The path of privatization and diversification is the cornerstone of Oman’s economic strategy. From successfully implementing several infrastructure projects, the country is enjoying increased attention from investors and benefiting from high foreign direct investment (FDI) inflows, which, according to Global Investment House, rose from $122.3 million in 2002 to an estimated $705.3 million in 2006.

Increased returns from non-oil activities showed not only the health of the country’s business environment, but also the success of its diversification policy, which began as a hedge against over-dependence on Oman’s natural resource endowments. However, the country’s budget continues to benefit from oil revenues, encouraging public spending, which does not appear to pose a threat to price stability.

Inflation registered smaller than its Gulf neighbors at about 3.2% in 2006. The figure partly reflects “the effects of high growth in the face of capacity constraints, in addition to the sustained influence of imported inflation as a result of the pegged system that the central bank has adopted to the domestic currency,” according Global Investment House.

Inflation is not worrisome

The Gulf trend of imported inflation from currency pegs to the dollar is not unique to Oman, but the government does not seem worried. According to the Oman Daily Observer, Executive President of the Central Bank of Oman Hamoud Sangour al-Zadjali said, “As long as the Omani rial is concerned, there is no plan to change the pegging.”

Leading the drive away from oil dependence is diversification aimed at developing the country’s natural gas reserves. The growth strategy of exporting liquefied natural gas (LNG) and implementation of LNG projects have made the sector the main economic driver with a growth rate of 60.7%, according to Global Investment House.

One LNG plan is by British Petroleum (BP), which successfully bid to develop two large natural gas fields in Central Oman. According to the Oman Daily Observer, BP plans to develop two gas fields in a 2,500 km area close to the existing gas field of Saih Nihayda as part of a government strategy to enhance gas production with the help of multinational firms.

After its gas sector, Oman is witnessing growth in the services sector, which reported a rise of 11.7% in 2006, from 8.5% growth in 2005. Most of the growth in services is led by communication and transport infrastructure growth, which grew by 25.4% in 2006, up from 3.4% in 2005.

oman is witnessing growth in the services

sector, which is reported a rise of 11.7% in 2006

The Sultanate’s banking sector also performed tremendously well. According to Global Investment House, Omani banking sector soundness “was reflected in their strong capital levels, further improvement in asset quality in the face of large expansion in banking assets, and remarkable growth in profits.”

In addition to increased banking performance, Oman’s financial sector remains healthy, despite the downward trend of financial markets in the Gulf. The benchmark Muscat Securities Market (MSM) Index ended 2006 at a yearly gain of 14.5%. MSM’s other figures include a market capitalization in 2006 of $16.19 billion and trading volume growth of 115.9%.

Diversification initiatives

Other diversification plans in the works include the construction of a large sugar refinery at the port of Sohar. According to Oxford Business Group (OBG), Al-Hafri Sugar Refinery signed agreements for constructing a $233 million facility to handle 660,000 tons annually. Al-Hafri’s strategy is aimed at harnessing the strong potential for regional growth, which is estimated at the 5 million tons of sugar gap produced by the shortfall between demand and supply in the Gulf.

Because of Oman’s fiscal health and prospects for industrial sector growth, Standard & Poor’s (S&P) gave Oman a stable rating of “A” on sovereign risk, currency risk, banking sector risk, and economic structure risk.

Research conducted by Jordan Investment Trust also finds Oman in a good situation, noting “Oman is geared up for local and foreign investments after the execution of several infrastructure projects, including the construction of road, water, energy, and communications networks. The economic and political stability the country enjoys and its invest-friendly environment are also value added for investors.”

Endowed with natural resources, including an abundance of liquefied natural gas (LNG), Qatar is witnessing an economic boom supported by the rising price of petroleum products. In recent years, the small state has used its petro-earned surplus to jumpstart a slew of development projects aimed at diversification. Focusing on education, entertainment, finance, etc., Qatar is revamping opportunities for its citizens through several long-term projects. The evidence of Qatari government spending is found in the country’s expanding budget, which rose from $7.42 billion in 2004 to $13.75 billion in 2006.

