COLUMN-Saudi oil wealth is again a magnet for western leaders: Kemp | Reuters


(John Kemp is a Reuters market analyst. The views expressed are
his own)

* Chart 1: tmsnrt.rs/2pWk87a

* Chart 2: tmsnrt.rs/2qrw5Fn

By John Kemp

LONDON, May 17 Saudi Arabia has again become the
favourite destination for western political leaders seeking to
promote arms sales and encourage other exports to boost their
economies at home.

UK Prime Minister Theresa May visited last month to promote
trade as the country seeks to diversify its export markets after
Brexit.

U.S. President Donald Trump is scheduled to make his own
pilgrimage to Riyadh later this week with reports suggesting the
two countries have been negotiating arms deals worth more than
$100 billion.

Britain and the United States are both angling to secure
part of the stock market listing following the planned sale of
shares in Saudi Aramco.

Both have major oil companies, oilfield service providers
and technology firms that hope to secure contracts to develop
the kingdom’s oil, gas, refining and petrochemical industries.

And both are also major financial services centres that see
lucrative opportunities helping the kingdom raise external
capital and manage its enlarged sovereign wealth fund.

But there is a contradiction between the kingdom’s need to
reduce its foreign spending and plans to build up domestic
industries on the one hand, and the hopes of U.S., UK and other
leaders for an export bonanza.

More generally, there is a tension between western
countries’ tendency to see the kingdom as a fabulously rich
customer and its current need to reduce foreign spending
following the slump in oil prices.

For the time being, it suits political leaders on both sides
to talk up the potential for deals, but some may turn out to be
long on symbolism and shorter on substance.

OIL FOR ARMS

The exchange of oil for security, and as one component
within this arrangement oil revenues for arms sales and other
contracts, is one that is familiar to both the Saudis and their
western counterparts.

During the 1970s and early 1980s, the financial aspect of
the transaction was called petrodollar recycling, with the
Saudis and other Gulf monarchies pledging to buy billions of
dollars of western arms and other products.

The aim was to shore up the balance of payments of the
United States and other western economies following the enormous
rise in oil prices after the 1973/74 and 1979/80 oil price
shocks.

Saudi Arabia and the other Gulf producers got higher oil
prices and revenues, and in exchange promised to recycle a major
part of the surplus back into the western economies via arms
purchases and investments.

Saudi Arabia’s fabulous oil wealth has always been a magnet
for western companies ranging from oil and gas to construction
and financial and professional services.

Saudi leaders and economists have sometimes complained about
the wastefulness of this spending and about being overcharged by
western businesses.

But in return for all this spending, Saudi Arabia has
cemented defence and security links with the United States and
ensured the kingdom’s diplomatic concerns are heard at the
highest levels in western capitals.

On the whole, the arrangement has suited both sides very
well for the last 40 years and the recent trips by May and Trump
should be seen within this context.

May needs to show that Britain can develop trading ties
outside the EU, while Trump wants to show he can cut the U.S.
trade deficit and create well-paid manufacturing jobs at home in
the United States.

For their part, the Saudis want to solidify and strengthen
U.S. and British diplomatic and military backing while they
remain in conflict with Iran.

AUSTERITY

The major problem is that the kingdom’s finances are under
severe strain as a result of the collapse in oil prices and an
expensive war in Yemen.

The government is running a substantial budget deficit and
has been forced to introduce tough austerity measures to trim
current and capital spending.

Even so, Saudi Arabia’s foreign reserves fell by $237
billion or 32 percent between August 2014 and March 2017,
according to data from the Saudi Arabian Monetary Agency (tmsnrt.rs/2pWk87a).

Foreign reserve assets have dwindled from $746 billion at
their peak in August 2014 to just $509 billion as spending has
systematically exceeded revenues (tmsnrt.rs/2qrw5Fn).

Saudi Arabia needs to maintain a large cushion of reserves
to maintain confidence in its currency peg and prevent a run on
the riyal.

Protecting the peg means there is an effective floor below
which reserves cannot be allowed to fall and although the
precise level cannot be known with certainty it is much higher
than zero.

The kingdom remains one of the world’s largest military
spenders but its spending was trimmed sharply in 2016, according
to the Stockholm International Peace Research Institute (SIPRI).

Saudi military expenditures totalled around $64 billion in
2016 but that was down from $87 billion in 2015 and $83 billion
in 2014 (“SIPRI military expenditure database”, SIPRI, 2017).

Saudi military spending ranked fourth in the world in 2016
behind the United States ($611 billion), China (estimated at
$215 billion) and the Russian Federation ($69 billion).

Military spending was still well ahead of the United Kingdom
($48 billion), France ($56 billion) or Japan ($46 billion),
underscoring its importance to armaments manufacturers.

But the arms procurement and military training budget is
under pressure from austerity like all other government
programmes.

LOCALIZATION

Saudi Arabia’s long-term development plan is to build up
domestic manufacturing and services sectors to reduce its
reliance on imports and foreign suppliers.

Stemming the outflow of foreign exchange by building up
internal capabilities is one of the central objectives of the
kingdom’s Vision 2030 plan.

Vision 2030 explicitly states “we plan to manufacture half
of our military needs within the kingdom to create more job
opportunities for citizens and keep more resources in our
country”.

Vision 2030 promises “we will work towards localizing
renewable energy and industrial equipment sectors” and “we will
continue to localize the oil and gas sector”.

On defence, Vision 2030 notes that only 2 percent of
military spending is currently within the kingdom and aims to
raise this to 50 percent by the end of the next decade.

Saudi Arabia will still remain a crucial customer for arms
makers in the United States, the United Kingdom and other
countries, and it is an important destination for a range of
other goods and services exports.

But beyond the high-profile signing ceremonies, it may not
be quite the fabulous cash cow for which western political
leaders are hoping.
(Editing by Susan Thomas)

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