LONDON, 26 September 2004 — “Business is booming in Saudi Arabia” was the emphatic message at a recent business seminar on the Kingdom organized by the Middle East Association in London.
The main driver of this boom has been the higher than expected world crude oil prices and the attendant substantial increase in production (by nearly one million barrels per day above the OPEC quota for Saudi Arabia), which in turn has fueled a construction boom.
According to a recent report by the National Commercial Bank, the largest bank in Saudi Arabia and the Arab world, Brent crude prices have averaged at $35.4 per barrel over the last eight months, and the outlook for the year 2004 is an average $35 per barrel.
This, says the NCB report, would translate into the average export price of a Saudi barrel of oil at $33 — up a healthy 22.2 percent on the actual price in 2003. More importantly, this price is a staggering $14 higher than the assumed price of oil in the Saudi budget for 2004.
Other indicators also point to a dynamic business cycle — the Tadawul stock exchange is up by over 70 percent; and liquidity in the financial system has increased substantially, fueled partly by returning capital from abroad and the investment of the new wealth at home.
The dynamics of the oil price bonanza will become even more apparent when the actual current account figures for 2004 are eventually published.
But based on the above crude oil price projections, an SR30 billion projected deficit for fiscal year 2004, will transform into a projected surplus of about SR130 billion, taking into account increased expenditures for such areas as security and defense; counter-terrorism; and telecommunications.
The good news is that Riyadh has announced its intention to allocate some SR41 billion of this surplus for a 5-year contingency investment in infrastructure mainly education, roads, water and sewage, healthcare, and housing.
The International Monetary Fund in its Article IV Consultation Paper on Saudi Arabia has repeatedly urged the Kingdom to utilize any oil price windfall in a planned and visionary way, and not merely to use it to service the Kingdom’s huge internal public debt, which at end 2003 stood at about SR660 billion. It seems that the bulk of the projected surplus for 2004 will be used to service this debt.
Both for citizens, foreign investors, and companies, the future looks bright, with the caveat that the political situation in the region does not deteriorate considerably, and the scourge of terrorism does not take hold.
As such, with its young population (some 70 percent of which are under 25) and future national revenues assured as the world’s largest oil producer (and therefore the best collateral), the Kingdom, according to both local and foreign businessmen offer tremendous business potential.
For foreign investors and companies, a major boon is the massive growth in oil and gas sectors over the coming decade.
“A wide range of manufacturing and services opportunities are available; participation of foreign and local investors is encouraged, and investment frameworks have been enhanced,” stressed Ali Al-Abuali, director of New Business Development at Saudi Aramco, the world’s largest oil company.
Over the next five years, according to Al-Abuali, Saudi Aramco plans five new crude increments; a new NGL recovery plant; and the expansion of the master gas system; the expansion and upgrade of refinery and distribution facilities; and the development of research and technology alliances.
Saudi Aramco is indeed the key magnet for foreign direct investment (FDI) and business interest. According to Khalid Al-Falih, vice president, New Business Development, Saudi Aramco, the company is budgeting a capital expenditure program of a staggering $34 billion over the next ten years for the above projects.
Others stress that the Aramco is forecasting a $20 billion capital spent over the next five years; and a further $17 billion spent on services and equipment over the same period.
Other Saudi utilities such as SABIC (Saudi Basic Industries Corporation), one of the world’s largest petrochemical companies, also plans several expansion and upgrades of its refineries and various plants, including the building of two new crackers in Jubail and Yanbu totaling $1.1 billion; and a new ethylene glycol plant totaling $1.5 billion.
The Kingdom remains the UK’s single largest market in the Middle East and North Africa (MENA) region. UK visible exports to the Kingdom totaled £1.8 billion in 2003. UK invisible exports (banking and insurance services) to Saudi Arabia totaled a further £2 billion, bringing a total export market for UK business in the Kingdom of £3.8 billion in 2003.
UK businesses have also invested £2 billion in the Kingdom, whether through the Saudi-British-sponsored Al-Yamamah Economic Offset Program or through private initiatives.
The British Offset Office, in fact, has recently concluded the 12th successful joint venture under the program, and has reached its target of providing £1 billion of inward investment into the Kingdom under the program.
Telecoms, IT, vocational training, are new areas which hold good opportunities in addition to the traditional sectors in oil, gas and manufacturing. The stable outlook for the Saudi economy is underpinned by a spate of positive rating reports on the Kingdom by ratings agencies.
