Economic impact from Saudi Arabia's succession

Saudi Arabia's state television announced at 0700 GMT on Monday that King Fahd died "With deep sorrow and pain, the royal court...mourns the death of The Custodian of the Two Holy Mosques, King Fahd, due to illness," said an official statement. The announcement followed a long period of ill health and was not a surprise. Crown Prince Abdullah was swiftly pronounced as King of the world's largest oil exporter.

Fahd's death naturally introduces some uncertainty. He has been the longest serving ruler of Saudi Arabia since the Kingdom was founded in 1932. His death follows that of another of the Middle East's region's significant leaders, Sheikh Zayed of the UAE who died late last year, and comes during a period of great change for the region.

Fahd's death also comes at a sensitive time for the oil markets. With crude already trading at record highs, his death is likely to have an immediate impact. Indeed prices have already spiked above USD61 per barrel, despite Saudi reassurances that its oil policy remains unchanged. However as we set out below, we expect the succession to be relatively smooth, so any market moves should be temporary.

There are three key issues:

1. The current economic boom has eased social tension
2. Succession is likely to be straightforward and smooth
3. The appointment of King Abdullah is positive for reform

The current economic boom has eased social tension

Saudi Arabia is enjoying an unprecedented boom, principally on the back of high oil prices. Oil revenues in 2004 hit a record high of USD 102bn and are likely to exceed this in 2005 (we estimate USD 118bn). As a result the Kingdom is likely to run a third consecutive annual public budget surplus - the first time in its history. Growth has spread to outside the oil sector. Non-oil growth hit a twenty five-year high of 5.7% in 2004. Awash with liquidity, the stock market is up 57% year to date (after a 100% gain in 2004). Structurally the economy has also improved. Government debt has fallen to 70% of GDP from over a 100% a couple of years ago and the central bank's foreign assets currently total USD 100bn or 20 months of imports. Political problems are much less likely to emerge during a period of economic prosperity.

Succession is likely to be smooth

As expected the throne passed to Abdullah, the most senior of the late King's remaining brothers and half brothers. The throne passes to the oldest surviving descendent of Saudi Arabia's modern founder King, Abdullah al-Aziz. Indeed Abdullah has been the de facto ruler of Saudi Arabia since 1996, after King Fahd suffered a debilitating stroke, and is well entrenched in the Saudi government. He was appointed First Deputy Prime Minister in 1982 and has been Commander of the Saudi National Guard (the internal army) since 1963.

Abdullah's previous positions of Crown Prince and First Deputy Prime Minister, and therefore next in line to the throne, has gone to the next eldest brother, Prince Sultan - a member of the Sudairi Seven*. He is currently the Defence Minister and in charge of Saudi Arabia's army and airforce. The previous Saudi ambassador to the United States, Prince Bandar is one of Sultan's sons. Although there will be inevitably be some uncertainty following the death of King Fahd, particularly given the longevity of his rule, the quick confirmation of Abdullah and Sultan should reassure domestic and international markets.

King Abdullah should be positive for reform

Although a religious conservative, Abdullah is likely to enact further economic and political reform. He has already supported some small but important economic reforms, in particular doing more to attract increased foreign direct investment and pushing for WTO membership. On the political front, Abdullah was behind Saudi Arabia's first municipal elections and has allowed mild criticism of the government in the press. He even hinted that more women should be allowed to work. In a rare development, he has publicly accepted the petition of reformers pushing for political change. On the issue of oil, there is unlikely to be any change in policy.

While security concerns, and vested interests for the status quo, weigh against a big bang of social and economic reform the current gradual pace of change should now accelerate. Reform is certainly needed to tackle Saudi Arabia's two biggest medium term challenges - creating jobs for its young population and diversifying the economy away from its reliance on oil.

Nonetheless while Saudi Arabia faces significant medium term economic challenges, the current oil windfall has provided an important economic cushion. Living standards are rising, unemployment has fallen and social pressures have eased. Overall we expect 5% real growth in 2005

This is an extract from a longer piece available to Standard Chartered clients.