There seems to be no end in sight for the wealthy nation. An outlook by Global Investment House expects Qatar to “record a strong trade surplus in 2007 as volumes of LNG and oil exports are likely to increase due to the expected increase in production.” The growing energy appetite of developing economies, in particular China, is likely to support Qatar’s mainstay industry in the medium term. Qatar’s gas development strategy will make the country “the world’s biggest exporter of liquefied natural gas,” according to Global Investment House, estimating an expansion of Qatari LNG production to 77 million tons by 2012 from around 25 million tons in 2006.

Yet not all news is positive for Qatar, as the country is battling against inflation and the currency’s peg to the dollar. Strong, double-digit growth in the money supply has increased consumption and inflation.

The banking sector

Large banks continue to control the country’s credit facilities and are led by Qatar National Bank (QNB), which tops the banking system with 39.1% of total assets and 43.2% of total deposits, in addition to a 43.3% market share of net loans and advances. New banks, including the Islamic-oriented Al-Rayan Bank and the more conventional Gulf Commercial Bank recently entered the market. The Qatari government is encouraging foreign attraction to the country’s banking sector by permitting joint venture projects with foreign participation, as long as Qatari partners own 51% of capital.

Liberalizing the telecom sector

Another industry set to liberalize is Qatar’s telecom sector, which has seen steep market penetration, recording 104% in 2006, up from 85% in 2005. Although Qtel (Qatar Telecom) currently has a monopoly over competition, moves by the government are underway to attract a second operator to the market. A report by Oxford Business Group (OBG) stated that “even though Qatar is currently one of the most saturated mobile phone markets in the world…there is still potential for a new operator to dial in to the lucrative market.”

While much of Qatar’s economy is continuing the trend of strong growth, the country’s financial sector, like most others in the region, reported downward trends, including loss in market capitalization for several stock markets. Nonetheless, encouraging signs are pointing to an up-tick in the near future, with development and infrastructure projects likely to have a spillover effect on other sectors. In addition, mergers and acquisitions activity is growing for Qatar. The OBG reported that while “it is widely agreed that M&A will not continue to enjoy the same boom witnessed in recent years [by most Gulf states], this is far from the case in Qatar, where large-scale investments outside the country are expected to remain very high.” The report attributes the positive outlook to high growth in government revenue and gross domestic product (GDP) from a rising oil price.

Foreign M&A activity by Qatar has the added benefit of creating a hedge against the dollar, to which the nation’s riyal is pegged. Concurrent with the dollar, Qatar’s currency is weakening against other major currencies and increasing the cost of imports. Many analysts agree the peg is also to blame for the nation’s inflationary pressures, as monetary policy, including interest rate policy, takes its lead from moves by the US Federal Reserve.

Combating inflation, managing extreme growth, and dealing with the dollar-peg are the challenges Qatar will continue to face in the medium term, yet the overall economic outlook for Qatar’s economy is likely to remain bright.

Bahrain follows the trend of other Gulf countries, including strong economic growth, worrisome inflation, and a vision towards economic diversification to non-oil sectors. The strength of Bahrain’s economy comes from continued price increases of oil. Price rises in the commodity brought the government’s budget from the red in 2005, at a deficit of $556.3 million, to a surplus of $686 million. Rigorous diversification efforts have lowered Bahrain’s dependence on oil, relative to other GCC economies, but oil price rises have blurred the contributions of non-oil sectors to the economy.

In addition to oil production, Bahrain plans to maintain its place as a regional refiner of crude oil. According to the Oxford Business Group (OBG), “currently, Bahrain’s sole refinery has a capacity to process 250,000 barrels per day (BPD), though less than 20% of this comes from the kingdom’s own fields, with the vast majority of crude coming from nearby Saudi Arabia through a single 54 km long pipeline.” Current projects aimed at expanding storage capacity and oil infrastructure carry an estimated value of $1.2 billion

the third largest contributor to gdp is the manufacturing sector which contributed 13%

Regional banking hub

After the oil and gas sector, the highest contributor to the country’s GDP is the banking and financial institution sector. The country is growing as a regional hub for banks wanting to tap into Middle Eastern markets, according to a report by Global Investment House. Total banking system assets grew by 26.1% from 2002 to 2006. Net foreign assets of the banking system increased 9.1% from 2005, to remain at $6.41 billion by the end of 2006.

