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WEEKLY NEWSLETTER
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Saudi Arabia
Index
Offshore drilling platform
THE DEVELOPMENT OF THE SAUDI ARABIAN ECONOMY has gone hand in
hand with the establishment and expansion of the Saudi state
during the last fifty years. The process of building the state,
fortified by oil revenues distributed through the modern
institutions of bureaucracy, worked to unify this economically
diverse country. So pervasive has been the influence of these
relatively young institutions that few vestiges of the old
economy survive unchanged.
Before the discovery of oil in the Arabian Peninsula, it
would be difficult to speak of a unified entity such as the Saudi
Arabian economy. Before the 1930s, the region that would later
come under the control of the Saudi state was composed of several
regions that lived off specific resources and differentiated
human activities. The western province, the Hijaz, for example,
depended chiefly on subsistence agriculture, some long-distance
trade, and the provision of services to pilgrims traveling to the
holy cities of Mecca and Medina. A plantation economy that grew
dates and other cash crops dominated the Eastern Province (also
known as Al Ahsa, Al Hasa, and Ash Sharqiyah). An extremely
hostile environment determined geographical separation of
peoples. Because permanent habitation could exist only where
there was water--at natural springs and wells--the long distances
between water sources isolated clusters of people and hampered
travel. The difficulty of travel also discouraged penetration
from the outside, as did the lack of readily exploitable natural
resources.
The discovery of oil in the Eastern Province in 1938 came
just six years after another major development: the establishment
of the Kingdom of Saudi Arabia, which unified a number of diverse
areas of the peninsula under one ruler. Moreover, the rebuilding
of Europe after World War II and its need for cheap, reliable
sources of oil greatly enhanced the position of the newly
established Saudi Arabian oil industry. The combination of these
three events formed the basis of the current structure of the
Saudi economy.
The quantum jump in revenues that flowed into the treasury of
Abd al Aziz Al ibn Abd as Rahman Saud (ruled 1932-53) fortified
his position and allowed the king to exert greater political and
economic control over the territories he had conquered. At the
apex of the economy was the state with all the mechanisms needed
to ensure the rule of the Saud family (Al Saud). The state became
the widespread agent of economic change, replacing the
traditional economy with one that depended primarily on the
state's outlays.
The conjuncture of these events also thrust Saudi Arabia, by
virtue of its location and its enormous oil assets, into the
center of the West's strategic concerns. At first the issue was
the reconstruction of Europe; later, however, the steady flow of
oil from the kingdom would be regarded as essential for
international economic stability. In this sense, Saudi oil
production and investment policies have assumed paramount
importance to the industrialized world and, more recently, the
developing world. This importance of oil to the West,
particularly to the United States, could not have been more
clearly underscored than it was by the Iraqi invasion of Kuwait
in August 1990 and may have been a key reason for the massive
military effort marshaled to expel Iraq from Kuwait. After the
Persian Gulf War (1991), Saudi Arabia's standing in the world oil
market increased, because it was the only major oil-producing
country that had significant excess capacity of crude oil
production and thereby a strong influence on international oil
supplies and prices.
Maintaining this position in the international oil market has
been the basis of Saudi economic policy in the early 1990s and
was likely to remain so in the near future. Despite attempts to
diversify the economy, developing a self-perpetuating nonoil
sector has proved more difficult than earlier Saudi planners had
envisioned. This is not to say that the government has not raised
the average Saudi citizen's standard of living to one of the
highest levels in the world and established for most of its
inhabitants world-class infrastructural and social services. But
sustaining real income growth still depended primarily on
government spending, which was largely facilitated by oil
revenues. Therefore, the government could not afford to neglect
the oil sector, the primary engine of economic growth.
Developing the oil sector was crucial to domestic political
stability, and it was the kingdom's importance as an oil producer
that guaranteed its protection during the gulf crisis. During the
early 1990s, it was becoming clear that with the expected decline
of oil production from the republics of the former Soviet Union,
combined with the stagnating output in other debt-ridden and
geologically constrained Organization of the Petroleum Exporting
Countries (OPEC) and non-OPEC oil producers, Saudi Arabia had the
chance to obtain a disproportionate share of any net increment of
crude oil demand over the coming years.
Saudi Arabia had set out to meet this challenge with a major
capacity expansion plan for its oil industry. First, the Saudi
Arabian Oil Company (Saudi Aramco, the national oil company)
accelerated plans to push sustainable domestic crude oil
production capacity by 1995 to between 10.5 million and 11
million barrels per day
(bpd--see Glossary)
from 8.4 million bpd
in 1992, with an increased share of lighter grades of crude oil
produced. Second, the Saudi Arabian Marketing and Refining
Company (Samarec) planned to upgrade its refineries to meet the
new environmental standards in the West and growing domestic
demand. Third, following its acquisition of
downstream (see Glossary)
assets in the United States and the Republic of Korea
(South Korea), the kingdom planned to purchase refining capacity
closer to key consuming markets. Although shrouded in secrecy
that made details observer, this strategy seemed designed to
obtain or increase Saudi Arabia's market share.
