Saudi Arabia: Selected Issues

International Monetary Fund. Middle East and Central Asia Dept.

doi:10.5089/9781475510621.002.A004

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Saudi Arabia

Selected Issues

Author: International Monetary Fund. Middle East and Central Asia Dept.

Publication Date:: 18 Sep 2012

eISBN:: 9781475510621

Language:: English

Keywords:: ISCR; CR; price; TFP growth; oil price; oil GDP; private-sector employment; Dutch disease; Oil prices; Total factor productivity; Employment; Oil; gas and mining taxes; Global; Asia and Pacific; Middle East; FDI receipt; China shock; trade pattern; Saudi Arabia's economy; merchandise export; Exports; Foreign direct investment; Real effective exchange rates

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This chapter evaluates economic linkages between Saudi Arabia and the rest of the world. These linkages go beyond the oil market to also include non-oil trade, remittances, aid, and FDI flows, as well as other financial relationships. Results from a global vector autoregression (GVAR) model show that Saudi Arabia’s economy is more sensitive to developments in China than to shocks in the Euro Area or the United States—in line with the direction of evolving trade patterns and China’s growing role in the global oil market. Outward spillovers from Saudi Arabia are likely to be felt most strongly in its immediate neighbors, though with some impact via remittances on Southern and Eastern Asia.

Abstract

IV. Global Interconnectedness: Economic Spillovers to and from Saudi Arabia¹

A. Introduction

1. As Saudi Arabia’s economy has expanded it has also become more connected to activity elsewhere in the world. Developments abroad can therefore have substantial implications for economic activity in Saudi Arabia, and what happens in Saudi Arabia can also have important bearing on other countries. Stronger international links mean that Saudi Arabia is exposed to heightened risks associated with the still fragile nature of the global economic recovery. At the same time, the current exceptionally strong growth in the Saudi economy will have positive ramifications for its trading partners.

2. This chapter evaluates the nature and strength of economic linkages between Saudi Arabia and the rest of the world. Beyond the oil market, links include non-oil trade, remittances, foreign aid, FDI, and other financial relationships. The destination of Saudi Arabia’s exports and the source of its imports and inward FDI is mainly advanced economies, but the share of Asia and, in particular, China, has been growing rapidly. In comparison, Saudi Arabia’s outward remittances, FDI, and foreign aid are more tilted toward countries nearby. These patterns influence how economic shocks are transmitted across borders.

3. The analysis suggests that the Saudi economy is particularly sensitive to developments in China, while outward spillovers are mainly felt in neighboring countries. Results from a GVAR model show that the impact on Saudi Arabia’s GDP from a negative shock to output in the euro area would be modest and about on par with a shock to output in the United States. The impact of a shock to output in China would be more substantial. In terms of outward spillovers, the results indicate that a positive shock to non-oil GDP in Saudi Arabia has a strong positive impact on the rest of the GCC as well as on Jordan, Lebanon, and Syria, but a smaller impact on countries farther away.

B. International Linkages

4. This section documents key real sector interlinkages between Saudi Arabia and the rest of the world. The analysis covers trade, remittances, foreign aid, and FDI, and it highlights the importance of Saudi Arabia for other economies in the region. Availability of data on bilateral non-FDI investment positions is limited, but to the extent that such financial linkages affect the way shocks to GDP are transmitted between countries, they are implicitly covered in the subsequent section.

Trade

5. The value of Saudi Arabia’s international trade has boomed in recent years. In 2011, Saudi Arabia’s total exports of goods and services amounted to some $355 billion or 1.6 percent of the world total, while imports were about half that amount. For exports in particular, this represents a sharp increase compared to the late 1990s when oil prices bottomed. In 1998, Saudi Arabia’s share in world trade was just 0.6 percent for both exports and imports. While oil continues to be the largest source of income, non-oil exports have increased over time, reaching almost 14 percent of total exports in 2011 compared to less than 1 percent in the late 1970s.

6. Trade with developing Asia has been leading the increase. In 2010, Asia accounted for about 60 percent of Saudi Arabia’s total merchandise exports and about 35 percent of its imports—in both cases an increase in the respective shares of about a third compared to the early 1990s. The bulk of this increase was due to trade with China, which went from an insignificant level in 1990 to 13 percent of Saudi Arabia’s exports and 11 percent of its imports in 2010 (Figure IV.1).

