We wish to thank Dr. Cordesman for sharing this report with readers of the Saudi-US Relations Information Service.

This report is provided in three parts.

• Part I - - Reducing the Threat of Terrorism
• Part III - The Issue of Political, Economic, and Social Reform

-- These strong conditions appear likely to continue into 2004. The key difference will be a likely overall decline in average oil production for Saudi Arabia, but the production cuts have successfully aimed to keep prices firm, so Saudi Arabia will still enjoy a year of strong oil revenues in 2004. Our initial forecasts for 2004 are for a small decline in GDP growth, due entirely to oil production declines not fully offset by higher government and private sector growth, 1.5 percent inflation, average oil prices for the year of $25 (average price for Saudi oil), a government budget roughly in balance, and a current account surplus of SR 28 billion ($7.5 billion).

-- Overall, Saudi Arabia's trade picture remains healthy. In 2003, we estimate that merchandise exports were about three times the value of imports. We calculate that total exports for 2003 were about $95 billion, of which $85 billion was oil exports, while total merchandise imports were $31 billion. When the import and export of services and transfers, such as worker remittances, are included to calculate the "current account," then Saudi Arabia ends 2003 with a current account surplus of $27 billion, the fifth year in a row of surplus and its largest surplus since 1981.

-- Generally when strong growth in Saudi Arabia is a result of oil sector performance, then the growth is not associated with strong job creation. The capital-intensive oil sector represents a third of the economy but only employs 1.5 percent of the labor force, so sharp moves up or down in oil sector performance have little impact on overall job growth and employment in the Kingdom, except indirectly to the extent that the higher revenues spur higher growth in government or the non-oil private sector. 

-- Private sector growth is where the new job creation is occurring. Our view is that the average 4 percent growth of the private sector in the past few years remains below the rate needed to create adequate new jobs for Saudis. Our estimate is that about 150,000 Saudi males are entering the labor force per year, and unemployment currently stands at about 13 percent for Saudi males. There is interesting new data published this year, however, that suggests the pace of private sector job creation is picking up and approaching levels needed to stabilize the unemployment rate.

-- Newly published data from GOSI provides us with the number of on-the-job Saudis making the pension contribution and shows that it has increased by an average of 141,000 Saudis per year for the five years of 1997-2001, compared with average growth of 34,000 per year for the period 1992-1996. Based on this data, private sector job creation may be stronger than we previously thought.

-- We expected 2003 to be a year of exceptional fiscal performance. Still the size of the 2003 budget surplus, at SR45 billion ($12 billion) was almost double our forecast of SR23 billion ($6.1 billion). The government used its unanticipated revenues to increase spending over the budget, grow foreign assets, and reduce debt. In 2003, spending was 19.6 percent over the budget. In 2002, the government spent 11.4 percent over the budget, and in 2001 the overspending totaled 18.6 percent. Overspending the budget by 10 percent or more is the historical pattern, with higher overspending in years of high oil revenues. In 2003, revenues exceeded the budget by 73.5 percent. In 2003 through November, the central bank had increased its foreign assets by $17.5 billion to $59.3 billion, according to the latest central bank data. Foreign assets now stand at their highest level since 1997, providing an important and substantial cushion to protect the currency's peg to the U.S. dollar.  

-- Our estimate is that debt declined by some SR20 billion ($5.3 billion) to stand at about SR630 billion ($168 billion) at year-end 2003. The SR15 billion ($4 billion) netted by the government for the privatization of Saudi Telecommunications Company in early 2003 was earmarked for debt reduction. At the current level, government debt would now stand at 80 percent of 2003 GDP of SR792 billion ($211.2 billion), down from 94 percent of 2002 GDP and a high of 119 percent of 1999 GDP. Our view is that a prudent goal would be debt at or below 50 percent of GDP.  

-- The combination of a large surplus, some debt reduction and the build-up of foreign assets represented the best year of fiscal performance for the Kingdom in the past 20 years. The foreign asset position of the government is strong, and debt, which has stabilized over the past several years, is now declining in both absolute terms and as a percent of GDP.  

-- Conditions are right for continued strong fiscal performance in 2004. The 2004 budget calls for spending of SR230 billion ($61.3 billion) and revenues of SR200 billion ($53.3 billion) for a deficit of SR30 billion ($8 billion). Overall, this represents a 10 percent spending increase over the 2003 budget, a larger increase than we have seen in recent years. We thus characterize this budget as mildly stimulative. However, the government can no longer be the engine of growth and job creation in Saudi Arabia, and there would have to be over 8 percent overspending of the budget to match the actual spending levels of 2003.  

