MONEY DEMAND AND SUPPLY IN SAUDI ARABIA

326 Pages·2008·11.13 MB·English

ACKNOWLEDGEMENTS
All praise to Allah, most gracious, most merciful for
his help, blessing and guidance, which gave me the patience
to accomplish this task.
I wish to thank my supervisor Dr Ghatak,Subrata for
his generous help and guidance during my study and to
acknowledge his invaluable advice, support and encouragement
in making this work a successful one.
To my mother, I owe a special appreciation, for her
great kindness and her endless source of love and support.
My gratitude, love and appreciation are for my wife, for all
her patience, encouragement and support.
Finally I would like to thank Margaret Christie for
her help and work in typing up this thesis.
(i)
TABLE OF CONTENTS
page
TABLEOF CONTENTS .............................................(1)
LISTOF TABLES.................................................(iv)
LISTOF FIGURES................................................(viii)
CHAPTER
I. INTRODUCTION..............................................1
1.1 Objective of the Study .............................1
1.2 Organisation of the Study ..........................3
1.3 Methodology and Sources of Data ................... 5
II. A REVIEW OF THE SAUDI ARABIAN ECONOMY.....................8
Introduction.............................................8
2.1 The Main Features of the Saudi Arabian Economy 9
2.1.1 The First Feature...........................9
2.1.2 The Second Feature..........................10
2.1.3 The Third Feature...........................12
2.1.4 The Fourth Feature..........................13
2.2 The Performance of the Saudi Economy: 1970-1986 14
2.2.1 The Performance of the Saudi Arabian Economy:
1970-1982 ..................................23
2.2.2 The Performance of the Saudi Arabian Economy:
1983-1986....................................24
2.3 The Composition of the Gross Domestic Product .......28
2.3.1 The Manufacturing Sector ....................29
2.3.2 The Agricultural Sector .....................31
2.4 The Foreign Sector...................................33
2.4.1 Imports .....................................33
2.4.2 Exports .....................................34
2.4.3 The Balance of Trade ........................35
2.5 The Monetary and Fiscal Objectives and Achievements 35
2.5.1 The Monetary and Fiscal Objectives of the
First Three Five-Year Development Plans 35
2.5.2 The Major Monetary and Fiscal Achievements 39
Conclusion................................................43
(ii)

III THE SAUDI ARABIAN MONETARY SYSTEM ......................... 45

Introduction............................................... 45
3.1 Monetary and Banking Development in Saudi Arabia:

1971-1986............................................ 46

3.2 The Money Market in Developed and Less-developed

Countries........................................... 49

3.3 TheSaudi Money Market .............................. 65
3.4 The Saudi Financial Institutions ....................69
3.4.1 The Commercial Banks.........................69
3.4.2 The Saudi Arabian Monetary Agency (SAMA) 71
3.4.3 The Specialised Credit Institutions ........73

3.5 The off-Shore Riyal Market in Bahrain ............... 80

Conclusion................................................ 88
Appendix A: Charter of the Saudi Arabian Monetary Agency

(SAMA) ...................................... 91

Appendix B: The Banking Control Law in Saudi Arabia 98
IV A LITERATURE REVIEW ON THE DEMAND FOR MONEY IN THE DEVELOPED
AND LESS-DEVELOPED COUNTRIES AND SAUDI ARABIA ............112
Introduction............................................. 112
4.]. A Review of the Literature on the Demand for Money in
theDeveloped Countries.............................. 113
4.2 A Review of the Literature on the Demand for Noney in
theLess-Developed Countries......................... V31..
4.3 A Review of the Literature on the Demand for Money in
SaudiArabia ........................................145
Conclusion................................................157
V THE DEMAND FOR MONEY IN SAUDI ARABIA ......................160
Introduction.............................................. 160 -
5.1 The specification of a Money Demand Function for the
SaudiEconomy ....................................... 163
5.1.1 The Scale Variables.......................... 163
5.1.2 The Domestic Opportunity Cost Variables...... 167
5.1.3 The External Variables....................... 172
5.1.4 TheDefinitionofMoney...................... 173
5.1.5 The Mathematical Form of the Money Demand
Function.................................... 176
(iii)
5.2 The Estimation and Interpretation of the Empirical
Results.............................................178
5.3 The Stability Test of the Estimated Demand Equations 208
forReal M0, M1 , M2 and M2 .........................
5.4 The simulation of the Estimated Demand Equations.....209
Conclusion................................................214
Appendix A: Factors Affecting Riyal Market Interest Rate:
An Empirical Investigation ..................217
Appendix B: The Data and Their Sources ..................222
VI THE MONEY SUPPLY PROCESS IN SAUDI ARABIA: A THEORETICAL AND
EMPIRICALINVESTIGATION ...................................235
Introduction ..............................................235
6.1 The Saudi Monetary Aggregates .......................236
6.2 Factors Affecting Changes in the Saudi Money Supply.. 238
6.3 The Monetary Base and Money Multiplier in Saudi
Arabia...............................................255
6.3.1 The Saudi Monetary Base......................255
6.3.2 The Controllability of the Monetary Base in
SaudiArabia ................................259
6.3.3 The Saudi Money Multiplier...................271
6.3.4 The Effect of the Non-Bank Public, the Banks,
and SAMASs Behaviour on the Money Multiplier 273
Conclusion................................................282
VII CONCLUSIONS AND RECOMMENDATIONS ...... .....................285
7.1 Conclusion ..........................................285
7.2 Recommendations .....................................290
REFERENCES.....................................................292
(iv)
LIST OF TABLES
page

