Chapter 1


Background


Saudi Arabia


Oil wealth, which led to dramatic standard of living increases in the Gulf for much of the second half of the twentieth century, no longer is enough to ensure the prosperity of several states. Living standards in Saudi Arabia, Bahrain, and Oman have remained at a standstill in recent years. For example, from 1980 to 1998, the Saudi economy grew at an average of 0.2 percent a year a stagnation that ended only when oil prices soared in 1999 and 2000. In Saudi Arabia, royal family members are increasingly demanding a share of private business transactions, whereas previously they had confined their role to the state’s oil sector and government-directed activities ( 2002). Although solid information on the amount spent on the thousands of royal family members is lacking, a common estimate is that each Saudi prince receives about 00 per month, with senior princes getting far more. Opposition groups, no doubt exaggerating, claim that 40 percent of government revenues go to the royal family. The lack of transparency in the Saudi economy only fuels speculation and conspiracy theories and inhibits foreign investment ( 2002)


As the economy of Saudi Arabia remains highly dependent on oil, the level of economic activity is largely determined by oil price and production developments. Government policy has aimed to encourage economic diversification, but the comparative advantage of the economy is in oil related activities, a situation which is unlikely to change for the foreseeable future. As the Kingdom accounts for at least one third of proven world oil reserves, it makes sense to exploit this resource, especially given the relatively low extraction costs compared to those in most other regions of the world (  2003). Living standards are relatively high in Saudi Arabia in relation to many developing countries and Arab states, but lower than in the smaller states. The level of per capita Gross Domestic Product (GDP) is important in determining what status a country should have in the WTO, with developing countries with lower per capita GDP given more lengthy transitional periods for reducing tariffs and phasing out trade barriers.


Saudi Arabia has argued that it wants developing country status, rather than have to introduce the more rapid trade liberalization agreed by the smaller GCC states when they were admitted to the ( 2003).


Economic growth will depend on how effectively the improved oil revenue flows are managed, over which there is greater uncertainty. The oil revenue windfall of 1999 may reduce pressures for reform and privatization, as the state can again contemplate capital spending. Nevertheless there are some encouraging signs that bode well for the future. The share of the private sector in GDP is increasing rapidly, from only 33 per cent in 1997 to 40 per cent by 1999. The measures taken to raise non-oil revenues are being implemented in full, with raised electricity tariffs, higher local petroleum prices for domestic consumers, increased work permit fees and departure taxes on foreigners expected to raise at least billion annually. Overall the most lasting effect of the oil price falls is likely to be the more diversified sources of revenue, and increased caution in increasing government spending in response to oil revenue increases alone ( 2003). The main economy of Saudi focuses on oil exploration and production. This kind of product brings most of the income to the country and it helps in making sure that their citizens can have good paying sources of income.


 


Economic Policies in Saudi Arabia


As seen in the past years and recent development of Saudi Arabia, the country are grown expressively ever since the reign of  2002).  Basically, the rules in Saudi Arabia with respect to their country leaders changed but the goal to improve the economic conditions of the country’s citizens while retaining the society’s Islamic values remained intact ( 2002).


Actually, the only nontraditional economic chances for Saudi citizens were linked to distribution of land, employment in the military, and some modest contracts and commissions (1997). During the reign of  his function as country leader is only limited. With his leadership, the revenue gathered was only adequate to perform minimal government functions.  Because of financial constraints, can’t even undertake economic and social projects. Even though his leadership leads to the development of the country’s oil resources, it only resulted to pay some wage payments to Saudis and local purchases of goods and services by foreign oil companies and this impact was only minor to the overall development of the country since the main beneficiary of oil exports was the ruling family and its tribal allies. As seen in the history of Saudi Arabia, at early time of 1970s, oil income was growing slowly ( 1997).  And because of this, the government suffers under financial constraint. With this respect, most of the decisions by the government of Saudi Arabia were largely concentrating about the use of resources wisely.


 


Ø      Oil Boom, 1974-85


In the early 1970s, the oil income of Saudi Arabia is growing slowly, thus the government created ways to increase their income from oil exports(1997). As reported, oil exports expanded significantly, royalty payments and taxes on foreign oil companies increased stridently, and oil-exporting governments, including the kingdom, began setting and raising oil export prices (1997). During this period, Saudi Arabia’s revenues per barrel of oil quadrupled from US.22 in 1948 to US.89 in 1970 ( 2002). Actually, at the year 1973, the price had reached US.56 and ascended to US and higher in 1974 following the Arab oil restriction introduced to force Western supporters of Israel throughout the October 1973 War (2002). Apparently, in 1982 the average export price per barrel of oil reached above US. And during 1973 up to 1980, the government of Saudi Arabia reached the oil revenues to the highest point.  Basically, it jumped from US.3 billion to US1.8 billion. With this expressive revenue, the government had now enough financial budgets to support structural development that would also help them to increase their revenues.


