Is there trouble ahead?

Deft fiscal control has left Saudi Arabia in better shape than most. But the kingdom’s sternest tests are still to come.


Deft fiscal control has left Saudi Arabia in better shape than most. But the kingdom’s sternest tests are still to come.

The final chapter in Robert Lacey’s recent portrait of Saudi Arabia, ‘Inside the Kingdom’, ends in rather a depressing manner. Citing interviews with members of the royal family, Lacey describes a scene in 2007 where HRH King Abdullah visits the site of the university that is set to bear his name — the King Abdullah University for Science and Technology (KAUST) — only to find that work had not progressed as far as he had hoped. Disappointed, King Abdullah returns home to Jeddah, and the book concludes with the monarch poignantly staying longer at his prayers that evening.

Two years later, a glittering launch ceremony in 2009 — featuring many of the Arab world’s leaders — welcomed the university’s first intake of graduate students. The opening of KAUST is, the country’s authorities hope, a new dawn for Saudi Arabia’s greatest natural resource. No, not that one. Oil revenues will still form the backbone of the economy for decades to come, but the kingdom’s rulers are aware that human capital is now both their most vital asset and biggest headache. Nowhere is the lack of a knowledge economy more obvious than it is when you look at the unemployment rate, which has spiked back upwards during the recession, after a few years of gradual decline. In June 2010, the Labour Ministry reported that the number of unemployed workers in Saudi Arabia had risen to 10.5 percent. It’s possible to argue that the figure might be acceptable in the face of the worst recession in living memory, especially when set against results being posted by countries like Spain, which saw fully a fifth of its workforce unemployed in April this year.

But the reality is that two thirds of Saudi nationals are under the age of 30, and the kingdom is struggling to find jobs for them. What’s more, this pool of potential but untapped talent is growing far faster than the country can realistically provide them with work. The latest official census, announced in April, shows that Saudi Arabia’s population grew by 800,000 to 27.1 million in the previous twelve months.

“From the economic angle, you need growth in the non-oil private sector to reduce unemployment. That sector is growing at four percent a year, but the labour force is probably growing faster than that,” says Rory Fyfe, the Economist Intelligence Unit (EIU)’s Saudi specialist. “A lot of growth in the non-oil sector is quite capital intensive and temporary workers dominate the more labour-intensive sectors. So it doesn’t look like they’re winning that battle at the moment.”

It’s a problem that is endemic not just in Saudi Arabia, but across the GCC. In a recent ranking of the world’s top 500 universities, only two of those were in the Gulf; the King Saud University in Riyadh and King Fahd University of Petroleum and Minerals in Dhahran.

Fears of a series of ‘lost generations’ — where youths succumb either to indolence or sinecures in the public sector — are now being openly voiced by the Gulf’s most important business leaders.
There’s no doubt that Saudi Arabia is putting its money where its mouth is in an attempt to solve this conundrum. In early August, the government submitted a $385bn spending plan that is designed to halve unemployment by 2014. Half the sum will go on manpower, education and training, with nineteen percent devoted to the healthcare sector and seven percent to housing.

“It doesn’t really represent a major new policy change. Saudi Arabia really needs a dynamic workforce if it’s going to come up with a diversified economy,” says Fyfe. “I think it does go far enough, but their economic forecasts are quite optimistic compared to ours. They’ve got unemployment coming down to five percent by 2014, and I think we are forecasting unemployment to stay at around 10.8 percent over the forecast period. We’re forecasting growth at just under four percent for the next five years, and their economic plan is based on a little bit more than that.”

Although much has been made about the $385bn figure — with some analysts trumpeting it as the largest stimulus programme as a percentage of GDP in the world — it does not really amount to anything new. The government’s budgets over the last two years have been exceptionally high, but in reality, Saudi Arabia has been carrying out a fiscal stimulus programme for the last 20 years, and if anything, the spending has actually been reined back a little in the last year. The kingdom increased fiscal expenditure by nine percent last year, but that is compared to an annual average increase of fourteen percent between 2003 and 2008.

“Everyone talks about the $385bn spending plan, but reason that Saudi Arabia’s fiscal stimulus compared to its GDP is so big is because GDP fell so much due to the oil collapse in 2009,” says Fyfe. “Their expenditure tends to track oil prices, so when it goes down they tend to withdraw fiscal stimulus. We are therefore expecting more expenditure in 2010 because oil prices are higher.”

But the general consensus is that the government has applied the correct pressure to the economy’s accelerator. Too much spending will force inflation even higher than it already is, while too little will risk spiking the vulnerable growth of the private sector. So while the government’s performance has been lauded, the jury is still out on the hesitancy of banks to match that fiscal largesse.

