X. THE GRIM OUTLOOK FOR THE SAUDI ECONOMY

Over the past decade, Saudi Arabia has suffered a series of huge budget deficits that were first covered by drawing from accumulated financial reserves and then by resorting to large-scale borrowing. Independent assessments predict that Saudi deficits will grow larger over the next five years. To meet those debts, Saudi leaders will either have to curtail some key aspects of government spending or hope for a miraculous turnabout in the future of the oil market. For the time being, Saudi Arabia faces a dismal economic situation and grim prospects for the future.

SAUDI DEFICITS, RESERVES, AND DEBTS

According to official accounts, Saudi budget deficits between 1983 and 1989 totaled $92.8 billion, an annual average of $13.3 billion. In 1990-92 inclusive, they totaled $48.2 billion, averaging $16.1 billion per annum. The current account of the balance of payments has also been in deficit since 1983. Cumulative current account deficits between 1983 and 1989 were $86.5 billion, averaging $17.4 billion per annum; in 1990-92, they totaled $51.4 billion or $17.1 billion per annum. In short, although oil revenues in 1990-92 exceeded all years since 1983, expenditures and imports grew far more rapidly. The Gulf War did not initiate deficits but it certainly aggravated them, probably for many more years to come.

In the early deficit years, the Saudi treasury covered deficits by drawing down deposits in the central bank that were accumulated during the earlier "years of plenty." As a result, according to official accounts, central bank foreign assets fell from a peak of about $145 billion in 1982 to $69 billion at the end of 1987. However, real foreign assets (mainly government bonds issued by the United States and other industrialized countries and deposits with the IMF) were much lower, since the official statistics include uncollectable debts of $28 billion owed by Iraq, as well as smaller amounts technically owed by other Arab states. In 1988, when real foreign assets dropped to dangerously low levels, the treasury began a program of internal borrowing. In 1988-89 combined, the treasury borrowed $18.9 billion from government institutions (mainly pension funds) and local commercial banks; in 1990-92 (combined), internal borrowing more than doubled to $43.5 billion as more money was needed to cover larger deficits. In 1993, an unnamed Saudi banker stated that government debt to Saudi commercial banks in the form of government bond holdings had risen from $4 billion in 1989 to $20 billion in 1993, equal to about 40 percent of total bank deposits. This is about twice the ratio of comparable government debt in the United States. Having largely exhausted the domestic market, future borrowing by the treasury will have to rely in larger measure on external loans.

Indeed, the Saudis have already begun to tap this market. The treasury borrowed $4.5 billion from a consortium of Western banks in 1991. And as noted above, Saudi Arabia borrowed £l billion ($1.8 billion) from British banks in 1992 to cover part of the shortfall in payments to the British arms suppliers.

In total, the IMF estimated Saudi public debt at the end of 1992 to be about $68 billion, including $15 billion in external debt. This was equivalent to 56 percent of GDP, with a forecasted rise to at least 60 percent by the end of 1993. Readily available financial reserves had fallen to about $12 billion by the end of 1992-the equivalent of about two months of imported goods and services.

These woeful figures, however, actually understate the critical condition of Saudi finances. Aside from direct borrowing by the treasury, state-owned firms have become major borrowers in recent years because the state can no longer provide necessary financing. Saudi ARAMCO and its subsidiary, for example, borrowed $2.9 billion from foreign and local banks, and other state corporations borrowed an additional $2 billion. I Another means of "borrowing" adopted by the Saudis has been lengthy delays in payments to contractors. In 1992 the U.S. Department of Commerce released a list of fourteen American firms with cumulative claims of about $500 million. There is every reason to assume that other foreign contractors suffered similar delays in payments. Local contractors have been complaining about this practice since the mid-1980s.

