Slump in oil prices rocks the Kingdom: Michael Sheridan, recently in Jeddah, writes that the Saudis' plight may well affect the UK arms deal

THE NEW confrontation with Iraq could not have come at a more inauspicious time for the Saudi royal family. It has served to focus attention on the Kingdom's own problems: deteriorating public finances and a rise in Islamic extremist opposition to absolute monarchy.

Of most concern to Britain is the progress of the second stage of the al- Yamamah arms deal agreed in 1988. Business and diplomatic sources in the region say that slumping oil revenues and social unrest have forced a severe squeeze on all public contracts. It is understood that much of the second phase of the pounds 20bn British arms deal has been delayed. Business analysts say it is likely that parts of the agreement will never be implemented.

Arms sales to Saudi Arabia form part of the Islamic opposition's agenda. Opponents of the House of Saud, condemn the arms transfers as wasteful and loathe the open political alliance with the West against another Arab power, Iraq. A climate of dissatisfaction is fed by declining real incomes and allegations of royal corruption and conduct incompatible with the strict tenets of Islam. The political project of the opposition is clear: the substitution of kingship by theocracy, accompanied by xenophobia and hostility to the West.

The origins of the al- Yamamah deal with Britain can be traced back to the mid-1970s, when Saudi Arabia, building up a treasure chest that at one point tottaled dollars 180bn, set out to modernise its defences. It was blocked by the Israeli lobby in Washington from buying F-15s and eventually chose British Tornadoes over French Mirages. With the purchase of British warplanes came a huge amount of subsidiary defence business for Britain. It is this business that is under threat. However, the precise situation remains unclear, because the terms of the contract under which the British government has designated British Aerospace to be chief contractor for a deal generating income for British defence companies have never been made public.

The Saudi economy has long been a source of perplexity to outside analysts. For example, the US State Department's intelligence and research committee has been unable to reach an authoritative calculation of total Saudi debt. But bankers in the kingdom say domestic banks are unable to absorb much more government paper, which finances the current deficit. Profit- and-loss figures at the state telephone company, the oil conglomerate Aramco and several state-owned financial institutions are all the focus of intense speculation.

The future political structure of Saudi Arabia, the world's largest oil producer, is also causing serious concern in Washington. At least four high-level US missions recently visited the the Kingdom and a little- publicised policy debate is under way within the Clinton administration.

The US Treasury Secretary, Lloyd Bentsen, made public statements of confidence in the Saudi economy during his tour. But a more cautious note was struck during a visit by the former US Middle East envoy Richard Murphy. Another delegation, whose presence was not announced, included the former CIA station chief in Riyadh and a team of security specialists who spent between four and five weeks assessing and improving government readiness.

At about the same time, the Saudi authorities arrested a number of religious and political dissidents in the country's central province after demonstrations over the detention of a mosque preacher. An Islamic opposition group in London, the self-styled Committee for the Defence of Legitimate Rights, claimed that more than 1,000 people were detained, while the goverment officially acknowledged 110.

Such visible crackdowns upon internal dissent increase the nervousness felt in Washington, where memories of the 1979 collapse of the Pahlavi monarchy in Iran remain potent. Informed sources say sharp words were exchanged at a meeting between the Saudi Defence Minister, Prince Sultan ibn Abdul Aziz and yet another American delegation including the State Department's Under-Secretary of State for the Middle East, Robert Pelletreau, and a member of the National Security Council, Martin Indyk.

The British assessment, shared by several other European countries, is that the Saudi monarchy is more resilient and less liable to sudden collapse than was the Shah's regime. King Fahd inaugurated a consultative council of 66 appointed worthies last December and it is hoped that this body will provide an outlet for debate and criticism.

There are signs that at least some in Washington are already beginning to think the hitherto unthinkable. Every new crisis induces instability and brings closer the day when, the pessimists say, the unthinkable will become the orthodoxy, as it did in Iran in 1979.