RIYADH, 2 May 2005 — Oil-export based liquidity has a multi-layered, multi-channeled impact on domestic economic activity as follows:

• First, the multiplier liquidity-creating effect of oil revenue has the potential to create as much as SR16 of new money for each oil riyal. Remember that over SR17 billion of new government spending, on average, enters the local economy each month!

• Second, the velocity of money, reflecting the turnover of money multiple times to finance economic activity, magnifies the impact a further six times (to SR96) for each oil riyal.

• Third, the resulting increase in nominal wealth (almost SR2 trillion increase in the stock market alone since 2002) feed additional rounds of transactions and demand.

Given this overwhelming firepower of oil-export liquidity, the surprise is that while money supply and nominal wealth has shown double-digit growth, real GDP has grown only at single digit levels. This is because much of the newfound liquid wealth has gone into three economic buckets: imports, equity and real estate. For real economic growth, what counts is the impact of demand on domestically produced goods and services.

Some sectors (cement, petrochemicals, construction), have responded to the increased demand by producing more, but most others have not. First, because it is “easy” to import the goods and services from abroad instead of making them here, but, more importantly, because the domestic business environment is not dynamic enough.

In fact, the rapidly growing stock market may have become something of a distraction for some local businesses — some are putting their profits into the local stock market and making easy money, instead of building new plants and factories! Growth in real wealth, not its monetary value, is the key measure of economic progress.

Real economic growth means increasing real GDP, not just their money value.

It means spending less than income as a nation, and using savings left over to invest in productive activities. It means importing less and producing more locally, and not sending large chunks of our wealth and savings abroad to invest overseas.

The key issue is how liquidity can be channeled to generate more real GDP instead of asset price bubbles.

The underlying challenge for the economy is to convert itself from a liquidity-driven to a demand-driven productive machine.

(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)