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(John Kemp is a Reuters market analyst. The views expressed are his own)
* Chart 1: tmsnrt.rs/2pWk87a
* Chart 2: tmsnrt.rs/2qrw5Fn
By John Kemp
LONDON, May 17 (Reuters) - Saudi Arabia has again become the favourite destination for western political leaders seeking to promote arms sales and encourage other exports to boost their economies at home.
UK Prime Minister Theresa May visited last month to promote trade as the country seeks to diversify its export markets after Brexit.
U.S. President Donald Trump is scheduled to make his own pilgrimage to Riyadh later this week with reports suggesting the two countries have been negotiating arms deals worth more than $100 billion.
Britain and the United States are both angling to secure part of the stock market listing following the planned sale of shares in Saudi Aramco.
Both have major oil companies, oilfield service providers and technology firms that hope to secure contracts to develop the kingdom’s oil, gas, refining and petrochemical industries.
And both are also major financial services centres that see lucrative opportunities helping the kingdom raise external capital and manage its enlarged sovereign wealth fund.
But there is a contradiction between the kingdom’s need to reduce its foreign spending and plans to build up domestic industries on the one hand, and the hopes of U.S., UK and other leaders for an export bonanza.
More generally, there is a tension between western countries’ tendency to see the kingdom as a fabulously rich customer and its current need to reduce foreign spending following the slump in oil prices.
For the time being, it suits political leaders on both sides to talk up the potential for deals, but some may turn out to be long on symbolism and shorter on substance.
The exchange of oil for security, and as one component within this arrangement oil revenues for arms sales and other contracts, is one that is familiar to both the Saudis and their western counterparts.
During the 1970s and early 1980s, the financial aspect of the transaction was called petrodollar recycling, with the Saudis and other Gulf monarchies pledging to buy billions of dollars of western arms and other products.
The aim was to shore up the balance of payments of the United States and other western economies following the enormous rise in oil prices after the 1973/74 and 1979/80 oil price shocks.
Saudi Arabia and the other Gulf producers got higher oil prices and revenues, and in exchange promised to recycle a major part of the surplus back into the western economies via arms purchases and investments.
Saudi Arabia’s fabulous oil wealth has always been a magnet for western companies ranging from oil and gas to construction and financial and professional services.
Saudi leaders and economists have sometimes complained about the wastefulness of this spending and about being overcharged by western businesses.
But in return for all this spending, Saudi Arabia has cemented defence and security links with the United States and ensured the kingdom’s diplomatic concerns are heard at the highest levels in western capitals.
On the whole, the arrangement has suited both sides very well for the last 40 years and the recent trips by May and Trump should be seen within this context.
May needs to show that Britain can develop trading ties outside the EU, while Trump wants to show he can cut the U.S. trade deficit and create well-paid manufacturing jobs at home in the United States.
For their part, the Saudis want to solidify and strengthen U.S. and British diplomatic and military backing while they remain in conflict with Iran.
The major problem is that the kingdom’s finances are under severe strain as a result of the collapse in oil prices and an expensive war in Yemen.
The government is running a substantial budget deficit and has been forced to introduce tough austerity measures to trim current and capital spending.
Even so, Saudi Arabia’s foreign reserves fell by $237 billion or 32 percent between August 2014 and March 2017, according to data from the Saudi Arabian Monetary Agency (tmsnrt.rs/2pWk87a).
Foreign reserve assets have dwindled from $746 billion at their peak in August 2014 to just $509 billion as spending has systematically exceeded revenues (tmsnrt.rs/2qrw5Fn).
Saudi Arabia needs to maintain a large cushion of reserves to maintain confidence in its currency peg and prevent a run on the riyal.
Protecting the peg means there is an effective floor below which reserves cannot be allowed to fall and although the precise level cannot be known with certainty it is much higher than zero.
The kingdom remains one of the world’s largest military spenders but its spending was trimmed sharply in 2016, according to the Stockholm International Peace Research Institute (SIPRI).
Saudi military expenditures totalled around $64 billion in 2016 but that was down from $87 billion in 2015 and $83 billion in 2014 (“SIPRI military expenditure database”, SIPRI, 2017).
Saudi military spending ranked fourth in the world in 2016 behind the United States ($611 billion), China (estimated at $215 billion) and the Russian Federation ($69 billion).
Military spending was still well ahead of the United Kingdom ($48 billion), France ($56 billion) or Japan ($46 billion), underscoring its importance to armaments manufacturers.
But the arms procurement and military training budget is under pressure from austerity like all other government programmes.
Saudi Arabia’s long-term development plan is to build up domestic manufacturing and services sectors to reduce its reliance on imports and foreign suppliers.
Stemming the outflow of foreign exchange by building up internal capabilities is one of the central objectives of the kingdom’s Vision 2030 plan.
Vision 2030 explicitly states “we plan to manufacture half of our military needs within the kingdom to create more job opportunities for citizens and keep more resources in our country”.
Vision 2030 promises “we will work towards localizing renewable energy and industrial equipment sectors” and “we will continue to localize the oil and gas sector”.
On defence, Vision 2030 notes that only 2 percent of military spending is currently within the kingdom and aims to raise this to 50 percent by the end of the next decade.
Saudi Arabia will still remain a crucial customer for arms makers in the United States, the United Kingdom and other countries, and it is an important destination for a range of other goods and services exports.
But beyond the high-profile signing ceremonies, it may not be quite the fabulous cash cow for which western political leaders are hoping. (Editing by Susan Thomas)