Building momentum: Hydrocarbons provide funding for further diversification

Flying in the face of ongoing global economic malaise which has seen many Western economies struggling to regain their composure, Saudi Arabia continues to post strong economic growth on the back of its thriving petroleum sector anchored by a steady political and financial base. Although higher-than-expected oil demand played a major role in producing a record budget surplus in 2012, a new wave of strong state expenditures has spread these revenues across a wide array of economic subsectors. As a result, the government has been able to accelerate its long-term strategic goal of economic diversification away from oil as well as address key social issues like education, employment and the availability of affordable housing. As the dominant economic force in the Middle East and North African region, in addition to playing a stabilising role as the world’s global crude oil swing producer, Saudi Arabia’s influence extends far beyond its own borders.

Adding Up

The world’s largest oil exporter again managed one of its highest economic growth rates with a preliminary real GDP growth forecast of 6.8% in 2012, following a healthy expansion of 8.5% in 2011 and 4.8% in 2010, according to data from the Saudi Arabian Monetary Agency (SAMA). These impressive growth rates were more than double the IMF’s estimated global GDP growth figure of 3.3% for 2012 and even outpaced emerging market growth of 5.3% as well as that of the broader Middle East region at 3.2%. Higher-than-predicted petroleum prices averaging $112 per barrel for benchmark Brent crude coupled with a 9.31% hike in oil exports yielded a nominal GDP figure of SR2.73tn ($727.54bn) in 2012, compared with SR2.51tn ($668.91bn) the previous year, according to figures from the Ministry of Finance. The impact of the elevated oil price was magnified by increased production, which rose from 9.3m barrels per day (bpd) in 2011 to 9.8m bpd in 2012.

Record annual government revenue of SR1.24tn ($330.46bn) in 2012 was fuelled in large part by oil export sales worth $347.2bn, up from $317.6bn in 2011, according to the National Commercial Bank. Driven by oil shipments, export revenue likewise rose from $364.5bn in 2011 to $396.5bn in 2012. Spurred on by an increasingly affluent population, imports have also risen substantially in recent years, although they are still outpaced by exports. The total value of imported goods rose from $86.4bn in 2009 to $96.7bn in 2010, $119.1bn in 2011 and $128bn in 2012, according to the bank. This trend looks set to continue going forward as construction and infrastructure projects progress in conjunction with higher levels of consumer spending.

Fuelled by high levels of government spending and commercial lending, the non-oil private sector also expanded by 7.2% in 2012, according to preliminary data released in January 2013 by the Ministry of Finance. This was just down from the 8.0% growth registered the previous year but higher than the 5.8% in 2010. Reflecting the ongoing efforts by the government to bolster the nation’s infrastructure, both the construction and communications sectors exhibited double-digit real GDP growth rates of 10.3% and 10.7%, respectively. The wholesale and retail trade sector also showed promising growth rates of 8.3% year-on-year (y-o-y); followed by manufacturing at 7.6%; electricity, gas and water at 7.3%; government services at 5.2%; finance at 4.4%; and agriculture at 2.6%.

Monetary Policy

Saudi Arabia’s currency, the riyal, is pegged to the US dollar at a rate of SR3.75:$1. This arrangement has been beneficial and many of the original factors that made the arrangement attractive at its inception in 1986 are still valid today. The linchpin of the economy, crude oil, is still priced in dollars, as are many imported goods. In addition, the correlation between commodity prices and the dollar is positive in the long term despite the negative correlation in the short term. As such, the recent boom in oil revenues has outpaced the growth of imports, resulting in a record trade surplus of around $268bn in 2012.

Given this interconnected relationship, interest rates in the country have remained low in recent years in response to similarly low rates in the US. The country’s base lending rate has remained fixed at 2% since 2006, shadowing the rates set near zero by the US Federal Reserve. These low rates look to continue in the short term as the US central bank is unlikely to raise interest rates until its economic recovery picks up steam (the US recorded a 0.1% decrease in GDP in the fourth quarter of 2012, according to the US Bureau of Economic Analysis) and unemployment falls below 6.5%. As such, Saudi investment bank Jadwa Investments forecasts no rate increase for 2013, with the repo (interest rate at which the SAMA lends money to other banks) and reverse repo rates (the rate at which SAMA borrows money from banks) maintained at their current levels of 2% and 0.25%, respectively.

