Saudi Arabia Going strong
While rising oil prices have benefited the Saudi Arabian economy and will continue to do so, economic growth may as well be driven by the non-oil sectors

With oil prices touching record highs, Saudi Arabia has reaped a financial windfall as the world’s top exporter. Petro-dollars have led to healthy budget surpluses for five years running and massive liquidity. Yet, even amidst bullish energy forecasts, many analysts believe the Kingdom’s economic future is found above the surface.

What excites them the most, they say, is the emergence of the non-oil sector. “The year 2007 will be the year in which the dynamic of the current economic boom shifts from the oil sector to the non-oil private sector,” Brad Bourland, chief economist at Riyadh-based Jadwa Investments, said. His sentiment is supported by strong figures. In 2007, non-oil private sector growth was 5.9 per cent, outpacing overall real GDP growth of 3.5 per cent. Non-oil exports increased by 24.9 per cent to US$28.5 billion, in part due to rising international prices for petrochemicals and associated by-products.

Promising sectors
Manufacturing, finance, telecommunications and transport have been tapped as promising sectors. In manufacturing, predicted to be the fastest growing sector over the next few years, Sabic has three massive petrochemical projects with foreign and local partners in Yansab, Sharq and Kayan, set to commence production over 2008 and 2009.

State-owned oil giant, Saudi Aramco, will enter the petrochemicals sector through the US$10-billion Petro-Rabigh complex, likely to come on stream in early 2009. Financial services are viewed as another promising field. In 2002, foreign banks were allowed to enter for the first time, and today 12 foreign banks have licences and 78 investment companies have been authorised by the Capital Market Authority. Analysts think foreign banks will perform best in several underserved business activities, such as investment banking, asset management and project financing.

Islamic banking, housing finance and insurance are other activities with considerable upside. Meanwhile, investors have begun flocking back to the equity market following a sharp downturn in 2006, drawn by healthy corporate earnings and attractive valuations, which should positively impact financial services. Telecommunication and transport have received boosts from deregulation and investment craze. Three new fixed-line providers received licenses in the first half of 2007, breaking the monopoly of Saudi Telecom, and a third mobile license was also awarded.

The construction boom will benefit the transport sector, which must move the huge volume of raw materials to construction sites. Other major rail, port and airport expansion projects are also ongoing.

Private sector growth
Sceptics doubt that the Kingdom is writing a new chapter in its economic history, but many analysts contend that the situation today is different from the oil boom a generation ago. They argue the pieces are in place to create sustainable private sector growth, pointing to several factors. First, the government launched a US$624-billion investment programme in infrastructure and industrial projects through 2020, to develop industries in which Saudi Arabia has a natural competitive advantage. These mega-projects include building six “economic cities”, an ambitious public-private partnership to create sustainable residential communities alongside industry.

At the same time, government spending has stayed prudent. In 2007, the budget surplus was a comfortable US$47.6 billion. The bottom line was helped by higher-than-projected oil revenue, while spending grew by a modest 12.7 per cent. Moreover, the budget lays emphasis on education, a critical area sorely in need of improvement. The country has a young and fast-growing population, with many recent graduates who lack the skills demanded by the marketplace.

“I think that the government is quite aware that education is one of the most important issues requiring to be addressed today,” John Sfakianakis, chief economist at SABB Bank in Riyadh said. “Look at the budgets of the Kingdom over the past few years and you will see very well that education has grown over the past few years, and will continue to grow.”

Second, economic liberalisation that began as part of myriad measures undertaken during accession talks to the WTO, has fostered an investor-friendly climate. Negotiations culminated in December 2005 when Saudi Arabia became a member of the international trade body, which analysts think could further boost foreign investor confidence. Third, the Kingdom has implemented a series of pro-business reforms. A significant step was taken recently, for instance, to overhaul the judiciary system by forming separate commercial, labour and administrative courts. Under the current system, commercial disputes are sent to ordinary sharia courts, which experts say were ill trained to handle complex business cases.

The results are beginning to show even if room for improvement still exists. Saudi Arabia jumped from 38 to 23 in the latest rankings of the annual World Bank’s ‘Doing Business Report’. “The evidence of the changes is pretty clear and manifest through many construction projects and growing skill shortages,” says Jadwa’s Bourland.

“There has been a major improvement in the regulatory environment, though in some cases, practice is yet to catch up with policy,” Bourland adds. “Saudi receives by far the largest amount of foreign investment in the GCC, but there are definitely more things that could be done. In particular, tightening mechanisms for contract enforcement and streamlining the processes for closing a business.”

Holding one-fifth of the world’s oil reserves and producing 11 per cent of world production, hydrocarbons will undoubtedly remain the economy’s bedrock. To cement that position, efforts are underway to modernise the country’s oil infrastructure. An additional US$80 billion is being invested to expand oil capacity by 3.5 million barrels per day over its current output to 12.5 million bpd by 2009.

On the back of high oil prices, Saudi Arabia has enjoyed five years of strong growth while slashing government debt. Real GDP growth in 2007 was the lowest since 2002, and compares with real growth of 4.3 per cent the previous year, which economists believe is due to a decline in oil output following an OPEC production cut in late-2006 and early-2007.

Domestic demand
While the entire region may be awash in petro-dollars, an important difference exists between Saudi Arabia and its Gulf neighbours, says Sfakianakis of SABB. “The (Saudi) boom is based on the growth in domestic demand, which is related to the size of the country’s economy, the largest in the Middle East and accounts for 51 per cent of the GCC economic output. The demand for instance we see in housing, is not due to the demand of expatriates who are coming into the country, but due to the growth of local demand, from the Saudis”. The flipside of growth has been rising consumer price inflation. Although inflation is significantly lower than other GCC countries, it reached a 12-year high in 2007 and people say the price increases have been felt.

Some economists stress the inflation is locally generated and not imported. Nonetheless, inflation concerns have fed into the debate over whether the riyal should be revalued or the dollar peg dropped altogether. However, Saudi monetary authorities insist the peg will continue and analysts believe the exchange rate peg will remain unchanged over the medium term. An issue casting a long shadow over Saudi Arabia’s future has been succession. But a degree of uncertainty was alleviated when King Abdullah issued regulations covering a new system of deciding the succession. The move was greeted warmly by most analysts, who acknowledge that political risk has been a factor undermining investment.

In terms of the 2008 economic forecast, assessments are widely upbeat. Since 90 per cent of total revenue is derived from oil, analysts expect high oil prices to continue generating large budgetary and current surpluses. Inflation, although still low by regional comparison, could remain above historical averages. But, on the whole, another year of strong performance is expected, particularly from the non-oil economy, which many believe will emerge as the main engine of economic growth.

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