ksa country report-oct[1].07

8/3/2019 KSA Country Report-Oct[1].07

http://slidepdf.com/reader/full/ksa-country-report-oct107 1/22

KSA – Economy Also available at ww w.hc-si.com

General Information

Ratings

S & P's short-term sovereigncredit rating

A-1

Fitch country ceiling rating AA-

Cap ita l Market Main Ind icators

2005 2006 YTD

Market

Cap (USD bn)646 327 356

Market

Cap/GDP (%)205.0% 94.0% N/A

Turnover (USD

mn)1,104 1,403 1,138

Market

Performance

(%)

114.0% -54.0% -0.3%

Market PE 19.7x 14.5x 14.4x*

* FY07 expectations

SummaryEconomic profile

Saudi Arabia is the largest economy in the Middle East and one of the biggestworldwide oil producers. Its fiscal and external balances are largely dependent on oilrevenues, generating an average of 82.0% of the fiscal balance income and 90.0% of the external balance proceeds. This makes the fiscal and external balances directlycorrelated to oil price and production shifts.

Fiscal balance floods with oil revenue Fiscal and external balances recorded new highs in 2005 with a surplus taken forward

into 2006. Arab Light oil prices jumped from USD34.53 per barrel in 2004, toUSD49.9 per barrel in 2005, and USD62.19 per barrel in 2006. Pricing now hovers ata YTD average of USD62.01 per barrel.

A diversification scheme was set to decrease the economy's heavy reliance on the oilsector. Four economic cities were established to serve that purpose and thegovernment has been allocating a considerable portion of its spending on

development projects.Inflation well below its GCC peers

Amid global inflationary trends, KSA managed to curb any attempts toward analarming increase in local prices. Monetary and fiscal policy were both utilized toreach such an end. Interest rates were raised following global monetary policy

tightening, as well as an increase in government expenditure on subsidies. It is worthnoting that although the Saudi riyal is pegged to the US dollar, with the recent Fedrate cut by 50 basis points Saudi Arabia chose not to follow suit on attempts tocontrol inflation in the KSA.

Concerns lying ahead

Concerns, however, are raised about KSA's ability to tame inflation rates withoutaffecting its diversification plan in the course of dropping oil prices. Also, theunemployment rate is growing since expatriates make up 88.4% of the private sectorlabor population, while 37.0% of the population lies below 15 years of age, accordingto statistics taken in 2006. This puts added pressure on the government to create

jobs in the future and to raise the current employment rate.

Table 1: Economic Indicators (FY02-FY07** )

FY02 FY03 FY04 FY05 FY06* FY07**

Real GDP Growth (%) 0.1 7.7 5.3 6.1 4.2 3.6

Nominal GDP (SAR bn) 707.1 804.8 938.8 1,182.5 1,307.5 1,346.4

Inflation-CPI (%) 0.2 0.6 0.4 0.7 1.8 3.5

Fiscal surplus (% GDP) (2.9) 4.5 11.0 18.4 20.3 14.1

Total External Debt (% GDP) 16.25 15.1 13.8 13.2 13.7 --

Government Debt (% GDP) 91.9 82.0 65.0 41.1 28.1 --

M2 Growth YoY (%) 14.5 8.4 21.3 10.0 20.0 --

Arab Light Oil Price, USD bbl, Avg 24.3 27.7 34.5 49.9 61.1 --

Oil Price, OPEC, USD/bbl average 24.36 28.09 35.70 50.64 62.29 --

Official Reserves (USD) 20.6 22.6 27.3 26.5 27.4 --

Exchange rate USD:SAR 3.75 3.75 3.75 3.75 3.75 3.75

* FY06 figures are subject to revision**FY07 figures are projected*Fiscal Year ends in DecemberSource: SAMA, NCB, BMI HC Brokerage

Disclaimer Analyst Reem Mansour, MA ECID

Tel + 2 02 3749 6008 (ext. 368)

e-mail [email protected]

Egypt Sales + 202 3749 6008

UAE Sales +971 4 20 66 888

This memorandum is based on information available to the public. This memorandum is not an offer to buy or sell, or a solicitation of an offer to buy or sell the

securities mentioned. The information and opinions in this memorandum were prepared by HC Brokerage from sources it believes to be reliable and from

information available to the public. HC Brokerage makes no guarantee or warranty to the accuracy and thoroughness of the information mentioned in this

memorandum, and accepts no responsibility or liability for losses or damages incurred as a result of opinions formed and decisions made based on informationpresented in this memorandum. HC Brokerage does not undertake to advise you of changes in its opinion or information. HC Brokerage and its affiliates and/or

its directors and employees may own or have positions in, and effect transactions of companies mentioned in this memorandum. HC Brokerage and its affiliates

may also seek to perform or have performed investment-banking services for companies mentioned in this memorandum.

Research Department

KSA Country Report

16 October 2007

Init iation of Coverage The Ace of Spades



KSA - Economy 2

Table of Contents

I. Summary 3

II. An Overview of the KSA Economy 5

III. Fiscal Surplus 7

IV. Monetary Policy 12

V. KSA Enticing Investors Appetite 17

VI. International Trade 18



KSA - Economy 3

I. Summary

Oil plays a major role in the economic performance of the Kingdom of Saudi Arabia; exposing theKingdom to external shocks stemming from international oil prices and production volatility. In2005, nominal GDP grew 25.5% largely fuelled by the hike in international oil prices and a

production increase. A decelerating rate in oil price hikes was manifested in 2006's nominal GDPgrowth rates, growing at 10.2%. In preventing the roller coasters rides driven by oil prices,officials have set a vision by the year 2025 to ensure economic diversification. In 2005, neweconomic cities came to light, creating a vibrant atmosphere to encourage private sectorparticipation and targeting the injection of investments worth SAR300.0 billion over the comingtwo decades.

Fiscal PolicySimilarly, the fiscal balance is highly dependent on oil revenue. As a result, 2006 marked a newrecord for the fiscal surplus to GDP ratio standing at 20.3%, breaking an all time high of 13.6%of GDP made in 1975. Arab Light Oil prices skyrocketed 45.2%, up from USD34.53 per barrel in2004 to USD49.9 per barrel in 2005 and USD61.1 per barrel in 2006. Expenditures were also onthe rise but were maintained at an average of 32.0% of GDP throughout the past few years.

