Macroeconomic Analysis of Saudi Arabia

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Topic: Business & Economics
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Introduction

This paper presents a detailed macroeconomic analysis of Saudi Arabia. The study will focus on four areas, namely, unemployment and inflation; fiscal policy and monetary policy; economic reforms; and balance of payments and exchange rate. Saudi Arabia is the largest economy in the Gulf Cooperation Council (GCC). It is also one of the fastest-growing economies among the G-20 countries.

Economic growth in Saudi Arabia is mainly driven by huge oil exports that account for nearly 75% of the government’s revenue (Kayed & Hassan, 2011). In the last decade, the government has focused on diversifying the economy to reduce its reliance on oil exports. This involved liberalizing the economy to attract foreign direct investments and expanding the country’s private sector. Despite these efforts, the country still faces economic challenges, such as the rising unemployment rate.

Unemployment and Inflation

Unemployment

Saudi Arabia’s unemployment rate has risen steadily from 5.7% in 2009 to 11.7% by the end of 2013 (Khan, 2013). The factors that explain this rapid increase in unemployment rate include the following. First, the high unemployment rate in Saudi Arabia is attributed to its poor education system (Khan, 2013). The country’s institutions of higher learning focus on imparting theoretical knowledge rather than vocational skills. As a result, there is a mismatch between the skills that Saudis have and the needs of employers in the private sector.

This increases the unemployment rate by raising employers’ operating costs. Specifically, employers have to invest in training programs in order to improve the skills of new hires in Saudi. In order to avoid this cost, employers opt to hire foreigners who have advanced skills and are able to create value for their companies as soon as they are employed. This explains the fact that Saudis account for only 10.9% of the workforce in the private sector (Khan, 2013).

Second, the high unemployment rate in Saudi is caused by wage disparities between the private sector and the public sector. The public sector offers a better remuneration package and job security than the private sector (Mohamud, 2013). As a result, Saudis prefer to work for the government in order to benefit from better pay. However, job creation within the public sector is limited since the government is committed to reducing public debts and expenditure.

Moreover, employers in the private sector are reluctant to employ Saudis who always demand high salaries. Thus, most jobs are taken by expats who accept low salaries, thereby enabling employers to reduce operating costs.

Third, the unemployment rate is high due to Islamic teachings that hinder female Muslims from mingling with their male counterparts at the workplace (Khan, 2013). Social reforms have led to an increase in the number of females who are graduating from universities in Saudi. This has led to high unemployment rate among women.

High unemployment will cause a reduction in economic growth in Saudi. As aggregate consumption reduces due to the high unemployment rate, economic activity will decline (Arnold, 2010). Thus, the country’s GDP will reduce. The high unemployment rate will also affect the equities securities market negatively. Listed companies will realize little or no growth in profits if the high unemployment rate leads to low purchasing power in the country.

The resulting reduction in corporate profits and cash dividends will cause significant capital loses as share prices reduce (Boyes & Melvin, 2012). The rising unemployment rate is also likely to create social unrest. This will destabilize the political system, thereby stagnating economic growth through disruption of business activities and destruction of property.

Unemployment can be reduced through the following strategies. To begin with, the government should improve the education system by implementing a new curriculum for higher education. The curriculum should focus on developing practical skills to enable Saudis to fit into the job market (Kayed & Hassan, 2011).

Cultural and religious restrictions should be eliminated to allow more women to participate in the job market. This will reduce unemployment among women. Moreover, the government should provide incentives to private employers to hire Saudis. For instance, the government can reduce the corporate tax for companies that hire Saudis to increase employment.

Inflation Rate

Saudi Arabia’s inflation rate reduced from 4.8% in 2012 to 3.5% in 2013. It further reduced to 2.8% at the beginning of 2014 (SAMA, 2014). This reduction is explained by the following factors. First, the reduction is attributed to the strengthening of the US dollar to which Saudi Arabia’s currency is anchored. The strengthening of the dollar has made imports from other countries apart from the US to be cheap in Saudi Arabia, thereby reducing inflation.

Second, inflation has been declining due to the reduction of global food prices. Saudi Arabia heavily depends on imported food. Thus, a reduction in food prices in the external market directly exerts downward pressure on inflation in the country (Romer, 2011). Third, the inflation rate has been declining due to the reduction of inflation in Saudi Arabia’s major trading partners such as China. The reduction of inflation in the major trading partners reduces the cost of imports, thereby reducing inflation.

The main effect of declining inflation is that economic growth will improve. Low inflation leads to high purchasing power (Hubbard, O’Brien, & Rafferty, 2013). The resulting increase in aggregate demand will improve economic activity and expansion of the GDP. Low inflation is also likely to reduce the unemployment rate (Hubbard, O’Brien, & Rafferty, 2013).