During the 1970s and early 1980s, the sharp increase in oil
prices relieved the chronic financial constraints that had
plagued the Saudi state since its inception. Massive oil
revenues, combined with delays in using the funds and the Saudi
economy's limited absorptive capacity, created large financial
surpluses in both the private and government sectors of the
economy. The vast majority of these assets were invested in
international financial institutions and in Western government
securities.
After 1982 government authorities were obliged to change
their emphasis from managing surpluses to coping with growing
budgetary and balance-of-payments shortfalls. With the downturn
in oil prices beginning in 1982, oil revenues to the kingdom
began to recede. Given the huge investment expenditures to which
it was already committed, the government was forced to finance
large budget and current account deficits of the external balance
of payments through foreign asset drawdowns. At first, the small
decline in oil prices was considered a necessary "cooling off"
period and a chance to review the investment program begun
fifteen years earlier. Facing an ever-worsening international oil
supply glut, the burden of reducing oil output under OPEC's newly
installed quota system fell largely on Saudi Arabia. The
kingdom's oil revenues therefore took a double blow--reduced
prices and reduced exports--not to mention the devaluation of the
United States dollar, the currency in which oil is sold on
international markets. By late 1985, responding to domestic
concerns, Saudi Arabia sharply boosted oil output in an attempt
to regain its market share and to impose production discipline on
other OPEC members. This policy led directly to the oil price
crash of 1986.
The replacement in 1986 of well-known Minister of Petroleum
and Mineral Resources Ahmad Zaki Yamani by Hisham Muhi ad Din
Nazir, and King Fahd ibn Abd al Aziz Al Saud's personal
intervention in the kingdom's oil affairs, were followed by a
more commercial approach to oil exports that was designed to
maintain Saudi Arabia's world market share. Greater OPEC
discipline and a revival in world demand, stimulated by lower oil
prices and rapid economic growth in Asia, helped return some
buoyancy to the oil markets after 1986. Nonetheless, oil revenues
in the late 1980s remained at 25 percent to 30 percent of levels
during the early 1980s and proved insufficient to cover
government expenditures and offset imports, thus perpetuating
budget and external payment deficits. The authorities further
reduced foreign assets and attempted to stanch capital flight
(aggravated by the short-lived Iranian military thrusts into Iraq
in 1986 and 1987 and the "tanker was" of 1987) and to induce the
repatriation of private capital through the sale of government
bonds. This strategy stemmed the hemorrhage. By early 1990,
following the end of the Iran-Iraq War two years earlier,
increased oil output and higher oil prices combined with
improving private sector confidence to revive an economy that had
contracted for several years in a row.
In the two months following the Iraqi invasion of Kuwait in
1990, all government efforts at restoring confidence in the
economy since the 1986 price crash evaporated, precipitating
another large outflow of private capital and a virtual standstill
in domestic investment. But as oil prices and Saudi output soared
to replace embargoed Iraqi and Kuwaiti oil, and with the arrival
of the United Nation (UN) coalition forces, calm returned to the
economy, helped no doubt by substantial expenditures related to
the war effort. After the war, the repatriation of private funds
and renewed economic confidence created what some journalists
called a "miniboom." Despite budgetary problems at home and
international economic problems, promising regional trade
prospects emerged. Such prospects consisted of new markets in
Iran, Central Asia, and South Asia, as well as the reconstruction
of Kuwait, that opened new opportunities for Saudi businessmen.
The Persian Gulf War was disastrous for government finances,
however. Higher oil revenues were insufficient to cover the
estimated US$60 billion that the war cost the Saudi government.
The authorities had to deplete the last of the financial reserves
remaining from the oil-boom days of the early 1980s. In mid-1992,
official external assets stood at the minimum needed for ensuring
confidence in the Saudi currency, the riyal, and for maintaining
prudent reserves. Although budgetary and external deficits have
been sharply reduced, the government was forced to borrow on the
international market and to reduce subventions to government
enterprises, such as Saudi Basic Industries Corporation (Sabic)
and Saudi Aramco, forcing such firms to seek capital overseas.
The status of government accounts in the aftermath of the
Persian Gulf War clouded the prospects for smooth financing of
the three major expenditure categories on the ruling family's
priority list for the 1990s: the oil-sector capacity-expansion
plan, major increases in defense and arms purchases, and the
maintenance of public investments to sustain the domestic
standard of living. The options faced by the government to
alleviate its financial constraints were limited, especially on
the oil revenue front, and debt financing would be clearly
unsustainable over the medium term. During the 1990s, therefore,
the government will probably strive for financial maneuverability
by reducing the dependence of the private sector on government
funds and by attempting to diversify budget revenue sources.
Data as of December 1992
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