7. Relative to the size of their own economies, trade with Saudi Arabia is highest with neighboring countries. Although this trade represents a minor share of Saudi Arabia’s total exports and imports, the countries where trade with Saudi Arabia represents the largest share of their own exports and imports tend to be within close geographical proximity (Figure IV.2). Bilateral trade data are subject to some uncertainty but suggest that the countries where Saudi Arabia accounts for more than 5 percent of outgoing exports are Jordan, Ethiopia, Egypt, Lebanon, and Syria. Exports from these countries to Saudi Arabia span a range of agricultural and light manufacturing goods. Imports from Saudi Arabia into neighboring countries are also significant and mainly comprise oil.

Remittances

8. Remittances from migrants employed in Saudi Arabia are another important source of income for many countries in the region. Outward remittances averaged 6.2 percent of GDP over the past decade and reached $26 billion in 2010, with most going to other Arab countries as well as Southern and Eastern Asia. World Bank bilateral remittances data indicate that remittances from Saudi Arabia represented more than 3 percent of GDP in Jordan and Yemen in 2010, and between 1 and 2 percent of GDP in another five mostly nearby countries (Figure IV.3). Accounting for about a quarter of Saudi Arabia’s total remittances outflows in 2010, India was the largest single recipient, but given the size of India’s economy these flows represented just 0.3 percent of its GDP.

Foreign aid

9. As the largest Arab donor, Saudi Arabia is a particularly important source of foreign aid for many countries in the region.² The two major transfer modalities are (i) direct bilateral aid extended by the government, and (ii) aid provided through national and regional developmental funds. In addition, there are contributions to major international donor agencies and through charitable institutions. The overall volume of Arab-provided aid has tended to move together with income in the donor countries and has, as a result, been correlated with oil prices.

10. Most Saudi aid has been provided bilaterally. Saudi Arabia has provided over $100 billion in bilateral foreign assistance since 1970, averaging about 1 percent of GDP over the last decade (Figure IV.4)—one of the highest levels in the world. Most bilateral aid is to Arab and other Islamic countries. Saudi bilateral assistance is mainly unconditional and grant-based. Even when involving loans, low interest rates and long repayment periods mean that the grant element is generally over 80 percent.

11. Saudi Arabia has also been a major contributor to assistance provided through various development funds. Since 1962, Arab development funds have disbursed about $104 billion, with Saudi Arabia contributing about 10 percent of the total through the Saudi Fund for Development but also contributing importantly to several of the regional funds (Figure IV.5), as well as to multilateral programs such as the PRGT and other IMF financing facilities. The bulk of disbursements has been to Arab countries (61 percent), followed by Asian (22 percent) and African countries (15 percent). Assistance has mainly been directed at project financing, with transport & communication and energy being the main areas, and with an increasing focus on the private sector over the past decade (Figure IV.6). In addition to traditional transfer modalities such as concessional loans and grants, this category of aid also operates through guarantees, technical assistance, and training. Financing is typically provided on a very low interest rate basis and the average grant element has been 40–45 percent.

Outward FDI

12. Saudi Arabia has also been a major source of FDI in the MENA region.³ Over the period 1985–2009, Saudi outward gross FDI to Arab countries amounted to about $20 billion, with Lebanon, Sudan, the United Arab Emirates, and Jordan the top recipients (Figure IV.7). In Lebanon, Sudan, Jordan, and Yemen, the amounts invested have been equivalent to more than 0.5 percent of these countries’ GDP over this period. In many cases, Saudi FDI has represented over 40 percent of Arab countries’ total FDI receipts from other Arab countries.

