Ala'a al-Yousef, S&P director for sovereign ratings in the Middle East and Africa, says the kingdom's decision to embark on the rating is not a precursor for international capital raising. 'Sovereign ratings are important for other reasons too. It [the rating] will allow sub-sovereign entities such as banks, oil companies and insurance firms to be rated.' In addition, says Al-Yousef, the rating will serve as 'an internationally recognised benchmark' and also support plans by the Saudi authorities - recently boosted by the approval of a new capital markets law - to establish a well-regulated domestic capital market.

S&P says the key supporting factors for the strong rating are macroeconomic stability, the high level of external liquidity and the government's strong investment portfolio combined with a favourable debt composition. 'The government has a reasonable track record in maintaining domestic stability,' says Al-Yousef. 'Despite several external shocks, the kingdom has maintained stability in its highly open economy, in particular a stable exchange rate, low inflation and a sound banking system. Ambitious reforms to liberalise the economy further, strengthen its institutional capacity and prepare for accession to the World Trade Organisation are well under way and should contribute further to its economic resilience.'

The government's high level of foreign exchange reserves, which - according to the Saudi Arabian Monetary Agency (SAMA - central bank) - stood at about $42,000 million at the end of 2002, and the absence of external debt have also played a role in securing the ratings.

Additional factors supporting the ratings are the government's substantial investment portfolio and the positive debt composition. Despite a domestic debt level of 95 per cent of gross domestic product (GDP), S&P considers the actual general government debt burden to be much lower. 'More than 80 per cent of it [government debt] is medium and long-term and held by the pension funds, the Public Investment Fund and other government institutions. Consequently, on a consolidated basis, the government's general debt is relatively low at 20 per cent of GDP,' S&P said.

S&P notes several factors constraining the ratings, notably the government's limited fiscal flexibility as a result of the high dependency on oil revenues and the large size of the government's payroll. However, S&P says, 'although oil revenues will remain volatile, conservative budgeting practices are expected to continue to reduce downside risks and prevent large budget deficits.' S&P forecasts that the budget will reach a deficit of 1 per cent in 2003, down from 3 per cent last year. For 2004/05, S&P forecasts deficits of 3.7 per cent and 6.3 per cent respectively, reflecting an assumed decline in oil prices.

S&P says the ratings are further constrained by the country's demographics, which put enormous pressure on the government to ensure sufficient private-sector growth and implement structural reforms. In addition, S&P argues that 'a slowly developing socio-political system' based on the need to preserve consensus among different interest groups and factions has slowed the pace of policy making.