According to Arab Press Digest, a group of businessman and companies from GCC countries plan to establish an international Islamic bank with $2 billion in initial capital. The new bank, United Islamic International Bank, will be one of the largest in the Gulf.

The third largest contributor to GDP is the manufacturing sector, which contributed 13% to the country’s GDP in 2005, from a contribution of 10.6% in 2004. Global Investment House uses this as evidence that diversification efforts are “bearing fruits.”

Building infrastructure

Much of the government’s diversification effort has focused not only on directly building up non-oil industries, but facilitating growth in the sectors through infrastructure improvement efforts, most of which were implemented with the intent to strengthen the country’s manufacturing and service sector base. Bahrain’s fiscal prudence has led to Standard & Poor’s (S&P) upgrade of Bahrain’s foreign currency debt rating to “A” from the lower level of “A-”, according to Bahrain Tribune.

The Arab Press Digest also reported that Bahrain has no plans to revalue their currencies relative to the dollar, even though other GCC economies are citing the need to form a common currency union among themselves. Bahrain’s neighbors cite two main harms of a dollar peg, including the loss of sovereignty over monetary policies as Gulf central banks follow the lead of the US in setting interest rates in addition to inflation, which is partially attributed to the peg and the increasingly feeble dollar.

According to Global Investment House, foreign companies are attracted to Bahrain for its “geographic environment, well-regulated authorities and low cost factor in setting up operations.” The group’s report maintains a positive outlook and notes Bahrain’s main challenges as continued diversification efforts into more labor intensive activities and further easing of the economy’s dependence on oil.

Partially-soiled by a report from Transparency International suggesting a rise in Bahrain’s corruption, the Sultanate responded quickly to allegations of corruption, according to the OBG, which reported that “Crown Prince Sheikh al-Khalifa declared at the beginning of October that the fight against corruption had to be made a priority and that no one, not even government ministers, would be spared if implicated in malpractice.”

Continued adherence to transparency, and a will to improve industries and attract foreign investors will support Bahrain’s efforts to maintain strong economic performance.

Barring an unprecedented and wholly non-expectable immense natural catastrophe and the slightly greater probabilities of another Middle East war or massive occurrences of domestic or imported terrorism, the outlook for Saudi Arabia’s development in 2008 is for another year of very significant growth. 

It is an absolute no-brainer that a country that derives about half of its GDP and four-fifths of its government revenues from oil and is the world’s leading producer of the commodity will thrive at a time when the barrel sells at close to double what this country needs for its fiscal sustenance — and the oil price outlook for the next few years is for no drop below this break-even point.

Tasks for 2008

That is not to say that Saudi Arabia won’t see a surge in challenges, which in the next 12 months could expand beyond the habitual challenges of properly managing oil production, diversifying the economy and creating employment to meet the needs of the kingdom’s young populace. Tasks which the Saudi decision makers will have to succeed in are: Making good on regulatory improvements, opening the enigmatic market, and controlling the dollar trap. The investment buzz words include petrochemicals, railroads, utilities, telecommunications, industrial cities, general construction, tourism, and education; add question marks under the headers environment, Saudization, regional politics, and international reputation.

In the second year after the kingdom’s accession to the World Trade Organization, Saudi Arabia got an exceedingly positive grade from the World Bank Group’s lectern in the master class on the right way of conducting business on the global playing field. According to the Doing Business 2008 score card by World Bank and International Finance Corporation, Saudi Arabia was among the world’s top 10 achievers for improvements of their business climate in 2007 and now is one of the 25 countries with the most business-friendly regulations on issues such as starting and operating an enterprise, trade and taxation, dispute settlements, and also the ease of winding down a business.   

Reforms cited by the World Bank and IFC as reasons for the improvement in the Saudi business climate included a reduction in the time for setting up a business to 15 days from 39 days, the establishment of a credit bureau for the commercial sector, abolition of a minimum capital requirement as multiple of per-capita GDP, and improvements in import/export procedures.

Saudi Arabia has initiated or announced further reform steps including plans to professionalize and partly privatize its stock market and revamp its index structures. In longer term moves, King Abdullah also recently took forward reforms of the judiciary and stipulated important details of the kingdom’s new succession planning procedures.  

