Saudi Arabia: Reform continues

Saudi Arabia is set to realise another strong economic performance in 2006. The economy witnessed buoyant growth, with nominal GDP growth expanding by 20.3% y/y in H1 2006 and we are forecasting real GDP growth of 6.0% for the year as a whole. Much of the buoyant performance in H1 came on the back of the 36.8% y/y jump in oil exports, although non-oil exports also performed solidly, increasing by 11.6% y/y. Despite this robust economic expansion, inflation remains relatively low (standing at 2.2% y/y in August), albeit increasing from a low average of 0.7% in 2005.

The high oil price will also result in the fiscal and current account surpluses reaching record levels in 2006 (see page 9). Part of the fiscal surplus has been used to continue to reduce government debt levels and we estimate that total debt will fall below to 20% of GDP by the end-2006. This is compared to a peak of 119% of GDP in 1999. Meanwhile, reserves have also been increasing, although much of the Kingdom's oil income has been directed towards foreign assets, rather than official reserves. Net foreign assets of the Saudi Arabian Monetary Agency (SAMA) have increased sharply, reaching SAR 756.9bn (USD 201.8bn) in Aug, up 32.1% from end-2005.

The high oil price and increased government spending has mitigated any wider impact of the fall in the stock market on the economy, although many individual retail investors have been hard hit. After steep falls in Q1, the Tadawul All Share Index (TASI) has seen further corrections from end-October. At the time of writing, the index has fallen by 52.1% year to date and by 17.7% from end-October. The main area likely to have been negatively affected is consumer spending, especially for luxury goods. However, along with the higher spending, the government has taken measures to soften the blow, including reducing gasoline and diesel prices by around 30%.

The government has also announced measures to support the stock market. This includes indicating in August that investment institutions and pension funds from other GCC countries will be able trade directly on the TASI. Furthermore, in November, the CMA issued long-awaited corporate governance guidelines. However, given the guidelines are voluntary, their impact is likely to be limited. In addition, a number of IPOs are planned going forward, these will help to increase the number of companies listed on the TASI. Demand for IPOs has remained relatively strong, despite the weakness in the stock market. Overall, these measures are positive for the development of the stock market, but are unlikely to restore confidence in the short term.

Along with measures to support the stock market, Saudi Arabia has forged ahead with its investment and reform program to boost the country's economic potential and create new jobs. Throughout the year, the government has continued to announce a raft of new investment projects in a wide variety of areas, including increasing oil and gas, refining, petrochemicals, infrastructure, mining and steel. The need for upgrading infrastructure was highlighted by the electricity and water shortages over the summer. Total planned investment over the next 5 to 6 years is estimated to be over USD 200bn, with a large proportion of investment in the non-oil sector coming from the private sector.

This higher level of investment, along with current spending from the government, will be important in supporting real GDP growth in 2007. This is especially the case given that net exports are forecast to detract from real GDP growth, with oil production expected to fall, along with oil prices. After the OPEC meeting in October, Saudi Arabia has indicated it will cut oil output by up to 380,000 b/d from November. Saudi has also indicated further cuts to output levels might be required in OPEC's December meeting to support the oil price. Meanwhile, the import bill is forecast to increase with the higher investment level. As a result, we forecast that real GDP growth in 2007 will slow to 5.0%.

On the reform front, the plans for Saudi Arabian Airlines have been redefined and bids have already been solicited for the catering arm of the airline. The government has also indicated it plans to reorganise the postal service and sell 49% of some operations. The government also has announced the expansion of King Abdullah Economic City, the development of four new economic cities in different areas and tax breaks for foreign firms investing in underdeveloped regions.

With regards to the financial sector, the government plans to develop a new financial centre in Riyadh by 2010. In order to increase Saudi employment linked to the centre, a new financial academy is planned to boost skill levels. The Kingdom's accession to the WTO is also driving financial reform; in October, the cabinet approved the licencing of 13 insurance companies to compete against the National Company for Co-operative Insurance, which had a monopoly.

Although there has been progress on the economic front, political reform has been slower. However, in October 2006, the Allegiance Committee was established, which will determine the future succession process. Although the succession after King Abdullah has been agreed, there is still a need to define the process beyond that point.

The Allegiance Committee, which comprises the sons and grandsons of Saudi Arabia's founder King Abdelaziz al-Saud, will vote on the eligibility of future kings and crown princes. The measure institutionalises consensusbuilding within the royal family by giving different branches of the ruling al- Sauds a say in the selection of kings. This has tended to happen in practice in the past, but has never been formalised. The Allegiance Committee could pave the way for the eventual emergence of younger rulers and the continuation of the reform program. The committee also aims to prevent infighting among the next generation of princes, which is vital for political stability. Furthermore, the formation of the committee aims to avoid the situation where the king is ill and unable to rule effectively, yet he remains on the throne.

Overall, 2006 has been a strong year for Saudi Arabia. The economic fundamentals have remained robust and the government has also made progress on its reform program and investment plans, which will help to develop economic capacity. The reduction in debt, build up of reserves and tapping into private investment will support investment levels going forward, despite the fall in oil price and output levels. Although these are positive developments, implementation is vital. Goals such as the development of financial centres, which will be important for increasing employment opportunities, are shared by other countries in the region that have progressed further down this path. Improving the investment environment and attractiveness of Saudi labour remains central to Saudi Arabia realising its full potential of the reform and investment measures announced this year.