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Saudi succession preparing for a tougher future - october 28 2011
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1. ECONOMIC RESEARCH 1 October 28, 2011 Saudi Succession: Preparing for a Tougher Future Page | 1 By John Prosser and Rachel Ziemba The anointment of Crown Prince Nayef, who has effectively been acting in this capacity for a number of years, will focus attention on those next in line and on the medium-‐term challenges faced by the economy. Nayef, and other immediate successors, are likely to be more conservative and security-‐focused than the current king and there is a risk that King Abdullah’s gradual reforms could be deferred. Politically, Saudi Arabia has to adapt to a much more uncertain regional political environment and weaker global growth—both of which will challenge its socio-‐economic model. The massive increase in spending has reduced the national fiscal cushion, which could heighten the risk of volatile oil prices and then force economic reforms as an era of deficits lie ahead. Few Surprises for Now The death of Saudi Arabias Crown Prince Sultan on October 20 is a reminder of the nebulous power structures upholding the kingdom’s ruling family. The issue of Saudi succession is never far from discussion, but the manner in which the new Crown Prince has been anointed has set a precedent—it is the first time an heir has been chosen when his immediate predecessor has not become ruler. As expected, King Abdullah’s half brother, Prince Nayef, was announced as the new Crown Prince on October 27. Nayef’s overall policy stance is not thought to be very different from that of the current king, who is again recovering from surgery, but his overall approach and focus is thought to be different. And he has much less popular support (like others in the line of succession). We do not expect any immediate changes, both because the King himself has an extensive power base, but also because there is general agreement within the ruling family about the broad tilt of policy. Changes may emerge on the margins, though. The anointment of Nayef, however, only came after the King had consulted with the Allegiance Council, a group of 33 direct descendants of King Abdulaziz—the founder of the modern kingdom—charged with overseeing the selection of the Crown Prince. Created by King Abdullah in 2006, it is the first time the council has been called into action. Assuming the House of Saud survives beyond its geriatric rulers, any young(er) pretender to the throne can be expected to emerge through a similar institutional process. Although the kingdom has largely evaded the pressure for political change seen elsewhere in the Arab world this year, this has come at the expense of massive government largesse—much of which involves hefty future commitments and has narrowed policy space. Ultimately, Saudi Arabia will have to reform—economically at least. Diversifying revenues (and broadening the tax base) could well force an increase in transparency. Such transformations may well coincide with the House of Saud’s long-‐anticipated generational shift. Whoever ultimately emerges will have a crucial role to play as they will be at the helm of a country in dire need of reform, and under international pressure to take a leading role in an unstable region. Demographic challenges, particularly finding employment for the vast number of youth and rising inequality, will push from within at a time when the global environment is less forgiving. Given these challenges, a smooth transition of power is paramount. www.roubini.com NEW YORK -‐ 95 Morton Street, 6th Floor, New York, NY 10014 | TEL: 212 645 0010 | FAX: 212 645 0023 | email@example.com LONDON -‐ 174-‐177 High Holborn, 7th Floor, London WC1V 7AA | TEL: 44 207 420 2800 | FAX: 44 207 836 5362 | firstname.lastname@example.org | email@example.com © Roubini Global Economics 2011 – All Rights Reserved. No duplication or redistribution of this document is permitted without written consent.
