Reforms vital to boost economic growth in Kingdom

www.arabnews.com By Mushtak Parker

LONDON, 6 January 2003 — With the threat of war against Iraq looming ominously over the region, and stability continuing to be undermined by the ongoing “war against terrorism”, the Gulf region is faced with a difficult year ahead in 2003.

The cushion of rising oil prices, due to the Iraq crisis and the prolonged strike by oil workers in Venezuela may give a false sense of economic security, underpinned by an immediate upward pressure on crude oil prices in first quarter 2003. By Jan. 1, 2003, the price for Brent blend crude was hovering over the $30 per barrel mark.

External factors apart, countries such as Saudi Arabia are faced with daunting internal economic challenges which are more to do with structural reforms than with the benchmark price of Brent crude.

Reports from Japan suggest that Saudi Aramco plans to cut oil exports to Japan, South Korea and Thailand, its three main Asian customers, in January 2003 by 22 percent. This apparently in line with the new OPEC agreement to cut production to sustain realistic world oil prices and to offset the impact of quota cheating by other countries.

While Asian economies, save Japan, are projected to enjoy the best GDP growth rates in 2003 by far, the impact of the sluggish recovery of the US, European, and Japanese economies may yet burst the projected Asian growth bubble, especially if the US, Europe and Japan sleepwalk into recession. The net impact would be a downward pressure on Asian oil imports.

Economists commend the Kingdom’s recent economic reforms including the adoption of a new foreign investment law; allowing foreigners to own land; and the introduction of a comprehensive privatization strategy. But they agree that the pace of reform has to be much more urgent, and reforms transparent, realistically budgeted, refined, and professionally implemented.

This was also the unequivocal message of the recent International Monetary Fund (IMF’s) Article IV Consultations on Saudi Arabia. The fund in addition recommended removing further barriers to entry, and urgent fiscal transparency and reforms.

At the ‘Future Vision for the Saudi Economy’ symposium organized by the Planning Ministry and the World Bank in October in Riyadh, speakers overwhelmingly acknowledged the problems facing the Saudi economy; the gaps in policy making; and the need for change to meet the challenges of a rapidly growing population, of which some 70 percent is under 25-years-old. In this context, compared to only two years ago, the Kingdom’s business and financial environment has changed significantly for the better.

During 2003, a new insurance law, stock exchange law, and capital markets law, will almost certainly be promulgated. According to Dr. Abdulrahman Al-Jaafary, chairman of the Finance Committee of the consultative Shoura Council, all 67 articles of the draft Stock Market Law, for instance, were debated and approved at end December 2002. A key provision of the new law is the establishment of a Stock Market Commission with judicial powers and reporting directly to the Council of Ministers, the Saudi Cabinet.

However, implementation of new legislation has been erratic in some recent instances. The adoption of compulsory motor insurance from November 2002 was both confusing and shambolic. Is the NCCI (National Company for Cooperative Insurance) the sole provider of the ruksha (insurance) or not? Is the ruksha issued against the driving license, driver, or vehicle? Is the cooperative insurance Shariah-compliant? These are perhaps questions to be answered in a separate analysis, but they were certainly not forthcoming at the time of their introduction. The reality is that Saudi police on the ground are now accepting motor insurance certificates issued by all legal insurance providers, not only NCCI, despite the latter’s earlier pronouncement that it’s ruksha is the only legally acceptable one.

There would be no room for such confusion when the capital markets and stock exchange laws are promulgated. Otherwise it will have the opposite effect and frighten investors and companies away. Without a flourishing capital markets, the growth of the financial services sector in the Kingdom will remain stunted and largely parochial. This in turn will affect the asset quality and product innovation of the sector in the long run.

In the area of foreign investment, while the establishment of the Saudi Arabian General Investment Authority (SAGIA) in April 2000, headed by Governor Prince Abdullah ibn Faisal, has gone some way in making the Kingdom a more investor-friendly environment, the acid test for attracting greater foreign direct investment (FDI) flows are the all-important economic reform package and regional stability.

In the period April 2000 to early September 2001, the value of FDI investments in the Kingdom reached $9.2 billion, according to SAGIA. However, since 9/11, this figure had dropped dramatically to $3.5 billion at the beginning of December 2002. While the fallout of the terrorist attacks in New York and Washington was undoubtedly an important factor, foreign investors continue to be frustrated by the agonizingly slow pace of socio-economic reforms in the Kingdom.

The new foreign investment law, for example, was widely welcomed, but its so-called ‘Negative List’ which stipulated those sectors of economic activity still barred to foreigners, though reviewed and revised a number of times, continues to be a point of friction. Telecoms, insurance, oil exploration, security, retail, education, transport are just some of the 19 economic sectors still barred to foreign investors, and there has been no indication from SAGIA or the Supreme Economic Council of further reforms with respect to the list.

Many bankers and corporates, including some in the Kingdom, would like it to be abolished outright, with the government retaining control through a golden share in strategic sectors such as oil exploration, and perhaps transport.

The Kingdom’s aggressive Saudization policy too is a negative for foreign companies, who prefer to operate in an open labor market, dictated by experience, qualifications, and the rubrics of market supply and demand.

These problems are exacerbated by the poor perception of Saudi workers among both national and expatriate managers; and an over-protective Saudi labor legislation which is a disincentive for foreign firms hiring locals because it becomes almost impossible to terminate the employment of unreliable and inefficient workers. The government to be fair has launched a training and education fund aimed at tackling unemployment.

