The welfare of a country and its position among other world nations is hugely determined by its economic policy. Saudi Arabia is one such country with a consistent and stable economy and is one of the most important international players. It is the largest oil exporter among the OPEC countries, its de facto leader, an influential player among the GCC countries and the most important partner of the USA in dealing with Middle East issues. In this essay, the economic policies and exchange rate policies of Saudi Arabia are discussed in detail. Also the foreign investments and operations of SABIC (Saudi Arabia Business Industries Corporation), one of the largest MNCs of Saudi is discussed.
Economic Policy Objectives – the Past and the Present. For thousands of years, subsistence farming had been the primary occupation of the people of Saudi Arabia. Due to the less productivity of agriculture, they adopted other activities like protection services for caravans and pilgrims and controlling small oases. Local craftsmen produced items that would cater to the needs of their neighbours as well as visiting pilgrims. International trade was unheard of until the colonial expansion of the Europeans began. Later Abduaziz, the first monarch of Saudi began the transformation of the economy by settling the nomads through the Ikhwan movement. Even then they struggled to become a self-sufficient economy.
The Oil Boom. The turning point in Saudi economy occurred when an American company discovered huge oil reserves in 1938. They established the Arabian American Oil Company (Aramco, now Saudi Aramco) and provided technical, financial and logical support and trained the Saudi workers in new skills. This opened up new opportunities for the kingdom. Even then, from 1948 to 1970 oil price per barrel increased from $0.22 to only $0.89. It was only after the 1973 oil crisis, when the OPEC nations proclaimed an embargo over oil production against the Western invasion of Israel, the price soared to $10 per barrel in 1974 and to $30 per barrel in 1982 (Saudi Arabia: A Country Study, Countrystudies.us). Between 1973 and 1980, the revenue to Saudi from oil increased from $4 billion to $102 billion. Petroleum sector now contributes to 90% of Saudi revenues. The following charts show Saudi oil production, export and crude oil price movement over the last century: (see fig. 1, fig. 2).
With the exponential increase in oil revenue, the dilemma arose as to whether the revenue should be invested back in oil or in other domestic sectors as well as to make international investments. In 1958, a planning agency was established in response to suggestions of the IMF (International Monetary Fund). In 1975, it was reorganised as the Ministry of Planning whose funding is controlled by the Ministry of Finance and National Economy. This Ministry has been formulating 5 year plans since 1970 to stabilise the Saudi economy.
Modernisation. By 1975, the government decided to start massive industrialisation using the country’s vast hydrocarbon resources. They also constructed huge airports, hospitals, schools, roads and ports. This industrialisation also opened up avenues for private and foreign investments. These investments from other advanced nations enabled them acquire modern technology as well. The economic planners decided that a separate subsidy programme would be necessary in education, health, agriculture and other social services. Only a technically sound workforce could take the new field of telecommunications to international standards. ICT (Information and Communications Technology) played a crucial role in the kingdom’s relationship with its international trading partners. However, the failure of the planners to foresee the oil price crash of the mid 80s, combined with the incessant subsidy programme eventually led to stagnation in the economy.
Crisis Management and Reforms. During 1986, the US dollar depreciated in value resulting in rapidly falling revenues for the Saudi government. This forced them to revisit their economic policy and make some fundamental changes in it. The government had to suspend the subsidies to private sector for capital spending temporarily. It raised the crude oil production capacity to 11 million barrels per day in 1995. Saudi Aramco purchased 50% of Star Enterprises in the US, a joint venture with Texaco and geographically expanded their investments. In order to revive the private sector growth, reforms in the financial sector became necessary. SAMA (Saudi Arabian Monetary Agency) was given more regulatory powers to prevent failures of private companies. SAMA ensured the banks complied with international capital adequacy requirements. They were encouraged to provide loans to private sector. Riyadh Stock Exchange was opened in 1990 for selling government assets.
The government also engaged in protectionist policies by imposing certain non tariff barriers such as preference for domestic commodities and local contractors. Selling of foreign financial products and services was barred in order to protect the national banks. Iraqi invasion of Kuwait made Saudi to increase its oil production to 8.5 million barrels per day to balance the oil shortage in the international market. The doubling of oil prices also helped the economy to some extent. To balance the depletion of private funds caused by Iraqi invasion, they engaged in external borrowing from commercial banks and export credit agencies.