Spending was mainly allocated to development projects moving in line with the year 2025 vision.Subsidies also went up 60.0% from SAR5.3 billion in 2004 to SAR8.5 billion in 2006 to buck attempts of local prices trailing the global inflationary trend. A spark was triggered, however,taking local inflation up to 3.8% in July 2007 from 1.8% in 2006 and 0.7% in 2005, still low byglobal standards but high for the KSA.

Monetary Policy & InflationIn the wake of global inflation, local prices were firmly tamed by utilizing monetary policy withofficial repo rates and reverse repo rates hiking to 5.5% and 5.0% in early 2007 against 4.75%and 4.25%, respectively, in January 2006. Pressures on inflation stems from (I) growing moneysupply (II) increasing rate of government spending and (III) US dollar weakening against othercurrencies. It is worth noting that due to credit tightening and concerns over economic growthof the US, the Federal Open Market Operations Committee (FOMC) decided on its meeting heldon 18th September 2007, to aggressively reduce fed rates by 50 basis points going down to

4.75%. Although the US economy is faced with inflationary risks the FOMC seems more worriednow over economic growth. Nevertheless, KSA refused to take interest rates downwards on theofficial repo rate and reverse repo rates as it realizes the importance of controlling the inflationrate for the time being. The differential went up to 75 basis points from 25 basis points.Money supply (M2) grew significantly in 2006, up 20.0% against a 10.0% rise in 2005 on theback of a 36.7% surge in time and savings deposits against 21.3% growth a year earlier. Thiswas triggered by increasing deposit rates and a downfall in the stock market. In the first quarterof 2007, M2 grew by 5.7%, generated by a 5.7% rise in time and savings deposits and 5.8%growth in demand deposits. Inflation during that period stood at 2.2%. Inflation as of July 30th 2007 stood at 3.8% YoY. Further pressures stem from an increase in government spendinggenerated by petro-dollar money, and further weakening of the US dollar against othercurrencies. KSA imports 72.0% from sixteen countries; Europe and Asia make up the biggestshare of the pie.

Foreign currencyFollowing the footsteps of its GCC neighbors and matching the GCC 2010 unity criterion, theSaudi Riyal is pegged to the US dollar at (USD1:SAR3.75). The trend has been preserved forover two decades now. It served the economic prosperity of KSA well, creating a favorableatmosphere for foreign investors with clear entrance and exit foreign exchange policy, however itreduces the effectiveness of KSA's monetary policy. The peg is expected to be maintained,especially since Saudi Arabia is not facing the alarming inflationary trend that plagued the UAE,for instance; most importantly, KSA is working hard on its diversification scheme, as anappreciation of the Saudi Riyal might decrease its exports' competitiveness in global markets.



KSA - Economy 4

Balance of PaymentsThe trade balance's well-being is highly correlated to oil price and production changes as oilproceeds make up an average of 90.0% of total export revenues. In due cause, the currentbalance surplus tagged its glorifying victory in 2005 by stamping a new historical high at 28.5%of GDP. This was sparked by the jump in oil prices, and production almost reaching its peak. The

trend is expected to be maintained because oil prices (Arab Light Oil) have rebounded to reachUSD68.76 per barrel in August 2007, after crashing to USD53.0 per barrel in the first quarter of 2007. Global political disorder, bad weather conditions, and rising GDP growth rates led oil pricesup.

The Road ForwardSaudi Arabia has been undergoing structural and economic reforms, improving its budgetallocation and working on decreasing its debt exposure as well as setting plans fordiversification, which proves the credibility of economic policies. Short-term risk can rise from adeep plunge in oil prices, while in the long term risks stem from a growing unemployment rate.



KSA - Economy 5

II . An Overview of the KSA Economy

PoliticsRuled by the Al Saud family, King Abdulah Bin AbdulAziz was recently appointed as the king of Saudi Arabia, and the successor to his brother the late King Fahed Bin AbdulAziz. Abdulah is

known to be pro-liberal, accelerating private sector gears in the economy and opening its doors toforeign exposure. The king's popularity can not be ignored despite some protests against Saudi

Arabia's close ties with the US and the rising unemployment rate.

Oil: Rolling the diceThe Middle East's largest economy, Saudi Arabia has a nominal GDP estimated to have grown at10.2% (SAR1.3 trillion) in 2006 against 25.5% in 2005 (SAR1.2 trillion) and real GDP growing at4.2% (SAR798.8 billion) in 2006 as opposed to 6.1% (SDR765.9 billion) in 2005. The Kingdom of Saudi Arabia (KSA) is ruled by petroleum (mining and manufacturing), constituting 28.1% of totalreal GDP in 2006. Hence, the relatively sluggish growth rate of 2006 is largely attributed to loweroil prices and production. Government services ranked second on the biggest contributors to realGDP list amounting to 18.0%, while the finance, insurance, real estate and business servicesfollow to constitute 12.5% of GDP.

Chart 1: Real GDP by sector (FY05-FY06*)

Manufacturing

11%

Producers of

government

services

17%

Finance,

insurance, real

estate & busniess services

12%

Mining &

quarrying

29%

Other

31%

FY 05

Manufacturing

12%

Producers of

government

services

18%

Finance,

insurance, real

estate &

busniess

services

13%

Minning &

quarrying

27%

Other

30%

FY 06

*Preliminary Estimates

Source: Central Department of Statistics & Information, HC Brokerage

In nominal terms, the oil sector comprised more than 50.0% of GDP in 2006 fuelled by the shootup in the Arab Light Oil prices. The oil price rally continues but at a slower pace, reachingUSD68.76 per barrel in August 2007. Global oil demand is expected to continue to go up as aresult of worldwide economic growth and bad weather conditions resulting from global warming.

Saudi Arabia acknowledged that relying on oil based revenue is an economic gamble; betting on oil

price volatility is a game that cannot be played indefinitely. In due cause, officials set a vision forthe year 2025 where ''the Saudi economy will be a diversified, prosperous, private-sector driveneconomy, providing rewarding job opportunities, quality education, health care and necessary skillsto ensure the well-being of all citizens while safeguarding Islamic values and the Kingdom'scultural heritage.'' Four economic cities have been established to work on reaching such a goal.Saudi Arabia provides 48.0% of total power generation in the region, and is the largest cementproducer in the GCC. This moves well in line with the plan.