ECONOMIC RESEARCH 2 Saudi tradition has seen most family disputes resolved quietly behind closed doors, and many elders within the family will be keen to keep it that way. Saudi Arabia’s de facto control of much of the Arabic-‐speaking media also Page | 2 ensures most spats are kept out of the headlines. Despite any illusion of calm, the future direction of the kingdom is likely to be a contentious issue. Degenerating Octogenarians At 87, King Abdullah is already two years older than his late brother Prince Sultan, who died October 21. Abdullah is largely recognized as a gradual reformer—encouraging the growth of private-‐sector industry and weakening the influence of the religious establishment on the judiciary and within education. The King, however, is ailing, and many of the country’s liberals are concerned that the gains (limited though they are) made under his reign may disappear when he does. In particular, Crown Prince Nayef, 77, has close allegiances to the country’s powerful and conservative clerics, as well as the security establishment, and is viewed warily by those seeking greater public accountability and women’s rights. Having served as interior minister since 1975, he has been responsible both for crackdowns on Islamic extremists in the wake of the September 11 attacks (and, more actively, threats to Saudi oil installations and members of the royal family), as well as persistent suppression of political protests—most recently smothering disquiet in the country’s Eastern Province. In this security capacity, he has close ties with the U.S. security establishment, which would, no doubt, be heartened by the solidification of the line of succession. Already a powerhouse in the Saudi establishment, Nayef was promoted to second deputy prime minister in 2009 as the Sultan’s health deteriorated—a role considered tantamount to a crown prince in waiting. In that capacity, he has headed the country in brief interludes when both King Abdullah and Crown Prince Sultan were concurrently undergoing medical treatment or taking part in foreign diplomatic events. Nayef is also one of the so-‐called “Sudairi Seven,” seven brothers born to King Abdulaziz’s favourite wife Princess Hassa bint Ahmed Al Sudairi, and famed for their influence within the House of Saud. Crown Prince Sultan was the second of the seven to die, following the death of King Fahd in 2005. Prince Salman, Governor of Riyadh since 1962, is the only other brother considered suitable for the throne. In fact, shortly after Sultan’s death, rumors swirled that Salman might be chosen ahead of his brother. This would be counter to the highly seniority-‐based system. King Abdullah is not a member of the Sudairi line, and his nomination as Crown Prince by King Fahd was seen as an attempt to maintain the balance of power within the family. As Abdullah took on increasing responsibilities from an ailing King Fahd in the mid-‐nineties, many of his attempts at reform were thwarted by Nayef and Salman. Regardless, any immediate successor would likely come from the Sudairi line. King Abudullah has taken several actions to counter the voting bloc of the Sudairis, including the creation of the Allegiance Council. The council has the power to accept or reject the King’s nomination for crown prince, as well as to judge when a current ruler is incapacitated. As such, the council is intended to formalize and add a modest amount of transparency, at least within the ruling family, so that the choice of heir is unlikely to cause division. The council is headed by Prince Mashaal, a close confidant of the King and another non-‐Sudairi considered to be out of the line of succession. Sudairi influence within the council is considered to be less than within the House of Saud more generally, and may have been a deliberate attempt to create an institution to prevent Sudairi dominance. The King’s decision to turn to the council, in the appointment of Nayef, suggests that a degree of institutional power sharing will be involved in future decisions. The increasing pressure for reforms—which could escalate should the likes of Tunisia, Libya or Egypt evolve into functioning democracies—will test the balance between conservatives and reformers within the family. www.roubini.com NEW YORK -‐ 95 Morton Street, 6th Floor, New York, NY 10014 | TEL: 212 645 0010 | FAX: 212 645 0023 | firstname.lastname@example.org LONDON -‐ 174-‐177 High Holborn, 7th Floor, London WC1V 7AA | TEL: 44 207 420 2800 | FAX: 44 207 836 5362 | email@example.com | firstname.lastname@example.org © Roubini Global Economics 2011 – All Rights Reserved. No duplication or redistribution of this document is permitted without written consent.
ECONOMIC RESEARCH 3 House of Saud Prepares for 3G Health permitting, the most likely line of succession will run from Abdullah to Nayef to Salman—the latter of Page | 3 whom could well nominate the first crown prince from the third generation. The shuffling of positions within the family, brought about by Sultan’s death, may highlight the frontrunners. Among them will be the son of Prince Nayef, Prince Mohammed, the sons of Crown Prince Sultan, Prince Bandar and Prince Khaled, and the sons of the late King Faisal, Prince Saudi, Prince Turki and Prince Khaled (see Figure 1). Figure 1: Saudi Family Tree Source: RGE With the King serving as prime minister and the Crown Prince as deputy prime minister, the role of second deputy prime minister is a natural third in line to the throne, and the title is expected to transfer from Nayef to Salman. The appointment of one of the younger generation to this position would be a strong indicator of a crown prince in waiting (even if Salman doesn’t lose his opportunity). However, the King could chose to leave it unfilled. Key ministries are a more likely place to signal future leaders. Nayef or Salman are likely to replace Sultan as defence minister; the pertinent question is then who replaces either of them as interior minister or governor of Riyadh, respectively. As assistant interior minister, Prince Mohammed may be in the running, although there may be some pressure to move away from the Sudairi dominance. The three sons of the late King Faisal are among the most influential non-‐Sudairi members of the third generation, yet long-‐time foreign minister Prince Saud is ailing and Prince Turki caused controversy in 2006 by abruptly resigning his position as U.S. ambassador, as he felt he was being undermined by King Abdullah and Prince Bandar. Royal Family Has a Weaker Hand The potential impact on oil production increases global interest in the succession. With output of around nine million barrels per day, Saudi Arabia is the world’s second-‐largest producer of crude oil, but holder of the largest reserves. Moreover, it controls the bulk of spare capacity within OPEC, and thus among oil producers. However, the price required to balance Saudi budgets (US$90 per barrel of Brent) is fast approaching a level that could add www.roubini.com NEW YORK -‐ 95 Morton Street, 6th Floor, New York, NY 10014 | TEL: 212 645 0010 | FAX: 212 645 0023 | email@example.com LONDON -‐ 174-‐177 High Holborn, 7th Floor, London WC1V 7AA | TEL: 44 207 420 2800 | FAX: 44 207 836 5362 | firstname.lastname@example.org | email@example.com © Roubini Global Economics 2011 – All Rights Reserved. No duplication or redistribution of this document is permitted without written consent.