Exchange Rate Policy. Exchange rate policy in Saudi is decided by SAMA which has the power to change interest rates (repo rate), bank lending principles and adjusting reserve ratios. The main objectives of the SAMA Charter are: stabilising the value of Saudi currency riyal, regulating the banking operations and forex dealers, issuing short and medium term government bonds for budgetary and balance of payment purposes (Al-Hamidy 301). Since most of the revenues are in dollars, Saudi links the riyal to dollar. It follows a fixed rate regime with the riyal value fixed at 3.75 per dollar since 1986 (Al-Hamidy 302). Riyal comes under pressure whenever oil prices fall or whenever oil exports decline. In such times SAMA balances the loss through forward market intervention. It enters into forward contracts with entities by either fixing future oil rates or the quantity of oil to be purchased.
Inflation is another important factor influencing exchange rates. Food and housing prices increase with increasing population creating a supply demand problem (Al-Hamidy 302). Such bottlenecks are addressed by subsidising essential commodities, thus improving the purchasing power of its people. Inflation targeting is not possible here as it has a fixed exchange rate. Moreover a supply crunch cannot be mitigated by trying to arrest inflation alone.
Impact of the Fixed Rate policy on Saudi Economy. The fixed rate policy is not without its drawbacks. When the dollar appreciates or when the oil price falls, this fixed rate makes it impossible for Saudi to realise the increased profits from its exports. Also whenever the US Fed reduces its interest rate, Saudi too had to cut its rate due to the dollar peg, though it had a rising inflation. When inflation is rising, a country is actually supposed to increase its interest rates. This deprives Saudi of foreign investments which would otherwise have been made in expectation of higher yield on a currency linked to the dollar. However de-linking the riyal from dollar can prove risky for Saudi because, it is also a big importer of goods like food items and other raw materials for its industries (Ellyatt, Cnbc.com).
Changes needed in Economic Policies. Saudi Arabian economy is relatively stable at present despite the global slump in oil prices. Hence the government should diversify its investments in order to absorb the sudden oil shocks. Job creation in the private sector needs to be improved to support the increasing working age population. It can peg its currency to a basket of currencies with a larger weightage to Euro instead of just the dollar as the world economy is not revolving around the US alone anymore. The National Transformation Programme unveiled recently seems to be promising most of the reforms needed to boost the Saudi economy in the current scenario. It envisages a $2 trillion Saudi sovereign wealth fund by adding its current assets, as well as the returns from selling Aramco shares, state owned real estate and industrial areas. Another important social change that can be effected is giving more economic independence to women, whose expertise and skills are yet to be properly tapped.
MNC in Saudi Arabia – SABIC. Saudi Arabia Basic Industries Corporation (SABIC) was founded in 1976. It is a diversified manufacturing company producing chemicals, industrial polymers, fertilizers and metals. Saudi government is 70% owner of SABIC. It is headquartered in Riyadh and has about 17 subsidiaries (Economic Essays, UkEssays.com). The products and production distribution of SABIC is depicted in the charts below: (see fig. 3, fig. 4).
Foreign Investments by SABIC. SABIC operates in more than 50 countries worldwide. It has factories, manufacturing sites, distribution offices, technology centre, application centres, corporation offices and storage units in China, Southeast Asia, Japan, India, South Korea and other areas of the world. SABIC also uses mergers and acquisitions to expand its global presence. In 2007, it acquired the Huntsman Corporation plants of the UK. SABIC Americas Inc. is a wholly owned US corporate subsidiary of SABIC. It acquired GE Plastics in 2007 and launched Innovative Plastics. SABIC also petrochemical production sites in Europe. It has also made shale gas investments in the US and also a $1 billion venture with China Petroleum and Chemical Corporation.
Foreign financing and reasons for using them. SABIC's success has made it a natural target for privatisation and foreign investment. Also Saudi needs significant foreign investments to offset a rapidly growing population and rising unemployment. So SABIC has entered into several joint ventures (JV) to bring technology, skills and development to Saudi Arabia.