BUDGET AND BALANCE OF PAYMENTS PROJECTIONS, 1993-97

In mid-1993, an IMF mission issued a report on the future of the Saudi economy. According to the report, large current account deficits (in the balance of payments) would not only persist but grow over the next five years from $11.3 billion in 1993 to $12.7 billion in 1994, $14.5 billion in 1995, $16.6 billion in 1996, and to $18.5 billion in 1997. For the five-year period, the IMF forecasted a cumulative current account deficit of a massive $73.4 billion. This would exceed even the $67.9 billion deficit of the previous five years (1988-92), much of which was attributable to the extraordinary costs incurred as result of the Gulf War. The IMF projections were based on certain assumptions regarding world oil markets, including the maintenance of the UN embargo on Iraqi oil and a moderate recovery in oil output in the former Soviet Union. Based on these and other assumptions, the IMF mission projected that Saudi oil production would expand by about 500,000 barrels per day over the course of the five-year period, and Saudi Arabia's annual oil export revenues would rise moderately from $42.3 billion in 1993 to $46.7 billion in 1997. (The mission assumed that foreign aid would be a very modest $1 billion per annum.) In addition to current account deficits, the IMF team also estimated a rise in the annual budget deficit from $6.1 billion in 1993 to $10.9 billion in 1997. Additional loans taken to cover the deficits would then increase the total outstanding public debt from $66.9 billion (56.2 percent of GDP) in 1992 to $108.1 billion (77.5 percent of GDP) in 1997. Annual interest payments on the debt would rise from $4.8 billion (7.3 percent of total government expenditures) in 1992 to $7.5 billion (11.8 percent of government spending) in 1997. These figures do not include repayment of principal on the loans. In short, the IMF mission forecasts a progressive deterioration of Saudi finances. If the last decade was bad, the next five years will be worse.

In theory, there are at least two ways for the Saudis to eliminate or at least substantially reduce current and future deficits: they can raise revenues to far higher levels, cut back sharply on expenditures, or both. Given past experience and present trends, however, neither option looks likely.

As noted, despite heavy public investment in economic diversification focusing mainly on industry and agriculture, Saudi dependence on oil revenues has actually increased, contrary to plans. Industry and agriculture received huge government subsidies in the expectation that they would substantially increase import substitutes and non-oil exports, thereby diminishing the country's dependence on oil exports. In reality, commodity imports (not including arms purchases abroad) rose from $17.1 billion in 1986 to $29.8 billion in 1992; this includes agricultural imports, which rose from $3.2 billion in 1986 to $3.8 billion in 1991. In the future, the above-mentioned IMF report projected that total Saudi commodity imports will continue to grow, reaching $37.6 billion in 1997. Non oil exports-mainly petrochemicals-were stagnant between 1988 and 1991 at somewhat over $4 billion per annum and then dropped to $3 billion in 1992, mainly as a result of lower prices. The IMF report projects a modest rise in non-oil exports to $5.6 billion in 1997.

In short, the IMF mission is skeptical of the overall efficacy of the diversification goals. It projects that non-oil exports will rise by less than $2 billion by 1997, while commodity imports will expand by almost $8 billion during the same period. The dependence on oil export revenues will increase father than diminish. Saudi Arabia is unlikely to offset deficits with increased income from non-oil related sectors and, if anything, deficits will grow and reliance on oil will be greater than ever.

If revenues will not increase, Saudi Arabia has the option of cutting spending. But the system of subsidies is so embedded in Saudi society and the economy that substantial decreases in government spending are highly improbable.

The real dimensions of subsidization are hard to measure since most are disguised or indirect; many are not explicitly called subsidies in the budget or are off-budget altogether. Direct cash subsidies, such as payments for crops to farmers, can often reach multiples of international prices. The most extreme case is the payment to wheat farmers, where the government buys the crop at multiples of the world price and then exports huge surpluses at low international prices. It has been estimated that if the government had reduced wheat production to the level of domestic consumption it could have saved $2 billion in 1991.

Cash payments to utilities (electricity, gas, and water) cover operating losses incurred because the government orders the companies to sell electric power at a fraction of the costs of production. Water for agriculture accounts for 80 percent of total consumption and is provided free of charge, while residential and industrial consumers are charged rates far below costs of production. As a result of these policies, water and electric power consumption continues to rise rapidly, requiring further investment in additional power and desalination plants. A report issued in 1993 noted that very low prices for electricity have "eroded any incentive for Saudi householders and businesses to economize." The annual growth in consumption has been 10 percent in recent years, implying a doubling of demand in about seven years. The report noted that demand is "perilously close to capacity" and that additional power capacity needed by the year 2000 will require investment of $12.5 billion. Similarly, the government is investing heavily in water projects in order to avert future shortages. These shortages are a direct consequence of government pricing policies and heavy subsidization.

The Saudi government also orders the state-owned oil company to sell refined oil products at prices far below international levels. This includes sales to consumers (such as gasoline) and to industrial users. Oil-related subsidies do not appear in the budget. In effect, they reduce the profits of the state-owned oil company, and thereby reduce the transfer of profits to the Saudi treasury. In addition to these direct subsidies, many housing, industry, and agriculture loans with zero or nominal interest rates also do not appear in the budget. Farmers also receive a wide range of other subsidies, such as imported agricultural machinery, irrigation equipment, fertilizers, seeds, feed, and other inputs at 30-50 percent below their cost. Industries likewise enjoy a wide range of subsidies in addition to power and water at very low rates, and loans at nominal rates of interest.

