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Middle EastMarch 3 2004

Laying macro foundations

Saudi Arabia had a bumper year in 2003 and the economic outlook remains good. Jon Marks considers where opportunity lies for both the government and investors.
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The Saudi economy is in transition, with the process of change underpinned by an excellent macroeconomic performance, buoyed up by high oil prices. Thanks to a convergence of happy circumstances, 2003 was a vintage year for the economy – the government has estimated total revenues last year at SR295bn ($79bn), producing only the second budget surplus since 1980 (SR45bn). Real GDP grew by 6.4% in 2003; nominal GDP rose by 12% (to SR792bn), reflecting the impact of high oil prices.

All this was on the back of the highest export earnings and current account surplus since 1981, with oil revenues reaching SR125bn – higher than budgeted in the late 2002 budget statement for 2003 – which fed into a fiscal surplus that was well beyond even the most optimistic analysts’ projections. There were two key reasons for this: Saudi oil production averaged 8.6m barrels per day (b/d) in 2003, its highest level for some years; and the kingdom’s Arab Light crude sold at $27.7 a barrel, its price highest average price since 1984.

The year ahead

By contrast, 2004 is not expected to be a bad year, but the government is not counting on another bonanza. According to Samba (formerly Saudi American Bank), the 2004 budget is based on 7.7m b/d output at $19 a barrel for Saudi crude. On this basis, the government forecasts a SR30bn deficit, with revenues at SR200bn. While forecast spending in 2004 is SR230bn – almost 10% up on the 2003 budget projection –this figure is actually 8% down on actual 2003 spending, which was 20% higher than the SR230bn initial estimate.

However, unless oil revenues experience a sudden and unexpected collapse, another budget surplus is possible, with National Commercial Bank (NCB) chief economist Said al-Shaikh forecasting a SR13bn surplus, based on estimated SR243bn revenue.

Analysts say that historically Saudi budgets have tended to underestimate income and spending. “By appearing to be conservative in its forecasts at a time of robust oil prices, the budget sends separate messages to two different audiences,” one analyst commented. “To the IMF and the global investment community, it suggests the authorities are keeping a tight rein on spending and maintaining fiscal prudence.” Meanwhile to the US government, “it suggests that the kingdom’s financial position is hardly flush and that the Saudis instead need to address their long-term structural inadequacies.”

Micro reform

According to the IMF, global investors and the US, focused microeconomic reform is needed to create a more responsive economy that can create the jobs Saudi Arabia so urgently needs. This chimes with the policy priorities of the ruling al-Saud family, which is seeking to address political grievances through a cautious opening that will include partial municipal elections.

However, many international bankers remain wary of Saudi political risk, which could impact on plans to raise project and equity finance.

To address such concerns, significant changes are under way and there are signs that the move towards reform is starting to affect the way Saudis think – as in the case of the insurance industry, where reforms so far have played a big part in deepening public consciousness about the concept of insurance.

Despite the rapid growth of the population and the rise of commercial banking in the past two decades, Saudi social mores remain founded in traditionally religious-centred concepts of community and family self-help. But measures such as the imposition of compulsory third-party motor cover are slowly spreading the insurance message throughout society, and these shifts are given expression in the new insurance legislation that will form the bedrock of modernisation and expansion in the industry.

As reform accelerates, so new opportunities will present themselves. Saudi Arabia has proved a reluctant privatiser, but the potential remains huge for private investment in major local corporates. This was shown by the biggest divestment to date, offering 30% of Saudi Telecommunications Company’s capital to local and other Gulf Arab private and institutional investors. Saudi Telecom listed on the Saudi Stock Market (SSM) early in 2003 after a 250%-oversubscribed IPO; it has since been a major contributor to the boom in the exchange.

The last really big privatisation IPO had involved the sale of 30% of Sabic in 1983. For two decades, Sabic was by far the SSM’s biggest stock, until Saudi Telecom. Investors expect a much shorter wait for the next big IPOs – although this being Saudi Arabia, a rush of corporate issues must wait at least until the medium term, rather than tomorrow.