ECONOMIC RESEARCH 4 to global stagnation. Energy policy has thus become more complicated in Saudi Arabia. We believe the kingdom will try to target a higher and narrower band for oil, but doing so could add to volatility. Page | 4 RGE has long emphasized the fiscal constraints that will bind Saudi Arabia in the coming years, and tough decisions will follow on spending patterns, subsidies and the balance between infrastructure, defense/security and other aspects of the public sector. In 2011, Saudi Arabia passed a raft of measures aimed at preventing the spread of revolutionary sentiment prevalent in other Arab states. Budget amendments for government employee salary increases and bonuses, unemployment benefits and housing and infrastructure investment came to US$37 billion, on top of the planned spending of over US$160 billion. This largesse exacerbated the already aggressive spending trajectory since 2006. While some of these measures are temporary, at least theoretically, many will increase spending expectations for future years. In addition to its government spending, Saudi Arabia has increased its implicit and explicit support for some of its neighbors, especially Bahrain. These pledges—seen as necessary for political stability—will come with an economic price. Going forward, Saudi officials will remain more parsimonious with outright investment abroad compared with their smaller, richer (on a per capita basis) neighbors, the UAE and Qatar. Figure 2: Government Spending Breaching Comfort Zone (US$/barrel oil price needed to cover govt spending) 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011f 2012f Budget Break even price average oil price Source: RGE If spending continues at a similar tilt, RGE expects that the government could be running a budget deficit as early as 2013. If, as RGE anticipates, Europe’s sovereign debt crisis induces a prolonged recession in developed markets and a fall in global oil demand, it could occur even earlier. Even if oil demand remains resilient, should OPEC output trimming fail to stabilize the oil price or political necessities prompt even more government spending, deficit territory is around the corner. Saudi Arabia does have ample reserves, and tends to hold more liquid assets than other GCC states, who rely more heavily on investment funds to safeguard national wealth, but it could begin tapping these reserves sooner than it would like. Elevated oil prices prior to 2008 allowed Saudi Arabia’s central bank (SAMA) to accumulate vast foreign assets. Despite dipping into these reserves in 2009 and 2010, RGE expects net foreign assets will rise to almost www.roubini.com NEW YORK -‐ 95 Morton Street, 6th Floor, New York, NY 10014 | TEL: 212 645 0010 | FAX: 212 645 0023 | firstname.lastname@example.org LONDON -‐ 174-‐177 High Holborn, 7th Floor, London WC1V 7AA | TEL: 44 207 420 2800 | FAX: 44 207 836 5362 | email@example.com | firstname.lastname@example.org © Roubini Global Economics 2011 – All Rights Reserved. No duplication or redistribution of this document is permitted without written consent.