All these subsidies are in addition to free health care, education, and other services provided to all Saudi nationals. Those who pursue higher education abroad, or require health services abroad, receive generous grants. The government also subsidizes telephone services, the national airline, and other consumer services.

In short, government subsidies are massive. One scholar estimated that the collective cost of all subsidies, including those not specified in official budgets, rose dramatically from 2.4 percent of GDP in 1975 to 36.1 percent in 1984; as a percentage of oil revenues, subsidies rose from 4.3 percent to 68.4 percent, and as a percentage of total government spending, from 4.7 percent to 71.8 percent in the same period.

CAN THE GOVERNMENT CURTAIL SUBSIDIES?

There were significant cutbacks in government spending when deficits began to emerge in the early 1980s, but these cuts were largely in the projects budget, i.e., mainly infrastructure spending which mostly affected foreign contractors and foreign workers. Foreign aid was also sharply curtailed, at least prior to the Gulf War. However, the wide range of subsidies and other current expenditures was hardly touched.

There are no official explanations as to why the Saudi leadership has refrained from cutting subsidies or imposing taxes, but the answer seems clear. It has been suggested that curtailing subsidies, which would require raising prices or imposing taxes, "may undermine the unwritten social contract between the royal family and the people, in which a portion of the kingdom's substantial wealth is distributed in return for acceptance of rule by the House of Saud. Government subsidies are not unique to Saudi Arabia. Indeed, they are quite common in both developed and less developed countries, and all governments find it extremely difficult politically to curtail subsidies. But the magnitude of Saudi subsidies is unique, and despite its autocratic form of government, the kingdom's rulers are in no position to threaten their own status by severing the economic bond that ensures acquiescence to their rule. According to Askari:

Subsidies once disbursed by the government, are difficult, if not impossible, to terminate. The population at large gets used to receiving government handouts, and important constituencies develop around individual subsidies and fight against [their] removal. In Saudi Arabia, this phenomenon is more entrenched than in other countries. Subsidies are all pervasive; they are large in magnitude and have a great impact on the daily life of the average Saudi. Subsidies are in part maintained to promote social stability.2

The "important constituencies" refer to royal princes and other "influentials." Leading members of the royal family are the principal beneficiaries of the munificent agricultural subsidies. When the above-mentioned IMF mission recommended to Saudi officials that subsidies should be curtailed, the latter responded that political and social considerations precluded a reduction in subsidies or increases in fees and charges.

The Gulf War and its aftermath underscore how powerful internal political and social impediments are to curtailing subsidies and/or imposing taxes. Despite the impending danger of an Iraqi invasion and the necessity to spend huge sums to defend the country, the government fully maintained subsidies and imposed no taxes. Indeed, a year after the war, in March 1992, the king even announced subsidy increases in the form of price cuts on gasoline, natural gas, electricity, and water. Charges on domestic telephone calls were eliminated and various business charges were reduced. King Fahd said that these measures were taken to "ease the burden of the cost of living on the citizens. The new rates imply an even larger subsidy. The deputy minister of finance estimated that the additional subsidies announced by the king would add $1.3 billion annually to budgetary expenditures, not including the extra expense involved in meeting additional demand created by the subsidies.

UNEMPLOYMENT: OVERT AND DISGUISED

Another aspect of government spending that is similar to subsidies is the policy of excessive hiring in the public sector. During the 1970s and 1980s, there was an implicit understanding between rulers and ruled that virtually all university (and even many high school) graduates would be given jobs in the public sector if they wanted them. According to official estimates, government employment rose rapidly from 469,000 in 1985 to 625,000 in 1990, an increase of 33 percent. These figures do not include the military and internal security forces, which have doubled in number since the Gulf War. In 1989, it was estimated that about 550,000 university and high school graduates would be seeking jobs during the first half of the 1990s. In 1989, the U.S. embassy in Riyadh reported that unemployment is emerging as a serious problem," in particular for university and high school graduates. They "have expectations based on [the) boom years, not present realities," the report stated. Although the government turned to the private sector to help the employment problem, this did not prove to be a solution. Only 10 percent of employed Saudi nationals are in the private sector, which generally prefers well-trained foreigners.

In January 1990, the king announced openings in 20,000 additional government jobs, not including positions in the armed forces. These "make-work" jobs are not classified as subsidies, but their impact is similar, insofar as they place an additional long term strain on the budget and, for social and political reasons, are difficult to terminate or curtail. However, it does appear that budgetary constraints have begun to restrict the number of new workers hired by the state, and, as a consequence, unemployment has begun to shoot upward in the 1990s. According to one unofficial estimate published in 1993, the unemployment rate among graduates has climbed to the dangerously high level of 25 percent.

