ECONOMY: First steps on the road to recovery

03 November 1995

BY KING FAHD'S own admission, the economy of Saudi Arabia faced a crisis in 1994. World oil prices fell to a 10-year low of around $11 a barrel and government oil revenues tumbled by a swingeing 29 per cent, to end the year at just $23,200 million. The kingdom recorded a current account deficit of some $10,000 million and nominal gross domestic product (GDP) rose by only 0.6 per cent.

This year has presented a stark contrast and prospects appear much improved. The year opened with the announcement by King Fahd of a series of fiscal reforms. Subsidies on water, electricity and petroleum were reduced; the domestic cost of refined products was increased; visa and work permit charges were raised; domestic airfares were hiked; and unlimited free local telephone charges were abolished.

The changes have both cut state outlays on subsidies and increased state revenues. The extra income from the revised electricity tariffs was gathered into a special fund, which has already been put to use financing construction of the much-needed PP9 power station in Riyadh. The moves have been welcomed as a bold departure in a country whose population has come to take state subsidies for granted. They also made for a striking contrast with the government's decision to slash utility charges as recently as mid-1992.

The launch of the reforms has also coincided with a period of higher- than-expected world oil prices. Oil revenues provide about 70 per cent of government revenues and the oil industry accounts for one third of GDP. Whereas the government had budgeted for an average oil price of $14.50 a barrel in 1995, Saudi crude oil has actually been selling for an average of $15.50 a barrel. Optimistic projections see Saudi oil holding at $16 a barrel through to the end of 1995. An average of an extra $1 a barrel a year nets the government $3,000 million in additional revenue, economists say. The kingdom has maintained crude oil production at a rate of 8.3 million-8.4 million barrels a day (b/d), compared with its OPEC ceiling of 8 million b/d.

Non-oil expansion

The current account has been further boosted by non-oil exports. The Saudi Basic Industries Corporation (Sabic) increased its profits to over $1,000 million in 1994. First half results for 1995 suggest that profits could hit $2,000 million for the full year. At the same time the import bill is falling. In 1994, the kingdom's imports fell 17 per cent to $23,300 million due to depressed local demand. Despite the signs of recovery no dramatic upturn in imports is expected this year.

By August 1995, the situation was sufficiently improved for King Fahd to tell journalists, 'We have succeeded in dealing with the crisis and have had to bear its consequences, which were not as harsh as shown by some international media. I can say we are in a better position as a result of the measures adopted.' Economists are pointing to the prospect of the first current account surplus for a decade and the first balanced budget since 1982.

The first fruits of higher oil prices and fiscal reform are already apparent. In March, the government issued special government bonds to cover some SR 5,200 million in payments due to contractors owed more than SR 10 million. The total outstanding to contractors was put at SR 20,000 million. Bankers estimate that less than half of this sum is still outstanding. In September, the government started paying the SR 2,700 million it owed to wheat and barley farmers for the two year period to mid-1994. The total would be paid off by the end of the fiscal year, Agriculture & Water Minister Abdullah Bin Abdul-Aziz Bin Muammar said in September.

The March bond issue was another development to be welcomed by cash-starved creditors. Many contractors had stretched their credit lines at local banks to the limits. Banks have also welcomed the bonds, some of which have found their way onto the international market. By September 1995, bankers estimated that the bond issue and cash repayments had covered about one half of government debt to suppliers. 'There are a number of signs that the new ministers have taken the view that they should wipe the slate clean and clear the old debt problem; the farmers have already received a big payment,' says Kevin Taecker, chief economist at Saudi American Bank. 'Payments could either be by cash or possibly by a second bond issue.'

The government owes some $3,850 million to local banks in dollar denominated direct loans. But, the authorities are reticent about the full extent of the domestic debt. Independent estimates by the Washington-based Petroleum Finance Company show total domestic debt rising to $95,500 million this year, equivalent to 81 per cent of GDP. The last of the kingdom's direct foreign debt was paid off in May, when the government paid the final instalment on the $4,500 million sovereign loan that was raised in 1991 to meet commitments made during the Kuwait crisis.