2.1 The Oil and Non-Oil Sectors' Percentage Shares of GDP

at Current and Constant Prices 15

2.2 Total Actual Government Revenue, Its Components and

Their Share of the Total Government Revenue 16

2.3 Budgeted and Actual Revenue and Expenditure 17

2.4 Gross Fixed Investment of Sectors at the Current Price

and their Percentage Share of Total Fixed Investment 18

2.5 Government Expenditure, Currency in Circulation and

Reserve, Monetary Base and Money Supply 19

2.6 Gross Domestic Product of Oil and Non-Oil Sectors, and

Kind of Economic Activity in Producers' Values 20

2.7 Percentage Distribution of Gross Domestic Production

by Kind of Economic Activity Within Sectors 21

2.8 Total Domestic Expenditure and Its Components at

Current Prices. 22

2.9 Growth Rate of Total Expenditure and Its Components 25

2.10 Growth of GOP and Its Components (1970-1986) 26

2.11 Growth Rate of Major Variables During Three Different

Periods 27

2.12 Total Exports and Imports of Saudi Arabia 36

2.13 The Exchange Rate of Riyal Against the Dollar and SDR 42
3.1 Total Assets/Liabilities of Saudi Financial

Institutions 52

3.2 Total Foreign Assets of SAMA and the Commercial Banks 53
3.3 Total Capital and Reserve of the Commercial Banks

and Specialized Credit Institutions 54

3.4 The Commercial Banks' Total Deposits 55
(v)

3.5 The Commercial Banks' Claims on the Private Sector,
and Credits of the Specialized Credit Institutions to

the Private Sector 56

3.6 Money Supply (M3) and Its Components 57

3.7 The Percentage Change of the Money Supply's Components,
the Monetary Aggregates, the Government Expenditure,

the Gross Domestic Product and Inflation Rate 58

3.8 Percentage Changes of the Monetary Aggregates, the
Government Expenditure, the Commercial Banks' Claims on
the Private Sector, and the Net Private Sector Balance

of Paiients Deficit in Saudi Arabia. 59

3.9 The Percentage Change of the Money Supply's Components

Riyal and U.S. Dollar Interest Rates 60

3.10 The Percentage Share of the Components of the Gross

Private Domestic Liquidity in Money Supply 61

3.11 The Ratio of the Money Supp ly's Components and the
Monetary Aggregates to GDP 62

3.12 The Ratios of the Total Deposits and the Commercial

Banks' Claims on the Private Sector to GDP 63

3.13 Income Velocity of Money (Non-Oil Sector), Inflation

Rate and the Non-Oil GOP's Growth Rate 64

3.14 Consolidated Balance Sheet of Saudi Commercial Banks:

Assets 74

3.15 Consolidated Balance Sheet of Saudi Commercial Banks:

Liabilities 75

3.16 The Saudi Commercial Banks: lotal Assets 76

3.17 The Saudi Comercial Banks: Total Deposits 77

3.18 The Saudi Comercial Banks: Loans 78

3.19 Distribution of Bank Loans and Advances by Economic

Sectors 79

3.20 Credit Disbursement by Government Lending Institutions 84

3.21 Number of OBUs Operating in Bahrain 85

3.22 Assets and Liabilties of OBUs 86

3.23 Currency Composition of Assets and Liabilities of OBUs 87
(vi)

5.1 The Growth Rates of Time and Saving, Foreign, and
Other Quasi-Monetary Deposits and U.S. and Riyal
Short-Term Interest Rates 183

