Oil prices rose above $100 a barrel for the first time since September 2008 as political turmoil in Egypt mounted during February.

The impact of the unrest on international oil markets presents Saudi Arabia with a mixed blessing. A projected SR40bn ($10.6bn) budget deficit in 2011 will likely turn into a surplus, giving the government ample ability to continue stimulatory spending. But it comes at a time when the state is trying to shrink its role in the economy and encourage the private sector to take more responsibility for providing jobs and economic growth.

The massive fiscal boost to stimulate the Saudi economy from three consecutive years of record budgets meant the government sector expanded by 5.9 per cent in 2010. This was the fastest pace of growth in 13 years, and it was well above the 3.7 per cent increase in the private sector.

Private contribution to Saudi Arabia GDP

The government wants the private sector to grow by 6.6 per cent a year in 2010-14 to hit its 5.2 per cent a year gross domestic product (GDP) growth target. But John Sfakianakis, chief economist at the local Banque Saudi Fransi, says the projections will be impossible to achieve under the current circumstances.

“The private sector needs to become more involved in the proper economy of Saudi Arabia,” says Sfakianakis. “It is an engine for growth, but a lot of the growth has just been coming from real estate and the stock market and not from long-term investment in industries that will create jobs for Saudis.”

The government is spending heavily in education and social projects to improve the skills of the local workforce.

The 2011 budget, the biggest in the kingdom’s history, includes a huge increase in spending on education and training; health and social development; and infrastructure, with rises of 8 per cent, 12.3 per cent and 10.4 per cent respectively. Combined, the three areas account for some 46 per cent of the budget. Riyadh has committed to building 610 new schools in the 2011 budget, in addition to the 3,200 already under construction. Education spending has more than tripled over the past 10 years, and, with SR150bn earmarked for 2011, it is the largest allocation in the budget.

The private sector needs to become more involved in the proper economy of Saudi Arabia

John Sfakianakis, Banque Saudi Fransi

The government has also started slowing the rate of spending growth as it tries to get the private sector more involved in the economy. The 2011 budget projects a 7.4 per cent jump in spending from 2010, a modest increase compared with a rise of more than 10 per cent nearly every year between 2003-10.

“Since the onset of the financial crisis, the state has taken up the slack for keeping the economy in motion,” says Sfakianakis. “The government has nonetheless slowed down the pace of growth in spending allocations to minimise overspending and compel private businesses to return to the drawing board.”

Job creation has become overwhelmingly the role of the state in the past few years. The private sector created 821,177 jobs in 2009, but relies mostly on expatriate labour for its growth. Part of the government’s plan to support the private sector will be through the allocation of SR47bn in loans to be made through government-owned credit institutions such as the Saudi Industrial Development Fund and the Public Investment Fund.

Funding support for private sector

These institutions have become a key source of liquidity for getting projects financed over the past two years as bank credit dried up. “These loans will be critical in financing projects in the social and human development fields and complementing private sector efforts to finance their own expanding investment plans,” says Fahad al-Turki, a Riyadh-based analyst for the UK’s Barclays Capital.

The private sector has been spoilt by the years of easy growth. There was no entrepreneurialism

Saudi banking executive

Securing financing has been one of the main problems hampering the private sector in the kingdom, as banks worry about making new loans in a depressed economic environment and corporates try to pay off debts rather than risk capital through expansion. As the economic environment improves, bankers in Riyadh say demand for credit is picking up. Loan growth is starting to follow, but only slowly.

After a lacklustre year in 2009 when credit markets contracted slightly, banks began to start lending again in 2010. It was a mixed picture, however, with some banks still shrinking their loan books, and others aggressively seeking new deals. By the end of 2010, credit growth was 6 per cent. Most analysts agree that it will not rise above 10 per cent before 2012, with a full recovery taking until 2013 to materialise.

By then Saudi Arabia will be reaching the end of its 2010-14 development plan and it looks unlikely it will have hit its 5.2 per cent GDP target even once during the first three years. Sfakianakis says a sustained period of growth, with levels reaching 6.5 per cent will be necessary to create jobs to absorb the rising number of young people entering the labour market. Figures for 2009 show that of the kingdom’s 18.6 million locals, 10.5 per cent are unemployed.

This could mean that a significant slowdown in government spending will take a while to occur. Although budgeted spending for 2011 is planned to only increase by 7.4 per cent to SR580bn, the total expenditure level could hit SR692bn, according to Barclays Capital. Even then the state is forecast to be left with a surplus of SR120bn because of the higher than budgeted oil prices.

Despite three years of record budgets, the government’s coffers are burgeoning. Domestic debt is declining, standing at SR167bn in 2010, compared with SR558bn in 2002. Foreign assets held by Saudi Arabian Monetary Agency (Sama), the central bank, totalled about SR438bn at the end of 2010, back to the level seen in 2008, after dipping in 2009.

The potential for civil unrest to hit the Gulf region also poses a risk that could push oil prices even higher. Saudi Arabia’s Petroleum and Natural Resources Minister Ali al-Naimi, hinted at the Global Competitiveness Forum in Riyadh in January that the kingdom could increase oil production in 2011 to counter rising prices. At the time, Al-Naimi said the market was “in total equilibrium in terms of supply and demand”. That was before political instability in Tunisia and Egypt caused prices to soar.

A growing government balance sheet, coupled with the wave of popular protests led by disaffected young Arabs, could make it harder for Riyadh to slow state spending further if the private sector is not quick to take up the slack and provide jobs and opportunities.

Job creation in Saudi Arabia

More attention needs to be placed on developing small and medium-sized enterprises. So far, most of the stimulus spending has gone to large private sector companies that have projects to fund.

Support for SMEs is included in the 2010-14 plan and the government is looking for ways to help nurture them, but more will be necessary if the private sector is to start creating jobs for locals.

“The private sector has been spoilt by the years of easy growth,” says a Saudi banking executive. “There was no entrepreneurialism, just a desire to get international firms to set up in Saudi Arabia. But they only want to bring in workers from outside. Real growth will come from Saudi companies that can access capital and expand, and they need more state support to succeed.”

The kingdom’s Majlis al-Shoura (consultative council) has given approval for the creation of an SME council. Naveed Siddiqui, chief executive of local investment firm Capitas Group, says this body needs to be given overarching powers to foster this sector.

Unless a coordinated effort takes place, Riyadh will struggle to hit the level of growth it needs to allow the government to step back from its dominate role in the economy.

State spending helped Saudi Arabia mitigate the impact of the global financial crisis, but unless the government scales back its support of the economy and a vibrant private sector takes its place, another crisis awaits.