From this development in Saudi Arabia, the society encompassed of groups of people eager to promote the modernization program ( 1997).  However, there are some elements within society or even within the royal family and the religious community who feared the social consequences of rapid economic transformation. Moreover, there are from the technocratic elite, were concerned about the economic consequences of such a rapid expansion in expenditures. One choice facing policymakers in the early 1970s was whether to limit oil production to a level that was sufficient to finance limited economic and social development or to permit production at a level that would meet world needs for crude oil. Selecting a fairly high production level would force a resolution on whether to use revenues for speedy domestic economic and social growth or long-term investments abroad. Actually, there were other policy options. Those groups who wanted to keep oil in the ground, except for that needed for limited development, argued strongly that this policy would best conserve the country’s resources for future needs.


With respect to this development, the choices come out at 1974, even though the decision-making procedure was not always clear or apparent. One issue was clear, on the other hand and that is where the domestic economic policy did not force oil production and export policies. Basically, the leadership of Al Saud pledged to maintain oil flowing at moderate prices, proportionate with world needs, in dispute that the kingdom was as reliant on the stability and affluence of consuming nations as those nations were on Saudi oil. Furthermore, if Saudi Arabia required making sure that oil would stay the power source of choice, moderate prices were necessary( 2002). During the mid-1970s, the government of Saudi Arabia had decided to re-invent the country by creating an industrialized economy and this is by means of the revenue gathered from oil production. In order to have an industrialized economy, the government had decided to invest the said revenue to hydropower.  This policy meant at least a decade of extremely large investments to construct the plants and the essential infrastructure. This means financing and building the gas-gathering system, the pipelines for gas and crude oil to bring the raw material to the two chosen main industrial sites.  Actually, the development effort also included many other projects, such as the huge and costly airports at Riyadh and Jeddah, hospitals, schools, industrial and plants, roads and ports. By the mid-1980s the massive expenditures totaled US0 billion ( 2002).


With respect to this development effort by the government of Saudi Arabia, this also entails such massive risks. Actually, the massive size of effort and the technology involved in this development required so many foreign workers which may possibly disrupt the society. In addition, the speed of modernization was also economically disruptive. Basically, during the process, there are some observers in Saudi Arabia that argued and questioned the Saudi refineries and petrochemical plants if they can efficiently managed and prove competitive within a reasonable time. As proof of this risk, by the early 1980s, Saudi Arabia had encountered economic and social tensions and that is because of the inflation of the mid- 1970s, the takeover of the in Mecca in November 1979, and disturbances in the Eastern Province in 1979-80–that dissipated only late in the 1980s.


 


Ø      1986 Oil-Price Crash


With respect to the previous policy of Saudi Arabia, the general thrust of Saudi economic policy went down to completely change the poly after the price crash of oil in 1986. The vital weakening of foreign assets, shared with the wide-ranging decline in oil revenues, required a revised economic policy. Aside from this trouble, the depreciation of the United States dollar on international financial markets also injured Saudi purchasing power abroad. As the impact of this problem continuously affects the overall progress of Saudi Arabia, the kingdom’s external terms of trade worsened rapidly because oil exports were largely denominated in United States dollars, and the bulk of Saudi imports came from countries whose currencies were appreciating relative to the United States dollar.


Reassessment of the development program became necessary. The most pressing undertaking was shoring up government finances, yet domestic constraints allowed only a few options, especially in terms of raising non-oil revenues. Imposing an income tax, for example, was out of the question partly because of its political dangers in a country where it was an unknown procedure likely to raise questions of income distribution and taxation without representation. Also an income tax appeared impractical because the bureaucratic difficulties involved in collection would be more expensive than the intake would justify.


 


Ø      Economic Policy in the 1990s


Although the resource base, income levels, and economic policies vary considerably among Arab countries, many of them share key development problems. In the 1990s, these included rapid population growth, inequality in the distribution of income and wealth, unemployment, falls in real earnings, and reliance on unstable and often external sources of income. Slow and irregular growth rates were a problem for countries with low per capita income levels and for those with rapid population growth. Some Arab countries suffered from both of these problems: they needed to “run” in terms of GDP growth in order to “stand still” in terms of income per capita. When GDP did not grow, they faced serious economic, social, and political tensions.


