JEDDAH: ARAB NEWS
Published — Sunday 25 November 2012
Last update 25 November 2012 6:19 am
Saudi Arabia shows some tightness in the local financial system, reflecting a scarcity of corporate deposits, but this appears to be abating and might in any case reflect strong investment growth in the nonoil economy. Local firms continue to report strong growth in new orders, with exchange rate movements helping make nonoil exports more competitive. However, the flip side is an increase in import costs which firms are finding difficult to absorb, according to a report by Samba Financial Group.
Samba extended its macroeconomic forecast and now expects average real GDP growth of just over 3.5 percent in 2013-14, but activity in the nonoil economy should continue at a 5 percent pace.
Mild stresses in the Saudi financial system have persisted. The loan-deposit ratio has crept up, and it even exceeded its SAMA-mandated level (85) in August and September, though has since fallen back somewhat. The main interbank rate, SAIBOR, has ticked up and the SR-USD 12-month forward spread is now in positive territory (just) indicating that markets think that the riyal is slightly overvalued, the report said.
These stresses largely reflect two factors: Accelerating loan growth to the private sector and a scarcity of deposits. Lending to the private sector grew at an average 15.5 percent clip in the third quarter, reflecting a buoyant nonoil economy, with large infrastructure commitments. However, deposit growth has not kept pace, growing at a more sedate 11.5 percent over the same period. This in turn reflects in part more discerning corporate customers looking for a higher yield on their deposits: The deposit rate spread over SAIBOR is understood to have widened in September and October, but has since narrowed somewhat. More fundamentally it points to a lively private sector where cash is being invested-usually involving imports of capital machinery - rather than kept in the bank. Thus, although a couple of banks are understood to be selling some of their assets in order to bring their L-D ratios into line with mandated limits, the stresses generally reflect a positive story where domestic demand is buoyant, the Samba report said.
This is underscored by the latest PMI data, which points to continued brisk growth, albeit lower than the stimulus-induced 7.1 percent in 2011. The overall PMI reading edged back a bit in October, but at nearly 60 this is still impressive, especially as PMIs across the globe are struggling to break 50 (the mark between expansion and contraction).
The "new orders" element continues to expand, and is feeding off firm public investment in education and health infrastructure, utilities, oil, gas and petrochemicals. The nexus between government investment and the private sector is contracting. Saudi contracting firms, which are especially numerous in the Eastern Province, generally provide civil works along with some basic manufacturing. Although business this year has been good, there are occasional stresses within the sector. Part of this is the nature of the business: Contracting firms have to provide large numbers of laborers and capital equipment often at short notice, and bottlenecks can lead to cashflow problems. Part is due to increased competition: The contracting space is fragmented and crowded, and increased competition from South Korean and Chinese contractors (who are often prepared to provide labor themselves) have kept a lid on margins. This is clear from the input-output prices of the PMI. The data show growth of input prices continuing to outstrip output prices, though there was some narrowing in October.
According to the Samba report, the "new export orders" component, which had been trending down in the face of weakening global demand has revived, posting two consecutive readings of almost 58 in September and October. This appears to reflect a couple of factors: First, China's economy picked up during this period, and with it demand for Saudi petrochemicals. Second, these petrochemicals have become more competitively priced thanks to exchange rate movements. China and South Korea, both important markets for Saudi petrochemicals, saw their exchange rates appreciate sharply against the US dollar (and thus the riyal) in September and October. This helps to explain why volumes of petrochemicals exports have held up reasonably well, even as global prices have sagged. Saudi Arabia's largest petrochemical firm, SABIC (Saudi Basic Industries Corp.), reported a 23 percent slide in third quarter profits despite an increase in volumes. Petrochemicals prices have been under pressure as a result of the US shale gas takeoff, which has radically lowered the cost of feedstock for US producers.
The flip side of a more competitive exchange rate is more expensive imports. The prices of purchases jumped in October as the euro as well as the renminbi and won climbed. The fact that Saudi businesses chose to raise output prices in October suggests that they may be no longer willing or able to absorb the steady increase in input costs which has implied quite severe pressure on margins. This might translate into somewhat higher consumer price inflation in the next few months, though for the moment inflationary pressures are subdued.
September saw a further year-on-year softening of inflation pressures to 3.6 percent from 3.8 percent in August, with rental costs weakening the most. Food prices ticked up, but modestly, with government subsidies continuing to offset the impact of higher barley and wheat costs. The main driver of price pressures was in the "other expenses" category, which likely reflects an increase in gold prices.
Oil production will remain the engine of growth and it sees a decline of about 3.5 percent next year as the market adjusts to additional supply from Iraq and the US. Demand is likely to be hampered by uncertainty over the US fiscal cliff. The demand picture is likely to be brighter in 2014, but ongoing supply additions from Iraq and the US and possibly Brazil will mean that Saudi output is likely to remain flat, while prices are expected to drift lower.
This will mean that government spending growth will be softer than the breakneck pace of recent years, though this is not necessarily a bad thing given the need to improve the efficiency of spending. Even so, with a population growth rate of 2.5 percent for Saudi nationals and a 3.4 percent overall rate, and pressing infrastructure needs (especially in transport, utilities and housing) average annual spending growth in the next couple of years is still likely to be around 6 percent.
Private sector growth
This will be enough to keep the private sector chugging along. An extra month's salary will be paid next year, owing to the Hijri calendar, which will give a boost to private consumption, and offer good support to the wholesale, retail and transport sectors. Large infrastructure projects, such as the Riyadh metro, along with ongoing investments in the oil, gas, refining and minerals sectors will underpin the vital contracting sector. There is also plenty of scope for the development of financial services (particularly if the mortgage market achieves critical mass. Taken together, these trends suggest that the nonoil sector will expand by some 6 percent in 2013, easing to around 4.2 percent in 2014, as private consumption growth falls back again. Overall GDP growth is set to fall to 3.9 percent in 2013 from an estimated 5.7 percent this year, largely reflecting the cut to oil production. Growth should ease further to 3.5 percent in 2014.
Inflationary pressures should remain stable. A generally weak global economy will contain the cost of imports, though much will depend on the direction of the dollar. Domestically, the addition of housing will be a slow and steady effort, but should help to dampen rental inflation. Therefore, according to Samba, average inflation edging down to around 4 percent by 2014.