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Saudi Arabia
The Economy
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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