Labor population dominated by non-SaudisThat said, Saudi Arabia has also embarked on a Saudization program that increases the number of Saudis in labor population. Population amounted to 23.63 million in 2006, 37.0% of which fallbelow 15 years of age. The population is growing at a high CAGR of 2.4% in line with its GCCpeers. The unemployment rate stood at 6.9% in 2005. The problem intensified in 2006 asexpatriates constituted 88.4% of the private sector's labor force while the unemployment ratestood at 9.1% for men, and 26.3% for women. This puts the economy at stake over the long-run.In due cause, the government has been reducing the number of visas issued to decrease thepercentage of expatriates.



KSA - Economy 6

KSA Today

The dependence of the KSA economy on oil revenue is reflected in the budget surplus and currentaccount balance. However, this raises its exposure to external shocks hitting hard on bothaccounts the fiscal and external balances. However, in the wake of robust global economic growth,global warming, and political unrest, oil prices are not expected to be seen near its 2004 levels(USD34.5 per barrel) or below, signaling continued prosperity in the economy of KSA.Nevertheless, the following are two major concerns (a) rising unemployment rate and (b) soaringglobal inflation rates. Although the government of Saudi Arabia has staged a good performance incontrolling inflation rates at 2.2% in the first quarter of 2007, inflation rates soared to 3.8% in July2007 YoY. The challenge lies in the government's ability to control inflation without having todramatically increase subsidies, which might affect its development plans and/or negativelyinfluence the target of decreasing a public debt.The economy of Saudi Arabia has set vigorous plans to decrease its reliance on the oil sector andup to date it has been impressively carrying it out.



KSA - Economy 7

II I. Fiscal Surplus

Being the biggest global oil exporter manifested in a fiscal surplus standing at 20.3% of GDP in2006, (SAR265.0 billion) against (SAR217.9 billion) in 2005, 18.4% of GDP.

Fiscal Budget at its Peak I) Expenditures

(i) Capital Expenditure in 2005 doubled on attempts to reduce dependence on oil revenue,nevertheless its share remains low, standing at only 4.3% of GDP and in 2006 it went up toSAR70.9 billion, representing 5.5% of GDP. Government spending on capital expenditure hasbeen rising significantly to pave the road for private investments. It is budgeted to amount toSAR140.0 billion in 2007, 36.8% of total expenditures; where SAR29.0 billion of which aredirected to the building of new educational facilities to promote human resource development;SAR5.6 billion to health care and SAR9.3 billion to municipal development which entails theconstruction of new ports, airports, roads, and bridges.

(ii) Current Expenditure gained the lion's share, amounting to SAR322.4 billion in 2006 upfrom SAR287.2 billion in 2005, 82.0% of total expenditures and 31.1% of GDP. The trend

continues in 2007 as capital expenditure is expected to reach 63.2% of total expenditures(SAR240.0 billion), according to officials' estimates. Subsidies amounted to 0.7% of GDP in 2006(SAR8.5 billion) as it jumped 60.0% from 2004 (SAR5.3 billion) to (SAR8.5 billion) in 2005 and isplanned to reach SAR12.8 billion in 2007, 3.3% of total expenditures. The increase comes in toaccommodate relatively rising local prices.

Chart 2: Average of Budget Allocations (FY01-FY06) and Planned Budget Allocations of majorsectors in FY07

FY01-FY06Subsidies

3%

Defense &

Security

35%

Transport &

Communication

Development

3%

Human

Resource

Development

24%

Infrastructure

Development

1%

Municipal

Services

3%

Economic

Resource

Development

3%

Public

Adminstrations

& others

19%

Health &

Social

Development

9%

Government

lending

institutions

0%

FY07

Defense

37%

Subsidies

3%

Infrastructure

Development

1%

Health &

Social

Development

4%

Transport &

Communicatio

ns

3%

Human

Resource

Development

27%

Economic

Resources

Development

4%

Municipal

Services

4%

Public

Administration

& others

17%

Source: Ministry of Finance & SAMA, HC brokerage

Moving in line with its 2025 vision and the Saudization program, the government plan seemedgenerous in spending on human resource development in 2007. This should build a strongfoundation to provide ''rewarding job opportunities, quality education'' and paving the road for

private investments, in part as an attempt to decrease reliance on oil generated revenue. Thebudget planned for 2007 allocated SAR96.7 billion to human resource development, up fromSAR87.2 billion in 2006. Government's interest in education development was growingremarkably since 2006; 6,800 new schools, four new universities and 56 new colleges wereplanned to be established in 2007. Vocational training was also in centre stage; a vast number of vocational centers were included in the construction plan.Saudi Arabia is encouraging the private sector to share in building the kingdom's infrastructure asa means to promote efficient allocation of the budget's resources. Nevertheless, KSA is providingworld class infrastructure.



KSA - Economy 8

II) Revenues(i) Oi l Revenue and other revenue: Heavy exposure to oil income floods the fiscal balancerevenues and leaves it subject to international oil price shocks and productivity ceilings set by theOPEC. Oil revenue made up 82.0% on average of KSA's total revenues over the past three years.In 2007, total revenue is expected to amount to SAR400.0 billion as opposed to SAR673.7 billion

in 2006. Although the breakdown of revenue is unavailable for 2006 and 2007, it is regarded thatthe government is conservative in projecting its yearly income where the actual 2006 totalrevenue came in 72.8% higher than the budgeted revenue that stood at SAR390.0 billion. Theprice of Arab Light Oil made an average of USD61.1 per barrel in 2006 where the governmentseems to have based its projections at much lower than that, hovering around late USD40.0 perbarrel if not less. It is worth noting that in the first quarter of 2007 the price of the Arab Light Oildropped to an average of USD53.0 per barrel yet made a rebound in the second quarter atUSD65.92 in June 2007, and at USD68.76 in August 2007.

(ii) Other Revenues: The breakdown for other revenues is not specified, however it is worthhighlighting that the government collects zakat (equivalent to tax) of a fixed rate of 2.5% onlocal firms and taxes non-Saudi firms at a 20.0% rate. In April 2000, income tax dropped from45.0% to 30.0% then a second reduction took place in April 2004, taking the rate down to a flat20.0% rate following the GCC's trend. The gas and oil sectors are taxed differently, 30.0% on theformer and 85.0% imposed on the latter. Personal tax rate for locals (zakat) is 2.5%, while forforeigners it stands at 20.0%.

