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The politics of Saudi subsidies.


IN SAUDI ARABIA, PETROL, WHICH COSTS 18 us cents a litre, is cheaper than a bottle of water. That's due to the billions of dollars the kingdom spends on subsidies for its population, which also cover food, electricity and housing. In the wake of the unrest sweeping the Arab world, the cost of these subsidies is set to rise even more, a trend which many bankers, economists and analysts fear could hinder the country's attempts to create the hundreds of thousands of new jobs it needs each year, as well as eating into the kingdom's oil revenues and oil exports. However, there are also far-reaching political implications to be considered.

John Sfakianakis, chief economist at Banque Saudi Fransi (BSF) in Riyadh, estimates that Saudi Arabia spends some 76 billion Saudi riyals, about $20.2 billion, on water subsidies every year, and another SR 50 billion ($13.3 billion) on keeping down the price of electricity. King Abdullah announced massive increases in government expenditure following the outbreak of protests in the country's Eastern Province. His measures call for additional spending of up to SR 485 billion ($130 billion) on everything from bonuses for government workers, extra funding for the military, security and religious authorities, housing and unemployment benefits and scholarships to new hospitals, schools and clinics, as well as an increase in existing subsidies.

How much of the massive new package will go to specific subsidies is not yet clear, but the Minister of Finance, Ibrahim Al Assaf, told the media in May that the kingdom had already spent SR 50 billion ($13.3 billion), mainly for the workers' bonuses. Given that the kingdom uses a considerable portion of its own crude oil production to desalinate water and generate power, the cost of underpinning both water and fuel costs for households this year could rise substantially.

In 2010, the cost of a barrel of oil averaged $80, compared to $61 in 2009, meaning that spending on subsidies had already risen markedly even before the King's latest announcements. By the end of May, the price of a barrel of oil was up another 9%, adding still more to the endless upward trend in the government's outlays. High population growth, and a dramatic rise in local consumption will add still more to the cost of the subsidies.

Last summer, Saudi Arabia diverted up to one million barrels of oil a day to generate electricity and to desalinate water, says Jamie Webster, an analyst at PFC Energy in Washington. He estimates this could reach 1.2 million b/d in the peak months of this year.

"With all the unrest and the desire to keep it at bay," he adds, "there's no way Saudi officials are going to enter into discussions or seriously contemplate raising domestic prices for energy." And, as other analysts and expert observers of the kingdom noted, for most of Saudi Arabia's 20 million population, cheap petrol, electricity and water is regarded as simply part of what they should receive in a country with such abundant oil wealth.

For the government, the additional spending, however massive, is unlikely to pose a big problem in the short term. The economy is expected to expand by an impressive 5.396 this year, according to analysts at Riyadh's National Commercial Bank (NCB). Oil production is slated to rise by more than 6% to 8.8 million barrels a day, which, together with higher oil prices, is forecast to produce near-record revenues of SR 828 billion ($221 billion) by the end of December. This, in turn, even with the extra expenditure, could result in a budget surplus, according to NCB, of nearly SR 63 billion ($17 billion) by the end of December.

Rising discontent

The real problem is that such high outlays, even if presently affordable, may spell deep trouble in the long term. By squeezing out the private sector, they are likely to hinder the development of Saudi Arabia's non-oil sector, especially the small and medium-sized enterprises needed to create jobs for the country's youth, more than half of whom are under the age of 25. Additionally, given that oil exports currently account for about 86% of government revenues, the need to consume more oil locally for domestic needs could leave less for export, thereby shrinking government coffers at the same time its expenditure is rising, apparently beyond its control.

"The Saudi government's substantial state spending programme ... has left a question mark over whether the country can successfully promote diversification away from its predominant reliance on oil by spurring greater private sector activity," BSF said in a study issued in May. "After exceeding 5% between 2004 and 2007, private sector growth has slowed to below 4% for the past three years, a rate that fails to encourage an adequate level of job creation for the kingdom's youth," the report noted. The real level needed to achieve that, BSF estimates, is closer to 6.5%.

Social safety nets

However, much more worrying, the BSF revealed that average Saudi incomes have been falling in real terms. Adjusted for inflation, "each resident was earning $8,550 in 2010, virtually on a par with the level in 1991". This is below "the peak of $14,773" reached in 1980, the bank notes. Such studies, although little publicised, raise additional questions about whether Saudi Arabia, despite its huge spending power, can avoid the rising discontent that has faced other Arab countries, when living standards for many people have gone down, rather than up.

Khalid Al Falih, the head of state-owned oil corporation, Saudi Aramco, estimates the kingdom's domestic energy demand could rise to the equivalent of 8.3 million b/d by 2028. But by diverting ever-larger amounts of fuel consumption to domestic use, governments throughout the Gulf states are nearing the point where domestic consumption will conflict with exports.

Even on the best of terms, with Saudi Arabia able to up its output thanks to both local and foreign investment in its oil fields, the country would then not be able to export more than 7 million barrels of crude a day, Sfakianakis estimates. That's about 1.8 million b/d less that is currently expected this year.

So what's to be done?

Two policy areas need immediate attention, according to international experts: first, subsidies should be directed at those most in need; and, secondly, Saudi Arabia needs to diversify its sources of energy, focusing more on natural gas and renewable energies such as solar and wind, thereby reducing its dependence on crude oil. This, they say, could help to alleviate the long-term problems facing the kingdom, as well as reassuring the world that the country's vast oil resources will be available to help support the global economy, as well as their own.

Subsidies should be directed at "people", rather than at "commodities", argues the IMF. Otherwise, they just help "the rich".

An IMF report, launched recently at the Carnegie Mellon Middle East Centre in the Lebanese capital, revealed that less than half- 40%--of the Arab world's population received just 20% of the benefits provided by government subsidies on items such as food and fuel. Instead, he argued, "social safety nets" should be set up to ensure that the wealthier sections of the population do not gain more than the poor from programmes ostensibly aimed at protecting the most vulnerable in Arab societies. In other words, subsidies should not just be provided for all, but primarily for those in need.

Equally important is the need for Saudi Arabia, like the UAE and Kuwait, to invest in energies that could save its own resources of crude oil for export, rather than draining it for domestic needs. At present, the kingdom is at the bottom of the Gulf states' league table when it comes to using natural gas for electricity generation, never mind using gas--a much more environment-friendly fuel--for water desalination projects.



Grants and subsidies

There's also the question of the subsidies Saudi Arabia gives to its own royal family. The most common mechanism for distributing Saudi Arabia's wealth is the formal, budget system of monthly stipends that members of the Al Saud family receive.

These can range from $800 a month ($9,600 a year) for the lowliest member of the most remote branch of the family up to $270,000 a month ($3.24 million a year) for one of the surviving sons of Abdul Aziz ibn Saud, the founder of modern Saudi Arabia.

In the mid-1990s, the total cost of these subsidies would have amounted to about $2 billion, according to the dispatches. This would have been about 5% of the annual budget of $40 billion.

Whatever the figures, it is clear than in the age of Facebook, Twitter, and growing concerns about human rights, freedom and climate change, Saudi Arabia, now and in the future, faces difficult challenges. What is also certain, is that there is a way forward, with new thinking, that can ensure both stability and progress, provided much-needed policy changes are adopted.
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Title Annotation:Current Affairs/SAUDI ARABIA
Comment:The politics of Saudi subsidies.(Current Affairs/SAUDI ARABIA)
Publication:The Middle East
Geographic Code:7SAUD
Date:Aug 1, 2011
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