While SAMA maintains the ability to adjust its interest rates independently in order to counter inflationary pressure, there has been little incentive to do so in recent years. If inflation were to accelerate in the near term, SAMA could also employ other methods to control the money supply such as issuing treasury bills, government sukuk (Islamic bonds) or adjusting bank reserve requirements. The Saudi interbank interest rate (Saibor), however, is more sensitive to the rising risk perceptions present in the international financial environment and has thus seen its three-month interbank rate climb from 0.78% in January 2012 to 0.996% in January 2013.

Doubling Down

While many debt-ridden EU countries continue to slash public spending and tighten the screws with painful austerity measures, Saudi Arabia presents the mirror image to these travails and is sitting comfortably, picking and choosing where and how to best utilise its fiscal overflow. Since 2006, Saudi Arabia has recorded a budget surplus every year with the exception of 2009, with the average annual balance amounting to SR245.13bn ($65.32bn), equivalent to 11.64% of GDP, according to figures from SAMA. As a result the country’s current account surplus ballooned to an all-time high of some $178.5bn by the end of 2012, up from the $158.8bn recorded the previous year.

In spite of government spending reaching a record high of SR853bn ($227.32bn) in 2012 after increasing 3.2% over the previous year, government revenues of SR1.24tn ($330.46bn) more than offset the free-spending policies. The country recorded a surplus of SR386bn ($102.87bn) in 2012, which is equivalent to 14.2% of GDP, the second largest ever behind the SR580.9bn ($154.81) recorded in 2008, according to SAMA data. Funding for investments reached a new high of SR265bn ($70.62bn) in a bid to stimulate the private sector, while priority spending areas for the year were defence, education and health care. The state exceeded its budgeted 2012 target of SR690bn ($183.88bn) by an impressive SR163bn ($43.44bn) or 23.6%. This is due primarily to the steep spending increases recently displayed in state budgets that have resulted in government outlays rising 83% in just five years. After spiking from SR654bn ($174.29bn) in 2010 to SR827bn ($220.39bn) in 2011, spending increases appear to be moderating, with forecast outlays of SR870bn ($231.85bn) in 2013 and declining to SR859bn ($228.92bn) in 2014, according to Jadwa estimates.

Big Spender

These free-spending policies are set to continue in 2013, with the government announcing an annual budget targeting revenues of SR829bn ($221bn) and expenditure of SR820bn ($281.53bn), which would leave a projected surplus of SR9bn ($2.40bn), according to forecasts by Saudi Arabia’s Ministry of Finance. In line with previous spending agendas, bolstering social services will remain a priority, with education and health care outlays accounting for a combined total of about 37% of spending, or SR304bn ($81bn). Infrastructure and transport are budgeted another SR65bn ($17.32bn), followed by water, agriculture, industry and other economic resources with SR57bn ($15.19bn), while municipality services are slated to receive SR36bn ($9.59bn).

The oil revenue windfall of recent years has allowed the government to adopt an expansionary fiscal policy; however, the authorities are mindful that without high oil prices and demand they risk overspending. If oil prices dip too far in the coming years as projected, the Kingdom could see its revenue streams curtailed and a deficit posted. The Economist Intelligence Unit predicts the Saudi budget will edge into deficit by 2015 with a minimal shortfall of 0.1% of GDP for the year, rising to 0.5% of GDP in 2016. The IMF forecasts this trend to occur slightly later in 2017 with expenditures ballooning to $301bn and exceeding revenues of $290.6bn. While sliding from a healthy surplus to a deficit is certainly cause for concern, the state still has a substantial safety net in the form of a portfolio of foreign assets held by SAMA valued at some $635bn in November 2012, according to the authority.