5.2 The Correlation Matrix of the proposed Money Demand
Functions' Explanatory Variables 184
5.3 The Estimated Demand Equations from Real M0, M1, M2
and M a 193
(In hese equations the real income is used
as a scale variable)
5.4 The Estimated Demand Equations for Real M , M1. M2
0
andMa 198
(In tese equations the expected income is used as a
scale variable)
5.5 The Adjustment Coefficient and the Long-Run Elasticities
of the Real Income (Non-Oil GDP), Expected Inflation, the
Saudi Riyal and U.S. Dollar Short-Run Market Interest Rate,
and the Saudi Riyal Exchange Rate against the U.S. Dollar
of the Estimated Demand Equations for Real M0, M1 , M2,
and M2a Which Are Presented in Table 5.3 203
5.6 The Chow Stability Test of the Estimated Demand
Equations of Real M , M1 , M2 and are
M?Which
Presented in Table g•3 210
5.7 Comparison of the Statistics of Actual and Simulated
Values of the Dependent Variable of the Estimated Demand
M2a
Equations for Real M , M1 , M2 and Which Are
Displayed in Table 5?3 211
5.8 The Simulation Statistical Equation Criterta of the a
Estimated Demand Equations for Real M , M1 , M9 and M2
Which Are Presented in Table 5.3 213
6.1 Oil Revenue, the Foreign Assets of SAMA, Government
Expenditure and Money Supply (M3) 246
6.2 Domestic Government Expenditure, Commercial Banks'
Claims on the Private Sector, Monetary Base and
Monetary Aggregates 247
6.3 The Growth Rates of Domestic Government Expenditure,
Commercial Banks' Claims on the Private Sector,
Monetary Base and Monetary Aggregates 248
6.4 Non-Oil GDP, Domestic Government Expenditure, Currency
in Circulation, Demand Deposits, Time and Saving
Deposits and Other Quasi-Monetary Deposits 249
(vii)
6.5 The Growth Rates of Non-Oil GDP, Domestic Government
Expenditure and the Components of Money Supply (M3) 250
6.6 Factors Affecting Change in Money Supply (M3) 251
6.7 The Growth Rates of the Factors Affecting Change in Money
Supply M3) 252
6.8 The Ratios of Domestic Government Expenditure, the
Commercial Banks' Claims on the Private Sector,
and Net Private Sector Balance of Payments Deficits to
Money Supply (M3) 253
6.9 The Long- and Short-Run Elasticities of Domestic
Government Expenditure, the Commercial Banks' Claims
on the Private Sector and Net Private Sector Balance
of Payments Deficit and the Adjustment Coefficients 254
6.10 The Components of Saudi Monetary Base 262
6.11 The Sources of Saudi Monetary Base 263
6.12 The Growth Rates of Non-Oil GDP, the Rates of Inflation,
the Number of Commercial Banks', and the Ratios of
Currency to Demand Deposits 279
6.13 The Growth Rates of Non-Oil GDP, the Rate of Inflation,
Riyal and U.S. Dollar Interest Rate and Ratios of Time
Deposits to Demand Deposits 280
6.14 The Saudi Money Multipliers of M1 , M2 and M3 281
(viii)
LIST OF FIGURES
page

5.1 U.S. Dollar and Riyal Interest Rates 185

5.2 Actual and Simulated Values of Real 204

5.3 Actual and Simulated Values of Real M1 205

5.4 Actual and Simulated Values of Real M2 206

5.5 Actual and Simulated Values of Real M2a 207

6.1 The Ratio of Currency to Demand Deposits 264

6.2 The Ratio of Time Deposits to Demand Deposits 265

6.3 The Saudi Money Multiplier of M1 266

6.4 The Saudi Money Multiplier of M2 267

6.5 The Saudi Money Multiplier of M3 268

6.6 The Growth Rate of the Saudi Monetary Base 269

6.7 The Growth Rate of the Saudi toney Supply 270
1
CHAPTER I
INTRODUCTION
1.1 THE OBJECTIVES OF THE STUDY
Saudi Arabia has an open economy with complete capital mobility.
Its people enjoy a high standard of living. However, the Saudi economy
exhibits several features of underdevelopment, such as limited
absorbative capacity, the existence of unorganised money and capital
markets, and the dependence on the export of one primary commodity,
viz., oil. Moreover, Saudi Arabia is an Islamic country where interest
on any type of loan or deposit is prohibited according to Islamic
teaching. During the 17Os and early 1980s, Saudi Arabia experienced
drastic increases in oil revenues which led to substantial increases in
government expenditure. Consequently, this provided the Saudi monetary
and banking system with a unique opportunity to expand and develop
within a very short period. The Saudi moy n'rt t'rt'r oim
unique case for study.
The major objectives of this study can be summarized as follows:
The first objective is to provide a clear picture of the Saudi
money market in terms of its main characteristics, its financial
institutions and the main obstacles facing that market and those
financial institutions.