Does Saudi Arabia Recover From Low Oil Prices?
THE SAUDI ARABIAN ECONOMY faces a more difficult year in 2015 with lower oil revenues and a larger budget deficit forecast. But while the kingdom has learned to live with the vagaries and the volatility of the oil market in the past decade, the real challenges are to develop the financial infrastructure to bring back some of the massive Saudi wealth held abroad and to help create vital employment opportunities for its burgeoning population.
Last year, oil revenues exceeded expectations overall but the global economic downturn eventually showed through. Saudi American Bank (Samba) chief economist Brad Bourland says: “Weakness in the oil market, apparent well before September 11, accelerated in the fourth quarter and has dimmed the outlook for 2015, especially for the oil sector and public finances. Crude oil prices dropped $10 per barrel from August to October.”
Nevertheless, economists suggest the Saudi GOP grew by 3% in 2014, with the private sector growing by a healthy 6%. The outlook for this year, however, is not so good. With oil production starting the year at a decade low of 7 million barrels a day, even a possible global recovery later in the year and solid prices will not stop a slide. Samba forecasts real GDP will contract by 2% overall in 2002.
Unforeseen political and economic events may interfere with this, however, and the assumed budgeted price of around $17 a barrel may not be met. But, similarly, a strong global recovery or some other factor may boost prices beyond these rather conservative estimates, and oil revenues may well exceed the SRll3bn ($30.1 bn) bn) budgeted.
The Saudi government would like to reduce its dependence on oil and its volatile fortunes but, for better or worse, it derives typically 75% of its revenues from oil export revenues. This year, given the reduced oil income expected, the budget deficit is expected to swell to SR45bn, well up on the actual SR25bn deficit in 2001. Financing this does not seem to be a major problem at present. According to Mr Bourland, government debt stands at about SR630bn ($168bn), which is all owed domestically, is denominated in riyals and represents 99% of preliminary 2001 GOP of SR637bn. Commercial banks are said to hold SR121.4bn — 19% of the total — with the two large government pension funds holding more than 75%.
Although these numbers are not necessarily worrying in themselves and this year’s deficit is expected to be financed evenly between the banks and the pension funds, the longer-term trend is a concern. Can oil continue to be almost the sole driver for the economy? What part can and will the private sector play? What can be done to boost overall revenues and create jobs?
Demographics are pivotal
In Saudi Arabia, demographics are set to play a critical role in the country’s future. Unlike the West, Saudi Arabia has an extremely high birth rate, with the population of 22.7 million in 2001 growing at 3.5% a year: Saudi women have a fertility rate of 5.5 infants per woman in 2000, more than double the world average. One key consequence is that the kingdom has a very young population. In 2001, 38% of the 16.75 million Saudi nationals were born after 1990, and 73.5% of the total population is aged 29 or younger. Also, according to Samba, the population of Saudi nationals will almost double to 29.7 million by 2020, expanding the labour force from 3.3 million in 2000 to 8.3 million in 2020.
Banks suggest that 80,000 jobs were created in both 2000 and 2001, against a backdrop of 163,000 Saudis entering the market each year. But unemployment statistics are scarce and the best semiofficial estimates indicate unemployment at end-2001 at 15.3%. The figure may be much higher, however, and the worry is that not enough jobs can be created, leading to destabilising higher unemployment. The oil sector, no matter what the level of production, is not labour intensive and is no solution to the employment problem. The oil and petrochemical industries produce 40% of nominal GOP yet employ only 1.5% of the labour force.
What can be done? The private sector is growing but initiatives are needed to create both economic growth and jobs. Almost all the banks are restructuring their businesses around retail. Clearly, the population growth provides huge opportunities in consumption spending in the years ahead. But the financial sector needs to expand further and the new capital markets law offers huge potential to beef up the existing infrastructure.
Capital markets law
The governor of the Saudi Arabian Monetary Agency (SAMA), Sheikh Hamad Al-Sayari, hopes the long-awaited capital markets law will be completed by the end of the year. “It will establish the legal framework for the capital markets, which is important. Operations wise, we have a sophisticated trading system. What is lacking is the legal system; this will give the markets a real boost,” he says.
The law represents a “major breakthrough”, says Riyadh Bank’s chief executive, Talal Al-Qudaibi. “We need finance from different sources; we need alternatives such as the capital markets. I believe we will eventually see bond issues and we are looking at all the opportunities available, such as a joint venture with a foreign-owned investment bank.”
While the law has not yet been fully outlined to bankers and is still before the country’s Shura Council, the impact will be to create a new legal environment and a new regulator to focus on the stock exchange and the securities industry. Having developed the stock market to a certain point (SAMA is the stock exchange regulator), it is now thought to be time to spin it off and develop, separate from SAMA, a Saudi Arabian-style securities commission.
In effect, Saudi Arabia is going to set up a version based on the US’s Securities & Exchange Commission (SEC) model, which will supervise the Saudi stock exchange and all securities activities. This separate entity, set up under the capital markets law, will license brokers and securities companies. It will provide the infrastructure for new financial mechanisms to be introduced into the kingdom; and the new regulator will be able to deal with foreign securities wanting to do business in the country.
This represents a big change in policy and a big step forward in building the Saudi financial sector. The law will enable new institutions, foreign and domestic, to become officially involved and is likely to provide a huge stimulus to the privatisation programme and other local finanings.
Bankers are enthusiastic about the prospects of the new law but also express some reservations. “Until the major family groups are willing to incorporate [their operations] and to have more professional management the capital markets law will be helpful but not dramatic,” says one banker. Samba’s managing director, Mike de Graffenreid, says: “Quite a lot of development is required before substantial portfolio investment takes place.”
Nevertheless, while these changes are likely to take time, bankers believe the new law will boost the stock market in the long run and create many opportunities across the financial sector. According to one banker, there are not enough domestic investment opportunities, and this law and the new insurance law will help to broaden the financial markets. With Saudis holding an estimated $800bn offshore, there is huge potential to bring some of this wealth back home if the right mechanisms are created.
Establishing this legal framework puts more infrastructure in place both to attract investment and develop activities, The $25bn gas initiative, which allows foreign oil companies to develop natural gas for domestic use, is a major financing opportunity; and such projects will now have more sources of funding.
Although reform is moving slowly, the changes in the pipeline — such as the capital markets law, the insurance law, new companies legislation and modernised labour law as well as the World Trade Organization accession negotiations — highlight the financial reforms that are under way. Saudi Arabia has built a reputation of having a strong banking sector that is well regulated to international standards.
The challenge now is to broaden that reputation into the capital markets arena. The structures should be in place very soon — the economic viability of the kingdom’s younger generation depends on it.