The word seems to be getting around: Saudi Arabia confronts a set of uncomfortable and unwelcome economic choices that will affect the royal family’s relations with its own citizen-subjects and with its big power allies in the West. For the past two decades, the kingdom’s treasury has served as an apparently limitless trough: royals and commoners could satisfy their acquisitive needs; Western finance and war ministries could count on Saudi orders for tanks, power plants and just about everything else to keep trade deficits under control and production lines rolling; the CIA could count on a cool billion to pay for its war in Nicaragua; and the Bush administration could ensure that the Saudis financed the biggest share of its Desert Storm extravaganza. Now it appears that Yasser Arafat, Bill Clinton and Yitzhak Rabin are counting on Riyadh to be a major funder of the latest PLO-Israel accord.
Some of the folks who sit behind big desks at the Bank of England or the US Federal Reserve have recently raised questions about how deep the Saudi official (as opposed to royal) pockets really are, and have judiciously leaked word and evidence of their concern. In early August, the Middle East Economic Survey, an oil and finance industry newsletter, published excerpts of an April 1993 International Monetary Fund report which hinted that “a broad-based review of policies” might be in order. The Survey commentary was more blunt: “Simply put, the country’s present economic and fiscal path is unsustainable.”  A few weeks later, the New York Times, tipped off by US government officials not infected with the clientitis that so afflicts the State and Treasury Departments, published two lengthy articles spotlighting the kingdom’s current financial straits and examining the consequences of these difficulties for Saudi-US relations, particularly for US arms sales. 
These articles, along with more sensationalist tabloid rehashes, momentarily sent the Saudi riyal tumbling and forced the country’s central bank officials to manipulate domestic interest rates to restore order. King Fahd alluded to foreign conspiracies attempting to undermine the kingdom. Saudi Minister of Finance and National Economy Muhammad Abalkhail responded that the kingdom had indeed spent vast sums (his estimate was more than $1 trillion) on the “transformation of the country from a tribal society to a modern state,” and gushed that “we feel proud of it.” 
The issue, though, is not the past level of spending. It is the ability of the Saudis to sustain current spending into the future. Oil revenues are expected to remain fairly stagnant at best. According to the New York Times, Saudi officials assert they will not cut back on some $30 billion worth of arms on order from the US, and will cut subsidies and domestic expenditures where necessary. The IMF report, though, cites the view of Saudi authorities that “at this time, political and social considerations precluded a reduction in subsidies or an increase in fees and charges.” 
Up to now, the government has relied primarily on domestic commercial banks to finance its deficits. If the deficits continue, as is likely, the country will have to turn to foreign borrowing. By any scenario, life as the Saudis and their friends have come to know it seems to be on the verge of change.
It is a cliché that Saudi Arabia’s government revenues are dependent on oil income, but one worth repeating. Earnings from official asset holdings have dropped, as they have been depleted to fund budget deficits. Fees and duties collected from the private sector have not kept pace with the government’s needs, and King Fahd recently cut utility fees further in an obvious political gesture. Oil earnings allocated to the budget have risen from 65 percent in 1985 to 77 percent in 1992 as a share of total revenues. Looking forward, it is likely that the government will do well to maintain the current level of oil revenues. If, or rather when, Iraqi oil returns to international markets, Saudi Arabia, like other oil exporters, will have to take a hit.
With oil revenues in decline, can the government increase domestic revenues? First, family rule in Saudi Arabia, and in most of the Gulf states, has been maintained through direct control over oil revenues. Any meaningful degree of taxation will trigger demands for a more open accounting of the kingdom’s finances. The questions raised by Kuwait’s National Assembly about the ruling family’s conduct of economic policy indicate what could be brought to the surface in Saudi Arabia. Second, resorting to higher business fees or import duties or even instituting indirect taxes (like sales taxes) might well precipitate a major loss of private sector confidence in the government. Third, the Saudis have no institutional apparatus to collect taxes efficiently and have shown no interest in creating one. Given the kingdom’s intricate patronage system, exemptions would undoubtedly ruin any taxation system. In the end, the government would have raised more political resentment than revenues.