Paying The Balance

The flip side of the substantial budget surpluses run in recent years has been a noticeable drop in the amount of domestic debt. From 2006-12 domestic debt declined from SR365bn ($97.27bn) to SR99bn ($26.38bn), representing an impressive drop from 23.5% of GDP in 2006 to just 3.6% in 2012, according to figures from SAMA. The amount of various government-issued debt securities held by commercial banks diminished by SR2.2bn ($586.3m) over the first 11 months of the year, while bank holdings of longer-term government bonds dropped by SR4.4bn ($1.17bn) to a record low of SR43bn ($11.46bn). Two government pension funds – the General Organisation for Social Insurance and the Public Pension Agency – hold the remaining government debt. These low levels of debt are expected to decline at a more moderate pace in the future, with Jadwa forecasting domestic debt of SR90bn ($23.98bn), equivalent to 3.2% of GDP, in 2013, and SR85bn ($22.65bn), or 2.9% of GDP, the following year.


While economic fortunes have been favourable in recent years with record budget surpluses, strong oil exports and increasing asset values, there is concern that too much of a good thing could lead domestic prices to spiral out of control. Inflationary control measures have been relatively effective since record oil prices pushed inflation to nearly 11% in 2008, averaging 5% from 2009-12. Influenced by lower food prices and an easing of rental price increases, overall inflation eased to an annual average of 4.5% in 2012, compared with 5.0% the previous year.

One of the primary factors exerting upwards pressure on the money supply has been an increase in consumer spending as a result of rising public sector wages and labour reforms. A series of royal decrees in 2011 hiked the national minimum monthly wage to SR3000 ($799.50) and unemployment benefits to SR2000 ($533) for Saudi nationals, along with a one-time bonus paid out to state workers equal to approximately two months’ wages. The impact of these increases could be amplified if more recent initiatives such as the Nitaqat Saudiisation programme are effective in bringing more unemployed nationals into the labour force.

Prior to the 2011 mandated wage increases, the average private sector monthly wage stood at SR1293 ($344.58), a 32% rise over the 2009 average wage of SR979.4 ($261.01) per month, but still less than half of the minimum wage for nationals, according to data from the Ministry of Labour. According to a 2012 remuneration study carried out by international human resources consultancy firm Mercer, salaries in Saudi Arabia are expected to increase at 6% throughout 2013 – the highest rate in the GCC. Aon Hewitt, another human resources firm, projected similar figures of 5.8% wage growth for 2013 in its “Middle East Salary Increase Survey 2012” after forecasting identical growth rates the previous two years.

The renovation, rent, fuel and water category remains by far the fastest-rising component of the economy in terms of inflation after increasing by rates of 14.2%, 9.5%, 7.8% and 8.0% each year between 2009 and 2012, according to data provided by SAMA. This far outpaced inflation rates in other sectors such as foodstuffs and beverages at 4.4%, followed by fairly modest growth in services and other expenses at 3.7%, home furniture (3.5%), education and entertainment (3.1%), and fabrics, clothing and footwear (2.9%).

Going forward, Jadwa Investments estimates inflation in 2013 will decrease slightly to 4.3% as prices outside Saudi Arabia ease, and provided that the US dollar does not weaken substantially. Continued high levels of government and consumer spending will be offset to an extent by declining rental inflation as thousands of new units enter the market in 2013. Relatively weak economic growth forecast for the US and Europe, from which Saudi Arabia imports roughly 40% of its goods, is also expected to ease inflationary pressure, although continued economic expansion in emerging markets and China could push up wholesale goods prices modestly if there is sufficient competition for base metals, minerals and construction materials given the large number of building projects under way in the Kingdom.

Strong Base

The naming of Saudi Petroleum and Mineral Resources Minister Ali Al Naimi as the world’s 32nd most powerful person in 2012 by Forbes magazine underscored the importance of the country’s oil and gas sector not only to the domestic economy but to the stability of global energy markets.

