Saudi Arabia: Ready for Take-Off?

Are there any hidden assumption of price rigidities in Saudi Arabia that might inhabit market force indicators from revealing the true economic health of the country, there by either preventing government policy actions from correcting the problems or otherwise making them ineffective and counterproductive? How difficult is it to invest and repatriate profits and how would you deal with the need for educated managers and executives that can operate effectively in Saudi Arabia?

Ans:
The case talks about vision of SAGIA which says “… to attract sufficient investment to achieve sustainable rapid economic growth, while capitalizing on the Kingdome’s competitive strength as global capital of energy and as a major hub between east and west“. This vision depicts the fact that high importance is given to oil revenues. In a survey of global competitiveness, high ranking of KSA is attributed by its macroeconomic stability. However it does not show major problems identified for doing business in KSA. Thehidden assumptions of price rigidities in Saudi Arabia, inhabitingmarket force indicators from revealing the true economic health of the country, shows the extent offoreign exchange exposure.Sustained real exchange rate misalignment can cause severe macroeconomic disequilibrium which is one of the threats for KSA.

Real exchange rate stability is crucial to developing countries since it affects capital inflows, foreign direct investment, and trade according to comparative advantage. KSA preferred to maintain a predictable riyal exchange rate. To achieve this goal, the monetary authority adopted a policy of a fixed exchange rate regime. It is well known that fixed exchange rates where foreign exchange reserves play a major role in money supply fluctuations are conducive to the transmission of foreign disturbances into the domestic economy. A small open economy like that of Saudi Arabia (where there is one dominant export sector) can be subject to severe exogenous shocks. It is important to evaluate the extent these oil price shocks transmit to the real exchange rate.

Another potential source of fluctuation in the real exchange rate in Saudi Arabia is oil production. Decisions regarding oil production have important consequences for oil revenues, government spending, and foreign exchange reserves. These, in turn, affect the exchange rate through the supply of foreign exchange as well as the demand for foreign exchange.

Given the importance of oil revenues and government expenditures as driving force in Saudi Arabian it is expected that monetary expansion would at most play secondary role in inducing expenditures. In Saudi Arabia context

a.Real income is dependent upon the ability to import goods and services rather than the ability to produce goods and services (other than oil); b.Government spending, even with a budget surplus, can still imply stimulativefiscal policy because most government revenues comes from abroad; and c.Stimulative fiscal policy leads directly to an increase in the money supply because of the underlying structure of the country’s financial markets i.e., their general underdevelopment.

Difficulties in investment and repatriating profits are caused by following factors:

a)Inefficient Government bureaucracy
b)Inadequately educated work force
c)Restrictive labor regulations
d)Inadequate supply of infrastructure
e)Lack of access to financing
f)Oil policy influences fiscal and monetary policy. Since oil production shocks are a major source of real exchange rate variability,it is important to develop a stable oil policy to stabilize the real exchange rate. The need is to diversify domestic production and export base to reduce the vulnerability of the economy to oil sector.

In order to deal with the need for educated managers and executives that can operate effectively in Saudi Arabia, I would prefer to implement following steps:

Education system reforms up to senior secondary level to attract more investment in education sector Set up more number of Industrial training institutions to narrow the gap of skilled labor force. Incentivizing the professional education sector by talent pooling and providing diversified job opportunities in various industrial sectors at home country level. Removal of protectionist approach for local employment of skilled and unskilled labor forces. Upper limit should not be more than 50% .

ii) What is the current domestic and international economic situation in the country relative to best performance measures for that country? SWOT Analysis
Strengths
1.Macroeconomic stability
2.Creation of SAGIA, centralisation in one government ministry and Investors’ information clearinghouse 3.Global capital energy
4.SAGIA’s one stop shops(OSS)
5.Cisco’s NETVERSITY program with public education organizations to provide advance business and technical training and 100% absorption to enrolled techies. 6.No serious impact of world economic and financial crisis

7.Slower economic growth. A softening of commodity prices, exchange rate trends, these all helping in curb inflation. Lower interest rate discourages the banks from holding and depositing cash with SAMA 8.Countries to which Saudi exports had surplus USDWeaknesses 1.Sophistication of company operations and strategy

2.Quality of national business environment
3.Inflation connected to rising energy prices
4.Internal entrepreneurship lacks infrastructure in place to support its growth 5.Supply of skilled workers and managers was small as per the high local demand. Skill shortage in areas of leadership, strategic thinking and communications 6.Perusing business related courses is less than 5%

Opportunities
1.14 people out of 100 are having computers .Low number of computers in use per capita 2.Favourable tax rates and tax regulation for FDI
3.Low level burden of Govt. regulations
4.Still low penetration rates across fixed line and mobile services 5.Consortia of telecom players in KSA with local interests
6.SAP larger presence to make enterprise software to manage business operations and customer relations and other telecom business activities aggressively with more local hiring 7.KSA’s agreement with CISCO to build ICT infrastructure in 3 of the planned economic activities 8.SAMA’s interest rate cut(5th since October 2008) to stimulate commercial bank lending 9.Increased Govt. spending in large expansion of crude oil output and refining capacity to counter the effects of falling oil prices, a freeze in local bank lending, and a declining stock market 10.Govt. Investments in rail infrastructure, healthcare and education sector will bring multiplier effects 11.Govt. increased spending on education sector, adding 10 new universities, totalling to 22

Threats
1.Government regulations for FDI in some of the ignored sectors 2.Inefficient government bureaucracy
3.Inadequately educated work force
4.Restrictive labor regulations
5.Inadequate supply of infrastructure
6.Lack of access to financing
7.Govt. protectionism for local employments. Saudization (up to 70% local hiring) gives the corporations to increased investments in training the Saudis they hired 8.Real GDP has been on target but inflation has not .