Basically, the government’s attempts to deal with the chronic budget deficits, largely through expenditure retrenchment, depletion of foreign assets, and the sale of development bonds, generally helped stabilize its financial situation by the late 1980s. It became clear by 1989 that the economy had battered some of the other problems, such as the growth of bad banking debts, the wave of bankruptcies of private companies, and the colossal outflow of private capital to overseas financial centers that followed the oil-price crash of 1986. During 1989 and 1990, economic planners had renewed optimism. New plans were made to put the oil and non-oil sectors of the economy on a certain footing. The perceived recovery in international oil consumption and prices provided regional policymakers the opportunity to resume spending to promote economic growth.


 


Banking and Financial Market in Saudi Arabia


As the world enters the twenty-first century, the most significant trend to impact successful corporate financial management will be the continuing globalization of business in general and financial management in particular.


There are no major U.S. or foreign corporations that do business solely within the confines of their own country. The need to deal with multiple currencies, worldwide money and capital markets where investment capital moves across borders at an increasing pace facing fewer and fewer barriers, a wide variety of accounting systems and tax laws, and a multitude of political risk environments is now a normal part of the responsibilities of a corporate financial manager ( 1997). This globalization of business does not change the fundamental theories of corporate financial management, but it does have a substantial impact on corporate financial practice and domestic financial markets. The only thing certain about the future is that finance and industry will continue to change, offering new challenges and opportunities to financial managers. The importance of competent financial management to the success and even survival of the modern business organization cannot be overemphasized (1997).


In history, Saudi Arabia is the largest Persian Gulf oil Kingdom founded by  in 1932. Through the years up to the current age, an absolute monarchy by the Saud dynasty was still the governing. After the death of , the  officially became monarch last August 2005. Basically, Saudi Arabia plays a dominant role in the Organization of Petroleum Exporting Countries since it is the world’s leading oil producer and exporter. Its succession to the   in 2005 has led to gradual economic reforms, but recent debates about the king’s successor have increased political tension and slowed the reform process.


According to  (2008), the economy of Saudi Arabia is 62.8.1 percent free, based on their 2008 assessment. This percentage makes Saudi Arabia in the world’s 60th freest economy. Its overall score is 1.2 percentage points higher than last year, partially reflecting new methodological detail. Saudi Arabia is ranked 6th out of 17 countries in the Middle East/North Africa region, and its overall score is above the regional average.


From this report, the monarchy has begun to liberalize aspects of foreign investment, but immense barriers remain in effect. Financial markets in Saudi Arabia are distorted by government influence, and the legal system is similarly subject to political influence. With this regard, financial evaluation is really vital for companies who are investing in this country. Basically, financial management is needed by companies to be able to compete in a changing environment. They have to ensure themselves that any transactions made will result in benefits for the company.


 


The Global Financial Market and Saudi Banking and Financial System


Within the neo-classical paradigm, capital flows where its marginal product is higher. As a result, the allocation of capital is more efficient and global welfare is higher when capital flows freely across national borders. As trans-border capital flows increase, economies are progressively integrating globally. The financial structures of economies as well as the world of finance are changing. This applies to both domestic and global financial markets. A quarter century ago, a businesswoman was restricted to borrowing from her domestic market. However, if she operates in an emerging market economy, several options are presently open to her. For instance, she can choose between issuing stocks and bonds in the domestic or foreign financial markets (2004). 


She can reduce her cost of capital if foreign currency loans are available at more attractive terms than the domestic loans, and these loans can be hedged by using a variety of financial products. She can also consider selling equity at foreign Bourses, which are far more liquid than the domestic ones. A functional definition of financial globalization is the integration of the domestic financial system of an economy with the global financial markets and institutions. The enabling framework of financial globalization essentially includes liberalization and deregulation of the domestic financial sector as well as liberalization of the capital account. In a globalize financial environment domestic lenders and borrowers participate in the global markets, and utilize global financial intermediaries for borrowing and lending. Trans-border capital flows tend to integrate the domestic and global financial markets and systems ( 2004).