13. The amounts and destinations for Saudi FDI to Arab countries have fluctuated over time. In 2009 and 2010, amounts were just a third of the level in 2006 (Figure IV.8). Reflecting the influence of large individual projects, investments in individual countries have often been lumpy. In 2007, for example, Lebanon alone accounted for the bulk of Saudi Arabia’s total investments in the region. Nevertheless, Sudan, Syria, Egypt, and Jordan have been comparatively steady recipients.⁴

Financial flows

14. Assessing the geographical composition of financial flows is complicated by limited data availability. Saudi Arabia does not currently report data to the Bank for International Settlements (BIS) nor participate in the Coordinated Portfolio Investment Survey (CPIS). Nevertheless, recently published data on Saudi Arabia’s International Investment Position indicate that foreign assets amounted to 157 percent of GDP in 2010 while external liabilities amounted to 47 percent of GDP—these numbers are underestimated as trade credit is not reported and overall coverage of the private sector is incomplete. At 63 percent of the total in 2010, reserve assets account for the bulk of foreign assets. Over 70 percent of reserve assets are invested in foreign securities while the rest is placed in foreign currency, deposits, and gold. The geographical composition of reserve assets is unknown, but given SAMA’s relatively risk-averse investment strategy, highly rated sovereign debt instruments are likely to account for a large share. The banking sector accounts for another about 10 percent of total foreign assets.

C. A GVAR Estimation of Spillovers

15. A GVAR model is used to disentangle and quantify the size and speed of the transmission of different shocks to and from Saudi Arabia. This approach uses a dynamic multi-country framework and is based on the model developed in Cashin, Mohaddes, and Raissi (forthcoming), henceforth referred to as the CMR model.⁵ It includes 44 countries/regions (among which is a single euro area region comprising eight of the 11 countries that joined the euro in 1999) including the MENA countries, to enable analysis of cross-border spillovers to and from the region. Together these countries account for more than 90 percent of world economic output. A range of variables is used in the model to capture both real and financial sector linkages. These are: output, y, inflation, π, real effective exchange rate, reer, short-term interest rates, r^S, long-term interest rates, r^L, real equity prices, q, oil consumption, c^oil, and oil prices, p^oil. While the model does not explicitly include all the variables discussed in the previous section, to the extent that developments in the variables discussed above are linked to movements in the variables that are included in the model they can be considered to be covered in reduced form. All data are collected at quarterly frequency from 1979Q2 to 2009Q4.⁶

Modeling framework

16. The GVAR model is constructed from a series of separate country-specific VARX^* models, which link core variables of each country to trade-weighted averages of corresponding foreign variables, according to the following dynamic specification:⁷

x_{i t} = δ_{i 0} + δ_{i 1} t + A_{i} x_{i, t - 1} + B_{i 0} x_{i, t}^{*} + B_{i 1} x_{i, t - 1}^{*} + ε_{i t,} t = 1, 2, …, T, i = 0, 1, 2, ..., N

where δ_i0 and δ_i1 are vectors of fixed intercepts and coefficients on a deterministic time trend, x_it is the vector of domestic variables, $x_{i, t}^{*}$ country-specific foreign variables are treated as weakly exogenous and constructed as cross-sectional averages of the domestic variables using bilateral trade during 2006–08 as the weights, ε_ij

x_{i t}^{*} = Σ_{j = 0}^{N} ω_{i j} x_{j t}

Given its dominant role in the world economy and its influence on oil prices and international financial market, the United States is treated differently from the other countries in terms of which variables are treated as foreign and hence weakly exogenous (Table IV.1).

^{Table IV.1.}

Variables Specification of the Country-Specific VARX^* Models

Source: Cashin et al. forthcoming.

^{Table IV.1.}

Variables Specification of the Country-Specific VARX^* Models

Non-US models		The US model
Domestic	Foreign	Domestic	Foreign
y_it	$y_{i t}^{*}$	y_US,t	$y_{U S, t}^{*}$
π_it	$π_{i t}^{*}$	π_U,S,t	$π_{U S, t}^{*}$
q_it	$q_{i t}^{*}$	q_US,t	–
$r_{i t}^{S}$	$r_{i t}^{* S}$	$r_{U S, t}^{S}$	$r_{U S, t}^{* S}$
$r_{i t}^{L}$	$r_{i t}^{* L}$	$r_{U S, t}^{L}$	–
reer_it	–	–	$r e e r_{U S, t}^{*}$
$c_{i t}^{o i l}$	$c_{i t}^{* o i l}$	$c_{U S, t}^{o i l}$	–
–	$p_{t}^{o i l}$	$p_{t}^{o i l}$	–

Source: Cashin et al. forthcoming.