It is therefore no surprise given the centrality of hydrocarbons to the economy that Saudi Arabia balances its annual budget based on an estimated breakeven point, which the price of oil must average or exceed for the state to be able to cover its expenditures. While its petroleum resources lead to ample surpluses in boom times (as evidenced over the past two years), planning a nation’s budget around volatile energy markets is a tricky undertaking. In the past, Saudi Arabia maintained comfortable surpluses through modest expenditures coupled with relatively high oil prices. And while prices currently remain strong, government expenditures have been rising by an average annual rate of 12% from 2002-12. As a result, the all-important breakeven point has risen from a modest $37.6 per barrel as late as 2008 to $85.2 for the 2013 budget, according to IMF projections released in October 2012. Jadwa Investments estimates the 2012 budget was predicated on a price of $69 per barrel.

Pivoting East

While exports and the trade balance sheet remain strong, the composition of Saudi Arabia’s primary trading relationships, as well as those of the GCC as a whole, have taken on a pronounced eastward orientation in recent years. Asian markets, led by dynamic rising powerhouses China, India and South Korea, are making continued inroads into trade routes dominated in the not too distant past by Western powers such as the US and the EU.

The Kingdom’s signature export, petroleum, serves as a case in point. While global demand for oil remains strong, the nature of trading partners is in the midst of a dramatic shift from West to East. For the better part of the 20th century insatiable appetite for oil from Western markets made these regions the primary destination for oil exports, a trade that is now witnessing a greater focus on Asia.

This shift is being spearheaded by China, which alone accounted for 71% of global energy consumption growth in 2011 as OECD consumption continued to decline, according to data from the “BP Statistical Review of World Energy 2012”. As global oil consumption reached 88m bpd on the year, China once again had the largest increase in oil consumption (505,000 barrels per day [bpd], up 5.5% over the previous year), while OECD consumption fell by some 600,000 bpd (a 1.2% decline). A dramatic shift in supply-side factors is further compounding the export trends as one of Saudi Arabia’s strongest traditional purchasers of crude continued to boost its own domestic production by exploiting substantial onshore production of shale liquids. The US posted the largest petroleum production increase among non-OPEC countries for the third consecutive year, boosting output by 285,000 bpd in 2011 and achieving its highest production level since 1998. As a result, US net oil imports were down 29% from their 2005 peak, while China’s net imports averaged 6m bpd, up 13% over the previous year. Asia’s comparative geographic proximity to the Middle East also has the added benefit of lower transportation and logistics costs.

Despite this trend, there are some limiting factors preventing a greater shift of trade to Asia. Firstly, China’s double-digit growth has slowed to 7-8% – by no means bad, but certainly down from the peaks of recent years. Secondly, many Asian countries also employ protectionist trade policies that make it difficult for foreign firms to compete. In addition, Western markets are still preferred for services, such as education.


The key to the Kingdom’s economic future lies in the success of its ongoing push for economic diversification. Virtually all the state’s strategies and spending tie into these plans which seek to expand a wide range of economic activities in the private sector, ranging from knowledge-based industries and services to heavy industrial activities. The non-oil private sector notched another year of strong growth in 2012 as real GDP was up by 7.2%, following an 8% rise in 2011, according to SAMA.

Ahmed M Al Ghannam, the director-general of the Saudi Export Programme, told OBG, “The non-oil contribution to GDP is increasing significantly. This is also reflected in our exports, where there is a huge growth potential. Through more coordination between the private sector and institutions such the Saudi Export Programme, and by harmonising policies aiming to promote non-oil industries, these figures can be multiplied.”

Spurred on by large transportation infrastructure investments and high mobile phone penetration rates (187% in the second half of 2012), the transport and communications segment of the economy led all private sector growth with a 10.7% increase. The construction sector also experienced a strong double-digit jump at 10.3% in 2012 after rising by 11.6% the previous year. This was followed by wholesale and retail trade with an 8.3% boost, followed by manufacturing with 7.6%, electricity, gas and water (7.3%), finance (4.4%) and agriculture (2.6%).


While rapid economic growth in recent years has vaulted the country’s per capita GDP from $17,157 in 2006 to $24,859 in 2012, according to Central Department of Statistics and Information data, unemployment remains a significant issue. Official figures show the unemployment rate has vacillated from 9.8% to 12% between 2006 and 2012. And it is the country’s young people who are finding it most difficult to get a job. Of the 656,096 potential workers within the 20-24 age range, nearly one-third (198,440) were unemployed, while another 12.8% of those aged 25-29 were also jobless in 2009.