Although the global financial markets remained in a state of flux throughout the twentieth century, transformations since the early 1970s have been nothing short of dramatic. The Global forces for change included advances in information communication technology (ICT), making remote access to trading systems ubiquitous. Also, innovations in ICT and the development of new instruments in the financial market became self reinforcing. Furthermore, financial deregulation and liberalization at the national level, opening up to international competition, and globalization of financial and real markets, were significant change agents (2004). 


Additionally, changes in corporate behavior, such as growing disintermediation and increased shareholder pressure for financial performance, were the prime movers behind the transformation in the financial services sector in the emerging market economies. Advancing globalization during the 1980s and the 1990s increased trans-border capital flows and tightened the links between financial markets in the emerging markets and global financial centers. Growth of global financial markets was further accelerated by improvements in the fundamentals, particularly by more rapid economic growth in the emerging market and matured industrial economies. It was also assisted by economic and structural reforms in the emerging market and transition economies. Lastly, the recent spate of banking and financial crises has accentuated the pressures for transformation. Notwithstanding the recent decline in capital flows, the evidence of the preceding quarter-century suggests that financial markets in the emerging market economies have become increasingly deep and resilient ( 2004). The state of global financial markets changes as different things happen in the environment.  The global financial markets are affected by different situations such as increase or decrease of the interest rates. It is also affected by improvements in the society, such as new trends in different industries.


Apparently, it has been evident that the context and issues related to global financial markets also reflects to the issues about globalization. Actually, globalization has become the most-talked about theme of the 1990s in the Western social sciences and various world discussions. The concept of globalization encompasses a host of interwoven processes which include increasing transnational movement of capital, goods, and people; closer ties through new communications technologies; a more complex international division of labor as a result of the dispersal of the production of goods and services to a number of different locations; a rapid turnover of ideas, of images, and of patterns and objects of consumption; a growing awareness of risks and dangers that threaten the world as a whole; a quantitative increase in, and growth in importance of, transnational institutions and globally interlinked political movements.  It basically involves the interpenetration of these processes both horizontally and vertically, and at national, sub-national, and transnational levels (1998).  Globalization is a huge step away from the traditional localism which has pervaded the mode of living in most countries of the world throughout the years.  Localism is the innate tendency of nations and communities to put constrictions on their openness to global issues.  It is a way of thinking that advances seclusion and emphasizes traditional concepts of community. 


(1998) stated that the present world system makes power accountable to money rather than to life.  It is a system that destroys life to make money and possesses the following characteristics: disintegrating social fabric of human society, rapidly growing gap between the rich and poor and rapid concentration of global economic power under the control of some two hundred mega-corporations that operate beyond the reach of any state or other public authority .  These corporations which utilize cheap labor from most Third World countries dominate the economic arena and labor markets and thus resulting to growth of labor-intensive Third World exports and oppression of local and foreign workers ( 1998). However, (2002) argued that humanity is now at the final stage of an “Era of Empire” where competition, violence and domination perpetuated for thousands of years.  This era features rule by the institutions of a suicidal global economy that are destroying the social and environmental foundations of human existence to make money for the privileged few.  Basically, it characterizes a period where there is unconscionable and growing concentration of wealth and power, and thus extravagance for a limited few. 


Apparently, the  (2002) reported four aspects of globalization that illustrate a more spontaneous interrelatedness between nations, cultures, economies and communities. Globalization is characterized by trade, capital movements, movement of people and spread of knowledge and technology.  First, globalization generally refers to an extension beyond national borders of the same market forces that have operated for centuries at all levels of human economic activity like village markets, urban industries, or financial centers.  Borders are now opened for freer flow of trade and financial transactions.   Developing countries as a whole have increased their share of world trade from 19 percent in 1971 to 20 percent in 1999 with export in manufactured goods having the strongest rise. Second, globalization allows movement of capital between national borders with direct foreign investment as the most important category (2002). (1998) stated that it signifies the expansion by the industrial economies into the developing countries and of the latter’s increasing integration into the world market and growing competitiveness particularly in the case of the newly industrialized emerging economies. Third, globalization makes workers move from one country to another partly to find better employment opportunities.  Most migration occurs between developing countries but the flow of migrants to advanced economies is likely to provide a means through which global wages converge.  It also opens the potential for skills to be transferred back to the developing countries and for wages in those countries to rise.  Lastly, information exchange is an integral aspect of globalization. Technical innovation, knowledge about production methods, management techniques, export markets and economic policies are made available to different economies and can be a highly valuable resource for the developing countries ( 2002). Moreover,  (2003) pointed out that the interconnectedness of nations has reduced the sense of isolation for many as a result of increased access to knowledge, lifestyles and trends available through technology, particularly the Internet.  Foreign aid has brought millions of dollars to developing nations while foreign companies have provided new technologies, access to new markets and new industries to the recipient countries.  Higher standards of living have occurred because of the introduction of more jobs through the new markets, and scientific and medical technologies have improved the quality of life. The latter part of the 20th century provides evidences that globalization reduced poverty.  More people have become better off at a faster pace in the past sixty years than ever before in terms of poverty, life expectancy, health, and education. The World Bank revealed that trade enabled the developing countries to grow at 4.3 percent per year during the 1990s, twice the rate of the developed world ( 2005).


