RIYADH — Saudi Arabia has announced its second public-sector wage increase in the course of two years. The first rise (15 percent) was instituted in 2005, following a 20-year pay freeze. It is estimated that this 2005 pay rise will have cost the government SR65 billion ($17.3 billion) by October 2008.

This latest move follows public-sector rises of 15 percent in Bahrain and Oman during 2007, whilst the UAE announced a massive 70 percent increase.

Across the Gulf Cooperation Council (GCC), governments have become attuned to growing calls for higher salaries to combat the rising cost of living.

Food and Rent

Inflation is a phenomenon which runs in parallel with a growing economy, such as Saudi Arabia’s rapid growth in recent years, particularly in the non-oil private sector. Inflation in 2007 rose to 4.1 percent, on the back of 2.2 percent the previous year; and whilst the figure has now been rising for five years — from 0.2 percent in 2002 — the price effect has been more widely felt in recent months, as inflation reached its 4.1 percent high.

Moreover, Saudis have an even greater sense of rapid increases, as prices in the two most important spending categories (food and rent) have been rising much faster than other categories in the price basket.

The cost-of-living index shows that food and beverage prices grew by 5.4 percent between 2005 and 2006, but then shot up by 7.5 percent the following year. Saudis are known for their enjoyment of food, so they certainly see and feel such a rapid rise.

Similarly, people have noticed significant increases in the cost of rent. About three quarters of all Saudis rent their homes, and virtually 100 percent of expatriates live in rented accommodation. In the 2001 to 2006 period, rents increased in the cost-of-living index by a meager 0.1 percent; but, within a year, the figure had hit 8.1 percent. So far, however, wage increases have not played a significant part in this price inflation.

The New Measures

On Jan. 28, 2008, the Saudi Cabinet approved a number of recommendations submitted by the Advisory Commission for Economic Affairs — part of the Supreme Economic Council. The Cabinet decided on 17 measures designed to impact in different ways on growing inflationary pressures within the economy.

The measures include a 5 percent inflation allowance, which will be added annually to the wages of government employees and retirees for three years; a 50 percent reduction in the port charges levied by the government on imports for three years; and a 50 percent cut in fees for passports, driving licenses, transfers of vehicle ownership and renewals of residence permits for domestic workers, again for three years.

In addition, a 10 percent increase in social insurance benefits was decreed, on the back of a 2005 increase through which the maximum annual social insurance allocation for families rose by 73 percent, from SR16,200 ($4,320) to SR28,000 ($7,467).

We, at SABB, estimate that these measures will together cost the Saudi state SR66 billion ($17.6 billion) over the three-year period. Within this, the wage allowance will account for around SR60 billion ($16 billion) and the reduced port fees for another SR1.25 billion ($333 million). The Cabinet also approved an allocation of SR10 billion ($2.7 billion) toward building low-cost housing units for the poor.

Prudent Approach

Two key reasons lead us to believe that the additional costs will not be an onerous burden on the state.

Firstly, Saudi Arabia continues to enjoy a fiscal surplus — estimated at SR175 billion ($47 billion) for 2008 — which can easily support additional or extrabudgetary spending. The only risk on the fiscal side over the next three years would be a severe fall in oil prices — which would run counter to our expectations for future oil-price behavior. The Kingdom’s 2008 budget is calculated on just $45 per barrel for Saudi ($50 for WTI); and while we expect the price of oil to subside this year — especially during Q2, due to seasonal variations and the global economic slowdown — this will not be sufficient to trouble the Saudi economy.

Prices could reach a low of $75 per barrel (WTI), but will tend to spike upward in the event of a geopolitical event or crisis. We estimate that the oil price (WTI) will average $78 per barrel, bringing the Saudi government revenues of SR715 billion ($190.6 billion) for 2008. Saudi Arabia’s total oil revenues for the year, it is estimated, will reach SR866 billion ($231 billion). Looking ahead, we do not expect oil prices in 2009 to drop below an average of $66 per barrel, reflecting continued strong demand, slow supply growth and a narrow margin of spare capacity.

With this in mind, we expect the Kingdom to maintain a healthy budget surplus for some years to come. Although it may decline as a percentage of GDP (as the economy continues to expand), the surplus will nevertheless remain above SR100 billion ($26.67 billion) until at least 2011, providing an ample fiscal cushion — even though current expenditure in the 2008 budget will surpass the anticipated increase of 11 percent and indeed probably reach 16 percent.

Secondly, the new measures are not permanent and could very well be revoked after the three-year period — although the social dissatisfaction this might cause could be reason enough to make them permanent.

Even if the salary rises become permanent after three years, which we expect they will, this commitment will not put too great a strain on the state’s coffers.