The innovations and reforms notwithstanding, the existential wheels of the Saudi economy are the same that they were in 1998 when then Crown Prince Abdullah made the first bold public statements on the kingdom’s need to diversify away from oil dependency.

The two main wheels in the national assets chamber are hydrocarbons and population growth. However, where these wheels had been spinning in a rather contradictory motion in the last phase of the 20th century under conditions of slow oil revenues and high population growth, the increased speed of the oil wheel in the past seven years has reversed the deficit tendency of the kingdom’s finances and is advancing the probability of turning Saudi Arabia’s domestic labor pool into the long-term resource that it ought to be instead of a cost factor weighing heavy on fiscal situation. The success of this economic sea change will depend on the success of the education and economic reform steps that are ranked top on the current Saudi agenda. 

Shrinking debt burden

The magnitude of the virtuous collaboration of the two economic wheels in Saudi Arabia emerges in the correlation of revenues and education investments. In 1999, national debt had climbed to 115% of GDP because of the high social costs (and a few military expenditures) that had burdened the coffers in the period of low oil prices which hit bottom in the $15 range in 1998.

As the oil price picked up in the new millennium, the kingdom could reduce its debt to 28% of GDP by the start of 2007 while boosting budget allocations to education and qualification measures. For the two years of 2006 and 2007, the total funding allocated to human resources development reached $49 billion and a flood of new schools and colleges was devised.

Whereas the forecast for total nominal GDP and oil revenues anticipates a slight contraction in the year totals for 2007, the debt burden is expected to shrink further to less than 25% of GDP. Real GDP growth is expected at 3.6% to 3.8% for 2007 with an improvement to possibly 5.8% in 2008. Non-oil GDP increases of up to 7% have been forecasted for 2007 and 2008. Inflation pressures are expected to increase from around 3.5% in 2007 to 4% or more in 2008 but will be less than in other GCC countries.

However, perception of the kingdom’s socioeconomic outlook would be seriously distorted if one reviews solely capacity developments on the production side of oil and petrochemicals or industrial goods. Population matters are the country’s real story. The demographics of Saudi Arabia forecast a net population gain of 4.5 million people between 2007 and 2015.

With a projected 29.3 million inhabitants by 2015, the country’s population increase and total labor force will be considerably less than the respective increases and totals in Turkey and Egypt, not to mention Pakistan and India across the Gulf which will add 27 and 143 million persons to their population bases in the next seven years. 

At the same time, Saudi Arabia’s demographic rise in the oil age signifies a nine time multiplying of the population between the baseline year 1950 and 2015, a ratio that exceeds the growth rates in most other countries. With so much increase concentrated in a short period and given the national circumstances of high energy needs due to climate conditions and shortages of easily available fresh water, it becomes very clear why Saudi Arabia is bound to face challenges on its socioeconomic path in the next two decades.

Growing importance

Seeing these factors on one hand and the cultural parameters of an expansion-oriented religious mindset on the other, the role of Saudi Arabia is one of a medium to long-term player destined to seek a position of strength and growing civilizational, economic, and technological importance in the Middle East and Western Asia.

On the short-term horizon, the performance of the Saudi economy in 2007/2008 is based on corporate earnings that improved in the second half of 2007 and are expected to be strong in 2008, on robust consumer confidence that will be reflected in spending growth for 2007, albeit at a lesser rate than in the record retail spending growth year of 2006, and on the continued course of expansionary government spending on infrastructure, industrial, and social investments. 

The reinvestments of Saudi wealth at present and in the coming years are staggered at a volume of $350 billion in oil and gas, petrochemicals, water and power, industry, and construction. Construction of six new economic cities is targeted with a price expectation in the range of $100 billion, which almost looks understated considering the scope of the planned urban realms and the creation of jobs for more than a million people.

Putting the number of jobs under development into perspective, Saudi statistics said the country’s private sector workforce was around 5.5 million persons in 2005. But almost 90% of the labor force are foreigners while the current unemployment rates of nationals in the kingdom (officially 6.9% in 2005 with an increase to over 9% in 2006) are surprisingly high for a country in the middle of a boom cycle which moreover has been pursuing its avowed Saudization campaign for preferential employment of citizens for at least a decade. 

