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Saudi reforms economy, benefits may be elusive

New mortgage law gave a temporary leg-up to banking stocks but such reforms will struggle to boost the private sector and cut unemployment

Reuters, Sunday 15 Jul 2012

After Saudi Arabia passed a long-awaited law covering housing mortgages last week, banking shares rocketed over 5 per cent in a single day as investors bet the reform would unlock a lucrative source of revenue for banks.

Since then, however, the shares have fallen back, giving up more than two-thirds of their gains, as investors focus on how the country's high land prices may slow the growth of the mortgage industry - while legal uncertainties mean it is not clear how profitable the business will be.
The stock market's performance underlines the hopes and fears surrounding economic reform in Saudi Arabia. By passing the mortgage law, the government has largely completed a sweeping revision of economic policy which it launched in the late 1990s. 
But making sure those reforms boost private sector growth and cut unemployment will remain a struggle.
A host of smaller changes is still needed to enforce the reforms, encourage competition and push companies into operating more efficiently. These changes may be difficult in the face of entrenched bureaucracies, a conservative judicial system and political pressures to improve workers' welfare.
"Policy direction has been pretty solid, but implementation has let it down sometimes. There's room for improvement on that side," said Paul Gamble, chief economist at Jadwa Investment in Riyadh.
"They've taken the big steps but there are still important smaller steps."
After global oil prices slid below $10 a barrel in 1998, Saudi Arabia launched a programme of reforms designed to diversify the economy away from its heavy reliance on oil, strengthen the private sector and create jobs for young Saudis.
These included opening previously off-limits sectors of the economy such as mining and utilities to private investment, strengthening regulation of the capital markets, joining the World Trade Organisation in 2005 and partially privatising big state companies in sectors including telecommunications.
Last week's mortgage law, passed after more than a decade of study, is a major plank in the reform programme. Though a limited form of home purchase loans was already available, based on banks making deductions from buyers' salaries, it will now become possible to secure mortgages against property, creating new options for investors, banks and property developers.
"We expect the market to mature a little bit better now with this in place. Demand is there from the customers," said Rehan Khan, chief financial officer of Saudi British Bank, the kingdom's fourth-largest lender.
Another reform under discussion is opening the stock market to direct investment by foreign institutions. Authorities have mostly completed technical preparations for this change, which would subject Saudi firms to more market discipline.
King Abdullah, who started the reform programme after becoming regent to King Fahd in 1995, is now 89. He has a new heir apparent after the death in June of Crown Prince Nayef, who was believed to be opposed to some further reforms. The new crown prince, Salman, is seen as open to economic restructuring.
"He certainly is very close to the business community and I think he will be supportive of reform, although not on the scale of King Abdullah," said a lawyer who has advised the government on key reforms, declining to be named because of political sensitivities.
The case of the mortgage law, however, illustrates how Saudi economic reforms can be less effective than they initially seem. It will not be clear until detailed regulations are published by the central bank in three months time whether the government will allow mortgage holders who default on repayments to be evicted - a key issue for the profitability of the banks.
Attempts to pass the mortgage law were delayed for years by opposition from powerful clerics based on Islamic opposition to interest-bearing loans and the concept of home repossessions.
"The basic framework is there but you have to actually roll out something that is going to be truly effective and transformational," said the lawyer.
The mortgage law's impact on the housing industry may be limited without action to increase the supply of land, by encouraging wealthy families who hold huge tracts to put them up for development. Earlier this year, Saudi media reported the consultative Shoura Council was considering the idea of imposing a tax on undeveloped land to improve supply, but that idea now appears to have been shelved.
Once economic reforms are set, it is not always clear whether they will be enforced consistently by administrative bureaucracies and the court system. Judges, who in Saudi Arabia are religious scholars, say governments have no right to interfere in their interpretation of Islamic law.
King Abdullah passed a series of judicial reforms in 2008 but has struggled to implement the changes, which include officially recording judgements to create an established history of precedent.
"How applicable is a contract drawn up under foreign law in Saudi Arabia? It's another area where you can have a policy decision, but implementation doesn't really happen, or doesn't happen as it should," said a Riyadh-based analyst.
And even when the government has decided in principle on reforms, it sometimes appears hesitant to push ahead with them if they risk becoming politically sensitive.
For example, based on contacts with government officials, many people in the securities industry expected the stock market to be opened to foreign investors in the first half of 2012. But that did not happen and there is now talk that the opening will be delayed until at least next year; an influx of foreign money could destabilise the market, potentially creating a boom-and-bust cycle that might prompt criticism of authorities.
Another area which economists believe needs reform is the domestic energy sector. Soaring power consumption driven by subsidised prices is causing growing volumes of oil to be burned, eating into the amount available for export.
However, the government's solutions have so far focused on expensive schemes to generate power with solar or nuclear technology - not raising electricity prices, which could anger industrial and retail consumers.
There are signs that economic reforms are having some success in boosting private business. The private sector expanded 6.3 per cent in the first quarter of this year, outpacing the state sector which grew 4.2 per cent, in a pattern that has prevailed for the last several quarters.
But the goal of weaning the economy off oil exports remains distant: non-oil exports accounted for only 12 per cent of total exports last year. And after years of buoyant global oil prices, which have boosted the country's foreign reserves to nearly $600 billion from roughly half that level five years ago, authorities may have lost the impetus for potentially painful economic restructuring designed to accelerate growth.
Instead, future economic reforms may aim primarily to address specific complaints among many Saudis: corruption, a housing shortage and a lack of high-paying jobs.
Labour market reforms since last year, for example, have made it harder to hire foreigners through a quota system while providing more unemployment benefits to Saudis. A planned reform would encourage companies to put Saudis in higher-paying jobs by pressuring employers to allocate minimum ratios of their payrolls to Saudi citizens.
Future economic reforms "might be quite different to the reform push in the 2000s, which was initiated in the austerity of the late 1990s when they faced a real fiscal crisis and had to do something about public sector spending," said Steffen Hertog, author of Princes, Brokers, and Bureaucrats, a book about Saudi politics.
He noted that after the Arab Spring uprisings around the Middle East last year, King Abdullah pledged $110 billion in spending on social benefits over several years, including building half a million houses, creating 40,000 new jobs and introducing unemployment benefits.
"This looks more like distribution policies" than growth-oriented reforms, Hertog said.
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