Saudi Arabia Economics: Dependanting of Oil

Introduction

Saudi Arabia’s socio-political development in recent decades cannot be discussed outside of this country’s economy becoming fully specialized to serve the needs of oil consumers in Western countries. Saudi Arabia’s export of oil accounts for 45% of the country’s GDP and for 90% of actual revenues, associated with the functioning of the Saudi economy. In its turn, the country’s economy is being strictly controlled by the Saudi government, which consists of members of King Abdullah’s family and which controls 95% of Saudi oil export, strongly associated with operations of governmentally owned ARAMCO Corporation.[1] In other words, Saudi Arabia can hardly be referred to as an independent nation, in traditional sense of this word. It is a vast desert with enormous deposits of oil, underneath its surface, which happened to be populated by people of Arabic origin, which prior to the discovery of oil in the thirties, had often led a nomadic form of existence. We can say that Saudi Arabia is actually nothing but a giant oil pump, the existence of which only makes sense for as long as it remains operational.

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In 2007, 92% of the country’s revenues accounted for the export of oil, even though that government has been trying to diversify the Saudi economy since the sixties. However, it has proven to be quite impossible, since there is nothing in this country, except for oil. Saudi Arabia continues to experience a shortage of human resources, which partially explains the fact 55% of Saudi employees, associated with the oil sector of the country’s economy, are foreigners. Saudi Arabia’s economy’s utter dependence on the dynamics on the international market of oil and the absence of its own manufacturing and agricultural capabilities, results in the creation of a situation when the government’s attempts to lessen the country’s dependence on oil export are doomed to failure. The sharp decline in prices for oil in 2008, produced a heavy impact on the overall state of the Saudi economy and had resulted in Saudi Arabia’s government dramatically cutting costs, associated with its initial intentions to make the country less dependant on the export of oil.

[1] Muhammad Al-Jasser and, Ahmed Banafe, Monetary Policy Transmission Mechanism in Saudi Arabia. 2006. (Bank for International Settlements 2006).

The Financial Markets

SAMA and Monetary Policy

  1. The main principle, upon which the Saudi Arabian Monetary Authority (SAMA) bases its policies, is keeping the steady exchange rate of Saudi Riyal to U.S. Dollar, by the mean of taking utilization of so-called “counter-cyclical fiscal policy”, when the government’s expenditures do not correspond to the overall state of Saudi Arabia’s economy at any particular moment. While striving to encourage the flow of foreign investments into the Saudi economy, SAMA had fixed repo and reverse repo rates, which are being sustained by subsidies from Saudi Arabia’s stabilization fund, in time when prices for oil go down. In its turn, this suggests that the exchange rate of Saudi Riyal to the U.S. Dollar does not relate to the actual state of financial affairs, within the country’s economy.
  2. SAMA’s main goal is to ensure the absence of discrepancy between the country’s monetary and exchange rate policies, while resorting to administrative measures as the ultimate instrument of accomplishing it. This is the reason why Saudi bank’s long-term interest rates cannot be thought of as the indication of Saudi economy’s vitality, as is the case in all semi-authoritarian countries. Basically, SAMA strives to encourage ordinary Saudi citizens to utilize the country’s “inner” currency, within the context of conducting a variety of financial operations. By doing it, SAMA is able to “kill two rabbits in one shot” – it stabilizes Saudi’s economy, by the mean of extracting the U.S. dollars out of inner circulation, and also reduces the cost of labor, within a country. The main drawback of such policy is that it can only be practiced for as long as the country’s political regime remains essentially despotism.

Stock Market

  1. The Stock Exchange in Saudi Arabia functions as the sub-division of SAMA. Its main characteristic is almost a complete “dematerialization” of trading practices. This partly corresponds to the establishment of the Saudi Tadawul Electronic Trading System in 2001, which allows traders to instantly acquire ownership rights for the stock of their interest via the Internet. From the year 2004 to 2006, the value of traded electronic shares on Tadawul Electronic Trading System had increased from 1.8 to 4.1 billion Riyals, with 75% of transactions being conducted by foreign traders. However, in 2008, the value of traded shares has been dramatically reduced (2.5 billion Riyals), due to a significantly lowered price for oil[1].
  2. Saudi Arabia’s first Islamic bonds have been issued by AlBilad Bank in 2006, after the bank had received a permission to launch these bonds by the Saudi King. Even though that the estimated value of these bonds in 2007 accounted for 1.9 billion Riyals, their issuance had failed to attract much attention, on the part of potential Islamic buyers, because the very concept of Islamic bond is relatively new, which leaves much room to interpretations as to what the actual value of such bonds stands for, in the first place. The Law of Sharia forbids charging interest as sin, which is why the buyers of these bonds are being primarily concerned with placing their capitals into “trustworthy hands”, rather than with the prospects of making a fast commercial profit. However, given the fact that Saudi Arabia is essentially a family-run commercial enterprise, with the behavior of its rulers hardly corresponding to the notion of Islamic morality, there is very little chance for Islamic bonds, issued by Saudi banks, to gain much popularity among citizens and among foreign investors.

