The effect of global financial crisis on Saudi Arabian economy Research Paper

The world is recovering from global financial crisis that started in 2007. The crisis is believed to have originated from collapse of mortgage firms in the United States of America. Since the Great depression of 1930s, the crisis is considered as one of the worst financial crisis to have hit the world.

The crisis had an effect on Saudi Arabian economy as well as world economic situation. Saudi Arabia is Middle East country that is undergoing rapid economic development; it has the world largest population of Muslims (Saudi Arabia Economic Statistics and Indicators). This paper discusses the effect of global financial crisis on Saudi Arabian economy.

Global financial crisis

The global financial crisis started at the end of 2007, it is believed that the collapse of Fannie Mac and Freddie Mac. The two companies were mortgage companies based in United States; they are the major companies that are believed to have lead to the crisis.

By the end of 2007, the two mortgage companies owned over 50% of the mortgage market in the country. American living standards and financial welfare was deteriorated by the high charges of mortgages to a point that the default rate increased drastically. Low earning people, who were a majority of home loan borrowers, were unable to finance their mortgages.

They claimed that the mortgages were expensive to service alongside other necessities; many decided forfeit the contract. The country was left in a state of financial depression. One may ask how the crisis then spread to the rest of the world; the world is becoming a global village with international trade and globalisation. The United States of America has the world largest economy; it is also a major player in international trade as a consumer, collection destination, and exporter (Shiller 12-23)

The situation that the country experienced at the end of 2007, reduce the countries disposable income thus saving for investment was reduced. This reduced production in the economy. With limited disposable income, consumption in the country was reduced.

Saudi Arabia has over a fifth of the world’s oil reserves; they export most of these. When other world economies are not operating well, then the country will lack market for its products. In 2007, oil exports to United States from Saudi Arabia accounted for 15% of total oil export from the country. This was only second from Japan that had 17% (Nanto 67-78). This meant that if United States economy is not operating well then Saudi Arabia will be directly affected.

Global crisis and economic development in Saudi Arabia

The major export of Saudi Arabia is oil; it accounts for the countries 90% of income from exports. Although at the click of the crisis the country shown some stability, as it continued to pump oil, then the effect came from other countries exerting pressure on the country’s export.

In July 2008, the price of barrel oil was $147 a barrel but within a period of six months, the price had gone down to $38 in December 2008. The prices waited until April 2009 to stabilize at $50 per barrel. This left the county devastated, as it could hardly meet the cost of production with such a price. The reduced price reduced income from oil a move that made the country expansion rate reduced.

Income from oil in Saudi Arabia was expected to fall from $285 billion in 2008 to $111 billion in 2009. A reduction in oil production was experienced where it was 9.113 million barrels per day in 2008 and 8.055 million barrels per day in 2009. Before the crisis, the economy of Saudi Arabia has been expanding drastically. International trade and demand for fuel in the international markets had favoured it. The decreased barrel cost affected the countries balance of payment and terms of trade (SAMA).

In 2004, the country experienced an economic growth rate of 7.6%, in 2008, it had 5.27%, and in 2010, the country has 0.6%. Although the country rate of growth was still positive compared to a number of other countries rate which was negative, its rate had greatly been checked by the trend in world economies. In 2008, the world experienced the highest cost in oils cost at $147 per barrel, though Saudi Arabia has a benefit on this increased cost being one of the countries that have high oil production what followed the boom in prices was more injuring that the benefits caused by the boom.

Saudi Arabia GDP in 2006 stood at SR799.9 billion with a nominal GDP of SR1.30trillion. The GDP was a 12.4% increase and 4.2% increase on nominal GDP (Saudi Arabia Economic Statistics and Indicators).

Global financial crisis and banking

Saudi Arabia has an Islamic banking system, were loans advanced to customers do not attract interest like in conventional banking but the bank and borrower invest money together and share losses and profits. Saudi Arabian Monetary Authority (SAMA) monitors the banking sector in the economy. The banking sector through was hit by the crisis showed some stability when in 2008 it expanded with 20% compared to 16% recorded in 2007 (Munawar, and David 34-67).

In the first quarter of 2008, the bank deposits increased to SR761.613824 billion, which was 6.1 percent to, this was a 24.35% increase from what was recorded in the same period of 2007. The money supply rate at the end of 2008 first quarter was 91.3a this is up from 90.3% in the same period in 2007.