Chart 3: Breakdown of Total Revenue (FY05 and FY06)

FY05

Oil Revenue

89%

Other

Revenue

11%

FY06

Oil Revenue

90%

Other

Revenue

10%

Source: Ministry of Finance, HC Brokerage

Celebrating the SurplusThe fiscal surplus in 2006 reached SAR289.7 billion against SAR217.9 billion in 2005 andSAR107.1 billion in 2004. This was generated by the continuous surge in oil prices that climbedfrom 2004 to 2006 by 77.1%. Although in the first half of 2007 Arab Light Oil prices averagedUSD59.36, that were dragged down by the first quarter 2007 prices that stood at USD53.0 perbarrel, hence a surplus is still expected.

The government expects a surplus of SAR20.0 billion with revenues amounting to SAR400.0billion in 2007. The government might be too conservative again with its expectations. Based onthe sensitivity analysis below shows that even with the most uptight conditions Saudi Arabia'sbudget will not lurk below the surface. We expect total revenue to rather hover around SAR421.2billion if oil prices stood at USD45.0 per barrel and production restricted to, at most, 8.5 millionbarrels per day. In 2005, Saudi crude oil production stood at 9.39 million barrels per day. In2006, the OPEC passed restrictions to its members, taking Saudi Arabia's output level down to9.12 million barrel per day. In the first half of 2007, production dropped further to an average8.54 million barrels per day.

Table 2: Oil Production

2003 2004 2005 2006 2Q07

Crude oil production (million b/d) 8.71 8.96 9.39 9.12 8.52

Arab light price (USD/b) 27.7 34.5 49.9 61.1 62.1 (YTD)

Source: OPEC, HC Brokerage



KSA - Economy 9

Expenditure is budgeted at SAR380.0 billion, SAR10.0 billion lower than last year. Based onhistorical records, expenditures averaged 32.0% of GDP over the past three years, henceexpenditure in 2007 is expected to hover around SAR400.0 billion if nominal GDP stands at1,329.2 billion, according to IMF GDP forecasts. That said, a scenario in line with today's markettranslates into a surplus hovering around SAR191.5 billion in FY07 with oil prices averaging at

USD60.0 per barrel and oil production output at 8.6 million barrels per day.

Table 3: Sensitivity analy sis (Fiscal Balance in 2007 )

2007 ( a ) 2007 (b ) 2007 © 2007 (d )

Saudi Arabia l ight oi l price (USD per barrel) 60.0 60.0 55.0 45.0

Oil production bpd increase (%) -8.5% 0% -8.5% -9.7%

Oil revenue 485.0 530.6 440.4 345.4

Other Revenue 106.5 116.5 96.7 75.8

Total Revenue 591 .5 647.1 537.1 421.2

Total Expendi ture 400.0 400.0 400.0 420.0

Surplus/ (Defic it ) 191.5 247.1 137.1 1.2

Source: HC Brokerage

The sensitivity analysis clearly proves the strong impact of oil prices and productivity on thebudget surplus. This puts KSA at stake if oil prices take a deep dip and production contracts whileexpenditures on education, human resources, and health increase to meet its 2025 vision target,let alone increased spending on subsidies to keep inflation rates in control. It is worth noting thatalthough some expectations foresee oil prices breaking USD60.0 per barrel on the back of globaleconomic growth, bad weather conditions and possible political upheavals, Saudi Arabia plays theprice moderator role within the OPEC while keeping strong ties with the US.

Table 4: Annual Governm ent Revenues and Expenditures

SAR Bi l l ion FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07*

Tot al R evenu es 2 58 .0 2 28 .2 2 13 .0 2 93 .0 3 92 .3 5 64 .3 6 73 .7 4 00 .0

Oil Revenue 214.4 183.9 166.1 231.0 330.0 504.5 604.5 -

Other Revenue 43.6 44.2 46.9 62.0 62.3 59.8 69.2 -

Tot al Ex pendi tu res 2 35 .3 2 55 .1 2 33 .5 2 57 .0 2 85 .2 3 46 .5 3 93 .3 3 80 .0

Capital Expenditure 18.4 31.6 30.0 33.5 37.6 62.3 70.9 140.0

Current Expenditure 217.0 223.5 203.5 223.5 247.6 284.2 322.4 16.3

Ov er al l Sur plu s 2 2.7 ( 26 .9 ) (2 0.5 ) 3 6.0 1 07 .1 2 17 .9 2 89 .7 2 0.0

O ve ra ll S ur pl us a s a % o f G DP 3 .2 ( 3.9 ) (2.9) 4.5 11.0 18.4 22.2 -

*2007 figures are budgeted

Source: Ministry of Finance, HC Brokerage

The chart below shows that deducting oil revenue from total revenue balance drags it into thered just like most GCC economies, even the UAE was no exception.



KSA - Economy 10

Chart 4: Impact of Oil Revenues on Budget

T. Revenues Include Oil

393

564.3

673.7

11.0 18.4 22.2

0

50

100

150

200

250

300

350

400

450

500

550

600650

700

FY04 FY05 FY06

Total Revenues( SAR billion)

Surplus % GDP

T. Revenues Exclude Oil

59.8

-24.3 -24.8

62.3 69.2

-23.7-25

-15

-5

5

15

25

35

45

55

65

FY04 FY05 FY06

Total Revenues

(SAR billion)

Deficit (% GDP)

Source: Ministry of Finance and Ministry of Economy & Planning, HC Brokerage

Government Domestic Debt on the DeclineIn public debt, the government staged a remarkable performance while taking it down from91.9% of GDP in 2002 (SAR650.0 billion) to an expected 28.0% of GDP in 2006 (SAR366.0billion), as announced by the Ministry of Finance. GDP growth rates coupled with fiscal balancesurpluses, running since 2003, both shared a hand in the positive note. The government hasbeen planning to buy back its outstanding treasury bills before its maturity, which reflects itsattempts to continue reducing its public debt. The floods of money coming in from oil proceedspreserves the trend. This makes the KSA eligible to join the GCC monetary union as expected in2010 as it sets a ceiling at 60.0% to GDP of public debt for each member. Furthermore, totalexternal debt to GDP is not a source of worry. It is expected to stand at 13.7% of GDP in 2006,

down from 16.2% in 2002.