Specifically, improved purchasing power will motivate Saudis to accept jobs in the private sector, even if the salaries are low. Low inflation will also reduce lending interest rates. The resulting increase in the money supply will spur economic growth.

In order to maintain an acceptable inflation rate, the government should avoid high expenditure. Moderate government expenditure will eliminate demand-pull inflation in the country by reducing competition for goods and services in the private sector (Heijdra, 2009). In addition, the government should avoid maintaining very low-interest rates.

This will control the supply of money, thereby preventing a rapid increase in inflation. At the domestic level, the government should improve its strategic food reserves to prevent an increase in inflation in the future. This strategy is based on the fact that the fluctuation of food prices is the main cause of inflation in Saudi Arabia. Thus, a stable supply of food will reduce the volatility of inflation.

Fiscal and Monetary Policy

Fiscal Policy

The government of Saudi Arabia is currently pursuing an expansionary fiscal policy. This involves increasing its expenditure on development projects (Ghazi & Starr, 2011). These include the construction of industrial centers, expansion of roads, and building airports. The government has also increased social welfare expenditure by constructing new schools and hospitals. The advantages of the expansionary fiscal policy include the following.

First, increased government expenditure will improve economic growth by supporting the demand for locally produced goods and services (Mankiw, 2011). The resulting increase in economic activities will result in an increase in GDP. Second, the expansionary fiscal policy will enable the government to reduce the unemployment rate. Increased expenditure in the government directly creates jobs in the public sector.

For example, expansion of schools and road networks will lead to the employment of more teachers and engineers by the government. In addition, private companies will employ more people to take advantage of the high demand as the government increases its expenditure. Third, the expansion of transport infrastructure and the education system will enable Saudi Arabia to attract foreign direct investments (Ghazi & Starr, 2011). This will boost economic growth and reduce the unemployment rate.

The main disadvantage of the expansionary fiscal policy is that it will lead to an increase in inflation (Sikdar, 2006). Since the policy leads to a significant increase in aggregate demand, the producers of various goods and services will have to ration their products through high prices in order to meet the needs of their customers. The price increase is likely to occur in the short-run when companies cannot increase their output to satisfy the effective demand.

Significant price increases will raise inflation, thereby stagnating economic growth and reducing the standards of living (Romer, 2011). The expansionary fiscal policy is also likely to increase public debt.

Currently, the government finances its expenditure mainly through oil exports. Thus, it will have to borrow from the public to offset its budget deficit if oil revenues decline. Increased public debt will lower economic growth in the future as the government uses a significant portion of its revenue to repay debts rather than stimulating economic growth.

Monetary Policy

Saudi Arabia’s monetary policy closely follows that of the US because its currency is pegged to the US dollar. Since 2009, the US has been pursuing an expansionary monetary policy that is characterized by large scale repurchase of debt securities from the public. As a result, Saudi Arabia’s monetary policy continues to be expansionary with the repo rate remaining at 2% and the reverse repo rate at 0.25% (IMF, 2013). The expansionary monetary policy will have the following effects on the economy.

First, the low repo rate means that commercial banks can borrow money cheaply from the Saudi Arabian Monetary Authority (SAMA). This will increase credit availability as commercial banks lower their lending interest rates to attract more customers. Similarly, deposit rates will reduce since the cost of borrowing money among commercial banks is low. As a result, there will be a net increase in money supply in the economy.

This will boost demand for investments and locally produced products, thereby increasing economic growth (Arnold, 2010). Second, the expansionary monetary policy will boost the development of the country’s banking sector. Specifically, low lending rates will increase the uptake of loans, thereby increasing the profits of commercial banks.

Third, low-interest rates will enable the government to solve the problem of the housing shortage in Saudi Arabia. Specifically, mortgage rates will be low in the country. This will enable more citizens to purchase homes.

Although the expansionary monetary policy is likely to encourage economic growth, inflation is likely to increase in the future. Undoubtedly, a significant increase in money supply increases inflation, especially if the supply of various goods and services fails to increase adequately in the short-run. High inflation will lead to capital flight as foreign investors shift their capital to countries with low inflation to avoid losing the value of their money (Argy, 2013).

Generally, capital flight will reduce economic growth and development of the capital markets. The expansionary fiscal policy will also discourage citizens from saving due to the expected reduction in deposit rates. Citizens will not be able to cushion themselves from the negative effects of limited credit availability in the future if they do not have adequate savings. In addition, commercial banks will have to depend on SAMA to access credit. As a result, the banking system will lack liquidity if SAMA increases the repo rate.

Effectiveness of Economic Growth Reforms

The government of Saudi Arabia has implemented several economic reforms to boost economic growth. To begin with, the government is “diversifying the economy to reduce dependence on oil exports” (Verma & Saleh, 2011, pp. 136-148). Diversification initiatives focus on expanding the energy, telecommunication, and technology industries.