The countries stability of the banking sector was also seen in the change in banking activities over the period of global financial crisis, the country recorded the worst banking growth rate in the years between 2002 and 2004, when the repo rate was as low as 2.0 and the highest in 2004 as 2.75. Between the year 2005 and 2010, the repo rate according to the determination of SAMA, increased marginally.

In 2005 through to 2010, repo in the country was at 4.75, 5.2, 5.5, 5.25 and 4.5 respectively. This shows strength in the banking sector despite the global crisis. The countries currency remains pegged to United States dollar and the country showed no intention to change the pegging (SAMA). (See the figure below on the changes in repo from 2000 to 2010).

In 2006, money supply in the economy increase by 14.9 percent. Using the Consumer Price Index SAMA announced an inflation rate of 1.6%. in 2010, the results of the country banking and economic performance has changed against the expected as it recorded a GDP of SR1.5Trillion in 2010, inflation had decreased to 2.2 and SAMA base had decreased to 4.50 (SAMA).

Despite the performance of the banking sector, the sector did not grow as it was expected since there were some issues brought about by global financial crisis that hit the sector, for example, there was a reduction demand of loans and the sectors that banks and individuals were investing in were not forth coming (Mahlknecht, 12-56).

Global financial crisis and stock Exchange

On October 11 2008, Saudi Arabian stock exchange recorded the lowest stock index falling below 6000 points (Gulf base). Saudi Arabian stock exchange has main players as mining industry, real estates, and telecommunication.

The operation of the stock exchange is dependent on the confidence that investors has on a certain economy and the company they are investing. The global crisis brought lack of confidence and lack of trust among countries stability. The expansion of companies and their expected gain from operation were reduced thus they were un-attractive for investment.

This notion and operation of the stock exchange led to a reduction in stock operations. Between the end of 2008 and 2009, the stock exchange had reduced with an average of up to 10%; this was the period that the market experienced the worst sludge for decades. International players were busier trying to solve their countries problems of global financial crisis thus their demand for Saudi Arabian stocks was reduced.

This lead to a reduction in the number of shares and securities traded in the market. The government also made deliberate issues to reduce speculation with government bonds and bills. This is when it reduced the return rate in an effort to favour lending through the banks and bank deposits. This affected the countries securities available for trade.

Initial public offers (IPOs), had been taking place in the economy however they were earning less capital than in subsequent years. In 2008, 2008, Zain Group raised $4.5 billion [Dh16.5 billion], and Saudi Arabian Mining Company raised $2.4 billion, to fund their expansion.

This was among the largest IPO in the year. Although they raised the money anticipated, they not as oversubscribed as the case would have been. In the first quarter in 2009, the country made 29 issues that raised $3.7 billion, the number of IPOs increased to 62 where it raised a total of $6.8 billion (Gulf base).

Global financial crisis and Saudi Arabia’s Real Estate sector

According to Saudi Arabia’s commercial Real Estate sector report for the third quarter in 2010, the effect of global financial crisis was more felt in real estate’s industry than it was felt by the entire economy. The economy faced a reduction in business in the real estate of up to 10% where rental and the value of housing reduced accordingly.

Global crisis brought about a contraction in lending rates in banks thus the demand for real estate’s also went down. People could hardly have enough money to demand for homes. In 2010, the situation seemed to have taken a different route while the government focused on a boost in the industry other than the traditional oil industry (Gulf base).

Policies taken to ensure the country recover effectively from the crisis

The government of Saudi Arabia has embarked on different measures to ensure that the country recovers from the crisis effectively. These policies are implemented in sectors for better monitoring and good results. The major policies that the government embarked on are expansion monetary and fiscal policies. This was in the efforts to ensure that there is an increased saving in the economy and loans were easily accessible (Bourland).

In October 2008, Saudi Arabian central bank through SAMA reduced the banks depository rate requirement to 7% down from 13%. This monetary policy was aimed at creating more finances in the economy that can be lend. One implication that global financial crisis had brought in the country is a decrease in borrowing since firms were fearing the high interest rate charged by banks and the uncertain future returns from investments. The ratio was changed but it did not change the time saving ration, which stood at 4%.

In a short period between October 2008 and January 2009, SAMA reduced the repo rate from 5.5% to 2.0. This was in the aim of attracting foreign investments in the country. More foreign direct investments the country has, the high the money in circulation and thus the disposable income of the people will increase.