Another area for urgent reform is that of statistics and information. Very often these are inadequate, non-transparent in terms of collation and methodology, too optimistic, and very poorly disseminated. An open statistical culture is seriously lacking, and this applies in general both to government departments and to private-sector corporates. Of course no one expects companies and agencies to divulge intellectual property, but information as to policy, strategy, performance, terms of trade, indicators and so on, ought to be in the public domain, and should be a right enshrined in law.

The lack of transparency in statistics is underpinned by the generally poor and under-developed corporate communications culture at the agencies and companies. After all, quality, reliable, independent, and up-to-date information is a resource and a vital tool which companies and agencies can use in formulating investment, manufacturing, marketing and other strategies.

Saudi Labor & Social Affairs Minister Ali Al-Namlah, for instance, admitted in October 2003 that “we don’t know the exact rate of unemployment due to the absence of correct information on the number of job seekers and vacant positions.”

Nevertheless, in the Saudi context the minister should be commended for his candour, and has now suggested ways how labor statistics and data could be better collated “by linking all labor offices in the Kingdom with the ministry’s database.”

Unfortunately, that would not suffice, for it is the methodology and criteria for collation that is important. In the UK, for instance, unemployment figures are based on the number of people signing on for benefits and seeking employment at job centers.

There is no distinction between male and female workers, although gender employment analysis can be extrapolated.

In Saudi Arabia this is not possible because there is no benefit system as in the UK. The official government estimate for Saudi male unemployment is 8 percent. However, most bank analysts put the figure at double the official rate at about 16 percent, while others still talk about 25 percent and higher levels of male unemployment.

Because unemployment is a sensitive issue in any economy, a key policy objective is to try to create jobs. In the Kingdom, most Saudis are employed by the state and its utilities. This, together with high defence commitments and the sluggish performance of the non-oil sector, puts pressure on public expenditure, which cannot be sustained through oil revenues only because of their volatility and dependence on world crude oil prices. With the result over the last decade or so, the Kingdom has had almost a persistent budget deficit, forcing the government to borrow more from local banks.

In 2001, for instance, according to the IMF, the Saudi budget showed a deficit of 4 percent of GDP. With the result that the government’s domestic debt increased to a staggering 92 percent of GDP in mid 2001. Only Italy of the G-10 countries has a domestic debt comparable to that of Saudi Arabia.

The Kingdom’s own forecast for this year suggests a smaller deficit for fiscal year (FY) 2002 than the earlier estimate of $12 billion, thanks mainly to rising oil prices. Revenues for FY2002 were projected at $41.9 billion against expenditures of $53.9 billion, but on the basis of an oil price of $16-$17 per barrel. Saudi oil prices have been hovering above the $25 per barrel since August 2002, and last week Brent blend crude prices were quoted at $30 per barrel.

Firmer oil prices into 2003 should mean a knock-on effect on reducing the budget deficit in FY2003. A recent Saudi British Bank study projected oil revenues in 2003 to jump to $54.7 billion. But expenditure too is projected to increase to $58.2 billion.

Increased oil revenues is not a panacea. It depends on how the extra revenues are utilized and whether public spending can be controlled. Any increase in the latter will immediately offset the windfall revenues. Not surprisingly, the IMF has strongly recommended a more efficient use of temporary unanticipated windfall rises in the oil price. Instead of using such revenues through stop-gap measures, it could be invested in a special Saudi Arabia fund to smooth out any budgetary shortfalls on a permanent roll-over basis. Because of non-transparency in fiscal policy, it remains difficult to assess allocation of resources. In fact, the fund rightly calls for government expenditure to be subject to explicitly defined rules and regulations.

In 2002, firmer oil prices will no doubt improve the fiscal situation. The IMF also projects the Kingdom to achieve non-oil GDP growth of 4 percent in 2002. The Saudi British Bank, however, in a recent study, projected that the Kingdom’s non-oil sector GDP growth in 2003 will fall to around 3.5 percent. This on the condition that economic fundamentals such as inflation, trade balance, buoyant oil revenues and good domestic liquidity, remain strong.

There is a clear acknowledgement by Riyadh that dependence on oil and gas for revenues is no longer a sustainable economic strategy. Saudi Finance & National Economy Minister Ibrahim Al-Assaf, speaking at the symposium in Riyadh, concurred that “dependence on oil revenues and consequently public spending as the main driving force for economic activity has made our economy vulnerable to changes in international oil markets. Heavy dependence on a main source of revenue linked to the developments in the world economy and conditions in oil markets constitutes a major challenge to the fiscal policy of the Kingdom.”

Privatization, another potential source of revenue, also is not the panacea that some monetarist economists would like us to believe. It is fraught with both structural, political and market risks, depending on which sector and utility. The slow uptake of the recent Saudi Telecoms (STC) partial sell-off is a poignant reminder of that. It is unlikely that the Kingdom will even contemplate the introduction of marginal income tax. But the pressure may be on to introduce an interim sales tax (VAT) during the coming year.

The economic forecasts for FY2003, in the Saudi context, are not going to change dramatically over the span of one year. It is too short an economic cycle. What the Kingdom needs is a definitive long term plan such as Malaysia’s 2020 Vision, not only for the macro economy, but also for the financial and other sectors.

This would give a clearer timetable and target for the introduction and implementation of reforms.