Higher oil prices have also made it possible to start rebuilding reserves. By the end of June 1995, total reserves minus gold stood at $9,420 million, 28 per cent higher than at the end of 1994.

Relying on the rial

A stable riyal-dollar exchange rate is a fundamental of Saudi economic policy, and the government has jealously guarded the $1= SR 3.75 parity. The Saudi currency is officially pegged to the Special Drawing Right and fluctuates within a narrow range, but in reality it shadows the dollar. According to the Saudi American Bank's September 1995 Outlook for the Saudi Economy, the currency is supported by $18,000 million-20,000 million in portfolio assets to back currency in circulation, $6,000 million-8,000 million in trade-related foreign exchange reserves, and some $20,000 million in unspecified assets. In addition, the Saudi Arabian Monetary Agency (SAMA - central bank) works with other major central banks to maintain stability.

Riyal interbank rates have eased in 1995 to less than 6 per cent, closely tracking US rates. In August, the repurchase agreement (repo) rate was increased to 6.15 per cent from 6.0 per cent to pre-empt any repetition of the speculation against the riyal that was seen in late 1993.

The local share market has responded favourably to the 1995 economic upturn. The NCFEI index rose more than 14 per cent in the third quarter of 1995. In the first half of the year, the market continued a decline which had begun in April 1992. In May, it dropped below 115.00, its lowest position since March 1991, and exactly half the level of three years earlier.

The volume and value of trading has increased steadily in the second half of 1995. The improvement comes on the back of the more encouraging outlook for the wider economy and the realisation that many stocks were undervalued. Lower interest rates have also stimulated the market. A plethora of good company results has further boosted activity. 'The share market is dominated by a handful of major players,' says one analyst. 'Nevertheless, it is a useful indicator of the kingdom's economic performance.'

The cost of living index experienced a jolt in the first quarter of the year, but the jump belies a more stable underlying picture. The index rose 4.5 per cent in the first three months to finish more than 5 per cent higher than a year earlier. The rise is explained by the increase in tariffs on water, fuel and electricity introduced in the 1995 budget. Indirect inflationary pressures are expected to be felt for the remainder of 1995 as costs are passed on to consumers. However, the underlying rate is expected to remain below 1 per cent.

Agriculture is one of the areas already undergoing reform. The kingdom was at one time the fifth largest exporter of wheat in the world. 'It was an absurd situation,' says one analyst. 'Subsidising wheat to achieve self-sufficiency is one thing. But selling subsidised wheat abroad at a fraction of the cost of production made no sense at all.'

Agricultural economies

In June, the government cut the subsidy it pays to wheat farmers by 25 per cent to SR 1,500 a tonne. As a result the US Agriculture Trade Office in Riyadh has revised downward its forecast for the wheat and barley harvests for 1995/96, which are planted in the autumn. The wheat crop is expected to be 2 million tonnes, 20 per cent lower than the previous harvest. The barley harvest is predicted to be 1.5 million tonnes, implying an import requirement of 4.5 million tonnes. Wheat output is expected to fall to 1.5 million tonnes a year in two or three years, equalling domestic consumption.

Although the reform measures adopted by the government during 1995 are seen as contributing to the economic recovery, it is the oil price which has underpinned it. The current, relatively stable situation is only sustainable if the oil price remains at $16 a barrel or more. While looking at various ways of reducing expenditure, the government is still searching for ways of reducing its vulnerability to the volatility of oil prices. In its sixth five year plan, covering the years 1996-2000, the priorities are diversification, fiscal reform, and privatisation.

Privatisation will not be an easy process. The corporations and ministries slated for eventual transfer to the private sector will require substantial restructuring before they can operate commercially. The process is very unlikely to be completed within the lifetime of the current plan, but analysts are optimistic.

'I'm bullish about privatisation,' says Samba's Taecker. 'Once the vision is there, everything will happen pretty fast. This is a country with a vast capital surplus.'

The flurry of international anxiety about the kingdom's finances has abated during the course of this year. As another budget year is planned and the actual figures for 1995 are collated, Saudi watchers will be looking for signs that the prudence shown in January 1995 will be maintained in the year ahead.

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