The most powerful benefit of the global economy is not economic at all, even though it involves important economic and business activities.  By enabling more people to use modern technology to communicate across traditional national boundaries, the international marketplace makes possible more than an accelerated flow of data. The worldwide marketplace encourages a far greater exchange of the most powerful of all factors of production – new ideas.  That process enriches and empowers the individuals in ways never before possible (2001).  The empowerment that comes with interconnectedness of nations, cultures and communities paves the way to what  (2002) called “Era of Community” in which life is the defining cultural value, cooperation and partnership are society’s organizing principles, and networking is the predominant organizational form.  It is also the most exciting moment of opportunity and challenge in the history of the species, because it opens the way to a new level of species maturity and potential.


With regards to the continuing development and progress in global financial market, Saudi banking and financial market also grow in order to meet the needs of the changing society. Actually, the capacity of the Saudi Arabian banking sector to respond to macroeconomic shocks has been considerably strengthened over the past decade. Historically, the operating environment has been one of output volatility emanating from pervasive dependence on the hydrocarbons sector and swings in investor confidence associated with regional uncertainties. This experience has helped shape fairly risk-averse portfolios and the bank-led financial system has functioned with substantial capital adequacy ratios (CARs), loan-loss allowances, and liquidity buffers. The sector is profitable, with returns on assets averaging over 2%, supported by a low-cost demand deposit base even as lending rates are determined internationally. Stability is underpinned by an effective regulatory and supervisory structure that proactively contains risk-taking through the articulation of lending limits, including to connected parties caps on individual and corporate indebtedness, and pre-approval requirements on foreign lending.


As shown in the discussion, the current global market are frequently dominated by a few large firms or interest groups, which, because of their size and geographical scope, can exploit such market failures as information asymmetries, monopoly power, and privileged access to markets; and, where it is perceived to be in their interests, engage in unacceptable social or moral behavior. Banking sector is becoming one of the fast rising markets in the world. More countries are becoming aware of this business trend. This trend affects businesses because it fully relates to the global financial problem. This trend creates an imminent need for changes in businesses and a sudden need for changes in business plans. We can’t deny that any country that has ups and downs in business and economics. Doing business in Saudi Arabia or any countries in middle east can be a good or bad thing depending on the industry and the economic trend the country is experiencing.


 


Saudi Dual Financial System (conventional banks and Islamic banks system)


Over the last decade, Islamic banking has experienced global growth rates of 10-15 percent per annum, and has been moving into an increasing number of conventional financial systems at such a rapid pace that Islamic financial institutions are present today in over 51 countries. Despite this consistent growth, many supervisory authorities and finance practitioners remain unfamiliar with the process by which Islamic banks are introduced into a conventional system. (…for continuation)


 


 


 


 


Comparison between Saudi Financial System and Islamic Financial System of Iran and Sudan


 


 


 


 


 


 


 


Macro Interest Policy in Saudi Arabia and the Dollarization


Saudi government policies regarding the business market pricing system has been alleged for lowering the prices of products and services without discussing it with the overall business industry. It is also criticized for practicing “dollarisation” wherein prices for Euro imports are converted into dollars, based on a discretionary exchange rate. Prices for imported products are calculated on the basis of the manufacturers’ wholesale and retail prices in the “country of origin’” the export prices to Saudi Arabia, and the CIF prices to thirty other countries. The lowest price is usually the end result which renders issues with the foreign companies since these companies come from markets that are different from Saudi Arabia relative to standards of living, product consumption patterns, income levels, and exchange rates or regulatory requirements. This practice has led to an estimated 20 percent loss for some foreign companies due to the wide gap between the values of Euro and Dollar.


 


 


The Special Characters of the Saudi Financial Market System


 


 


 


 


 



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