Clouds over Riyadh: Oil-rich Saudi Arabia is living beyond its means. Peter Torday looks at the tough decisions it must take

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The Independent Online
FOR MORE than two decades the oil wealth of Saudi Arabia has been taken for granted. The country owns a quarter of the world's proven oil reserves. It bankrolled the Gulf war and is a long-standing financier of the International Monetary Fund. With the industrial world still stuck in recession, Saudi Arabia and the Gulf states are more than ever regarded as a valuable source for plugging the global capital shortage.

But recently the Saudi image has begun to look distinctly tarnished. Concern that the Saudis are living well beyond their long-term ability to pay their way is undermining the riyal on foreign exchange markets and raising questions about the kingdom's ability to borrow at prime lending rates.

What is extraordinary is that this perception was not shattered earlier. This is partly because the kingdom's growing financial difficulties were masked by a boost to oil revenues of between dollars 40bn and dollars 50bn when Iraq's oil was embargoed, and the Saudis benefited from an increased market share and higher Gulf war oil prices. That figure almost entirely financed the dollars 55bn war chest demanded by the US and its allies.

A confidential IMF report this summer rang the first alarm bells about whether the Saudi current account deficit can be sustained. Although recent suggestions that the kingdom is close to bankruptcy are unsubstantiated, there are doubts whether Saudi Arabia can continue to finance its twin current account and budget deficits without a radical change in policies.

The implications are significant. There is concern within the Group of Seven leading industrial countries - especially from the US authorities and the Bank of England - that a financial crisis in Saudi Arabia could undermine the IMF and hit foreign banks and suppliers, particularly arms manufacturers.

The Bank of England, perhaps concerned about the potential impact of a sudden withdrawal of large Saudi investments in the UK property market, has let it be known that it believes the Saudi financial situation could become untenable in the next few years. And although Saudi spending on armaments appears virtually sacrosanct, questions have been raised about the long-term viability of massive arms supply contracts, such as the Al Yamamah deal between London and Riyadh, which could be worth up to pounds 25bn between 1985 and 2000.

But the real issue is political. Can Saudi Arabia summon the political will to raise revenues or cut spending sufficiently to ensure its ability to pay its way over the next few years?

That is what the G7 would like - without, of course, cancellation of the lucrative arms contracts that benefit Britain and the US.

The IMF, for one, is in no doubt that changes are needed and that Riyadh is capable of making them. Middle East experts monitoring the Saudi economy are less confident.

For one thing, the necessary changes assume that Saudi policy-makers think and act like Westerners. During the past decade, Saudi Arabia has run down much of its dollars 121bn in foreign currency reserves, although reports that they have vanished altogether are exaggerated.

But the IMF now believes that, as a result of high spending on imports, mounting debt service bills and low oil prices, the current account deficit for 1992-96 is an unsustainable dollars 74.2bn, five times higher than the fund's 1991 estimate.

There is also uncertainty because analysts do not have as complete a picture of the kingdom's financial position as they would with any Western industrial country.

Economists monitoring the kingdom believe that Saudi Arabia has at most dollars 46bn of hard currency reserves to finance the deficit.

Even though demand for imports is expected to ease, softer oil prices are eroding Saudi Arabia's ability to boost export earnings. The newsletter Middle East Monitor and other sources estimate that the kingdom's external and domestic debt could exceed dollars 100bn by the end of 1994 - or close to 100 per cent of gross domestic product.

Because of its widespread system of subsidies and the absence of general taxation, Saudi Arabia has run annual budget deficits of between dollars 4bn and dollars 18bn since 1983. When the era of high oil prices came to an end in the mid- 1980s, the subsidies did not.

They are, moreover, extremely difficult to dismantle. Subsidies were increased after the Gulf war to win the support of ordinary Saudis. They cover all aspects of life from education, health and welfare to turning the desert into wheat fields on a scale that makes Saudi Arabia the sixth-largest wheat exporter in the world.

The danger is that if King Fahd's government tries to cut back these subsidies significantly, it may lay itself open to the charge from opposition Islamic fundamentalists that nothing had first been done to stem financial corruption.

Nevertheless, reports are circulating in Riyadh that a cut in spending of between 7 and 15 per cent may be made in the new year. That would mean that the kingdom had made a significant effort to tackle its current account problem.

The introduction of a general system of taxation could, however, carry high political risk for an absolute monarch who might face demands for real political representation in return. In addition, John Roberts, an economics consultant and editor of MEM, said: 'A system of taxation would be a signal that the kingdom was not the oil-rich state of either Western or Saudi imagination.'

Another option is privatisation. The government owns large shareholdings in institutions whose shares are already traded and Saudi banks are sufficiently liquid to help to finance privatisation. But the recent cancellation of the Aramchem petrochemicals project - a proposed partnership between the state and Western oil companies - has some questioning whether the royal family would genuinely welcome private investment in key Saudi industries.

Borrowing is another source of funds. However, that the kingdom is already heavily indebted and could face upward pressure on borrowing margins is one deterrent. Another is the reluctance of some Western banks, notably the British, to participate in Saudi loans. As a result, suspicions have grown that Saudi Arabia is borrowing indirectly via export credit facilities in the West and through loans raised by Western partners on the capital markets.

Loans to the government already account for 40 per cent of deposits in Saudi banks and the royal family has enjoyed lavish access to the banking system. The largest bank, the National Commercial Bank, is said to hold huge unpaid loans owed by the royal family.

It is becoming clear that even Saudi officials are fed up that problems are not being confronted. Prince Abdullah Faisal Turki al-Saud, chairman of the royal commission on the country's two industrial cities, Jubail and Yanbu, said recently: 'Nowadays in Saudi Arabia, bankers do not want to say anything or write anything.'

Aside from dwindling returns on shrinking foreign assets, and downstream petrochemical revenues, Saudi Arabia's chief source of revenue is income from oil exports, which jumped from dollars 24bn in 1989 to dollars 40bn in 1990 after the kingdom reaped the benefits of the embargo on Iraqi oil exports and lifted production to about 8 million barrels per day. Income rose to about dollars 45bn in 1992, but earnings on this scale are likely to tail off as oil prices hit a post-Gulf war low.

Revenue from 1 million bpd goes to pay for the Al Yamamah contract, the construction of mosques and other long-term projects. That leaves the kingdom a hostage to the fortunes of the oil market and emphasises that the government must soon take the axe to spending.

(Photograph omitted)

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