The government is committed to liberalizing the economy by eliminating barriers to international trade. In a bid to improve efficiency, the government has focused on privatizing its large companies. Saudization is also an important policy that the government continues to implement to increase the employment of Saudis in the private sector. These reforms have had the following achievements in the economy.

To begin with, economic liberalization efforts in Saudi Arabia have led to increased FDI flows and economic growth (Rogmans & Ebbers, 2013). In 2013, Saudi Arabia emerged as the best investment destination among the Arab countries. It accounted for 25.8% of the total FDI flows in the Arab world (Roberts & Almahmood, 2013). This achievement is attributed to the government’s efforts to eliminate tariff and non-tariff barriers to trade.

Saudization policies have not achieved the expected results. In the last five years, Saudi Arabia’s GDP grew at an average rate of 6.25% (Mohamud, 2013). Contrary to the government’s expectation, the rapid economic growth did reduce the unemployment rate among Saudis. This failure is mainly attributed to the fact that the quota system that the government is using to force private sector companies to employ Saudis has failed. For instance, in the last four years, two million jobs were created in the private sector. However, only five hundred thousand jobs went to Saudis (Rogmans & Ebbers, 2013).

The efforts made by the government to develop the private sector through privatization and fostering the growth of private companies have been very successful. In 2013, the private sector grew by 6.2%, thereby creating new jobs in the economy (IMF, 2013). Privatization has reduced the government’s participation in the economy and enabled more citizens to have ownership in the country’s largest corporations. This has facilitated the redistribution of wealth from the government to the public.

Thus, inequality and poverty have significantly reduced in the country (Kayed & Hassan, 2011). In addition, privatization has enhanced the performance of the country’s corporations in terms of corporate governance and profitability. For example, SABIC has emerged as the world’s second-largest petrochemical company in the world after its listing at the Saudi Stock Exchange.

The reforms that have been implemented to diversify the economy are also effective. In the last four years, the non-oil sector expanded at an annual average rate of 7.5% (IMF, 2013). Moreover, non-oil exports grew by 14% in 2013 (IMF, 2013). As the non-oil output increases, Saudi Arabia will be able to maintain stable economic growth. In addition, rapid growth in key sectors such as manufacturing, technology, and banking will enable the country to create more jobs.

Effects of Balance of Payments on Exchange Rate

In the last four years, Saudi Arabia maintained a balance of payments surplus of nearly 20% of its GDP (Rabobank, 2012). This surplus is mainly attributed to improved earnings from oil exports. The balance of payments surplus means that the payment made by the country to its trading partners is less than those it receives from other countries (Saqib, 2013). In this context, there is a net inflow of money into Saudi Arabia. As a result, the country’s currency is expected to strengthen.

However, this has not been the case since Saudi Arabia’s exchange rate is fixed. The government, through SAMA, intervenes in the foreign exchange market by purchasing the excess foreign currency to restore the exchange rate to its fixed level. As a result, the balance of payments surplus does not have a significant effect on the country’s exchange rate (Akikina & Al-Hoshan, 2003).

Saudi Arabia had a low foreign debt of approximately 13% of its GDP as at the end of 2013. In addition, the country’s “debt service ratio on existing obligations is less than two percent of its export earnings” (Rabobank, 2012, p. 8). The low foreign debt level has been achieved through effective debt management strategy. The government has opted to delay payment of its domestic debts in order to repay its external loans.

Moreover, the government of Saudi Arabia has strategically chosen to pay its foreign debts using oil export earnings (Rabobank, 2012). In order to avoid escalation of foreign debts, the government has opted to borrow in the domestic market to finance its budget.

This strategy is not likely to have significant negative effects on economic growth in the short and medium-term since Saudi Arabia’s overall debt is less than 30% of its GDP (Roberts & Almahmood, 2013). This implies that additional borrowing in the domestic market is not likely to crowd-out investments in the private sector. However, economic growth is likely to stagnate if the public debt exceeds 70% of the country’s GDP.

Conclusion

Saudi Arabia has achieved rapid economic growth in the last five years. The rapid growth is mainly attributed to increased oil exports and the effectiveness of the economic reforms that have been implemented by the government. The major economic reforms that have been implemented include diversification of the economy, privatization, and liberalizing the economy. Apart from these reforms, the government has focused on implementing expansionary fiscal policy to spur economic growth.

Despite achieving high economic growth, Saudi Arabia’s unemployment rate is still very high. The factors that account for the high unemployment rate include salary disparities between the private sector and the public sector, as well as, lack of the right skill set among Saudis. In this regard, the government should address the problem of rising unemployment rate by improving the education system. Additionally, the government should incentivize the private sector to employ more Saudis.

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