JEDDAH, 20 February 2006 — In a three-year long bull run since 2002, the Saudi stock market has created over SR2.1 trillion in new wealth for the Kingdom’s citizens. Perhaps another SR1 trillion or more of this wealth has been created in the real estate market. According to Riyad Bank’s Saudi Economic Review, the sheer size of the figures is mind-boggling and raises the question, “Where does this liquidity come from and what kind of impact does it have on the Saudi economy?
The report explained that the key to understand the impact of liquidity on the economy is to understand the meaning of “liquid wealth.” “Liquid wealth” means those assets that can be sold (or bought) easily and thus transformed into cash. The word “liquid” means that an asset can be sold (or bought) relatively easily. A broader concept is “liquid wealth”, defined as the total of all liquid assets like bank accounts, mutual funds, equity shares, etc. held by individuals or businesses. Liquid wealth is a key driver of consumption and investment, and thus, economic activity or income.
Is oil revenue a form of liquidity?
Liquidity and money supply are often used interchangeably to mean the same thing, but in functional terms, liquidity is a broader concept. While money supply has a specific role to play in an economy, namely, a medium of transactions, liquid wealth has an even broader role.
Dr. Khan H. Zahid, chief economist and vice president at Riyad Bank, said, “The distinction is important because when people say that Saudi Arabia’s oil exports create liquidity, what they really mean is that oil exports create new wealth (wealth transformed from below the ground to above the ground). Thus Saudi Arabia’s oil export generated revenues may enter the economy initially in the form of money, but its impact on economic activity occurs mainly because it increases the country’s financial wealth,” Zahid said.
How oil-export liquidity enters the Saudi economy?
Although oil revenues enter the economy initially as money, its impact on economic activity results primarily from the fact that it is national wealth. Oil export liquidity enters the domestic economy as, what economists call “high-powered money”, i.e., currency (foreign or local).
According to SAMA regulations each riyal of currency issued by SAMA must be backed by an equivalent amount of foreign currency (dollars) or gold. Thus, oil exports are, in principle, the basis of all riyals in the Kingdom. However, not all oil export revenues enter domestic liquidity. Oil exports could be spend abroad or invested overseas. This part does not affect domestic currency. Secondly, oil revenues brought home by the government do not enter domestic liquidity until the government spends it locally. SAMA, in its annual reports, call this the government’s net domestic spending. In 2004, this amount totaled SR244 billion.
This high-powered money allows the banking system to create even more money in a modern fractional reserve banking system.
What are the latest figures on the Kingdom’s liquidity?
In the Kingdom, the broadest measure of money supply is M3, which includes cash held by the public, demand deposits, time and savings deposits, and quasi-monetary deposits. As of December 2005, the latest Saudi Arabian Monetary Agency (SAMA) data show that M3 stood at SR546 billion.
The next layers of liquidity include: (1) domestic shares held directly and indirectly (through mutual funds) by the public, and (2) foreign bank deposits, equities and other financial assets held by domestic residents.
Latest Tadawul data show total market capitalization was SR2,423 billion at the end of 2005, by far the largest component of the Kingdom’s liquid wealth. The Bank for International Settlements (BIS) published data showing that as of September 2005, Saudi deposits held in BIS banks totaled SR307 billion.
In addition, SAMA data show that, as of December 2005, net foreign assets of Saudi banks totaled SR26 billion and SAMA itself also had foreign assets totaling SR564 billion.
Real estate is the next layer of liquid assets because it is also relatively easy to buy and sell. Riyad Bank has no hard data on the market value of this wealth in Saudi Arabia, but some industry sources put it at SR1 trillion. Adding this gives us a total liquid wealth of over SR3 trillion in the Kingdom. The sheer size of the figure, it is over 3 times the country’s GDP in 2005, highlights the magnitude of the impact that liquidity can have on domestic economic activity.
The figure also highlights the over-sized impact of the domestic equity market. Market capitalization of the Saudi stock market was SR280 billion in 2002 and SR590 billion in 2003. The large growth in equity wealth is bound to have a large impact on domestic spending on consumer goods, imports, etc.
How liquidity impacts domestic economic activity?
Liquidity impacts domestic economic activity by affecting the demand for goods and services and assets. Demand has to be met either by supply or it will result in price inflation (or a combination of both).
Liquid wealth is a key driver of consumption and investment, and thus income (i.e., gross domestic product (GDP). But, the liquidity can also be invested in financial assets instead of real investment. Think of this liquidity as money sloshing about in different buckets of domestic economic activity: Consumption, imports, savings, direct investment, equity and mutual funds and real estate. The process is fraught with danger. Instead of creating economic growth, the liquidity can end up creating inflation (“too much money chasing too few goods”).
In an open economy, the additional demand can be met either from domestic or foreign sources. If demand is met from increased domestic production, this results in a direct increase in GDP. If the demand is met from foreign sources, then it simply increases the country’s imports. Of course, the increased demand can also result in inflation, especially for those goods and services with domestic supply constraints.
Available Saudi economic and financial data suggest that the large increase in liquid wealth in the Kingdom in recent years has had the following impact on the Kingdom’s economic activities: (1) the country’s imports from abroad have increased greatly, (2) while the impact on domestic production (real GDP) has been more muted, (3) prices of local equity have risen tremendously (due to limited supply of shares), (4) real estate prices have increased greatly, and (5) prices of locally produced goods and services have increased.
What are the future challenges of liquidity to the economy?
According to the Riyad Bank report, the underlying challenge for the economy is to convert itself from a liquidity-driven to a demand-driven productive machine. This is the goal of economic reforms and the structural changes that the government is pursuing. From membership into the World Trade Organization (WTO), to the new capital market law; from privatization to increasing market access and competition; from providing jobs to citizens to enhancing their skills and education; from empowering consumers to energizing investors — the goal is to make the country a lean, mean productive machine.
“For many other countries around the world, the problem is that they do not have the money needed to finance consumption, investment and economic growth. For the oil-rich countries of the Middle East like Saudi Arabia today, money is not the problem. The issue is how to use this money properly to finance real investment in factories and businesses that are the real drivers of economic growth,” said Zahid.