How feasible are budget cuts? Government outlays fell from a peak of $70 billion in the early 1980s to $55 billion in 1992. Adjusting for inflation, these declines are even greater. The bulk of the cuts were capital expenditures, which would have fallen anyway with the end of major infrastructure programs. Current expenditures supporting domestic consumption were barely pruned. Military and security expenditures constitute a large part of current spending. During the last decade these have averaged 32 percent of total government outlays. A sizable domestic constituency is supported by these expenditures, mainly in the form of salaries and other benefits. The National Guard, for example, has played a key role in absorbing members of sedentarized tribes since the 1940s. The political loyalties this engenders buttress the relative influence of certain princes — National Guard commander Crown Prince ‘Abdallah, for instance. Military expenditures also form a sizable part of princely private income. “If a prince heads a ministry or some other government department,” writes Michael Field, “it is accepted in Saudi Arabia, though not in most of the Gulf states, that he is entitled to draw on the budget of that department, or take a share of its spending on major projects.” 
Pressures to maintain foreign arms imports also come from overseas. The $9 billion McDonald Douglas F-15 aircraft deal announced by George Bush during the 1992 US election campaign is a case in point. Since the Gulf war, Saudi Arabia has promised to buy more than $26 billion in US weapons, and Clinton administration officials “say they see the [military] sales as crucial to keeping American arms makers afloat while the American military shrinks.”  Similarly, Saudi Arabia has virtually kept British Aerospace afloat with its purchases of the Tornado jet fighter.
A rapidly growing component of non-military current expenditures is interest costs, which have grown from zero in 1988 to nearly 10 percent of 1992 spending and are likely to rise to 15 percent in the next two years. Since a good part of the ruling family’s legitimacy depends on maintaining affluence, other items in the current spending category are firmly linked to maintaining domestic income levels. Salaries directly support consumption, but so do subsidies, which form large overt and hidden costs to the exchequer. Saudi citizens enjoy a variety of essential goods and services at a fraction of what most other countries’ citizens of similar income levels have to pay, and have come to regard these subsidies as entitlements. 
The same is true of production subsidies. The Saudi private sector sees cheap gas, free utilities and interest-free loans as a major incentive for investing its funds in the domestic economy. Without these inducements, it is unlikely that much of the private sector’s resources would be deployed domestically. Agricultural subsidies are a major source of income for members of the royal family, who are very large landowners.  Production subsidies, furthermore, are a major incentive for encouraging foreign direct investment. The massive petrochemical capacity installed during the 1980s through joint ventures with foreign multinationals relied on cheap feedstock, and free utilities and land. (Current expansion should raise domestic capacity to 40 percent by 1995.)
A substantial amount of current domestic spending maintains past infrastructure investments and props up the private construction companies created to build it. Most serious private fortunes were made from building something in the kingdom. The overseas prod is also present in the non-military sector. Recently, the potential for selling $6 billion worth of Boeing passenger planes to Saudia Airlines prompted a trip to Riyadh by Secretary of Commerce Ron Brown and a phone call to the king from President Bill Clinton himself.
With domestic and foreign politics hindering policy changes that could increase revenues and/or decrease spending, how will the government control the budget deficits which have averaged close to 13 percent during the last four years? Even keeping current expenditures flat in nominal terms is extremely difficult, given inflation, domestic interest costs and subsidies, and would still leave deficits of 8-10 percent of GDP in the next several years.
So far the government has utilized its foreign reserves, domestic borrowing and a relatively small amount of foreign borrowing to finance its budgetary shortfalls. The official estimate of Saudi foreign reserves is $72 billion (including those of the AGIs), but it is widely acknowledged that a substantial portion — $45-50 billion — are “non-performing” loans to Iraq and other countries. The IMF’s balance of payments account for Saudi Arabia shows an extraordinary shift of more than $22 billion of “other capital movements” into the country in 1991, which almost surely represents a considerable chunk of Saudi assets still abroad prior to the Gulf war, and casts doubt on the estimate of $8.5 billion in investment income receipts for 1992. Saudi Arabia no longer has the assets abroad to fund future budget deficits, since the statutory requirements of backing up the Saudi riyal and covering the monetary system’s external liabilities are close to the real level of performing assets of $20-30 billion.
Domestic debt at the end of 1992 was $62 billion, around 52 percent of GDP. Until 1991, this debt was covered largely by shifting government money around, which had some ramifications because foreign assets were converted into riyal assets. Since 1991, the government has come to rely more heavily on borrowing from the domestic banking system. With domestic banks buying government bonds, and public enterprises such as Saudi ARAMCO, SABIC and others funding their investments through domestic debt rather than direct government spending, public sector debt is estimated to account for nearly 35 percent of the assets of commercial banks.