Chart 5: Total External Debt to GDP

30.532.5

34.9

40.6

47.4

05

10

15

20

25

30

35

40

45

50

2002 2003 2004 2005 2006

U S D B i l .

1011

12

13

14

15

16

17

18

19

20

G r o w t h R a t e

T. External Debt (USD billion)

T. External Debt (% GDP)

Source: SAMA, HC Brokerage



KSA - Economy 11

Conclusion

Like many GCC economies, the Kingdom of Saudi Arabia is heavily dependent on oil revenue tomaintain a budget surplus. However, government spending is increasing on capital equipments,education, and human resource development, which should positively affect the economy in thelong run and create opportunities for investing in other sectors. This should help diversify its

portfolio eventually and decrease its reliance on the hydrocarbon sector. Meanwhile, the fiscalbalance is highly correlated to oil price and productivity changes. A plunge in either hits the fiscalbalance hard. On the other hand, government spending is increasing yet maintains an average of 32.0% of GDP with more allocation shifting towards development projects. With its recentinclusion in the WTO, Saudi Arabia has taken serious steps to promote private sector's rolethrough stimulating privatization and encouraging private investors in infrastructuredevelopment. This should ease the burden on government spending.That said, international oil prices are not expected to witness a sharp fall at the wake of worldwide events of accelerating growth, global warming, and political instability. Even with adrop to USD45.0 per barrel of oil, the fiscal balance is expected to lie firmly in the black.



KSA - Economy 12

IV. Monetary Policy

Heading towards the GCC monetary unity, Saudi Arabia pegged its Saudi riyal to the US dollar at(USD1:SAR3.75). It is expected to maintain the peg, especially since it is not plagued with heavyinflationary pressures.

Lowest Inflation Rate Among PeersThe inflow of petro-dollar money and the increase in liquidity did not result in an alarming surgein inflation rates. It inched up 2.2% in the first quarter of 2007, as opposed to the samecorresponding period last year and 1.8% in 2006. In July 2007, inflation inched up 0.8% fromJune 2007, standing at 3.8% YoY. The government managed to stop prices from dramaticallyshooting up, unlike the UAE where inflation hit 11.3% in 2006. However, it is worth highlightingthat inflation in the UAE was largely driven by rent price hikes which constitute 36.14% of theConsumer Price Index (CPI) making it unfair to compare it to the KSA. The reason is that theweight of rent is not disclosed in the KSA CPI. Rent is grouped with renovation, fuel and water,which recorded a surge of 5.9% from fiscal year 2006 to May 2007. On the other hand,Transport and communication fell 2.2% from fiscal year 2006 to May 2007. Since both items arealso grouped in one category it is difficult to define the reason of the drop. However, Saudi

Arabia has been active in the telecom sector opening its doors for competition which limits priceincrease.

Chart 6: Inflation rates KSA, EU & US (2002 -2006)

0.2

0.6

0.3

0.7

1.8

1.6

2.3

2.7

3.4

3.6

2.3

2.25

1.9

2

2.3

0 1 2 3 4

2002

2003

2004

2005

2006

EU

US

KSA

Source: IMF, ECB, BMI, SAMA, HC Brokerage

Inflationary Pressures and Risks(i) Dollar depreciation: Further depreciation in the dollar puts pressure on local prices. Saudi

Arabia imports 72.0% of its imports from sixteen countries, mainly from Europe and Asia, whichis large enough to exercise pressure on inflation. One way the government tries to accommodatethat is increasing subsidies expenditure which amounted to only 0.7% of total expenditures in2006. But, the government has set plans to allocate its spending on development projects tomaintain a budget surplus; such extra expenses might destabilize the government's plan. A plunge in oil prices is when the situation aggravates.



KSA - Economy 13

Chart 7: Correlation between EUR:SAR & CPI (FY02-1H07)

0

1

2

3

4

5

2002 2003 2004 2005 2006 1H07

G r o w t h r a t e ( % )

CPI

EUR:SAR

Source: Bloomberg, HC Brokerage

(ii) Government spending: The increase in international oil prices boosts injections of hot moneyinto the economy. This raises money supply. But since the government is the main beneficiary of oil proceeds, then only when government spending increases market liquidity grows remarkably,pushing prices upwards. Government expenditure grew by 25.3% in 2006 against 18.4% in2005.Money supply (M3) growth rate in August 2007 grew at 18.9% YoY and 19.3% in 2006. M1

grew by 8.8% (SAR338.9 billion) in August 2007 against 10.% (SAR312.7 billion) in 2006.

(iii) Domestic demand: An increase in local demand and GDP growth rates has shared a hand inrising inflation rates. Private final consumption grew by 6.5%, as opposed to 9.5% in 2005.Private consumption constituted 25.5% of total GDP in 2006.

Table 5: Consumer Price Index Breakdow n (FY01-1Q07)

CP I FY01 FY02 FY03 FY04 FY05 FY06 1Q07

97.8 98.0 98.6 98.9 99.6 101.8 104.2Food & Beverage 97.6 98.0 98.6 103.4 106.5 112.2 118.2

Fabrics, Clothing and footwear 92.9 92.3 91.8 89.6 88.3 87.8 86.2

Renovation, rent, fuel and water 100.1 100.0 100.0100.3

100.0 101.0 104.9

Home furniture 97.3 96.8 96.2 94.5 94.9 95.2 95.8

Medical care 100.7 100.8 101.0 101.4 101.4 102.7 103.8

Transport and telecommunications 96.3 96.4 94.8 94.2 91.8 89.7 87.6

Education and entertainment 99.5 99.3 98.7 98.1 98.4 98.6 98.7

Other expenses and Services 98.8 100.8 103.2 103.9 106.4 114.7 117.2

Source: Ministry of Economy & Planning, HC Brokerage

Real interest rates remain positive

Saudi Arabian Monetary Agency (SAMA) uses the official repo and reverse repo as instruments tocontrol market liquidity and tame inflationary pressures. SAMA took official repo rates on a seriesof upward rides reaching 5.5% in April 2007. Reserve repo rates witnessed the same fate,hitting 5.0% for the same period, up from 4.25% in early 2006. Three months inter-bank rates(SIBOR) also inched up to reach 4.87% in August 2007, up from 4.82% in January 2007.Hence, real interest rates remain positive with the inflation rate standing at 2.2% in the firstquarter of 2007 and 2.5% in first half of 2007. In July 2007 it stood at 3.8% YoY.



