As the macroeconomic manager of the largest economy in the Middle East and the world's biggest oil producer and exporter, namely Saudi Arabia, Muhammad Al-Jasser, governor of the Saudi Arabian Monetary Agency (SAMA), is only too aware of the impact of macro-economic management on the real economy and the lives of ordinary people. These include managing the interest-rate policy for the financial sector; inflation; and exchange rate policy of the Saudi riyal which since 1986 has been pegged to the US dollar.
On whether he has learnt any lessons from the developments in the above cities in guiding the future macroeconomic, monetary and fiscal policy of SAMA, Al-Jasser remains coy. But during a discussion chaired by Adrian Wood, professor of International Development at Queen Elizabeth House, Oxford University, after delivering a "tour de force" lecture titled “Macroeconomic Management in an Oil Economy: the Case of Saudi Arabia” in the historic Examinations Hall at Oxford University Wednesday night, Al-Jasser was adamant that macroeconomic stability is the clear and present challenge for any country including the Kingdom.
"We have created a stable economy with a predictable monetary and macroeconomic policy. Our policies are based on transparency and SAMA regularly publishes the most up-to-date projections and data relating to monetary and fiscal policies and the financial services sector. The stability of our exchange rate management is also a mainstay of our macroeconomic policy," he maintained.
Al-Jasser who was educated at the University of California, was recently named as “The Central Banker of the Year” by The Banker magazine, which is part of the Financial Times stable of publications. Given the added importance of the Saudi oil economy, the governor's comments are always sought after and last night was no exception. In fact, he was invited to deliver the lecture by Nazir Tun Abdul Razak, chairman and CEO of Malaysia's CIMB Bank Group and younger brother of Malaysian Prime Minister Najib Tun Abdul Razak, on behalf of the Oxford Centre for Islamic Studies (OCIS).
Al-Jasser identified four main challenges of managing the Saudi economy - the policy challenges posed by the unpredictability of oil revenues; the challenges of employment and economic diversification; the implications of the global financial crisis of 2008-09 for the Saudi financial system and what part Islamic finance can play in the future; and the current challenge of food price inflation.
The governor reminded that the Kingdom occupies a unique position in Islam as it is the site of the faith's two holiest places. But over the past 70 years, Saudi Arabia has also become known as the biggest source of oil for the world economy. The Kingdom he stressed has a quarter of the world's proven oil reserves, which are estimated to last for almost another century. Not surprisingly, SAMA has been dubbed "the central bank of oil."
Predicting accurately world demand and the price of oil is nigh impossible. Saudi Arabia seeks to stabilize oil prices by maintaining spare capacity when demand is high, while being prepared with others to cut production when prices are low. The Kingdom believes that a stable predictable oil price is good for the world economy. However OPEC's attempts to stabilize prices and to reduce volatility have not been successful. Today, the dollar oil price in real terms is about where it was 30 years ago.
Like other large oil exporting countries, Saudi Arabia faces the challenge of managing the macroeconomic impact of oil revenue. While oil revenue provides useful resources to the economy (some 80 per cent of government revenues), its management raises a number of difficult issues such as revenue volatility and the management of the budget risks channeling this volatility to the nonoil sectors of the economy.
"As oil price fluctuations tend to synchronize with the global economic cycle, our budget is designed for counter-cyclicality, with more spending during downturns and restrained spending in good times. This is the essence of our counter-cyclical policy. When oil revenues are low, the government runs a budget deficit. When necessary, government debt is issued to supplement revenues. The economy runs an external deficit as well, and foreign exchange reserves held by SAMA go down to pay for imports. When the oil revenues are high, we run budget surpluses and external surpluses, and we repay our government debt. In short, foreign exchange reserves are the cornerstone of Saudi Arabia's counter-cyclical fiscal policy," he explained.
However, it is very difficult to estimate how much of a “safety buffer” Saudi Arabia needs in its foreign exchange reserves. The real proof of the success of Saudi Arabia's macroecnomic policy is that since 1987 the Kingdom had only one year of negative growth in 1999.
