Saudi Arabia is not immune to the debt crisis in the European Union.

“A default that involved Spain and Italy would almost certainly lead to a seizing up of eurozone — and quite possibly global — interbank markets,” says Saudi-based Samba bank.

“Even if the financial shock was confined to the zone itself, European demand for raw materials and manufactured products (mainly from emerging markets) and services (mainly from North America) would shrink dramatically and this would be enough to imperil the global economic recovery.”

A fresh global recession would see demand for oil and petrochemicals—Saudi Arabia’s main exports—fall away sharply, thus squeezing the country’s main source of foreign exchange, notes the bank. “Nevertheless, the Saudi government would likely sustain spending growth by drawing down some of its foreign assets—as it did in 2009.

“On the upside, a weaker euro—a near certainty in a situation of debt contagion—would mean cheaper imports for Saudi Arabia. The EU accounts for around 28% of total imports, the second largest source after East Asia.”

Other key points from Samba report:

• Standard & Poor’s downgrade of the United States has had a little impact on Saudi Arabia for now.
• The kingdom has an intimate financial and economic relationship with the US based on the currency peg (in place since 1986) and the Saudi government’s holdings of hundreds of billions of dollars’ worth of US government debt. Given these circumstances, the downgrade would have been worrisome, but in the event had only a limited impact.
• However, if the dollar weakens significantly, then the Kingdom can expect to pay more for its imports (of labour as well as goods and services), though a weak dollar would—all other things being equal—boost demand for its exports, says Samba.
• Lower oil prices and a weaker external environment might keep a lid on private investment growth in the second half, though the country’s fundamental strengths remain unimpaired, and the economy is likely to outperform most emerging markets this year.
• Project activity cooled down in the second quarter and a number of large projects have been put on hold in recent months, including the $30bn Tabuk Economic City and the $25bn Ras al-Zour Resource City. But large projects such as Dow Chemical/Saudi Aramco (Sadara) petrochemical joint venture in Jubail should provide a steady stream of contract awards, both in the second half of 2011 and into 2012.
• “Other large infrastructure projects set to develop over the next few months include the Qurrayah independent power project; the Medina airport expansion; training and medical facilities for the security forces; and Jeddah’s Kingdom Tower, recently awarded to the Bin Ladin Group.”
• However, corporate investment may ease off due to lower oil prices. “This is largely psychological: if firms think that lower oil prices will oblige some retrenchment in government spending (even if not the case) then they might trim their own investment plans.”

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