9.Too much dependence on energy prices, decline in its prices from decrease I demand generates shocks for economy 10.Govt. Project delays in completion due to slowdown. Manufacturing sector’s sharp decline in profit due to slowdown in 2008 11.Growing budget deficits function of recovery in oil prices .Recovery is expected to come in picture in late 2010 12.Too much exposure to oil revenue is having devaluation in SAMA’s foreign assets 13.Pegging of Riyal to US dollar requires KSA monetary policy in line with U.S. monetary policy 14.Current account surplus decline due to lower oil prices resulted in lower interest earnings on investments in US. In case of current account deficit, resulting drawdown in international reserves to support the riyal peg to U.S. dollar to current level will be in danger. Subsequent larger fiscal deficit than planned will hurt Govt. ability to stimulate economy 15.Net exchange rate exposure vis-à-vis Europe, Export –import scenarios drastically keep on getting changed with Euro or U.S. dollar appreciation-depreciation to each other 16.Efforts to establish a single currency for GULF Cooperation Council of nations, though it is deferred for longer period in future

iii) Is Saudi Arabia currently following appropriate economic policies from a domestic as well as an international perspective? Provide supporting justification for your answer.

Saudi Arabia is on right track of economic reforms in order to attract FDI from international perspective and on domestic level it is doing quite well to diversify domestic production and export base to reduce the vulnerability of the economy to oil sector. There are few exceptions as well. Following aspects are discussed below to support this stand:

1.Creation of SAGIA, centralisation in one government ministry and Investors’ information clearinghouse. SAGIA emphasis on energy, transportation and ICT. 2.Creation of SAGIA’s one stop shops(OSS), centralized wide range of critical services for investment friendly initiative 3.Reforms in education sector enabled foreign players to narrow skill gap .One of the initiative is Cisco’s NETVERSITY program with public education organizations to provide advance business and technical training and 100% absorption to enrolled techies. 4.SAP larger presence to t make enterprise software to manage business operations and customer relations and other telecom business activities aggressively with more local hiring 5.Slower economic growth. A softening of commodity prices, exchange rate trends , these all helping in curb inflation. Lower interest rate discourages the banks from holding and depositing cash with SAMA. 6.Favourable tax rates and tax regulation for FDI

7.Low level burden of Govt. regulations on foreign players to increase FDI 8.SAMA’s interest rate cut(5th since October 2008) to stimulate commercial bank lending 9.Increased Govt. spending in large expansion of crude oil output and refining capacity to counter the effects of falling oil prices, a freeze in local bank lending, and a declining stock market. 10.Govt. Investments in rail infrastructure, healthcare and education sector will bring multiplier effects. 11.Govt. increased spending on education sector, adding 10 new universities, totalling to 22.

Exceptions:

Govt. protectionism for local employments. Saudization (up to 70% local hiring) gives the corporations to increased investments in training the Saudis they hired. Pegging of Riyal to US dollar requires KSA monetary policy in line with U.S. monetary policy. Floating real exchange rate would be good option to minimize the transmission of foreign disturbances into the domestic economy. Efforts to establish a single currency for GULF Cooperation Council of nations would decrease foreign players’ confidence in terms of direct investments in KSA. Growing budget deficits is a function of recovery in oil prices.Since oil production shocks are a major source of real exchange rate variability,it is important to develop a stable oil policy to stabilize the real exchange rate.

iv) Should WCC proceed to invest in production and distribution facilities? Explain and justify your recommendation.

As per the facts given, I would recommend that it would be good move for WCC to risk building a manufacturing plant and distribution center in Saudi Arabia, and strengthen the company’s competitive position abroad. Above recommendation is based on following aspects discussed below: 14 people out of 100 are having computers .Low number of computers in use per capita is huge opportunity to invest in emerging market like KSA. The size of the Saudi Arabian ICT market provides excellent operational scale. Because Saudi society is young (61%) and growing rapidly, its consumer market is weighted heavily towards technologically literate early adopters. No serious impact of recent world economic and financial crisis on KSA strengthens its macroeconomic stability Favourable tax rates and tax regulation for FDI and low level burden of Govt. regulations Improved technological environment in KSA with presence of CISCO and SAP will improve skill gap and business process integration respectively.

Govt. Investments in rail infrastructure, healthcare and education sector will bring multiplier effects. Govt. increased spending on education sector, adding 10 new universities, totalling to 22 in order to narrow skill gap and improving human capital. Increasing supply of qualified software engineers coming available due to public and private training initiatives. KSA’s unique access to energy makes it an attractive location for a range of activities across the ICT value chain.For example, ICT-enabled services providers (such as data centers) will be able to leverage Saudi Arabia’s unique access to low-cost power and state-of-the-art communications infrastructure to efficiently service global customers. Equipment and component production are also highly energy-intensive and require significant use of petroleum derivatives such as chemicals and plastics. Combined with KSA’s attractive setup incentives, these advantages translate into considerable cost savings for hardware manufacturing and assembly activities. Threats discussed in SWOT analysis are low to moderate ones, which can be rectified by Govt. machinery in time.