This greater reliance on commercial banks has two implications. First, this domestic debt is for all practical purposes just like foreign debt, given the absence of capital controls in Saudi Arabia. With riyals freely convertible, the government competes with the Bundesbank and the US Treasury for Saudi private investment. Saudi interest rates have tracked those in the US with nearly perfect synchronicity, but doubts about the country’s credit worthiness may force the government to raise interest rates to induce private banks to buy government paper. Second, there is a great danger government debt will “crowd out” private borrowing. Either development could destabilize domestic financial markets and lead to a large outflow of funds to safer havens. Propping up the domestic banks and supporting the riyal could end up costing the Saudi Arabian Monetary Agency its remaining foreign assets.
A related issue concerns the integrity of the Saudi banking system as a whole, especially given questions about the financial status of Saudi Arabia’s largest bank, the National Commercial Bank (NCB). For the most part, the other 11 Saudi banks that constitute the system appear to be sound — judging from their less than adequately audited financial statements — having recently strengthened reserves, built assets on the Riyadh stock exchange and registered record profits by boosting their loan portfolios. 
The NCB, the oldest and the largest by far, is owned by the bin Mahfouz family, one of whose members was indicted in the US on charges of “embezzling” from BCCI. The NCB’s numerous difficulties include a sizable quantity of bad loans, most of which were made to royal family members. International depositors of BCCI have brought suit in Great Britain against Khalid bin Mahfouz to the tune of $10.9 billion. If the judgment goes against NCB and bin Mahfouz, the Saudi government will have to get involved, with potentially destabilizing consequences for the Saudi financial system.
The Saudi government could finance its deficits overseas, and two factors will likely lead Riyadh down the path of external indebtedness. First, foreign governments are likely to lend substantial funds to Saudi Arabia to finance the purchase of their exports. The US Export-Import Bank is funding the Boeing deal, and other government export credit agencies are gearing up for similarly huge lending programs. Creative financing deals cobbled together by various government agencies will attempt to sustain Saudi arms purchases. 
Second, international commercial banks and private sector suppliers will continue to lend short-term to their clients in Saudi Arabia. Short-term debt, by my estimate around $15 billion at the end of 1992, could virtually double during 1993 and 1994 to satisfy domestic funding requirements.  Foreign creditors still regard the private sector — and some public enterprises such as ARAMCO — as creditworthy. In this way, Saudi government agencies borrowing locally could disguise foreign borrowing.
External debt gives the government a few more years of breathing space and time to slowly ease in budgetary changes — the scenario described in the case of the US budget deficit a few years ago as a “soft landing.” Given the political rigidities in the system, it is unlikely the regime will be able to take advantage of this opportunity. If it cannot, and if oil prices remain in their current range, a “hard landing” becomes a less remote possibility.
 Middle East Economic Survey, August 9, 1993.
 New York Times, August 22-23, 1993, based on interviews with US and Saudi officials, and Saudi banking sources.
 New York Times, August 26, 1993.
 Middle East Economic Survey, p. B4.
 Michael Field, The Merchants: The Big Business Families of Saudi Arabia and the Gulf States (Woodstock, NY: Overlook Press, 1984), pp. 101-104.
 New York Times, August 23, 1993. The report goes on to say that Prince Bandar ordered many of these items without the knowledge of Finance Ministry officials, illustrating that the technocrats within the government do not fully control expenditures.
 Jill Crystal has argued this for Kuwait: “As welfare functions become the norm, as services become legitimate claims on the state, they: are seen less as examples of the rulers’ largesse and more as rights that citizens, not subjects, can claim from the state.” Oil and Politics in the Gulf: Rulers and Merchants in Kuwait and Qatar (Cambridge: Cambridge University Press, 1991), p. 176.
 See Vahid Nowshirvani, “The Yellow Brick Road: Self-Sufficiency or Self-Enrichment in Saudi Agriculture?” Middle East Report 145 (March-April 1987); and Hossein Askari, Saudi Arabia’s Economy: Oil and the Search for Economic Development (Greenwich, CT: JAI Press, 1990).
 Another source of instability emanates from the recent success of banks in selling shares on the stock market. A loss of confidence in the banking system may result in a run on banking shares and trigger a system-wide fall in stock prices. Between 1989 and 1992, the value of banking sector shares increased by 430 percent and now account for 52 percent of the total value of domestic shares traded. (Saudi Arabian Monetary Authority, Money and Banking Statistics, First Quarter 1993).
 See New York Times, August 23, 1993, for the 1992 Pentagon decision to waive certain fee requirements for Saudi purchases.
 I base this estimate on OECD and Bank for International Settlements data.