“The government has broadly done what it can, but the reason we’re not seeing the full impact of this is because the banks have become very cautious in lending money,” says Paul Gamble, head of research at Riyadh-based Jadwa Investment. “The government has taken various administrative steps to make more money available for the banks to lend — cutting reserve requirements, retiring debts etc — and the banks are very liquid. But they’re ultimately unprepared to lend.”

Having said that, there is little doubt that the situation is improving. Lending to the private sector has gone up every month this year, although only by about 0.6 percent per month instead of 2.5 percent in the period before the recession. As is the case elsewhere in the Gulf, the pipeline of cheap and easy credit has vanished, with banks requiring greater transparency and carrying out due diligence on potential borrowers. While no-one could argue that this process isn’t long overdue and welcome, it is still coming at a tough time. On the private sector front, Saudi is now ranked at an impressive thirteenth in the world — above Japan, South Korea and Switzerland — by the World Bank’s ease of doing business survey for 2010, eighteen places higher than last year. It is ranked first in terms of registering property and seventh in terms of paying taxes, although it sits at a worrying 140th in terms of enforcing contracts.

“If you look at what the government is doing and the general fundamentals of the economy, then growth has actually been a bit disappointing, but that’s hardly the fault of the government,” says Gamble. “One thing they could do more in an environment where bank finance is difficult to come by is to enliven the debt markets. The few sukuks we’ve seen have generally been pretty heavily oversubscribed by the banks.”
An area where opinion over the government’s performance is divided is that of inflation. Saudi Arabia is one of only a handful of developed countries where inflation is growing, and of the 44 countries for which Reuters produces comparative figures, only Turkey’s rate is higher. Earlier this month, Banque Saudi Fransi revised its yearly inflationary forecast from 4.7 percent to 5.3 percent, with chief economist John Sfakianakis stating that the issue had now re-entered the spotlight.

“A month ago, I would have said that this wasn’t a worry. But the export ban in Russia, droughts around the world and international grain prices going up by 50 percent — these are the kind of things that led to an inflationary spike in 2008,” says the EIU’s Fyfe. “Food prices in Saudi Arabia have already been picking up all year, with food price inflation at six percent in the year to June. Although rental price inflation is falling, that’s only because of the massive rises in the years before, so we’ll probably see rent inflation stabilising around eight to nine percent.”

Fyfe thinks that the risk of an inflationary spike is “quite high”, especially if the dollar weakens, thus making food even more expensive. But Jadwa’s Gamble believes that long-term concerns over inflation — those not connected to immediate food supply issues — are largely limited to rents, and that those concerns are something the government is happy to live with.

“This is a reflection of a shortage of property — in particular a shortage of affordable property for those on lower and middle incomes. Rental inflation had been above ten percent for most of the last three years and though it recently slipped into single digits, it’s likely to start going up again, probably as early as this month,” he explains. “Inflation elsewhere is partly a by-product of government policy. The government has decided to spend a lot of money stimulating the economy, which will inevitably generate some inflation. They’re of the view — and I agree with it — that it’s better to keep the stimulus going than start to pull back because you’re worried about inflation.”

As Saudi Arabia’s economy continues to grow, a recent worry has been the domestic use of oil, amidst ever-greater energy consumption at home of about eight percent a year. The country has been searching for gas deposits to offset that trend, but onshore finds have thus far been disappointing. But while crude export volumes could be reduced, new refineries coming online and the stratospheric rise of the Saudi petrochemicals industry means that the export of petroleum and petroleum-related products will help to balance out that loss.

Even if oil drops down to $50 a barrel next year, as an analyst at JP Morgan Chase argued in mid-August, Gamble believes that would not put the brakes on government spending. “We got down to the $30-a-barrel mark in the first half of last year, when government spending was very strong. So $50 wouldn’t stop the government, but what it would do is have a big impact on the private sector, and you would then see a slowdown in activity not driven by the government and government contractors,” he says. “You’d see a sharper impact on the stock market and lower consumer spending so that would dampen the non-oil private sector. But the government itself is in the midst of a long-term, sensible spending plan. It can comfortably finance this from drawing down its reserves.”

Perhaps one of the most obvious signs of external confidence in Saudi Arabia’s performance has been the fact that foreign direct investment (FDI) has barely missed a beat, dropping from $39bn to $35bn during 2009. Furthermore, overall GDP still grew at 0.6 percent last year, despite oil production contracting at eleven percent and the collapse in the cost of a barrel — which is in itself a remarkable achievement. There is no doubt that these solid fundamentals have formed a backdrop for 86-year-old King Abdullah’s programme of liberalising reforms, but the real tests still lie ahead. Failing to solve those puzzles will leave the graduates of Saudi Arabia’s bright new universities facing an indifferent future.

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