Saudi Arabia’s sovereign ratings raised

Capital Intelligence, the international rating agency, has raised Saudi Arabia’s long-term foreign currency and local currency ratings to AA- from A+ and its short-term foreign- and local-currency ratings to A1+ from A1. The outlook for Saudi Arabia’s ratings is ‘stable’.

The upgrade reflects the continued strengthening of the public and external finances along with improved prospects for faster economic growth over the medium to long term, the Capital Intelligence report said.

As the world’s largest producer and exporter of crude oil, Saudi Arabia has benefited greatly from the upward movement in oil prices over the past five years. Hydrocarbon liquidity and the expectation that oil prices are likely to remain at elevated levels over the coming years has supported increased public and private sector investment and underpinned the launch of several industrial and infrastructure mega projects.

The propitious economic setting has also enabled the authorities to move ahead with structural reforms geared to increasing private sector involvement in the economy, raising the level of foreign direct investment, and enlarging the non-oil export base. Real non-oil GDP expanded by 5.6% in 2005-07 and is projected by CI to average just over 6% in 2008-10.

The central government budget has posted substantial surpluses averaging 13.6% of GDP over the past five years and is projected to remain in large surplus over the medium term. Fiscal policy has been reasonably prudent and CI estimates that the budget would still be in surplus even if oil prices were to fall by 50% from current levels to USD 45 a barrel. Accumulated surpluses have increased the government’s net financial asset position to about 77% of GDP, bolstering its capacity to absorb potential shocks.

Saudi Arabia’s external accounts are also very strong. Supported by high oil prices and a small but expanding non-oil manufacturing base that includes petrochemicals, CI expects the current account surplus to average almost 20% of GDP in 2008-2010, which is a little below the average for the past four years (25.6%). External developments will continue to facilitate the accumulation of official foreign assets, which are currently more than five times as large as estimated public and private sector external debt.

Saudi Arabia’s ratings are constrained by the challenge of generating sufficient job opportunities for a fast-growing workforce, the budget’s heavy reliance on oil revenue, institutional weaknesses including less transparency and accountability in government operations and policymaking frameworks compared to higher rated peers, and geopolitical risk factors.

CI notes in particular that recent economic growth performance has not been sufficient to stop unemployment from rising. The jobs challenge is exacerbated by the country’s demographics, with the population expected to increase by around 40% by 2020. Saudi Arabia will need to generate faster, self-sustaining private sector growth to prevent potentially serious social and fiscal strains emerging in the long run. The employment impact of current initiatives on Saudi nationals could be small unless the link between the education system and the labour market is strengthened through further reforms to school curricula and higher education and by improving the quality of vocational training.

The authorities will also need to ensure that industrial and infrastructure projects in support of growth and jobs are undertaken in line with the absorptive capacity of the economy in order to avoid excessive pressure on resources and prices and to prevent an upward shift in inflation expectations.