Capital Market Authority

  1. Capital Market Authority (CMA) was established in 2003 by the decree of the Saudi King. Its main functions include: granting trading licenses, monitoring activities that take place on the Tadawul Stock Exchange and protecting the rights of investors. CMA conducts “annual market surveillance” and uses the data, obtained during the course of such surveillance, to come up with recommendations as to the measures that need to be taken against companies and private traders that violate Saudi Stock Exchange’s rules and regulations. The monitoring is being done by CMA officials keeping a close track of financial transactions at Tadawul, for the purpose of insuring their transparency. [1]
  2. In order for foreign and domestic corporate traders to be licensed by CMA, they need to establish their high financial reliability, in the eyes of CMA officials, to agree to provide CMA with information, in regards to their trading activities, upon the request, and to also prove that their participation in Tadawul’s trades would benefit Saudi economy. However, as practice shows, CMA is often being utilized by Saudi authorities to extract bribes from potential investors, since authorizing these investors to conduct operations on highly lucrative Saudi Stock Exchange market, often allows them to make huge profits, within a very short period of time.

Investment in Saudi Arabia

Regulations

  1. In 2000, Saudi Arabia’s Council of Ministers had introduced a new foreign investment law, which allow foreign investors to hold 100% of ownership rights on real estate property and which also makes it legal, on their part, to indulge in a variety of different investment activities at the same time. Moreover, once foreign investors prove that their participation in Saudi Arabia’s economic life would result in the creation of at least new 500 jobs, they can be exempted from being the subject of taxation for as long as two years. Thus, the economy of Saudi Arabia can be characterized by rather extensive commercial opportunities, it provides to foreign investors. In its turn, this explains why in 2008, foreign investments in Saudi Arabia’s economy had reached its all-time high – $3.8 billion. At the same time, before being issued licenses that allow them to operate in Saudi Arabia, foreign companies must agree to observe the laws of Sharia, while conducting their business on Saudi soil, which often discourages Western specialists from deciding to pursue their professional careers in Saudi Arabia.
  2. Saudi Arabia’s government particularly welcomes the investments that would result in developing country’s social infrastructure, while understanding perfectly well that these investments are being rightly viewed by foreign shareholders as the least lucrative. Therefore, Saudi authorities provide domestic and foreign businessmen with additional incentives, in order to encourage them to consider investing in the country’s construction projects and in its food industry. For example, in 2001, the owners of the Burger King franchise were being granted an exclusive right to establish a restaurants’ chain in Er-Riyad and had been promised a governmental grant to subsidize the running of these restaurants for the duration of the first three years, on the condition that Burger King would not serve pork while operating in Saudi Arabia. Today, there are five Burger King restaurants operating in Er-Riyad alone, although it is only during the course of the last two years that they began generating some profit. It appears that the commercial attractiveness of investing in Saudi local projects directly relates to the process of this country becoming less clerical. Such a process had begun in 1995, but Saudi society still has a long way to go, before many Western companies would be willing to establish their long-term presence in this country.