KSA - Economy 14

Chart 8: Official Repo Rate, FED Funds Rate and Euro Rate

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

S e p - 0 5

N o v - 0 5

D e c - 0 5

A p r - 0 6

M a y - 0 6

J u n - 0 6

J u l - 0 6

A u g - 0 6

S e p - 0 6

D e c - 0 6

M a r - 0 6

J u n - 0 7

S e p - 0 7

Official Repo

Fed

ECB

Source: SAMA, FED & ECB

Chart 9: Inflation and 3 months deposit rates (FY03-1H07)

0%

1%

2%

3%

4%

5%

6%

2003 2004 2005 2006 1H07

G r o w t h r a t e

0.00%

3 months deposit r ate

CPI

Source: SAMA & Bloomberg, HC Brokerage

A story of interest ratesWorld-wide heightened growth caused global inflationary pressures and urged central banks totighten monetary policies. In the US, the Federal Open Market Committee (FOMC) raised Fedrates upward 17 times from a 50-year low of 1.0% in 2003 to 5.25% in 2006. Being pegged tothe dollar, local Saudi interest rates followed suit. It is worth pinpointing, however, that thegovernment is stacked with USD24.7 billion worth of foreign exchange reserves which helps it towithstand dollarization pressures. This is supported by the perception that the real effectiveexchange rate of the Saudi Riyal is strengthening against the USD upon large current accountsurplus. The FOMC cut fed rates to 4.75% in September 2007 however Saudi Arabia did notfollow to control any inflationary attempts.

Table 6: Inflatio n and Interest Rates (FY03-1Q07)

2003 2004 2005 2006 1H07

Interest rate

SAR Average 3 months deposit rate (%) 1.6 1.7 3.7 5.0 4.9

USD Average 3 months deposit rate (%) 1.1 1.5 3.4 5.1 5.3

Euro Average 3 months deposit rate 2.2 2.0 2.1 3.0 3.9

Inf lat ion rate

CPI (%) 0.6 0.3 0.7 2.2 2.4




KSA - Economy 15

Foreign exchange

SAMA maintained the Saudi Riyal peg to the US dollar at (USD1:SAR3.75) for over two decadesnow. Adopting a flexible exchange rate system or revaluing the USD:SAR peg are both notexpected. The GCC monetary unity requires a peg to the US dollar, and a revaluation willdecrease the country’s export's competitiveness in international markets. Although dollar

devaluation imposes inflationary risks, it is worth noting that the government has been doing agood job in containing inflation in light of the USD devaluation.

Foreign exchange earningsOil exports represent 90.0% of total exports (SAR703.7 billion in 2006) and is considered thecountry’s main foreign exchange earner. Saudi Arabia attracts investors’ interest and FDI,however, a breakdown of capital transactions on the balance of payments is not revealed toestimate its importance. Other exports and services receipts amount to SAR131.9 billion in 2006,which is considered a minor portion when compared to oil receipts. This becomes a majorconcern when international oil prices and production decreases, thus negatively influencing thekingdom's foreign exchange earnings.

Table 7: Foreign Currency Earners and Percentage Contribution (FY0 4-FY06)

SAR Bi l l ion FY04 % FY05 % FY06 %

Export Proceeds 471.3 92.3% 675.3 93.7% 789.2 92.0%

Oil exports 414.1 81.2% 604.0 83.8% 703.7 82.1%

Other exports 57.2 11.2% 71.3 10.0% 85.5 10.0%

Services Receipts 39.2 7.7% 45.4 6.3% 68.2 8.0%

Investment Income 16.0 3.1% 18.6 2.6% 38.8 4.5%

Oil Sector (bunker Oil) 1.3 0.25% 1.8 0.25% 2.1 0.25%

Other 21.9 4.3% 25.0 3.5% 27.3 3.2%

Total 510.5 720.7 857.4

% GDP 54.4% 60.9% 64.2%

*FY06 figures are subject to revision


Money Supply

Money supply (M3) growth rate in August 2007 grew at 18.9% YoY against 10.1% in 2006. M1grew by 8.8% (SAR338.9 billion) in August 2007, against SAR312.7 billion in 2006. This wastriggered by the continued rally of interest rates hikes accompanied with a faltering path of localstock market encouraging investors to safeguard their investments into deposits. Petro-dollarmoney has also helped in the surge of money supply to a certain extent since the mainbeneficiary of oil proceeds is the government. Hence, international oil price hikes will continue toboost local liquidity growth only if the government increases its spending.

Table 8: Money Suppl yEnd of Period 2005 End of Period 2006 August 2007

M1 SAR Bn 283.5 312.7 338.9

Currency outside Banks AED Bn 64.3 69.3 65.6

Demand Deposits AED Bn 219.3 243.4 273.4

M2 SAR Bn 448.8 515.9 605.7

Time & Savings Deposits SAR Bn 165.3 226.0 263.2

M3 SAR Bn 55.7 660.6 727.2

Other Quasi Monetary Deposits SAR Bn 105.0 122.0 124.9

* M1, or narrow money: money in circulation outside the banking system and demand deposits in local currency

** M2, or assets that can easily be converted into money: time and saving deposits in local currency, demand deposits in foreign

currency and foreign currency time and saving deposits

**M3: M2 + other quasi-monetary deposits




KSA - Economy 16

Managing mark et liquidity through repos and reverse reposThe government uses the official repo and reverse repo to maintain local price stability andcontrol liquidity and ease pressure on the USD:SAR peg. In due cause, a series of rate hikesstarted in 2004 following FED rates.

Trailing SAMA's interest rate upward, deposit rates had little choice but to follow suit. Theaverage Saudi riyal three months deposit rate stood at 4.87% in July 2007, while Euro basedthree months deposit rate stood at 4.16% for the same period with the differential standing at80 basis points and 60 basis points lower than the US dollar based three months deposits in

August 2007. This trend has been taking place since the second quarter of 2006 and the reasonbehind that is buyers' perception that the Saudi Riyal real effective exchange rate hasappreciated against the US dollar on the back of injections coming from oil driven revenue. Talk and expectations have been revolving around a Saudi riyal-US dollar de-pegging rather than arevaluation of the riyal after the recent aggressive fed rate cut.

