transform the Rabigh refinery into a fully integrated petrochemicals complex.
The PetroRabigh project (costing $10.3bn) is designed to produce 18.4m tonnes of benzene and high-quality fuels (including gasoline). The first phase is due online this year. The sponsors have implemented the second-phase of expansion that involves building 17 new chemical derivative units.

The most ambitious [planned] venture to date is between Aramco and US’s Dow Chemical, which calls for building a complex at Ras Tanura, on the Gulf coast. Integrated with Ras Tanura refinery and Ju’aymah gas processing plant, the grassroots facility will have 30 downstream manufacturing units producing over 300 different products. And, when fully operational, the giant petrochemicals plant is expected to increase total capacity of upstream- and downstream products to 4m and 7m tonnes/year, respectively. An expected start-up date is 2013 or possibly longer and will represent the largest single foreign investment.

Last year, banking consortia were invited to tender for mega-project costing between $20-26bn. It could be delayed because of credit squeeze. Apicorp, the Gulf’s leading energy investment bank, thinks tapping conventional project finance may prove harder for private investors. Bankers, however, expect increased ‘sukuk’ (i.e., the Islamic bond) issuances in the coming years. The one silver lining of current downturn and weakening raw material prices (especially steel and copper) is easing of engineering, procurement and construction (EPC) costs. Consequently, Aramco has asked contractors to provide revised bids on about $30bn worth of upstream projects.

More significantly, the Kingdom is fostering private enterprise by improving business climate in tune with global norms. SABB put it: “It doesn’t lurch from one trend to another but moves steadily forward.” Saudi Arabia’s ranking in the World Bank’s Ease of Doing Business index has surged from 67th in 2004 to an impressive 16th by 2009. This compares favourably with regional peers – Bahrain (18th), Qatar (37), the UAE (46), Kuwait (52), and Oman (57), respectively. The International Finance Corporation’s annual survey of 118 countries noted: “Saudi Arabia has been a very strategic and active reformer in the past three to four years. It has streamlined business processes and completely eliminated the minimum capital requirement, which had been a major barrier to doing business, especially for SMEs.” Concurrently, the number of new businesses doubled in 2008. Hence, the potential for wealth creation.

Last year, Saudi Arabia, a top regional reformer, facilitated business start-ups by continuing to simplify formalities for commercial registration and reducing registration fees by 80%. The time to start a business fell by three days. Riyadh strengthened protections for minority shareholders through new provisions that prohibit interested parties from voting on the approval of related-party transactions and imposed heavier penalties on directors for misconduct. It sped the property registration with a comprehensive electronic system for registering title deeds. Moreover, the Ministry of Commerce introduced tighter deadlines for bankruptcy procedures. Auctions of debtors’ assets should now take place more quickly than before (see Table 2).

Riyadh under a strategy, known as the “10 by 10 programme” inspires to occupy the top 10 places globally for doing business by 2010. The programme devised by the Saudi Arabian General Investment Authority (SAGIA) in 2006, targets regulatory reforms and developing special economic zones. But achieving higher ranking requires improving foreign direct investment (FDI) regime, specifically dismantling remaining barriers upon foreign companies. Brad Bourland of Jadwa Investment, believes: “There is still more bureaucracy involved in setting up a business than there needs to be. And navigating Saudi government offices can be challenging for Western businessmen.”

Looking ahead, the government is encouraging industrialisation with a view to increasing non-oil exports and private sector jobs. Jobless rate among Saudi nationals was 9.8% in 2008, according to the Economy & Planning Ministry. The National Industrial Cluster Development Programme (NICDP), officially launched in 2008, targets five specific industries for future investments – namely automotive, metals processing (chiefly aluminium and steel), plastic packaging, construction and consumer appliances. Keys to developing alternative industries are building ‘economic cities’ – each focusing on diverse sectors, such as mineral refining, finance, transport and logistical services, ITC, agribusiness and electronics (see The Middle East, April 2009).

Amr al-Dabbagh, governor of SAGIA, said: “The economic cities are a vital ingredient in the future of Saudi Arabia.” Of the six planned cities, four have been launched by SAGIA, of which the King Abdullah Economic City (KAEC) is the largest with price tag of $130bn and managed by Dubai-based Emaar Properties and Saudi Aseer. The KAEC (projected population of 2m) will have six components: residential communities, industrial zone, commercial district, tourist resorts, educational district, plus a large seaport on the Red Sea. Developers tentatively expect 2030 as completion date. SAGIA has introduced fiscal incentives and 100% foreign ownership rights to invest in various projects.

In marked contrast with 1998 oil-induced recession, Saudi Arabia is now structurally sound with increased financial capacity to absorb exogenous shocks and return to high trend-growth in 2010 as crude prices rebound to $70/barrel.
Despite falling revenues, the country has ample resources to meet spending targets. In essence, a stronger Kingdom will help boost much-needed intra-regional trade and investments, which, in turn, should protect the Gulf from future economic downturns in Europe or North America.
MOIN SIDDIQI, Independent Economist, based in London. - This article first published in The MiddleEast magazine.

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