Saudi banks account for a bulk of SABIC’s funding. However SABIC has secured loans from foreign institutions like GCC banks, Japanese, European and US banks (Kawach, Gulfnews.com). These funds are used for expansion purposes in other countries. In 1997, Sadaf a JV between SABIC and Shell Oil Company of the US launched a $1 billion expansion plan to boost the production capacity of its Jubail plant (Cordesman 496).
Successes and Failures due to foreign operations. The new plants of SABIC in China and Europe had been successful in attaining their full capacity since the day of their establishment. Also it expanded sales and services to African countries like South Africa and Morocco. Innovative Plastics has worked with global auto makers in developing innovative materials that by substituting for metals, offer designers greater scope for styling complex designs, improving fuel efficiency and substantial reduction in greenhouse gas emissions. SABIC through its corporate social responsibility programmes has provided education, electricity, health and environmental services in various countries where it has plants and operations. However there are some small failures too in the course of every business and SABIC is no exception to this rule. During the global financial crisis of 2008-09, SABIC lost its net income by 95% worldwide. The drop in demand for plastics, chemical products and the decline in the auto industry had an adverse effect on the profits of the MNC. It had to lay off employees in countries like the US, the UK and India to cut costs and manage losses.
Reasons to invest overseas. There are several reasons for SABIC to invest in foreign countries. The primary reason is for expansion and in search of new markets for its produce. Other important reasons include diversification and the accumulation of strategic assets in the country of operation that can act as a balance against asset value depreciation in their domestic market. This also helps SABIC acquire the local technical expertise and resources cheaply, reduce transportation costs and circumvent the local trade barriers. It can exploit the prevailing low tax policies, rental policies, low interest loans, subsidised energy and reduced environmental regulations.
Hedging Programmes. SABIC is exposed to interest rate risks in the course of its business. So it hedges against interest rate risks through derivative instruments such as interest rate swaps, which is a contractual agreement between two parties to exchange their interest payments. Usually one would be of fixed rate and the other would be floating rate payment. However, there is no assurance that the exposure is fully covered. SABIC limits the risk of default by entering into transactions only with selected financial institutions and by adhering to fixed limits.
Risks faced in countries of operation. The cultural, legal and economic systems of these countries in which SABIC operates have various effects on its business. In 2012, the US Environmental Protection Agency (EPA) and US Department of Justice imposed a civil fine of $1 million on SABIC and its US subsidiary. They had to improve their leak detection and reduce the hazardous emissions in the surrounding areas.
The taxation policies in the country of operation too has a toll on SABIC’s revenue. Indian taxation policies are better than those in the US and the UK. So SABIC has established two manufacturing plants in Bangalore and Shanghai, employing a total of 500 workers.
Another problem faced both in domestic and international factories is the strike by its workers. When the situation gets out of hand, SABIC had to move its operations to some other location. Apart from these, SABIC has to take care that it does not hurt the cultural sentiments of the local population through its commercials in print and visual media (Economic Essays, UkEssays.com).
Conclusion. According to the IMF, Saudi Arabia has been one of the best performing economies of the G-20 in recent years, with the average rate of real GDP growth third behind China and India. The fiscal position is also very strong with the lowest debt-to-GDP ratio and the highest fiscal balance among the G-20 economies. Within the Middle East region, Saudi Arabia is a generous provider of financial assistance, and large remittance flows from expatriates working in the country provide important income flows to countries in the region and in south Asia. From this position of strength, it has started adopting open market policies and diversification in its investments. Whether this new non oil approach is also beneficial to Saudi economy is yet to be seen.
Works Cited
Helen Chapin Metz, ed. Saudi Arabia: A Country Study. Washington: GPO for the Library of Congress, 1992. Web.
Cordesman, Anthony H. Saudi Arabia Enters the Twenty-First Century: The Political, Foreign Policy, Economic, and Energy Dimensions. Westport: Praeger, 2003. Print.
Al-Hamidy, Abdulrahman. "Monetary policy in Saudi Arabia." BIS Papers 57 (2011): 301-305. PDF File.
Ellyatt, Holy. Will Saudi Arabia now abandon its dollar peg? CNBC International, 29 Dec 2015. Web.
Kawach, Nadim. Sabic eyes US funds for expansion. Gulf News, 8 Nov 2001. Web.
Economic Essays. Issues faced by Sabic while Implementing Internationalisation. UK Essays, 23 Mar 2015. Web.