ConclusionThe government of Saudi Arabia managed to tame inflation rates since 2005 and throughout2007 amid global inflationary trends, rising money supply growth rates, and a devaluing dollar.

Increasing interest rates seems to have resolved the situation.Interest rate hikes accompanied with a stock market correction encouraged investors to investtheir savings in deposits which increased money supply (M2), growing at 20.0% in 2006,SAR538.7 billion and reached SAR602.2 billion in August 2007.If USD devaluation against other currencies persists import prices will increase, eradicating profitmargins and decreasing the money supply, and thus decreasing pressure on inflation with localprices going up on the back of expensive products. However, KSA’s exports will become cheaperin international markets. So far the government utilized fiscal policy in conjunction withmonetary policy to stabilize the inflation rate. Subsidies grew by 60.0% from 2004 (SAR5.3billion) to 2006 (SAR8.5 billion), but carrying forward this trend might eventually stagger a fiscalsurplus.



KSA - Economy 17

V. KSA Enticing Investor's AppetiteSaudi Arabia redefines benchmarksRacing its GCC competitors, Saudi Arabia ranked number 38th in 2007 in the world (second in theMiddle East after Israel); according to the IFC’s "Doing Business" report. Kuwait and Oman have along way to go before competing with KSA's placing. The Saudi Arabian General Investment

Authority (SAGIA) was established in early 2000 to promote private investments in growthacceleration. ''SAGIA’s mission is to achieve rapid economic growth in the Saudi Arabian economyby creating a pro-business environment, providing comprehensive services to investors, andfostering investment opportunities in key sectors of the economy. In pursuit of this mission, SAGIA has recently announced the launch of four greenfield, privately developed economic cities acrossthe nation''. In 2005, King Adbdullah Economic City was established with a focus on industrialsector and educational development. In 2006, the following three new cities came to light: 1-Prince AbdulAziz Bin Mousaad Economic City which focuses on the agro-industrial sector, mining,processing industries. 2- Knowledge Economic City which concentrates on IT, Islamic studies andmedical research. 3- Jazan Economic City which has oil and copper refineries, aluminum andpetrochemicals industries. Investments in these cities amounts to SAR165 billion (USD44 billion).

In aggregate terms, SAR300 billion worth of investments are planned to be lured in over thecoming two decades. This is part of the plan to make Saudi Arabia one of the top economiesattracting FDI globally.Gross fixed capital formation in 2006 is estimated to have stood at 17.0% of GDP, 9.8% of whichis expected to be generated from the private sector in the non-oil field, far exceeding that of government investments standing at 5.2% of GDP. All the while, the oil sector accounted only for2.0% of GDP worth of investments. This goes well with the government's plan heading towardsdiversification.

SAGIA is planning on reaching its goal through creating a favorable business atmosphere,exceptional infrastructure, and a lavishing environment to professionals in the economic cities, farexceeding standards set by industrial parks and free zones.



KSA - Economy 18

VI . In terna tiona l Trade

A) Current Account

The trade balance surplus was maintained in 2006, amounting to SAR557.0 billion as opposed toSAR470.7 billion in 2005. Outstanding oil export proceeds made 90.0% of total exports in 2006.Other exports represent a minor portion since the economy is mainly dependent on the oil sector.The wave of high international oil prices and production almost reaching its maximum capacitystamped remarkable results. Oil has been and is expected to remain the main trade balanceearner.

Table 9: BoP Contribu tors as Percentage of GDP (FY06)I tem Percentage to GDP

Oil Exports 54.1%

Non-Oil Exports 5.9%


Chart 10: Exports by Category (2002-2005)

0%

20%

40%

60%

80%

100%

120%

2002 2003 2004 2005 2006

E x p o r t s

Chemical products Ref ined oil products Construction materia ls & s teel Other materia ls

Source: General Port Authority, HC Brokerage

Other exports growth has been sluggish, exposing the trade balance to external shocks. It grew by8.7%, which was offset by imports that grew 11.3% in 2006. Nevertheless, throughout the pastthree years an average 44.0% of total imports came in the form of machinery and transportequipments. This puts the diversification plan on the right track, as it should accelerate the non-oilexports' growth rate.Saudi Arabia's efforts to promote exports were further encouraged by an export program startedin 2003 by the Saudi Development Fund to provide financial support and insurance to non-oilexporters. The insurance policy covers risks of defaults in payments to non-oil exporters resultingfrom political or commercial reasons. The program joined the International Union for Credit andInvestment Guarantors (Bern Union) in October 2003.

Table 11: Imports Breakdown

(%) total imports FY03 FY04 FY05 FY06

Machines, appliances and equipments 21.8 22.1 24.3 25.8

Food stuff 16.2 15.0 14.8 12.4

Chemical and metal products 13.7 13.8 13.5 12.9

Textiles and clothing 5.4 4.8 4.3 4.1

Metals and their products 9.1 10.0 10.7 15.2

Wood and jewelry 2.0 2.3 2.5 1.7

Transport equipment 21.3 21.4 21.0 19.3

Other goods 10.5 10.6 8.9 8.6

Tota l imports (% ) 100.0 100.0 100.0 100.0




KSA - Economy 19

In services, investment income continued to go up in 2006 reaching SAR25.9 billion up 40.0% YoY and making 47.6% of total services receipts. Services payments, however, dragged the servicesbalance down heavily, weighted by other government services and private transfers. Privatetransfers account for 21.6% of total payments where about 88.4% of the labor population (5.4million) are non-Saudi.