Join Market

  1. Gulf Cooperation Council (GCC), which was founded in 1981 and which currently lists Qatar, Saudi Arabia Bahrain, Kuwait, Oman and the United Arab Emirates as its members, used to be essentially a loosely defined trade bloc. However, given the formal removal of trade barriers between countries-members, institutionalized on January 1, 2008, it can now be best referred to as a geopolitical entity, just as is the case with the EU. The GCC market’s main characteristic, is the fact that it is being almost completely dominated by banking stocks, which reveals the existence of GCC as having basically one purpose – it allows countries-participants to coordinate their actions, while manipulating prices on the international market of oil. Saudi Arabia’s share in the GCC market is estimated to account for 73%. Given the fact that the well-being of the ruling royal dynasty in Saudi Arabia directly relates to the country’s ability to affect the price dynamics on this market, the emergence of GCC can be discussed within a context of Saudi Arabia striving to expand the sphere of its geopolitical influence. Saudi Arabia and other monarchies of the Gulf simply want to reduce America’s economic influence in the area to a minimum, while continuing to rely on this country’s military might, as the ultimate mean of protecting their “sovereignty”. Therefore, GCC can only be formally referred to as economic organization, the existence of which implies the establishment of a common market, simply because GCC members do not produce anything but oil, which they do not sell to each other but export to Western countries, Japan and China[2].
  2. The earlier statement provides us with insight on what represents GCC’s main challenges. In the eighties, GCC members, and especially Saudi Arabia, did not enjoy complete independence, while setting policies for the continuous exploitation of their natural resources – they were nothing but pawns in America’s geopolitical game, which viewed the economic destruction of the Soviet Union as its foremost goal. There was a shortage of oil, throughout the eighties, yet the price for oil in 1986 went down to $10 per barrel, due to the combined efforts of the U.S. and Saudi Arabia, which in its turn, had resulted in the collapse of the Soviet Union a few years later. However, the members of the Saudi elite had lost billions of dollars, because of it. This is the reason why Saudi Arabia (as well as other members of GCC) now actively strives to ensure American military presence in the area of the Persian Gulf while stubbing America from behind, whenever is possible (financing Al-Qaeda). The “kings” in countries of GCC are interested in keeping the oil prices as high as possible, while being perfectly aware that, once their oil deposits become depleted, they will go back from riding Rolls-Royces to riding camels. Yet, they need to have American troops in the area, in order for them not to be squashed like parasites by their own people. The creation of GCC was a formalization of the Gulf country’s ruling elites’ intention to protect their corporate interests. However, given largely an irrational essence of such their intention, it appears to be highly doubtful that GCC will continue to remain an effective organization in the long run. This constitutes GCC’s main challenge.

Conclusion

  1. Despite Saudi Arabia officials’ strive to diversify the country’s economy; it appears very unlikely that they would ever be able to succeed in it, simply because their country is situated in the middle of the desert. Once there is going to be no oil left in Saudi Arabia, there would be nothing for the country’s economy to be based upon. Therefore, there can be only one way for Saudi rulers to prevent their country from being reduced into one among many Third World nations-bankrupts: acquiring new oil deposits by the mean of pursuing an aggressive foreign policy. It appears that the Saudi government understands this fact very well, which is why Saudi Arabia is actually the biggest importer of weapons and military equipment in the whole world, with its army considered as the world’s sixth strongest military power. Thus, we would recommend Saudi rulers to pay less attention to diversifying the country’s economy, and to direct their full attention towards gaining a complete military dominance in the area of the Persian Gulf, because only this can guarantee a continuous flow of foreign investments into Saudi economy in the future[1].
  2. As we have shown earlier, the geopolitical existence of Saudi Arabia only makes sense for as long as it continues to provide Western countries with comparatively cheap oil. Due to the enormous profits, Saudi rulers make on an day basis, they can still effectively deal with popular discontent among Saudi citizens, by creating an illusion that all Saudis benefit from their nation’s oil riches. However, such a situation will not last forever, because Saudi oil deposits are expected to become fully depleted in 100-150 years from now. Therefore, apart from the fact that Saudi Arabia remains one of the most repressive societies on Earth, there are also not many purely economic reasons (except for the ones related to oil exploration and establishing mobile phone networks) for Western companies to consider investing in the Saudi economy.

Bibliography

  1. Al-Jasser, Muhammad and Banafe, Ahmed “Monetary Policy Transmission Mechanism in Saudi Arabia”. 2006. Bank for International Settlements. Web.
  2. Mohamedi, Fareed “The Saudi Economy: A Few Years Yet Till Doomsday”. Middle East Report. (185) 13, 1993: 14-17.
  3. Meyer-Reumann, Rolf “The Banking System in Saudi Arabia”. Arab Law Quarterly (10) 3. 1995: 207-237.
  4. Zainab, Abu “Gulf Cooperation Council to Launch Common Market in January 2008”. 2007. Centre for Research on Globalization. We.
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