Overall, from a fiscal perspective, the incremental increase in the wage allowance can be seen as prudent, and fully in line with the general spending prudence of the state. We should keep in mind that wages and salaries comprise a large chunk of the current expenditure within the budget. During the days of budget deficits, which Saudi Arabia consistently ran between 1983 and 2000, wages and salaries formed the bulk of current expenditure, as spending was cut to a bare minimum.

Misleading Comparisons

In practice, it is not strictly accurate to compare the new Cabinet measures with recent initiatives in other parts of the Middle East designed to combat price pressures in their respective economies. The Saudi economy is far bigger than any other in the GCC, producing 51 percent of the GCC’s total GDP. The scale of the economy, different demographics and the size of the public-sector labor force should all be taken into account when comparing Saudi Arabia with the rest of the GCC.

The cost of living in Dubai or Abu Dhabi, for example, is far removed from the cost of living in Riyadh or Jeddah. According to a 2007 survey conducted by Mercer, Dubai is the 34th most expensive city in the world and Abu Dhabi is 45th.

Riyadh, on the other hand, does not feature in the top 75 most expensive cities. Moreover, inflation in Qatar and the UAE has been in double-digit figures for the past two years; while rents have risen by over 20 percent year-on-year in Oman and the UAE and, in the case of Qatar, by more than 100 percent in the past two years. In contrast, Saudi Arabia has seen relatively moderate increases.

The 70 percent public-sector wage increase in the UAE will cost the government an estimated SR13 billion ($3.5 billion), whereas an increase at the same rate would cost the Saudi state an estimated SR133 billion ($35.5 billion), equating to a little more than the UAE’s total budgeted spending for 2006.

Controlled Inflationary Pressure

We do not believe that the salary measures taken — 5 percent rise per annum — will lead to any significant upward inflationary pressures in 2008. The annual increase in 2008 will amount to no more than 2.3 percent of the Kingdom’s money supply, so its effect on money-supply growth will be minimal. Prudent fiscal management does not support salary increases above the rate of inflation — especially during periods of rising inflation, as is currently the case in the Kingdom. Continual public-sector salary increases run the risk of enticing too many Saudi nationals to seek government jobs. Steep public-sector rises should be followed by similar increases in productivity, which is not easy to achieve in any setting.

In addition, public-sector salaries are often a signal to the rest of the economy, providing the private sector with a benchmark. But the degree to which government increases will have an impact on private-sector salaries is related, in part, to the degree of the private sector’s reliance on expatriates. As most of the private-sector work force in Saudi Arabia is expatriate, we expect the impact to be subdued.

Locals have much more bargaining power in the labor market than expatriates, leading to higher salaries. In Oman and Bahrain, where the work force has a much higher proportion of nationals, the impact appears to be far greater.

The 5 percent salary increase for the first Muslim year, beginning Muharram 1 (Jan. 10), is close to the running rate of inflation. Higher pay has a tendency to produce higher consumption, and comparative cross-country data shows that raising salaries by more than the rate of inflation, in times of rising inflation, leads to even higher inflation. And while the popular expectation in the Kingdom was for a much bigger public-sector pay rise, such a move would have run contrary to proper inflationary management.

We do expect that inflation in Saudi Arabia will climb to 5 percent in 2008, but that it will begin to reduce in 2009 and 2010 as supply-and-demand bottlenecks are resolved, food prices subside moderately and wholesale/retail speculation lessens. Although public salary increases will outpace the inflation rate of 4.7 percent in 2009 and 4.3 percent in 2010, overall pressure on prices will not push inflation above the expected rate for 2008. However, we do anticipate that rents will be an important contributor to inflation in years to come, as affordable housing remains scarce.

The public-sector wage rise will tend to “pass on” inflationary effects in the economy, helping keep them containable.

If salaries remain above the rate of inflation, purchasing power will be partially restored as public sector wages grow in real terms (above the rate of inflation). However, the days of zero or near-zero inflation in the Kingdom are now over.

The Cabinet Measures in Detail

The government will add an annual 5 percent “cost of living allowance” to the salaries of its employees and retirees, for a period of three years.

Although initially perceived by many people as a simple 5 percent salary increase, the allowance is actually a compounded annual increase of 5 percent over the next three years. In this way, the first year increase will be 5 percent, followed by increases in the second and third years which respectively represent 10.25 percent and 15.76 percent of the initial salary. So by 2010, public sector salaries will effectively have risen by nearly 16 percent. Of course, this remains a temporary measure which could be phased out after the three-year period; and, at the same time, it is not clear what kind of “cost of living allowance” will be allocated to those who newly join public-sector service in 2009 or 2010.

