Saudi faces time of reflection

Two years of robust oil prices have helped underpin the Saudi fiscal and external accounts and combined with low interest rates fuelled strong liquidity driven growth of the non-oil sector.

However, the authorities have failed to take full advantage of the situation. Structural fiscal problems persist, economic reform remains bogged down by politics, unemployment problems are worsening and state interference in the economy remains too high.

Geopolitical uncertainties are adding to problems. Demographic pressures are at the forefront of government ambitions to accelerate sustainable economic growth, which in 2002 fell to 0.7%.

According to the 2000 population survey, around 40% of Saudis are aged under 30 years old. Unofficial estimates put current unemployment among nationals at around 16%, a figure that looks set to increase without fundamental structural economic changes.

The authorities' policy of Saudisation of the workforce (the forced replacement of expatriate workers with locals) is by itself insufficient to absorb the large numbers entering the labour force each year. A large wages differential between Saudis and expatriates (see chart opposite) adds to the problem.

The only credible longterm solution is to raise sustainable growth. This can not be done without a radical overhaul of the economy. State dominance of the economy must be cut, the role of the private sector promoted and reforms introduced to provide a conducive investment environment.

However, Crown Prince Abdullah's efforts to drive forward the reform programme face continued opposition from both within the royal family and among the local population. Implementation of reforms has failed to live up to government rhetoric.

Abdullah's Gas Initiative aimed at encouraging international oil companies (IOC's) to invest in downstream gas development, and considered a benchmark for the reform programme, remains stalled. Proposed legislation concerning capital markets and taxation has also not materialised. The sale of Saudi Telecom shares earlier this year, is a step in the right direction but further progress is needed.

The government also needs to address deep-rooted structural fiscal imbalances. Government finances remain too dependent on oil revenues, public spending on salaries and debt service is too high and capital spending too low.

Reining in rampant over-spending, diversification of the revenue base and reduction of the budget deficit and public debt are key objectives of the Ministry of Planning's current five-year development plan (2000-2004).

The 2003 budget targets spending at SR209bn ($55.7bn). Although 3.5% higher than those budgeted in 2002, this is 7% lower than the spending outturn of SR225bn last year and will be difficult to achieve.

Government revenue is budgeted to fall by 17% to SR170bn ($45.3bn)compared with actual revenues in 2002, implying a SR39bn ($10.4bn)deficit. As in the previous two years, however, revenue projections are modest, reflecting a conservative oil price assumption.

Even allowing for some fall off in prices, as well as production, once regional uncertainties ease, revenues are likely to come in above budget. Whether this translates into a substantially lower budget deficit depends on curbing over-spending.

Reduction of the fiscal deficit would help contain the government debt stock, which we estimate to be close to 95% of GDP, as will the planned sale of some state assets.

Despite regional uncertainties, the Saudi economy should improve on its performance last year. Oil will benefit from increased output and in the short term, high prices. The high oil prices of the past two years combined with low interest rates will further underpin non-oil sector activity, though sentiment will suffer because of current regional uncertainties.

The outlook for 2004, however, is dampened by the prospect of weaker oil prices, lower production and a cyclical upturn in US interest rates.