CORRUPTION, WASTE, AND INEFFICIENCY

During the 1980s, labor productivity was decidedly negative: total employment rose far more rapidly than non-oil GDP. Much of this inefficiency stems from the bloated bureaucracy, but those segments of the private sector that benefited from generous government handouts also had little incentive to improve efficiency.

Between the mid-1970s and mid-1980s, the government spent massively on infrastructure, much of which has since been underutilized. Aside from the large waste of resources, this infrastructure requires continuing large outlays on operations and maintenance. But since the emergence of budget deficits, the government has tried to cut costs by unwisely reducing the quality of maintenance. This policy is counterproductive. Between 1986 and 1992, annual budget outlays on operations and maintenance fluctuated in a narrow range of about $6 billion, despite the fact that the infrastructure was expanding as new projects were being completed. According to the projections of the IMF mission, these expenditures will rise to $8 billion in 1997.

Another systemic problem in the Saudi economy is corruption, for which there is obviously no verifiable data. Anecdotal evidence, however, is overwhelming. In this context, of course, the term "corruption" is used in its Western sense, because in Saudi Arabia these payments may be entirely legal. A 1987 survey by Fortune listed King Fahd as the second richest person in the world (following the ruler of Brunei) with an estimated personal fortune of $20 billion. In addition, there are thousands of princes and their numerous retainers who, reputable media report, "rake off 30 percent commissions" for arranging business transactions on behalf of foreign companies seeking contracts with the government. By law and custom, foreign businessmen must have a local sponsor, often a member of the royal family, in order to do business with an official body. It has also been reported that an undisclosed share of the profits from Saudi crude oil exports is reserved for the private accounts of members of the royal family. In the oil industry this is referred to as "princely crude. The princes also have other sources of income from various business ventures in which they exploit their influence to obtain franchises and favorable treatment. The kingdom's huge military expenditures are another lucrative source of income for some princes and high-ranking officers. There is good reason to believe that some of the contracts for military equipment, or at least their scope, were influenced by the incentive for individual profit.

In 1987, the Saudi central bank drew up a debtors' blacklist of those who had defaulted on loans to the commercial banks, which completely avoided mention of the royal family. Evidently, Saudi banks are forced to lend to members of the Al Saud. In 1993, it was reported that banks held billions of dollars in uncollected loans made to members of the ruling family. An unnamed Saudi banker explained that banks had no choice but to respect the wishes of an absolute monarch.

In addition to the princes, there are others with considerable influence who benefit from these practices. The Petroleum Economist quoted unnamed Middle East analysts who believed that $10 billion disappears annually from "kickbacks and skimming. Obviously this figure is an estimate, but even if only half true, it constitutes a considerable drain on the state treasury. It is ironic but telling that one of the few areas of growth in recent years has been palace construction on behalf of the extended royal family.

In an article entitled "As If There Was No Tomorrow," The Middle East noted that the Saudi budget for 1993

... fail [ed] to address the issue of relentless annual deficits.... Deriving income from any form of taxation is simply unthinkable; the increase in subsidies [in the 1993 budget] ... indicates that the government is moving in precisely the opposite direction to making demands on the public. The kingdom may have a voracious appetite for weapons but certainly cannot digest all the material it buys. As the Kuwait crisis demonstrated . . . when the Kingdom's security is called into question, it promptly turns to the U.S. But the Saudi armed forces are a symbol of national pride and not likely to be asked to go short.... Spending on education, health and social welfare will rise inexorably in the coming years . . . [since] population is growing by over 3 percent ... per annum. . . . An ever larger proportion of government resources will have to be devoted to servicing the growing official debt. It will be far from easy to break out of the self-perpetuating circle. Uncomfortable choices will have to be made at some stage. The alarming thing is that the government seems to display no interest in tackling the issue.

Since the government cannot control expenditures, its "policy" is to hope for an upturn in oil revenues.2 This, however, is wishful thinking and poor governmental planning. The growing financial problems of Saudi Arabia and so many other oil-exporting states implies that they will make every effort to expand productive capacity and increase oil exports. At the same time, due to conservation, environmental concerns, a shift toward natural gas, and other factors, demand will continue to be sluggish. The inevitable result is lower prices. In addition, there are two major factors on the horizon that will depress oil prices even furtherIraq's eventual return to the export market and the probable turnaround in production from the former Soviet Union.