Although economic growth and diversification have created jobs, the vast majority have gone to expatriate workers. As of 2012 about 8m foreign workers held roughly 90% of all private sector positions. As a result, Saudi Arabia has become the second-largest source of outward-bound remittances behind the US, and sent out $28.48bn in 2011, according World Bank statistics.

This challenge has persisted despite strong efforts by the government in recent years to institute a variety of Saudiisation programmes designed to bring more nationals into the labour force to supplement and replace the 8m-strong expatriate labour force employed in the country. These efforts have intensified over the past few years as new and more comprehensive programmes, coupled with stronger enforcement incentives, have been rolled out (see analysis). These initiatives act as the tools necessary to realise the ambitious employment goals laid out in the ninth development plan, which call for the creation of 1.12m new jobs for nationals by 2014.

Tackling Corruption

Corruption remains a concern, particularly in light of efforts to increase foreign investment. To counter this problem and promote proper conduct among the Kingdom’s business community, the Council of Ministers approved the National Strategy for Maintaining Integrity and Combating Corruption in February 2007. Mohammed bin Abdullah Al Sharif, the president of the National Anti-Corruption Commission, told OBG, “There is no doubt that combating corruption enhances foreign investors’ confidence in the Saudi economy. Studies have shown that there is an opposite relationship between corruption and foreign investment. Transparency is key to this, particularly in regard to bureaucracy. In addition to a legal framework that assures rights, investors are encouraged most when they see an efficient and transparent process for setting up a business or project.”

“There is a huge need to transform the way many family-run businesses are structured in Saudi. Nepotism is still a big problem, as is corporate governance,” Mohammed Moumena, the CEO of Edward Kelley & Partners, told OBG. The commission has plans to enhance the level of transparency in banking transactions in particular. “We are working in coordination with the Saudi Arabian Monetary Agency to oblige banks to adopt plans and projects to protect the integrity of transactions and combat corruption,” Al Sharif said, pointing to the central role of the Financial Investigation Unit of the Ministry of the Interior in this. The unit, which is authorised to monitor, investigate and disclose suspicious transactions, is responsible for carrying out anti-money-laundering efforts. “The commission has no trouble obtaining the information needed from banks to verify cases of corruption,” said Al Sharif.

Another major objective is to improve the government procurement system by ensuring transparency when dealing with state agencies. The Council of Ministers Resolution No. M/58 2006/9/27 was designed to organise competition and procurement procedures carried out by government agencies, with the aim of achieving transparency in all stages of competition and government procurement through such measures as public disclosure of the names of applicants, the value of their offers and the winner of the bid. The overriding principle is that projects must be undertaken at fair, competitive prices.


While global oil demand remains a fickle beast affected by a wide array of complex factors, Saudi Arabia’s position as a leading global exporter of crude is steady. Insulated to a degree from stagnating Western economies by virtue of continued demand for oil from Asia and other emerging markets, Saudi Arabia can look forward to strong export revenues, with oil production and price levels only expected to drop modestly in 2013. Continued exploration efforts along with increased infrastructure and capacity building of its existing fields are ensuring adequate supplies to meet both global demand and the growing domestic appetite for energy. These traditional strengths are in turn being bolstered by new efforts to expand natural gas production.

In the non-oil sector, the government’s continued investments in infrastructure and social services should continue to fuel growth, particularly in the private sector. The country’s ongoing stability in the midst of regional turmoil will also provides an attractive safe haven for foreign investment in many areas. The IMF has forecast GDP growth of 4.2% for 2013. In a report released in January 2013 Jadwa Investment also estimated growth at 4.2%, with the oil sector set to contract by 1.5% due to a decline in output of 2.3%, while the non-oil sector will pick up some of the slack, growing by 6.3% on the back of the state’s investment drive. Looking to the long term, the unprecedented overhaul of the educational system, as well as the Saudiisation drive, should see a growing number of nationals participating in a more diversified Saudi economy.

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