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Global Economic Outlook
Saudi Arabia: Q2 2010 Outlook
By Rachel Ziemba and Ayah El-Said
- Oil and government-influenced domestic demand growth have prompted economic growth revival.
- New financial instruments and strong growth prospects are prompting capital inflows, but asset market risks remain possible.
- Subdued credit growth is a risk to private sector activity.
Outlook Update: A Top Performer as Oil Output Picks Up
Saudi Arabia should have one of the strongest growth rates in the GCC, lagging behind only Qatar. Government spending, private sector revival and a rebound in oil output should lead to real GDP growth of 3.8% in 2010 after flat output in 2009. Saudi Arabia’s extensive savings position (over US$450 billion in central-bank-managed foreign assets at the end of 2009) helped cushion the economy in the global recession and seed growth thereafter. Stronger oil prices and output (the hydrocarbon sector should climb about 4%) strengthening industrial output and continued fiscal stimulus should drive growth in 2010 and 2011. The country’s surplus, banking system and improved growth brought credit ratings upgrades, including a February 2010 upgrade from Moody’s to its foreign- and local-currency government bonds. RGE remains concerned about slow credit extension, which could keep growth below potential again in 2011, and the need for labor market and other reforms could be an additional drag.
Growth Dynamics: Government Spending Reinforces Domestic Demand
Government spending will support domestic demand, which is critical in an economy where private sector activity accounts for 50% of GDP. Industrial output, especially of petrochemicals, began to grow on a y/y basis towards the end of 2009, and consumption also started to revive. Point of sale transactions (a proxy for retail sales) grew 7% from December 2009-February 2010 from the previous three-month period and 24% y/y. RGE anticipates that consumption and investment growth will remain shy of the 2007-early 2008 pace.
Part of our caution stems from the persistence of subdued credit conditions. Even in late 2009, banks remained reluctant to lend and companies to borrow. Lending to the private sector grew only 1.6% y/y in February 2010—albeit twice January’s pace. RGE expects credit conditions to improve in 2010, but private sector credit extension should climb 6-7%, much less than the double-digit pace of recent years. Government funds will only partly meet this gap. Project financing needs are extensive, especially in the hydrocarbon, manufacturing and utilities sectors. Local banks will likely be the main credit providers, and government spending will fill the gap.
The revival in domestic demand and higher food and commodity prices will exert upward pressure on inflation but headline CPI growth will remain well below 2008 peaks. RGE expects price growth of around 4% in 2010. Inflationary pressures fell steadily after peaking in H2 2008 but began picking up in early 2010, with the CPI climbing 4.6% in February 2010—the fastest since June 2009. Gradually rising rents and food prices will be partly offset by sluggish money supply and credit growth. M3 growth slowed in February to 5.6% y/y from January’s 8.3%. Inflation is set to pick up in 2011, as the domestic and global economy strengthens.
Figure 1: Money Supply Suggests Muted Inflationary Pressure
Higher oil prices and output increases will widen Saudi Arabia’s external and fiscal balances. The current account surplus should widen from almost 20% of GDP in 2009 to around 35% in 2010, and non-oil trade should benefit from stronger global demand, particularly from Asia. Non-oil exports grew by about 17% in Q4 2009 (q/q annualized). A deceleration of global growth, which RGE anticipates, could constrain export growth.
Supply-demand mismatches in the real estate sector will support prices, and the new mortgage law should open up financing. Local banks, encouraged to lend, could turn to property to widen the income base.
Risks: Excessive Exuberance in Financial Markets?
Despite its diversification efforts, the Saudi economy remains driven by oil and oil-related inflows, which makes a weakening of global oil demand the major risk for the Saudi economy. Gradual supply increases will offset demand from emerging markets. The continued run-up in the oil price above US$100 per barrel could prompt demand destruction, and Saudi Arabia might have to intervene to balance the market.
Another domestic financial shock, such as a default of large conglomerates, remains a risk. The need to write down more assets would put pressure on the banks. Banks are still concerned about the lending environment and prefer to build up deposits at the Saudi Arabian Monetary Agency (SAMA), despite the hit to their interest margins. Total bank credit declined by 1% in 2009 compared to 25% in 2008. Lending activity, especially to the private sector, remains sluggish, growing only 1% y/y in January and February 2010. The contribution of non-oil sector will remain low, dampening economic output. Non-performing loans will continue to rise, peaking in 2010. Q4 results suggest several banks have made provisions for most of their bad debts.
The opening up of the Saudi Stock Market to foreign investors may increase volatile portfolio inflows. Attracted by the revival of growth and oil prices, domestic and regional exuberance have boosted the Saudi Tadawul 12% through the end of March 2010, outperforming other GCC markets. Given uncertainties in the global and regional outlook and the speculative nature of local markets, the risk of reversal is not insignificant. The creation of new financial instruments, such as Saudi-based exchange traded funds (ETFs), and easier access by foreign investors could prompt new inflows.
Regional security issues could pose risks to the global energy trade and to Saudi interests. Responding to Iran’s program might contribute to regional instability, a risk to Saudi Arabia’s position. Yemen’s acting as a haven for international terrorists likewise poses a threat on Saudi Arabia’s border.
Policy Implications: Yet Another Expansionary Budget
In 2010, Saudi Arabia is continuing its expansionary fiscal policy of the past half decade. Saudi Arabia’s tendency to spend more than budgeted means that spending growth could exceed the planned 14%. The 2010 budget increases spending for the agriculture, infrastructure and utilities sectors to 9% of the budget. RGE still expects a rather narrow fiscal surplus in 2010 relative to the surplus level prior to the global slowdown, but Saudi Arabia’s budget is now reliant on an oil price of more than US$60 per barrel.
Figure 2: Annual Public Finances
Inflationary pressures will pick up over the course of 2010 as the output gap closes, but lower credit and money supply growth could keep monetary policy accommodative. With the Fed set to remain on hold until H1 2011, Saudi officials will have limited space to respond, turning to liquidity withdrawals rather than interest rate hikes. Interest rates (2% benchmark rate) will remain negative in real terms.