ECONOMIC RESEARCH 5 US$550 billion in 2011. Similarly the government has little debt and direct external debt, meaning it does have space to borrow. However, we imagine that Saudi Arabia will be wary of building up too much debt, particularly as Page | 5 it struggled with (albeit domestic) debt burdens in the 1990s. Figure 3: Saudi Arabia’s Official Foreign Assets Still Climbing (US$, billions) Source: SAMA, RGE Figure 4: But Not So High on a Per-‐Capita Basis... 300% 600 250% 500 200% 400 150% 300 100% 200 50% 100 0% 0 Bahrain Kuwait Oman Qatar Saudi Arabia UAE Sovereign Wealth per capita (US$ 1000) Sovereign Wealth/GDP (left axis) Source: Moodys, Central Banks, RGE Population and GDP from 2010, Sovereign Wealth and reserves data In the medium term, the government will have to pursue greater reforms and find new sources of revenues or cut spending. One particularly thorny area concerns subsidies. Domestic energy subsidies eat away at other spending and, by fuelling demand, undermine export prospects. Saudi Arabian oil demand per capita has skyrocketed, far www.roubini.com NEW YORK -‐ 95 Morton Street, 6th Floor, New York, NY 10014 | TEL: 212 645 0010 | FAX: 212 645 0023 | email@example.com LONDON -‐ 174-‐177 High Holborn, 7th Floor, London WC1V 7AA | TEL: 44 207 420 2800 | FAX: 44 207 836 5362 | firstname.lastname@example.org | email@example.com © Roubini Global Economics 2011 – All Rights Reserved. No duplication or redistribution of this document is permitted without written consent.
ECONOMIC RESEARCH 6 outpacing demand growth in fast-‐growing EM oil importers like China and India. That oil used—not only for transportation, but also for power (an inefficient use)—adds to demand. This implies that even more efforts will go Page | 6 into the search for natural gas to power the economy, but also that higher domestic prices may be needed to encourage investment in alternatives as well as change consumption patterns. Food subsidies are a related issue. Figure 5: Per-‐Capita Oil Consumption Spiking (barrels a day per capita) Source: BP, World Bank, RGE The willingness to enact reforms may well depend on how rapidly Saudi Arabia’s fiscal health deteriorates. Cushioned by sustained oil revenues, the current generation of leaders is likely to be more comfortable passing the buck of reform on to the next generation. Next year’s budget, to be released in December, is the earliest opportunity that any change in sentiment could be translated into policy. We expect that the government will try to hold the line on spending, as in fact they did with last year’s plans. However, we expect they will again overshoot the target. RGE doesn’t expect the reshuffling of the royal pack to have a dramatic impact on spending patterns in the near term. Despite all the talk of Prince Nayef’s conservative streak, Abdullah is still the man at the top and is likely to continue his glacial reforms. In the event that Nayef comes to power in the next couple of years—a window in which the government may still have a modicum of fiscal leeway—it is questionable whether he has broad enough support within the House of Saud to do anything other than rule by consensus, much as Abdullah has done. At the margin, he may be able to protect spending on areas considered vital for national security (defense, which has historically absorbed over 36% of spending) or support for the religious establishment. Nayef—or any future King, for that matter—will likely exert greatest influence by steering the line of succession. Those successors will likely be the ones to have to navigate the toughest conditions, without the luxury of a bottomless fiscal account. The above content is offered for the exclusive use of RGEs clients. No forwarding, reprinting, republication or any other redistribution of this content is permissible without expressed consent of Roubini Global Economics, LLC. All rights reserved. If you have received access to this content in error, RGE reserves the right to enforce its copyright and pursue other redress. RGE is not a certified investment advisory service and aims to create an intellectual framework for informed financial decisions by its clients. This content is for informational purposes only and does not constitute, and may not be relied on as, investment advice or a recommendation of any investment or trading strategy. This information is intended for sophisticated professional investors who will exercise their own judgment and will independently evaluate factors bearing on the suitability of any investment or trading strategy. Information and views, including any changes or updates, may be made available first to certain RGE clients and others at RGEs discretion. Roubini Global Economics, LLC is not an investment adviser. For questions about reprints or permission to excerpt or redistribute RGE content, or for a PDF version, clients should contact their RGE account representative. www.roubini.com NEW YORK -‐ 95 Morton Street, 6th Floor, New York, NY 10014 | TEL: 212 645 0010 | FAX: 212 645 0023 | firstname.lastname@example.org LONDON -‐ 174-‐177 High Holborn, 7th Floor, London WC1V 7AA | TEL: 44 207 420 2800 | FAX: 44 207 836 5362 | email@example.com | firstname.lastname@example.org © Roubini Global Economics 2011 – All Rights Reserved. No duplication or redistribution of this document is permitted without written consent.