A Saudi investor monitors stock prices on screen.

JEDDAH: Saudi Arabia’s decision to open its stock market to foreign investors is part of an accelerating series of economic reforms that may culminate in the most far-reaching change yet: higher domestic energy prices.

The Kingdom remains deeply dependent on oil exports, leaving it vulnerable to any big downturn in global energy prices and the time, decades from now, when its crude reserves begin running out.

The opening of the $550 billion stock market to direct investment by foreign institutions, announced on Tuesday, is part of efforts to correct this — along with other changes introduced in the past three years including labor market reforms and a new mortgage lending law.

Saudi authorities now appear to be calculating that significant changes to the economy can wait no longer — and that with high oil prices swelling state finances, they have an opportunity to make reforms that could become more difficult later, when conditions are less comfortable.

“I expect more efforts in the reform process over the next five years, given the huge wealth and forecasts that oil prices will remain over $100,” said Abdulwahab Abu Dahesh, a prominent Saudi economist.

“The political jitters around us helped to raise wages, reform the labor market, allocate SR250 billion for housing and speed up the launch of the mortgage law,” he said.

Since 2011, the government has shown it is willing to see considerable short-term disruption to the economy as it pursues long-term reforms.

Labor market quotas and fees have made it harder for firms to hire cheap foreign workers.
The earnings of companies which rely heavily on foreign labor — particularly in construction, retail and transport — have been hit hard, more than halving in some cases.

In recent months the impact has started to feed through into the economy as a whole; the growth of Saudi Arabia’s nonoil private sector slowed to 4.4 percent year-on-year in the first quarter of 2014 — the slowest pace in at least a decade — from 6.2 percent in the previous quarter.

Saudi authorities have largely resisted pressure from the business community to water down the labor reforms. They are calculating that the long-term benefits — the prospect of moving more Saudi citizens into private sector jobs, and limiting the billions of dollars which foreign workers remit to their home countries each year — outweigh the costs.

Labor Minister Adel Al-Fakeih said in January that Saudi Arabia had doubled the number of its citizens working for private companies in the 30 months since it launched the labor reforms.
Similarly, the government introduced a mortgage lending law last year as a step toward reducing the housing shortage.

Meanwhile, liberalization of the civil aviation industry promises to improve services by allowing in new private sector airlines.

The stock market reform is a step in the same direction.

The motive is not financial; many big Saudi companies are so rich that they have no need of foreign money.

Instead, authorities hope big foreign fund managers will act as activist shareholders in Saudi Arabia, pushing for improvements in efficiency and better corporate governance while helping to make companies more international.

In particular, authorities want foreign investors to facilitate stock market listings by the family-owned firms which still account for large parts of the non-oil economy.

“One of the main challenges for family businesses is to be sustainable over time across generations,” said Fahad Alturki, head of research at Jadwa Investment in Riyadh. “Being listed on the market facilitates stability and sustainability of these companies.”

There is plenty of skepticism about Saudi Arabia’s reform drive.

Huge bureaucratic and political obstacles persist; for example, the mortgage law may not stimulate house-building much if the conservative courts fail to apply it and wealthy land owners refuse to sell some of their holdings into the market.

But there are initial signs of success: last year, the nonoil sector’s contribution to real gross domestic product rose to 78.7 percent, the highest level since at least 1970, from 62.9 percent in 1998.

Authorities have not yet passed the biggest test of their commitment to reform: reductions to the huge energy subsidies which keep domestic fuel prices for consumers and industrial users among the lowest in the world.

The subsidies lead to waste, encourage Saudi industrial firms to rely on ultra-low energy prices instead of pushing themselves to become more efficient, and consume large parts of the state budget.

The International Monetary Fund thinks the government could start running annual deficits as soon as 2018 because of such spending.

Without subsidy reform, Saudi Arabia could eventually start consuming so much of its oil that it has to cut back exports.

It is the sixth-biggest oil consumer globally despite being only the 19th largest economy, and consumed more than a quarter of its production in 2013, BP’s world energy review shows.

In the last few years, senior government officials have made comments suggesting subsidy reform is on the agenda; in May last year, for example, Economy and Planning Minister Mohammed Al-Jasser told a Riyadh economic conference that subsidies needed to be cut.

There is still no clear sign that serious plans are being laid, however, for what could be the most painful and politically sensitive reform so far.

Jim Krane, an energy studies fellow at Rice University’s Baker Institute for Public Policy in the US, said Saudi Arabia could cut its gasoline demand by a third through eliminating subsidies and letting prices rise.

But he added, “The reform is politically toxic. Perhaps the biggest risk implied by reforms of subsidies and social contracts is the possibility of unrest.”

 
[wpResize]