Standard & Poor’s in May 2004 affirmed Saudi Arabia’s A/A-1 foreign currency and A+/A-1 local currency sovereign credit ratings, and its stable outlook on the Kingdom.
The ratings reflected the government’s favorable balance sheet, net asset position, and its strong external liquidity, with foreign reserves, according to SAMA (Saudi Arabian Monetary Agency) projected to increase from $62.4 billion in 2003 to $65.4 billion in 2004.
The Kingdom benefits from a highly open economy, which has recently been subject to a spate of ongoing structural reforms in preparation for the Kingdom’s eventual accession to the World Trade Organization.
Another rating agency, Cyprus-based Capital Intelligence (CI), in August gave the Kingdom a stable outlook and has raised the country’s long-term foreign currency rating to A, from A-, and its short-term foreign currency rating to A1 from A2. CI has also assigned a long-term local currency rating of A and a short-term local currency rating of A1 to Saudi Arabia. These are all investment grade ratings.
The upgrade, says Capital Intelligence, reflects the improvement in the country’s external balance sheet and CI’s expectation that the external finances will remain comfortable for the foreseeable future.
Given current favorable oil market dynamics, Capital Intelligence projects a budget surplus of around 5.8 percent of GDP in 2004 (excluding any receipts from privatization or mobile phone licenses).
This should enable the government to both accumulate foreign assets and pay down part of its domestic debt for a second consecutive year.
The central government budget, says CI, also remains over-dependent on income from oil exports, which generally account for 75-80 percent of total revenue.
The non-oil revenue base is narrow and lacks buoyancy. The upshot is that government cash flow is very vulnerable to volatile oil prices over which the government has little influence.
The lack of revenue flexibility is exacerbated by significant expenditure rigidities, with outlays on politically sensitive and mandatory items such as wages, security/defense and interest payments accounting for the bulk of total spending.
With oil prices at a high, Saudi banking is also booming, with the country awash with cash. This against a background of a strong performance by the banking sector in 2003 when the aggregate net profits of SR12.45 billion generated by the Kingdom’s 10 domestic banks increased by 16.4 percent year-on-year.
This has largely been the result against a macro-economic background of high oil prices and therefore revenues and a budget surplus; high liquidity; and a low interest rate environment.
This trend has continued through to first half 2004. NCB recently announced a 20.4 percent increase in net profits for first quarter ended 31 March 2004 of SR 933.4 million ($249 million) compared with SR 742.6 million ($190 million) for the comparable period in 2003.
The rate of return on average assets similarly increased to 3.2 percent from 2.9 percent for the same period in 2003.
Cynics will argue that the real test for the Saudi banking sector will come after the country’s imminent accession to WTO and once the full impact of economic and financial liberalization starts taking effect once the grace period expires.
How will they then face up to the competition and develop new revenue streams and products and services?
The Saudi banking sector is by far the most powerful and liquid in the Middle East. While it currently operates from a position of strength in the GCC, it remains to be seen how well it would stand up to the rigors and challenges of financial market liberalization.
HSBC Middle East Chief Executive Officer and Vice Chairman David Hodgkinson, for instance, is cautiously bullish about the region’s economic prospects and about HSBC Middle East’s commitment to the region, which includes further expansion of its activities.
HSBC Middle East, Hodgkinson confirmed, has applied for an investment-banking license in Saudi Arabia under the new capital market law. The Capital Markets Authority is also finalizing the provisions of the new Capital Markets Law, with approval expected in October.
The establishment of the new Al-Bilad Bank in September 2004, which operates under Islamic principles, is a new reminder of the strong growth of the Islamic banking sector in the Kingdom.
Rumors were rife, albeit unfounded, that NCB is converting into a dedicated Islamic bank. However, NCB is converting its entire retail banking outfit into Islamic retail banking, with the eventual aim of converting all its branches into dedicated Islamic banking ones, with only those areas which do not have current equivalents in Islamic finance continued on a conventional banking basis.
A recent study for HSBC Middle East Business Confidence Index showed that some 48 percent of companies with sales of more than $100m operating in or are from the Middle East stressed that they expect to use Shariah-compliant financial services more over the next few years.
According to HSBC’s David Hodgkinson, in Saudi Arabia, some 95 percent of all new borrowing (both business and consumer finance) in First Quarter 2004, was reportedly done on an Islamic finance basis.
At this rate, suggest the bankers, the demand for Islamic banking products and services, especially for consumer finance and investment services, will outstrip those for conventional financial products.