Table 12: Remittances as a percent of GDP (2001-2006)

SAR Bi l l ion 2002 2003 2004 2005 2006

Remittances of expatriates 59.5 55.4 50.8 52.4 54.6

% of GDP 8.5 6.9 5.5 4.5 4.2


Table 13: Current Account (FY03-FY0 6)

SAR bi l l ion FY03 FY04 FY05 FY06

1. Merchandise trade (FOB) 221.7 317.3 470.7 557.0

A) Oil Exports Hydrocarbon 307.5 414.0 604.0 707.1

B) Other Exports 41.1 57.1 71.2 77.3

Of which Re-exports Exports 4.9 9.2 10.7 12.3C) Imports (-) 127.0 153.9 204.5 227.4

2. Services and Transfers -1 16 .5 -122.5 -133.2 -1 99 .3

A) Receipts 33.5 39.2 45.4 54.4

I) Investment Income 11.1 16.0 18.5 25.9

II) Oil Sector 0.9 1.2 1.8 2.1

III) Other 21.4 21.9 25.0 26.3

B) Payments 150.0 161.8 178.7 253.8

I) Freight and Insurance 11.4 13.8 18.4 20.9

II) Oil Sector 16.0 14.2 18.5 36.4

III) Other Private Services 18.3 27.6 35.9 48.0

IV) Other Government Services 48.8 55.2 53.2 93.6

V) Private Transfers 55.4 50.8 52.4 54.6

3. Current Account Balance (1+2) 105.1 194.7 337.4 357.6

Current Account Ba lance as % of GDP 13.0 20.7 28.5 27.3


Trade with GCC

Imports from GCC countries is on the rise, up 19.3% in 2006 (SAR30.6 billion) from 11.5% in 2005(SAR25.6 billion), 10.7% (SAR17.9 billion) in 2004 and 8.7% (SAR12.0 billion) in 2003. The rise inexports, however, did not keep up with the fast pace, making it a net importer from GCC countriesover 2004, 2005, and 2006. Trade with the GCC grew in 2006, comprising 12.3% of total imports,eating away from the share KSA’s main sixteen trade partners.

Table 14: Main Non-Oil Trade with GCC m arkets (Import & Exports)

SAR bi l l ion 2003 2004 2005 2006

Imports Exports Imports Exports Imports Exports Imports Exports

UAE 7.6 6.2 9.4 7.5 12.4 8.7 15.3 11.0

Bahrain 2.3 1.7 5.7 2.0 10.0 2.7 12.0 3.3

Kuwait 0.5 2.9 0.8 4.0 1.0 4.3 0.9 4.8

Qatar 0.8 1.3 1.0 1.9 0.7 2.6 1.1 3.7

Oman 0.6 1.0 0.8 0.9 1.3 1.3 1.3 1.4

Total 12 .0 13.2 17.9 16.5 25.6 19.8 30.6 24.2

Source: Ministry of Economy and Planning, HC Brokerage

Trade with the w orld

The largest share of the kingdom's imports come from sixteen countries, mostly from Asia and thedeveloped world. The major blocks of which are, the US (14.7%), Japan (8.0%), Germany (8.2%),and China (8.7%). Although Saudi Arabia imports from various countries, making its portfolio well

diversified, the currencies of these countries are appreciating against the US dollar, indicatinginflationary pressures.



KSA - Economy 20

Table 15: Geographical Distribution of Im ports

(% ) 2003 2004 2005 2006

USA 15.0 15.3 14.8 14.7

Japan 10.3 9.8 9.0 8.0

Germany 8.9 8.1 8.2 8.2

Mainland China 5.9 6.6 7.4 8.7

UK 5.9 5.7 4.7 4.0

Italy 4.0 3.4 3.8 3.9

South Korea 3.7 3.8 3.7 3.8

France 3.7 3.5 3.4 3.9

India 3.0 3.2 3.1 3.7

Australia

Brazil 1.7 1.7 2.2 1.8

Switzerland 1.9 1.9 2.1 1.6

Finland 1.3 0.7 1.7 1.7

Thailand 1.5 1.2 1.7 2.0

Holland 2.0 1.8 1.7 1.4

Sweden 1.5 1.7 1.6 1.6

Six teen Countries total 73.0 71.2 72.0 72.0

GCC countr ies 8 .7 10.7 11.5 12.3

Other Arab countr ies 3.5 3.5 3.7 3.2

Rest of the w or ld 14.8 14.6 12.8 12.4

Total Imports 100.0 100.0 100.0 100.0


Imports from the US have been declining since 1995, reaching 14.7% of total imports in 2006,down from 21.5% in 1995. On the other hand, upon vigorous growth rates taking place in theeconomy of China, imports grew significantly reaching 8.7 % in 2006 against 2.7% in 1995.

B) Capital AccountThe only net inflow recorded in the capital account was the oil sector and other capitaltransactions amounting to SAR2.4 billion in 2006. Other private capital, commercial banks, andofficial capital reserves recorded net outflows of SAR360.1 billion. Robust growth attracts foreigninvestments which best serves the diversification plan and nourishes the capital account, yet it alsoincreases income outflows.It is worth noting that although FDI is not clearly stated on the capital and financial account,according to the UNCTAD, FDI in KSA in 2006 amounted to USD4.6 billion, 22.8% of total FDI inthe GCC, representing 1.3% of GDP. It is worth noting that although KSA ranks second inattracting FDI in the GCC it is far behind the UAE which drew in investments worth USD12.0 billionfor the same year.

Table 16: Capital and Financial Account (FY03-FY0 6)

SAR bi l l ion FY03 FY04 FY05 FY06

Capital movements and Reserves -105.1 -194.7 -337.4 -357.6

A) Oil Sector and Other Capital Transactions (net) -2.1 -1.2 1.7 2.4

B) Other Private Capital (net) -38.1 -70.6 -108.9 -18.3

C) Commercial Banks 11.4 -6.0 20.6 -44.2

D) Official Capital & Reserves -76.2 -116.8 -250.8 -297.5




KSA - Economy 21

Conclusion

The current account balance to GDP reached a high of 28.5% in 2005, up from its lowest deficit in1995, amounting to 3.7% of GDP. The rise was triggered by the jump in international oil prices.The trend was maintained in 2006 and is expected to be sustained since a huge bulk of total

exports come in the form of oil, and oil prices are not expected to see a huge drop (retreatingback to a 2004 level standing at USD34.53 per barrel) from its current levels averaging USD62.01per barrel year to date. Over and above, KSA is planning to raise its oil production to 12.5 millionbarrels per day in 2009 from a current production capacity of 8.54 million barrels per day, as of the first half of 2007.

As for the Saudization program, the more it diffuses into the economy, the more workers'remittances will drop, positively affecting the trade balance. But until then, coupled with theplanned increase in oil production, the trade balance surplus is expected to shrink with theincrease in workers remittances and capital outflows generated by profit repatriation.



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ksa country report-oct[1].07

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