Saudi Arabia: on course for another good year

The year 2003 proved an outstanding one for the Saudi economy. Oil output and prices were sharply higher, economic growth soared to 6.4%, the current account surplus trebled to USD 27bn and the government budget moved into surplus for the first time since 1981.

Economic growth will be much lower, and may even contract on the back of projected weaker oil revenues, but confidence is running high. The combination of windfall oil revenues and low interest rates will drive non-oil and private sector activity.

Prospects for economic reform are also encouraging. A host of stalled reforms were approved last year. More are expected in 2004. Income tax rates on foreign investors were reduced from 45% to 20% in February and talks on Saudi's accession to WTO are expected to be complete by mid-year.

There is still a problem with implementation: both the new capital market and insurance laws have yet to be implemented, but things are moving in the right direction.

Windfall oil revenues have boosted domestic liquidity and sentiment. Spreads on Saudi forwards, which during the height of the Iraqi war crisis were over 500, have collapsed and look set to move into negative territory in the near future.

In February the government announced that it was halting automatic monthly debt issues with immediate effect, a move that has added to surplus liquidity. And in mid-March, the Saudi Arabian Monetary Agency (SAMA) surprised the markets, cutting riyal interest rates by 25bps.

The cut brings Saudi rates into line with US rates and should stimulate corporate investment and an already booming local stock market, which after rising 76% in 2003, is already up 11% since the start of the year.

First-quarter oil sector activity has been much better than envisaged. Not only have prices remained surprisingly high but output has also exceeded expectations.

OPEC's benchmark basket price has averaged close to USD 30.5 per barrel so far this year, identical to the average price in Q1 2003. Saudi crude output is also stronger than expected, averaging 8.5 million barrels per day (mbpd) in January and February.

Oil output is expected to ease back as OPEC attempts to defend prices. However, given current levels of crude prices, cuts will be less than agreed at the cartel's 10th February meeting. Then OPEC agreed to tackle both quota violations (running at around 1.5 mbpd) and cut its official output ceiling by 10% to 23.5 mbpd.

For Saudi this equated to a cut of 800,000 bpd. However, given current prices, cuts will be much less. Further volume cuts may be necessary during the traditionally quieter second and third quarters. Average crude production is expected to be around 7.8 mbpd this year, versus 8.8 mbpd in 2003.

The government expects to earn SR 200bn (USD 55bn) of revenues in 2004, of which oil exports generate around 80%. The government does not make public its oil price assumption, but characteristically Saudi budgets are based on conservative price assumptions.

The 2004 budget is no exception: data suggest an average price assumption of USD15-19 per barrel. This is well below current prices and significantly less than the most conservative price estimates for 2004. Barring a collapse in global oil demand, Saudi oil revenues should again come in above budget.

Surplus oil revenues combined with renewed confidence will help drive non-oil growth again this year. Beyond this, however, growth prospects are less certain.

Oil prices are not expected to remain at current levels indefinitely. Any post election slowdown in the US could undermine both prices and output. It is therefore essential that the current economic reform momentum is maintained.

Key economic indicators: 2001 2002 2003 2004 2005
GDP: %, y/y 1.2 0.7 6.4 1.0 1.5
Inflation: % -0.8 0.3 0.7 0.7 0.5
Budget balance: % of GDP -3.9 -5.7 5.5 0.0 -4.0
Current account: USDbn 9.4 11.7 27.0 7.0 2.0
Current account: % of GDP 5.0 5.0 12.5 3.4 1.0