With the late December announcement of a $155bn budget for 2011 and its earlier approval of a $385bn development plan for 2010-14, Saudi Arabia is set to become the land of opportunity for international firms in the coming years.

Leaders are all too aware, disaffected youths represent the biggest threat to their authority

From the mid-1990s, it was the UAE that was the dominant economic force in the region. Thanks to a boom in real-estate development in Dubai, the emirates saw the fastest population growth in the GCC and its banking sector grew to become the largest in terms of assets.

But the global economic downturn changed all this. Amid a tightening of liquidity and the disappearance of real-estate speculators, growth in the UAE has been slow since 2008. Dubai has spent the past 12 months battling a major debt crisis and many of its ambitious property schemes have been abandoned. Abu Dhabi, expected to be the new growth story in the UAE, was obliged to help out its neighbour and as a result it too has had to scale back its projects.

Population planning in the Gulf

With one of the biggest populations in the Gulf, the largest proven oil reserves in the world and a desperate need for infrastructure development, Saudi Arabia’s potential over the next decade is immense.

The kingdom’s massive spending plans are being driven by rapid population growth, which is putting pressure on the state to liberalise the economy, create more jobs and to improve social infrastructure.

In the next 10 years, significant progress will have to be made to avoid a surge in unemployment among young people. As the kingdom’s leaders are all too aware, disaffected youths represent the biggest threat to their authority.

In 2011, the total population of Saudi Arabia is expected to be around 27.7 million, with around 8.6 million non-Saudi residents in the country and an unemployment rate among locals of 10.6 per cent. The Planning Ministry forecasts that by 2020 the population will hit 33.5 million, of which 29.7 million will be Saudi nationals, and 3.8 million expatriates.

As a large Middle East democracy, [Iraq] could overtake Saudi Arabia as the regional powerhouse

To address these challenges, Riyadh has set out a long-term development programme that extends until 2024. It aims to double per capita income from SR43,300 ($11,546) at the end of 2004, to SR98,500 at the end of 2024. That will require an average annual growth in gross domestic product (GDP) of 6.6 per cent.

The scheme is broken up into several five-year plans and the latest for 2010-14 calls for average GDP growth of 5.2 per cent a year and to halve the unemployment rate to 5.5 per cent.

Sustaining oil growth

The kingdom’s vast earnings from oil exports, which according to Banque Saudi Fransi totalled some $200bn in 2010, will fund this investment drive. But a reliance on oil revenues is unsustainable over the long-term. Domestic energy demand is expected to rise from 3.4 million barrels a day (b/d) of oil equivalent to 8.3 million b/d of oil equivalent by 2028. That will leave around 7 million b/d for export.

With the latest budget announcement, it appears Riyadh is already taking note. Although the kingdom has drawn up a record allocation for 2011, it marks a slowdown in budgetary expansion. Forecast spending is just 7.4 per cent higher than the $144bn budgeted for 2010. The previous seven years’ budgets have mostly been set 10 per cent higher.

Spending has also been based on a conservative oil price assessment of about $58 a barrel, which means if prices remain at current levels the government will avoid falling into deficit.

While Riyadh was prepared to use its oil wealth to sustain the economy during the 2008-10 global recession, in the long-term, it hopes the private sector will become the main engine of growth. The long-term development programme calls for the private sector to grow from 52.3 per cent of the economy in 2004 to 69.3 per cent in 2024, an annual growth rate of 8.1 per cent. As a result, the oil sector will shrink from 27.5 per cent of total GDP to 17.9 per cent in 2024.

As the private sector expands and new sectors of the economy are developed, the government hopes that more jobs for Saudis will be created. There are also plans to start using public private partnerships (PPP) to more rapidly develop infrastructure, including the Medina airport project that could be the beginning of a long pipeline of transport PPP schemes. Meeting the power and water needs of the population will also require significant investment.

The King Abdullah Financial District will develop the infrastructure necessary to encourage the world’s largest financial institutions to expand local operations, while the development of several economic cities around the country, although impacted by the credit crisis, will help meet the goal of encouraging development throughout the country and improving education facilities and opportunities.

Internal issues - education key

King Adbullah has spearheaded a major government investment drive in education infrastructure in Saudi Arabia, including the King Abdullah University of Science & Technology and the Princess Noura University. In August 2010, the Education Ministry also signed contracts for 22 projects to increase capacity at the kingdom’s universities, valued at a total of SR2bn.

The hope is that through this education programme the participation of Saudis in the economy will increase, ending a reliance on expatriate labour. Already Saudi Aramco has introduced a policy of trying to obtain new design work for its projects using local labour, rather than having the work done abroad.

How successful this strategy is over the long-term will depend to a large extent on the direction taken by the next generation of leaders in Saudi Arabia. King Abdullah’s strategy of slow and steady reform may not have met some expectations of what needs to be done to develop a modern, competitive, knowledge-based economy, but he has managed to tread a difficult path between the reform-minded and the conservatives with aplomb.

There is much still to be done though, and it is unclear what direction the country will take under a new leadership. Even with King Abdullah’s generally lauded attempts to combat extremism and terrorism financing in Saudi Arabia in the aftermath of 11 September 2001, reports from US secretary of state Hilary Clinton in December 2009, leaked by whistleblower website Wikileaks, say “More needs to be done since Saudi Arabia remains a critical financial support base for Al-Qaeda, the Taliban, Lashkar-e-Taiba, and other terrorist groups.”

Although steps have been taken to institutionalise the passage of leadership in the country through the establishment of the Allegiance Institution in 2006, both Crown Prince Sultan bin Adulaziz and second deputy prime minister Prince Nayef bin Abdulaziz are eldery and in poor health. One local analyst says there is the potential for several quick transitions in leadership of the country. What impact this will have on reform longer-term is impossible to tell.

Middle East relations

It is not just internal factors that will affect the business climate in Saudi Arabia. The stabilisation of Iraq and its development potential could offer a huge market to businesses in the region. As a large Middle East democracy, it could overtake Saudi Arabia as the regional powerhouse.

That is reflected in further documents released by Wikileaks that indicate that Iraqi officials see Saudi Arabia as wanting to “promote the formation of a weak and fractured Iraqi government”, according to a September 2009 report by then US ambassador in Baghdad Christopher Hill.

Over the past decade, and through the financial crisis, Saudi Arabia has shown that its leaders have learnt the lessons of past oil price cycles. They have repaid debt, invested wisely offshore and developed a strong regulatory system that has prevented the financial system from creating the kind of problems that emerged in other Gulf countries in 2009-10.

That has put them in the position to start a new decade with an investment boom that has already helped the country avoid recession and will make Saudi Arabia an attractive market for any business operating in the region.

Inevitably, there will be challenging periods for international businesses in Saudi Arabia over the next 10 years. The potential for unrest as a result of disenfranchised youth, a clumsy handover of power, or the weakening of the oil market are real risks. Sticking it out through the ups and downs will be essential to making a success of Saudi operations.

In 2004, the US’ Citigroup sold out of local bank Samba. That bank is now one of the largest in Saudi Arabia, and Citigroup is eager to return. It has a lot of bridges to build before it can. Other companies would do well to avoid that mistake.