Al-Jasser strongly defended the Kingdom's fixed exchange rate regime in which the riyal peg to the US dollar has stayed intact since 1986. "We believe this policy has served us well. Due to its credibility, it gives certainty to investors in an area where capital flows are predominantly in dollars and allows interest rates to track US rates with a small premium. In addition, business confidence in the peg allows domestic banks and corporates cost effective access to external borrowing (i.e. a lower risk premium). Trade and financial transaction costs are minimized as oil is priced and paid for in dollars and the bulk of imports are priced in dollars," he stressed.
He disagreed with suggestions that a more flexible exchange rate and devaluing the riyal would help Saudi Arabia manage big swings in external balance, because it ignores the composition of the country's exports, which are overwhelmingly oil and gas. Similarly, he dismisses any revaluing of the riyal when, as today, oil revenues are strong and inflation is on the rise, because it would not slowdown the export sector, nor affect growth, which is driven by oil revenues. Indeed, imports would become cheaper. However, the resultant wealth effect for consumers might well aggravate inflation by increasing domestic demand. "Indeed, a revaluation is akin to a fiscal stimulus at a time when the economy is running on all engines," he suggested.
Al-Jasser warned that the Kingdom must prepare for a future without oil revenues and diversify its sources of growth through exploiting other minerals on the Arabian shield such as gold, phosphate, bauxite, copper, iron, lead, tin and non-metallic minerals.
This is important because the oil and gas sector cannot alone provide productive employment for Saudis. Many jobs in the private sector, he added, are held by non-Saudis and Saudi employment is concentrated in the public sector. This is a challenge. Although population growth has slowed markedly in recent years, it is still about 1.9 percent per year (compared to the world average of 1.1 percent). The average Saudi is aged 22 years (for comparison the average Briton is 40 years old).
The Kingdom he added has an ambitious structural reform agenda to improve growth led by the private sector. Government spending on investment this year is forecast to be 15 percent of GDP. Massive projects are under way in infrastructure - railways network), petrochemicals, electricity, gas and water, telecommunications and IT, tourism, education and training.
Due to reforms to both the domestic and foreign investment regimes, foreign direct investment (FDI) inflows have increased and accounted for 43 percent of capital formation in 2009, and the stock of FDI is equivalent to 40 percent of GDP. According to UNCTAD, the Kingdom now ranks l7th in the world in terms of inward FDI performance. However, there are limits to the pace at which Saudi Arabia can prudently increase its spending. But the good news is that the Saudi non-oil sector is both more stable and faster-growing now than the oil sector and held up well during the crisis of 2008-09. "This is encouraging but it must be remembered that the true test of its resilience is how it performs when the oil market turns down again.
SAMA, he explained, has always taken the view that it should be extremely conservative in dealing with bank regulation. This approach helped cushion the impact of the global crisis on Saudi Arabia and the Gulf region; although the region was not immune to its economic impact. "Actually, we learned a painful lesson: however prudent your domestic banks are, you cannot escape the fallout from a global banking crisis. As international banks withdrew funding lines from banks in the Gulf the monetary authorities had to take action in both conventional and unconventional ways: Cutting rates, guaranteeing deposits, injecting capital and lowering reserve requirements."
In this respect Riyadh fully supports the tighter Basel III capital standards, which Al-Jasser maintains are unlikely to be a burden on Saudi banks as their balance sheets are relatively liquid and well-capitalized.
Al-Jasser confirmed that Shariah-compliant banking products and services account for about 38 percent of the banking sector assets in Saudi Arabia. The challenge for SAMA is how to expand the role of Islamic financial Institutions in the interbank money markets and to design tools that will be Shariah-compliant but at the same time allow SAMA to manage liquidity in the money market, especially repo agreements.
On burgeoning food price inflation, SAMA believes that openness and free competition is the best way to keep a lid on inflationary tendencies. Foodstuffs account for 26 percent of Saudi Arabia's Consumer Price Index (CPI). "There is no substitute for food: you have to eat. So, conventional ways of dealing with inflation by putting up interest rates or tightening fiscal policy do not work in this case. In 2008, we took action to subsidize key foodstuffs and this worked reasonably well to tide over the time until world food prices began to fall again," he added. Inflation in 2008 remained relatively high at 11.2 percent, but according to Al-Jasser it should come down to 5.3 percent in 2011.