At the junction of 2007 and 2008, the Saudi Stock Exchange is a good proposition for playing catch-up with the bourses of the other member countries in the Cooperation Council of Arab Countries in the Gulf. Although the sentiment among regional analysts has been for the greater part of 2007 that the correction phase of Arab emerging bourses was winding down, the Tadawul Index stayed sluggish for most of the year and on some mid-October days was a tad negative when compared with the start of the year. Retail investors who had been burned worse than most neighbors in the correction of 2006 were slower than these neighbors in returning to the stock game. The SSE started what could become a local bull march in November of 2007, though, and valuations suggested in November that the SSE has some of the Gulf’s most attractive price plays to offer. 

The sub-sectors with the strongest gains to the end of November were insurance — an outlier in more than one way as the sector supplied a big chunk of the year’s primary market action and the newly listed companies started trading on a wave of speculative interest from retail investors — followed by agriculture and industrial stocks. Banking, cement, and telecom values on the other hand are regarded by a number of analysts as sectors where 2008 could see quite good gains.

To keep the dollar peg or not

A fashionable debate in the third and fourth quarters of 2007 is the dollar peg of the riyal and other GCC currencies. Will Saudi Arabia revalue the riyal, or perhaps switch its peg from the dollar to a currency basket? One aspect of this issue is the plan for a GCC economic and monetary union, which has been put on the agenda for 2010.

The balance of currencies is important for a monetary union and the EU’s pioneering acts in building the euro zone have shown an example of firmly aligning currencies in preparation for the step — but it is not unperceivable that the union could come even if some central banks take a slow step away from the dollar peg. However, the while the GCC union is still verbally on the table, the indications of actual implementation on the 2010 timeline are rather weak and ahead of a GCC meeting in Qatar in early December 2007, the political, institutional, and other nation-level obstacles to the step seemed larger than the currency issue.   

The second specter raised in conjunction with the dollar peg is that of imported inflation and self-coercion into following the Federal Reserve’s monetary policies. Analysts have taken differing views in this debate: some regional investment researchers, such as EFG-Hermes, reasoned that prioritizing of domestic concerns in determining of interest rates will be likely to change the Saudi approach away from following the Fed and eventually could lead to increased currency flexibility in the medium term; by contrast, analyst views from inside the Saudi economy seem to be leaning toward continuity of the monetary status quo that has served the kingdom for 21 years. The SABB financial group wrote in its fourth quarter economic report for 2007, “we continue to believe firmly that the Saudi riyal is not going to be revalued.”

Beyond the monetary issues, Saudi Arabia faces a definite need to assert its role as economic value producer and viable business location on the international map. This is where the improvements in the regulations for foreign direct investments and economic participation of non-citizens are crucial. The political perception of Saudi Arabia in Western populations is marred by negative image factors on women’s and human rights, perceived shortfalls in tolerance and individual freedoms, and, in general terms, substantial cultural distance.  

In the past, the cultural distance to developed countries stayed in place while the economic interaction happened in the oil sector through trade and joint ventures with a few corporate partners. Intensification of trade ties and funds flows has occurred on all levels in 2007 from outgoing remittances by foreign workers and heightened investments in global petrochemicals in Europe, the Far East, and the US through the state-backed petrochemicals giant SABIC which expanded its existing international operations and bought GE Plastics n a strategic move. In parallel, the Saudi aim is to attract foreign direct investments into the kingdom at a much greater rate — talk is of luring in $80 billion within 10 or 20 years.

Business leaders with experience in Saudi Arabia advise patience in expecting the implementation of reforms and changes. It would be naïve and dangerous to assume that the kingdom would shape shift into a society molded after the wishes of its economic partners in the developed countries. The question is if the reform impetus will be sufficiently strong to change the hermetic Saudi economy of the past into a hermeneutic state exemplary of a third millennium Islamic national identity and of the new Arab role in the global community. 

From the side of Saudi interests, it is clear that this fortuitous ratio of oil revenues and current account surpluses will not stay as strong as it can be expected for the seven years starting in 2002 and lasting into 2008 or a perhaps a little more. The global economy will not stay on a broad expansion course forever, and the country wants to be ready when the oil price cycle swings again.