Moving Beyond Oil

Newsweek International 2005-06-27 23:03:20Saudi Arabia is still widely seen as the classic oil state, with all the dysfunction that label implies. So it may come as a surprise that today it flourishes mostly outside the oil patch. In 2005, non-oil activity should grow by 6 percent, three times faster than the oil industry and its fastest clip in more than two decades, estimates the Samba Financial Group. Brad Bourland, Samba's American-born chief economist, says that the real excitement in Saudi Arabia today "has nothing to do with oil." Since the late 1990s, Crown Prince Abdullah has been trying to reduce Saudi reliance on oil wealth. The result: construction and real-estate markets are booming, thanks to a move five years ago to allow foreign ownership of property. A revised banking law and low interest rates have energized the financial sector, and new lending last year matched oil revenue as a driver of money-supply growth. Since 1999, the non-oil sector has expanded far more steadily and strongly than the oil industry (graph). "Five years ago the Saudis realized they had reached a point where they needed to make the leap beyond brick-and-mortar development" and to wean themselves off oil, says a Western diplomat with years of experience in the kingdom. "At the time I was not confident they would do it. And now five years later they have made numerous steps in the right direction." An aggressive privatization program has driven up Saudi share prices by 520 percent since 1999, an indicator that is by definition a measure of confidence in Saudi's non-oil sector, because the state oil company, Saudi Aramco, is not publicly traded. Last year the telecommunications, manufacturing and construction sectors powered the non-oil sector's expansion of 5.7 percent, and also accounted for some of the hottest IPOs. The sale in recent months of shares in such state-owned giants as Saudi Telecommunications Co. and insurance provider NCCI have provoked so much interest that scuffles among punters have erupted in banking halls, where stocks are purchased. The boom has been remarkably Saudicentric, so far. Past periods of expansion were wholly petroleum-led and powered by multinationals. But after the 2003 bombing of an expatriate compound in Riyadh, the foreign business community all but vacated the kingdom. British Airways, which once did a lucrative trade on its London-to-Riyadh route, recently ended the service due to lack of customers. Because the Stock Exchange is not widely open to foreigners, nearly all of the new money in the market comes from Saudis, including billions that have been repatriated from the United States since 9/11. That explains why the rise of Saudi Arabia as a non-oil economy has only recently begun to attract international notice. Yet nothing could be more important to the kingdom's battle with extremists than creating an economy that is not dependent on and distorted by oil. After 9/11, it was widely noted that one possible source of the anger feeding Saudi extremists was the dramatic decline in per capita GDP, which had fallen by two thirds since the 1970s, due to the drop in real oil prices and one of the fastest population-growth rates in The World (currently about 3.5 percent). Today there is no question that the spike in oil prices since 2002 has accelerated economic growth, but the Saudi economy had been growing 4 to 5 percent since 1998, driven by the non-oil sector. The result was a marked rise in per capita GDP from $8,092 in 1999 to $9,574, the forecast for 2005. If prosperity is a decisive weapon against terror, the Saudis are gaining ground. Perhaps prompted by the emphasis U.S. President George W. Bush has placed on advancing democracy in the Middle East, international attention has focused on fledgling experiments with elections. Yet that's not what excites average Saudis. As the kingdom prepared for its first municipal balloting this March, Riyadh's Arab News reported with some dismay that while citizens showed little interest in registering to vote, they were lining up early and in droves for a first chance to buy shares in a state-owned bank. The dismay may be displaced. No vote will directly attack the high unemployment (officially 10 percent, but by some estimates much higher) that has created an idle pool of potential recruits for Al Qaeda. While the oil sector accounts for one third of the economy, and much of its recent growth, it employs relatively few people. The non-oil sector accounts for the remaining two thirds of the economy, and is its real long-term hope for growth and jobs, a point not lost on the crown prince. A Saudi official close to the monarchy says the acts of terror going back to 9/11 have "turbocharged" reform. Business is now charging ahead at companies like Advanced Electronics Co., which started out in the early 1990s as a partnership between the kingdom and the Pentagon, working mainly on military contracts. Since then the Saudi government has encouraged AEC to pursue private customers, and it now makes circuit boards and switching systems for companies like Loral and Lucent, as well as Saudi telecom and transport firms. Last year profits rose 300 percent, to $123 million. "We need local capabilities that go beyond oil," says Ghassan Al Shibl, AEC's president and chief operating officer. "The government is shifting the burden of growth on companies like us." The cornerstone of the government's diversification drive is a commitment to invest $30 billion by 2010 to make Saudi Arabia The World's leader in petrochemicals, like plastics and rubber. Unlike petroleum itself, these products are recession-resistant, and would help the kingdom weather cyclical slumps and attract "downstream" industries like tires and synthetic textiles. Over the last 12 months, the government has announced $8.7 billion in deals involving foreign companies in the Jubail industrial zone, home to The World's largest petrochemical complex. If the Saudi drive to diversify the economy is starting to pay off, however, its "Saudization" campaign-the effort to replace foreign workers with Saudis-is not. The kingdom of 26 million people still relies on 6 million expatriates, from blue-collar workers to computer engineers. Most young Saudis still prefer a secure government job and pension, but the bloated civil service is no longer hiring. In February, hundreds of thousands of college graduates answered a call for a handful of public-sector jobs. The government recently extended a filing deadline for taxi licenses because so few Saudis applied. The number of Saudis pursuing medical, engineering and teaching degrees continues to lag behind those studying languages, literature and religion, officials say. Changing the work culture will be as big a challenge as creating the jobs necessary to bring down unemployment. The regime hopes to transform all this with its most potent fiscal injection in years. After a period of belt tightening that cut government debt from 119 percent of GDP in 1999 to 66 per-cent last year, the 2005 budget calls for a public-spending program that some economists say amounts to the country's second modernization drive, after the hectic period of road- and bridge-building 30 years ago. It includes a mandate to train young Saudis through a network of vocational schools, as well as the multibillion-dollar stimulus for non-oil-related industries. Slowly, the good news is trickling out of the kingdom. The new budget allows for an unprecedented level of foreign investment, which at about $1 billion annually still amounts to a fraction of Saudi Arabia's $248 billion GDP. International banks including JP Morgan and Deutsche Bank have applied to set up branches in Riyadh. Increasingly, European and Asian firms are filling the vacuum left by U.S. rivals, who are still shying away from the country. After Dow Chemical abruptly withdrew from talks on a $4 billion petrochemical project in 2003, Japan's Sumitomo quickly took Dow's place. French companies have been particularly active in scouting openings in sectors like tourism and transport: a subsidiary of the French railway giant Societe Nationale des Chemins de Fer has expressed interest in a share of a planned rail system linking Riyadh and Jidda on the Red Sea to Jubail on the Persian Gulf coast. It is tempting to dismiss Saudi reform efforts as a mirage that will be swept away by windfall oil profits. Some Saudi analysts say the government is already backtracking on such initiatives as a more transparent budget process. Yet those who emphasize the conservative side of the monarchy ignore how dramatically Saudi Arabia has changed since it was established just 80 years ago, blossoming from an isolated desert kingdom into the largest economy in the Middle East. At the least, the monarchy has never been under more pressure to change, or shown more seriousness about moving beyond oil.