-- Our forecast for overall fiscal performance for 2004 is for actual spending of SR255 billion, revenues of SR253 billion, for a small SR2 billion deficit.  Spending increases in the 2004 budget come in the categories of Human Resource Development (education), up 28.4 percent from 2003 budgeted levels, and in Social Development (which includes health care, social welfare and labor affairs), up 45 percent from the 2003 budget. In education, three new universities are being opened in the Kingdom and receive their first budget allocations, and technical education and vocational training receives an 87 percent increase in its budget. While these categories of spending have risen in past years, they generally have not grown to this extent, reflecting the focus now being placed on improving education and workplace skills development.  

-- Typically, non-oil revenues provide about SR40 billion, or 20 percent of budgetary revenues from sources such as investment income, taxes, customs duties, and fees.  The amount and sources of non-oil revenues have not changed significantly in many years nor do they appear likely to change in the 2004 budget. Investment income will likely rise in 2004 as the foreign asset portfolio of the central bank has grown. No significant new taxes are likely to have an impact on the 2004 budget, although there is some discussion of an eventual value added tax (VAT).  No privatization is on the horizon in 2004 of the magnitude of the sale of STC in 2003.  The government may sell down its ownership of a major bank as it lists on the stock market in 2004. Even with revenues from this sale, the government is likely to achieve only modest debt relief in 2004 from privatization proceeds.

-- The Saudi stock market enjoyed a strong gain.  For the year, the Tadawul All Share Index (TASI) was up 76.2 percent to 4,437.58, an all-time high. But unlike most other markets, this exceptional performance marks the fifth consecutive year of a bull market. The market rose 43 percent in 1999, 11.3 percent in 2000, 7.6 percent in 2001 and 3.6 percent in 2002.  Aided by the listing of STC early in the year, the Saudi market, already the largest in the Middle East, doubled its market capitalization during the year to end the year at SR585.4 billion ($156.1 billion). The market is up 214 percent since January 1, 1999, providing an average price appreciation of 25.5 percent per year for the past five years.  In addition, the companies listed in the Saudi market pay substantial dividends, averaging for the overall market more than 3 percent per year. Earnings of the major companies, STC, the petrochemical giant SABIC and the banks have generally kept pace with the price run-up, so the overall price to earnings ratio of the market, excluding the Saudi Electric Company, is 18, compared with 16 at year-end 2002.  All the major sectors of the market showed strong gains this year.

-- During 2003, the U.S. dollar depreciated in value against the Euro by 17.9 percent, and this has become an issue widely discussed locally.  How much did this depreciation cost Saudi Arabia in 2003 in additional costs for imports? Again, assuming roughly the same volume of imports from the same countries in 2003 as in 2002, we calculated that the total additional cost to the Kingdom, based solely on the riyal's depreciation against the nine major non-dollar currencies was SR10.49 billion ($2.8 billion). In other words, the SR102.7 billion in imports from these countries in 2002 would have cost SR113.2 billion in 2003. Some 77 percent of the total added cost comes from Euro, British Pound and Japanese Yen denominated imports.  The depreciation of the riyal against these currencies accounts for SR8.04 billion ($2.14 billion) of the total SR10.49 billion ($2.8 billion) additional cost.  

-- At the same time that the dollar was depreciating, raising Saudi Arabia's import prices, the Kingdom was enjoying higher volumes of oil exports at higher prices as well. Oil prices rose by 14 percent in 2003. According to our calculations, the Kingdom earned approximately $20 billion more from oil exports in 2003 than in 2002, so its additional import costs due to the dollar devaluation were more than completely offset by much higher oil revenues. Producing oil at roughly 8.7 million b/d, the Kingdom needed less than $1 per barrel in higher oil prices to offset the $2.8 billion in additional costs for its imports. Each additional $1 per barrel in oil prices, sustained for a year, brings the Kingdom an additional $2.9 billion in oil revenues.  

-- The depreciation of the dollar has prompted much local media discussion of converting the oil market trade to Euros or moving the Kingdom away from pegging its currency to the dollar. We think both of these moves are extremely unlikely, and we would point out the still extensive dollar-based trade with the Kingdom. While 2002 imports from the Euro area of SR25.4 billion exceeded imports from the United States of SR19.7 billion, total imports in 2002 from the United States and from countries whose currencies are pegged to the dollar (the GCC and China) totaled SR39.6 billion, or one third of total imports. While it may seem lucrative to be Euro-based during a period of strong Euros, Saudi Arabia has gone through other periods of dollar declines, such as in the mid-1980s, and dollar appreciation, such as the mid-1990s, and was prudent to maintain a steady currency policy throughout the period.  

-- Overall, Saudi Arabia's trade picture remains healthy. In 2003, we estimate that merchandise exports were about three times the value of imports. We calculate that total exports for 2003 were about $95 billion, of which $85 billion was oil exports, while total merchandise imports were $31 billion. When the import and export of services and transfers, such as worker remittances, are included to calculate the "current account," then Saudi Arabia ends 2003 with a current account surplus of $27 billion, the fifth year in a row of surplus and its largest surplus since 1981.