Following their announcement in Saudi Arabia, the pay rises were quickly compared to the 70 percent increase given to the government work force in the UAE in November 2007. Again, the comparison with the UAE is highly misleading. The UAE government employs a few over 283,000 (2006 figure) from a total work force of 2.8 million across all sectors of its economy. The Saudi government employs around 1.8 million people — or nearly 25 percent of the country’s labor force. More importantly, 96 percent of the public-sector work force is comprised of Saudi nationals.

According to the Gulf Research Center (GRC), the Ministry of the Interior alone, including its various security departments, employs some 500,000 Saudis.

A pay rise in Saudi Arabia similar to that in the UAE would have had a significant effect on the economy as a whole and on inflation in particular. Moreover, a salary increase above the rate of inflation would have a high-spending effect, as Saudis comprise 92 percent of the public sector and are more inclined to spend than save — unlike expatriate workers who save and remit to their home countries.

The government will bear, for a period of three years, 50 percent of all port fees levied.

We estimate that the state will bear a cost of SR1.25 billion ($333 million) in unearned port fees over three years. Although we need to observe what effect these lower fees will have on imports, we do not expect a significant impact. Also, the ruling does not apply to import duties, which remain unaffected. We estimate that import duties in 2008 will reach SR12.8 billion ($3.41 billion), in line with the continuing increase in the volume of imported goods.

The government will increase social insurance benefits by 10 percent.

The annual total of social insurance payments now amounts to SR830 million ($221 million), which benefits some 600,000 Saudis. Based on 2005 figures, around 80 percent of them are receiving low-income support benefits.

Students, the blind, those inflicted by inclement weather and the families of some prisoners also receive state support.

The government will bear, for a period of three years, 50 percent of the fees relating to passports, vehicle licenses and ownership transfers, and renewal of residence permits for domestic workers.

These measures are intended to socially resonate with Saudis and decrease the level of indirect taxation.

Over the years, citizens have complained that indirect taxation — such as fees paid to the state — have been on the rise. The charges for issuing a passport (SR300), for transferring vehicle ownership (SR150) and for renewing residence permits of domestic workers (SR600) will all be halved — as will the current charges for renewing the car license (SR300), for a rental car license (SR400), for a pick-up van license (SR750) and for a truck license (SR1,100). Passports are re-issued every five years, while residence permits for domestic staff have to be renewed every year. As of 2005, Saudi Arabia had 13.4 million registered vehicles. The government will expedite construction of public housing, for which an amount of SR10 billion ($2.66 billion) has already been allocated, in addition to the existing annual allocations for such housing.

The state of the housing market is an ongoing concern. Although the construction of public housing is very much a priority, the market is experiencing undersupply and demand continues to increase — with Riyadh alone undersupplied by more than an estimated 350,000 housing units in 2008. Increasing rents are also of concern, as a lot of Saudis do not own their own home.

According to the Ministry of Economy and Planning, home ownership fell in the five years up until 2005 from 65 percent to 55 percent, due to a shortage of real estate financing opportunities and insufficient provision of loans by the REDF (Real Estate Development Fund) to meet the growing demand. Moreover, we believe that, since 2005, home ownership in the Kingdom has continued to decline. The waiting period for a REDF loan is now around 13 years.

The implementation of the mortgage law will be a huge boost for home ownership as banks and other financial institutions increase their housing credit exposure. We estimate that the total outstanding housing credit of the banks will not exceed SR6.5 billion ($1.73 billion) in 2008.

The ministry also reports that the percentage of unoccupied houses ranges between 12 percent and 15 percent of the total housing stock. This indicates that house prices are rising beyond the purchasing power of a large part of the local population and that homes are remaining empty for speculative reasons.

We do not believe that the huge land-price inflation seen over the past two years is healthy, and we assume that this imbalance is adding still further to the difficulties facing Saudis who wish to build their own homes.

The recommendations of the Advisory Commission also called for the establishment of the national housing authority, which was indeed founded in 2007 to push for the construction of low-income homes.

But the introduction of the new mortgage law is of even greater importance, reflected in the urgency which the Cabinet called for its enactment (which is still pending).

In addition, there was a call to simplify procedures for recruitment, in a way that does not contradict the directives on Saudization and that does restrict increases in wages of the skilled private-sector work force. The leeway within which the private sector will be permitted to operate remains to be seen, bearing in mind the shortage of local skilled labor and the wage inflation that is evident among qualified Saudis. Identifying and recruiting qualified expatriate employees during a GCC-wide boom is also a challenge.

A further recommendation aimed to enhance competition and safeguard consumers from unfair practices, with a direction for the Ministry of Culture and Information to coordinate better consumer information campaigns.

Finally, the commission suggested continual review of procedures related to the pricing and registration of medicines. In February 2007, the Ministry of Health is expected to hold the first of its periodic — every two or three months — reviews of medicine prices, both imported and locally manufactured.

(Dr. John Sfakianakis is chief economist at SABB. He is based in Riyadh.)