Reform initiatives

Meanwhile, Saudi Arabia is coming to terms with the consequences of an upturn in Jihadist violence and calls for accelerated reform from many in its predominantly youthful 20 million-plus population. For many young Saudis, reform means, above all, providing a policy platform for job creation and increased opportunities in an economy where state companies still dominate in some key sectors, and where significant changes are required to meet the demands of globalisation.

Many of these changes are now being steadily enacted in everything from WTO membership – which has been debated over several years, and which will happen soon, drawing the kingdom ever closer into the global economy – to the important new Capital Markets Law.

Change is rarely implemented in a dramatic fashion in Saudi Arabia. One major issue is that heightened anticipation levels over the scale of the promised reform programme is tempered by the reality of slower progress on implementation. Key legislation remains in the pipeline, such as the capital markets and insurance laws, which have received cabinet approval, but have yet to come into force due to their slow pace through the Saudi administrative and political system.

But for all the frustrations, significant change is coming, and while reforms work their way slowly through, Saudi commercial banks and corporates have time to evolve their strategies to compete. Foreign banks are set to feature large on the local scene.

While most local banks cannot compete with foreign investment banks’ wider product portfolio, incoming international institutions may need to access local banks’ distribution networks. Cooperation, as well as competition, may prove the hallmark of the Saudi economy’s gradual opening up.

Towards globalisation

WTO membership is expected soon, after long and protracted negotiations, led on the last laps by Trade and Industry Minister Hashim Yamani. The final phase has involved concluding talks with the US, for decades a key ally, but with whom relations have been strained as security priorities and political perceptions have shifted post-11 September, 2001.

Joining the WTO has proved fraught with difficulties for the Saudi authorities – not least on the question of exclusions due to religious sensibilities – but is also provides opportunities for key players such as petrochemicals giant Sabic, a state-owned entity (for whom privatisation will follow at a later stage) whose strategy is based on positioning itself as a global player in basic petrochemicals and a key regional producer of basic and intermediate products.

Sabic officials are keen to insist that WTO membership can only be for the good, even though the Chemical Harmonisation Agreement that all new WTO members sign will significantly reduce tariffs and allow new competition into the Saudi domestic market. Accentuating the positive, they say that coming under the WTO umbrella will protect Sabic against anti-dumping measures taken unilaterally by members. Chief executive Mohammed Al-Mady believes WTO membership will make Sabic “even more global in nature”.

Saudi companies will be forced to become more competitive. Indeed, competition is intensifying on all fronts. For mighty Sabic this means the emergence of regional rivals such as Qatar and Iran – both of whom have massive petrochemicals schemes – and from Saudi private sector investors. As the boundaries between oil and petrochemicals becomes blurred with deregulation, Sabic finds oil giant Saudi Aramco encroaching on its patch. Sabic is negotiating a new cracker – an oil fractionation plant – with Saudi Aramco to be located at Jubail, but Saudi Aramco is now considering its own cracker as part of a major downstream expansion of the Rabigh refinery complex.

These trends are making Saudi corporates think differently. Mr Al-Mady wants to steer Sabic towards a credit rating – which is eminently possibly now that Saudi Arabia has a sovereign rating with Standard & Poor’s (S&P). Bond issues and other financing could follow, to help finance Sabic’s ambitious expansion plans, which includes more international merger and acquisition (M&A) activity.

International potential

Pointing to the potentials for international involvement, in autumn 2003 Sabic signed deals with Shell and Total to take gas, soon after the European majors had been awarded unprecedented concessions to prospect in the Empty Quarter. This was instead of the original Saudi Gas Initiatives Project (GIP), a more ambitious scheme to attract foreign upstream and downstream to the jewel of the national economy, hydrocarbons.

The GIP’s widely publicised failure said much for the problems of negotiating innovative – and in Saudi terms, politically sensitive – contracts in the kingdom. The Saudi authorities’ subsequent success in drawing in a number of foreign companies for gas exploration and production operations says much for the potential as Saudi Arabia opens up.

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