^{Table IV.1.}

Variables Specification of the Country-Specific VARX^* Models

Non-US models		The US model
Domestic	Foreign	Domestic	Foreign
y_it	$y_{i t}^{*}$	y_US,t	$y_{U S, t}^{*}$
π_it	$π_{i t}^{*}$	π_U,S,t	$π_{U S, t}^{*}$
q_it	$q_{i t}^{*}$	q_US,t	–
$r_{i t}^{S}$	$r_{i t}^{* S}$	$r_{U S, t}^{S}$	$r_{U S, t}^{* S}$
$r_{i t}^{L}$	$r_{i t}^{* L}$	$r_{U S, t}^{L}$	–
reer_it	–	–	$r e e r_{U S, t}^{*}$
$c_{i t}^{o i l}$	$c_{i t}^{* o i l}$	$c_{U S, t}^{o i l}$	–
–	$p_{t}^{o i l}$	$p_{t}^{o i l}$	–

Source: Cashin et al. forthcoming.

17. The individual VARX^* models are then solved in a global setting and can be used for impulse response analysis and generalized forecast error variance decomposition. Although estimation is done on a country-by-country basis, the GVAR model is solved for the world as a whole, taking into account that all variables are endogenous to the system as whole. This is done by aggregating the country-specific models using a link matrix containing all the bilateral trade weights.

Spillovers from developments abroad

18. The sensitivity of the Saudi Arabian economy to developments abroad is examined by evaluating the impact on Saudi variables of shocks to output in its key trading partners. Specifically, we study the generalized impulse responses of Saudi GDP, inflation, real effective exchange rate (REER), and oil consumption to a one standard deviation negative GDP shock in the euro area (EA), the United States, and China. We also consider the generalized forecast error variance decomposition, which provides the percentage of the forecast error variance of the Saudi variables that is explained by other variables in the model (244 in total). These results provide additional intuition on the transmission channels through which foreign GDP shocks affect economic activity in Saudi Arabia.

19. The results show that a negative output shock in the euro area or the United States has relatively little impact on the Saudi economy, whereas the sensitivity to shocks in China is more substantial. The spillovers vary depending on a host of factors, including the size of bilateral trade flows as well as other real and financial sector linkages present in the data. After four quarters, the impulse response to a one standard deviation reduction in China’s real GDP shows a highly significant 0.5 percent decline in Saudi real GDP (Figure IV.9).⁸ The impact of a one standard deviation real GDP reduction in the EA or USA is much smaller, with Saudi real GDP in both cases falling by only about 0.1 percent after 4 quarters.⁹ These results partly reflect the effect that economic developments in each of these countries have on oil prices, with the China shock producing the biggest decline in oil prices and adversely affecting the Saudi economy. The results also show a strong link between the impact on output and Saudi Arabia’s real effective exchange rate, with the larger decline in output for the China over time giving rise to a more depreciated REER (a rise in the REER).

20. The variance decomposition indicates that shocks to activity in Saudi Arabia’s main trading partners account for only a small part of the overall variation in Saudi variables, while the effect of an oil price shock is much larger (Figure IV.10). The generalized forecast error variance decomposition of Saudi GDP shows that shocks to oil prices explain a much larger share of the forecast variance than do the shocks to output in China, EA, and the United States.¹⁰ Across the variables shown, shocks in China generally have a larger impact than shocks in the EA and United States, highlighting the greater sensitivity of the Saudi economy to real sector shocks in China than to than to those originating in the EA or USA.

Outward spillovers from Saudi Arabia

21. The CMR model can also be used to evaluate the sensitivity of other countries to developments in Saudi Arabia. Here we focus on the regional impact and consider the four-quarter impulse responses arising from a positive one standard deviation shock to non-oil GDP in Saudi Arabia.¹¹ Such a shock could be thought of as resulting from a policy decision to provide fiscal stimulus. The results indicate that real GDP in the other GCC countries, as well as in Jordan, Lebanon, and Syria, responds strongly to higher non-oil GDP in Saudi Arabia, with elasticities ranging from 0.2 to 0.4 (Figure IV.11). The impact on other countries in the region is more muted. For Jordan, Lebanon, and Syria, the results are in line with the substantial ties documented in Section B above and reflected in the trade weights used in the model (Table IV.2). Apart from Bahrain, where merchandise trade with Saudi Arabia (mainly Saudi crude oil that is refined in Bahrain) is also substantial, merchandise trade with other GCC countries is limited and the strong impact being picked up by the model indicates the presence of other transmission channels, such as financial markets or services trade.

