EXECUTIVE SUMMARY

The kingdom of Saudi Arabia faces a grim economic future. Contrary to predictions in the late 1970s and early 1980s of rising prices for Middle Eastern oil, world oil demand and prices have followed a downward trend since 1981-82, resulting in a reduction in Saudi oil revenues. Since 1983 Saudi Arabia has stopped accumulating financial surpluses, forcing it to draw down its financial reserves and, since 1987, to resort to large-scale borrowing.

These erroneous predictions also misread how oil-exporting countries react to vast increases of oil income. The assumption was that they would not increase spending as rapidly as they earned income and would thus accumulate huge financial surpluses. However, like other countries in a similar position, Saudi spending did keep pace with revenue, and when the revenue slowed to a trickle, Saudi Arabia decided it could not decrease spending commensurately.

The dramatic leap in Saudi oil export revenues in the 1960s was soon surpassed by government spending, causing budget deficits by the late 1960s. Increasing Saudi oil revenues in the early 1970s quickly paid off the debt and led the government to step up spending in the development plan of 1975-80. By 1977, however, a glut in the oil market forced down prices and reduced revenues. The resulting budget deficit led Saudi leaders to draw on accumulated financial reserves.

The oil shock of 1979-80 once again boosted Saudi revenues. Although another glut emerged by 1980, the Iran-Iraq War halted the downward pressure on prices and raised revenues in 1980-82. As they did after the first shock, Saudi leaders planned additional expenditures in the development plan of 1980-85. By 1983, however, an unexpected drop in revenues wiped out the fiscal surplus from the previous years. Outside of minor attempts to cut spending on foreign aid, and despite a downtrend in revenues, the Saudis continued to increase expenditures, particularly off-budget military outlays.

By 1985, the drastic fall in production levels and oil prices greatly reduced revenues and the government decided to increase its volume of sales. The result for 1986 was a worsening of the oil glut, a decrease in prices, and a level of Saudi oil export revenues that were far below earlier estimates.

Since fiscal year 1983, Saudi Arabia has suffered from budget deficits and deficits in current accounts in the balance of payments. These deficits were first covered by drawing on foreign assets, and after 1987 by government-issued bonds. Attempts to diversify the economy, create agricultural self-sufficiency, and reduce the number of foreign workers in the Saudi labor force were largely unsuccessful, with the cost of the efforts themselves only draining the economy further. By the end of the 1980s, Saudi Arabia was more dependent on oil revenues than before. The Gulf War aggravated the long-term deficits that have resulted from a continuing policy of government expenditures in excess of oil export revenues. This is due to the huge military cost of the war, exacerbated by the decision to actually increase domestic subsidies in times of crisis.

In the future, deficits are likely to continue to grow, barring any serious effort by Riyadh to curtail major aspects of government spending. While raising revenue through taxes and cutting back sharply on subsidies would offer hope for economic rehabilitation, there is no evidence that Saudi leaders are willing to risk the domestic unrest such a policy might produce. Instead they appear to be relying on the unlikely event that the oil market makes a miraculous recovery.