The government created cash deposits in the country in local and domestic currency like Dollar and Euros in the efforts to increase circulation of money in the economy. The influx of cash in the economy was in the efforts of reducing placement of long time deposits with banks.

Treasury bill and bonds billing were reduced by 50bp, than Saudi Interbank deposit rate (SIBID), the rate remained 20% lower than the normal rate until second quitter of 2009. This move is seen as to discourage speculation in government bonds but encourage deposits in banks. The deposits in banks in creased the money available for lending and the economy was likely to develop. The government also considered extending banking deposits that domestic banks had on behalf of government corporations.

This meant that banks had more finances to extend credit to the people. Another strategic move that the government embarked on was to give confidence to depositors that the economy through SAMA was stable that it can guarantee the safety of their deposits. Saudi Interbank deposit rate (SIBID) played a significant part in ensuring that there is confidence among local and international depositors (Yahia 23-33).

The government is specifically targeting an increase in FDI; this is through investments in mega projects to attract FDIs. An example of such mega projects includes the establishment of six economic cities, in each of the countries six towns in the effort to attain sustainable and equality in all sector and areas development.

The government is also considering a look at non-oil industry, which has been overlooked as the economy concentrate on oil industry. It has put on measures to improve the sector like construction and agriculture. The timely policies have made the county least affected by the global financial crisis in all the GCC.

In 2009, international monetary fund (IMF), concluded article number IV with the Saudi Arabian government. The article aimed at providing an opportunity for the country to have some stimulus package to facilitate an increased leading in the economy.

The article recommended the mechanisms available for Saudi Arabia to strengthen its monetary and macroeconomic policies and implement structural reforms in the economy. The country has been ranked the fourth in Asia in terms of ease of doing business and the sixteenth in the world, the government needed to take deliberate measures to retain this confidence among the people. It facilitated lending rates to private entities.

The government embarked on measure that facilitated international trade, it removed trade barriers to make commodities affordable in the country thus creating more savings and the increase in goods and services exported to the country that lead to an increase in demand in the market. The country started exporting services to different countries that enabled its economy was not limited to the domestic market.

The country has embraced Muhammad Yunus, Grameen banking system. This is a system were loans are given to low earning business without the need for solid assets. The move and incorporation of the system in Islamic Banking is aimed at assisting the less fortunate in the society access loans for self-development. The efforts made by the system is to ensure that there is minimal over reliance with white collar jobs but youth can diversify and invest in other sectors of the economy (SAMA).

Current market performance

Saudi Arabia is one of the countries which was least affected by the global financial crisis, the country was assisted by strong economic policies and rapid government response to issues. In 2008, there was a reduced demand in oil products in the world and the cost of oil barrel had reduced drastically, this affected the economy revenue from oil sector. However, the government was quick to respond to the reduced demand and invested in expansion of the non-oil industry.

The industries include construction, real estates, transport and agriculture. These sectors were strong enough to drive the economy. The government also aimed at attracting international investors in the country through various economic policies, these included policies made to attract investors in the economy such as increasing the lending rate. The banking sector showed a lot of strength over the period and the authority of SAMA was felt all along in the economy.

The authority was able to control costs of lending and guarantee depositors that the economy was strong enough to handle the crisis. Stock exchange though was affected by the crisis is doing well to recover from the crisis. In w2010, the sector is expected to have an increase in business more particularly in IPOs, which are expected to raise. Government initiatives have made the recovery of the country more rapid and promising (Suleman 12-45).

Conclusion

The world is under recession from global financial crisis, no world economy was left unaffected but the extent differed. Saudi Arabia, is one of the countries that were least affected by the crisis because of its strong macro-economies. The major effect that the company felt was from reduced demand of oil in the global market and reduction in oil prices. To recover from this fluctuation of oil prices, the government embarked on strengthening the non-oil industry to fuel the economy.

Though the banking sector was affected, the sector shown some strength in recovery and the degree it was affected. The Saudi Arabian central bank and SAMA, devised measures that boosted lending in the country, these policies include reduction in statutory deposits with central bank, extending government deposits with the banks and discouraging investments in bonds and bills. Currently, Saudi Arabian economy is on its way to full recovery, thanks to rapid and timely efforts by the government.

Works Cited

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