^{Table IV.2.}

Trade Weights with Saudi Arabia Based on Direction of Trade Statistics, 2006–08

Sources: Direction of Trade Statistics; and Cashin et al. forthcoming.

^{Table IV.2.}

Trade Weights with Saudi Arabia Based on Direction of Trade Statistics, 2006–08

GCC		Maghreb		Mashreq
Bahrain	20.8	Algeria	0.2	Egypt	7.4
Kuwait	2.4	Libya	0.1	Jordan	21.7
Oman	1.9	Mauritania	0.2	Lebanon	5.7
Qatar	2.2	Morocco	5.4	Syria	12.3
UAE	2.1	Tunisia	0.7	Iran	1.0

Sources: Direction of Trade Statistics; and Cashin et al. forthcoming.

^{Table IV.2.}

Trade Weights with Saudi Arabia Based on Direction of Trade Statistics, 2006–08

GCC		Maghreb		Mashreq
Bahrain	20.8	Algeria	0.2	Egypt	7.4
Kuwait	2.4	Libya	0.1	Jordan	21.7
Oman	1.9	Mauritania	0.2	Lebanon	5.7
Qatar	2.2	Morocco	5.4	Syria	12.3
UAE	2.1	Tunisia	0.7	Iran	1.0

Sources: Direction of Trade Statistics; and Cashin et al. forthcoming.

References

Beidas-Strom, S., 2011, Economic Policy Spillovers: Saudi Arabia in the Global Economy,” in S. Beidas-Strom, T. Rasmussen, and D. Robinson (Eds.), Gulf Cooperation Council Countries: Enhancing Economic Outcomes in an Uncertain Global Economy, (Washington: International Monetary Fund)
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Cashin, Paul, K. Mohaddes, and M. Raissi, forthcoming, “A Global Model of MENA Business Cycles,” unpublished manuscript, International Monetary Fund.
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Dees, S., F. Mauro, M. H. Pesaran, and L. V. Smith, 2007, “Exploring the International Linkages of the Euro Area: A Global VAR Analysis,” Journal of Applied Econometrics, Vol. 22, pp. 1–38.
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Prepared by Ghada Fayad, Mehdi Raissi, and Tobias Rasmussen.

Data for this section are mainly based on the Joint Arab Economic Report, which is published annually by the Arab Monetary Fund and includes a chapter on Arab developmental aid. These data primarily cover official assistance; less is known about the magnitude of private charity.

Data for this section are mainly based on several issues of the Investment Climate in Arab Countries Report, published annually by the Arab Investment & Export Credit Guarantee Corporation.

Saudi Arabia has also been a major destination for inter-Arab FDI, with gross inward FDI increasing from $12 million in 1995 to about $12 billion in 2009. Cumulative inflows over 1995–2009 amounted to $64 billion, making Saudi Arabia by far the largest recipient of inter-Arab FDI. Sudan was second with about $16 billion; much of that came from Saudi Arabia.

The CMR model is an extension of the GVAR framework of Dees et al. (2007).

Where quarterly data are not available (e.g., the series for real GDP in Saudi Arabia), annual series are interpolated.

For simplicity the model is shown with only one lag but is implemented with up to two lags.

This result is somewhat stronger than that obtained by Beidas-Strom (2011), who, using the IMF’s GIMF model, finds that an approximately 1 percent decline in Asian GDP (resulting from a negative productivity shock) reduces Saudi Arabia’s GDP by about 0.2 percent.

A one-standard error GDP shock in the United States, the Euro Area, and China corresponds to 0.3, 0.25, and 1.4 percent, respectively.

Shocks to output in China, EA, and the United States together explain only about 2.5 percent of total output variation in Saudi Arabia, whereas oil prices explain about 6 percent, and the remainder is explained by the other 240 variables in the model. The very large number of variables in the model will tend to reduce the contribution from any single variable; these results are therefore more meaningful in a relative than in an absolute sense.

To evaluate outward spillovers, we use non-oil GDP rather than total GDP for Saudi Arabia, because oil GDP is volatile and heavily influenced by oil prices, and to better capture the role of Saudi-specific developments.

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