RIYADH - The Q1 survey reveals that business confidence in Saudi Arabia remains high. The economy is growing strongly, despite inflationary pressures, and businesses are reporting significant rises in production capacity. Sixty-four percent of respondents forecast capacity to increase further over the next two quarters. In the same period, companies expect bank lending to be very strong, signaling vibrant corporate growth. Initially, the new SABB Index stands at 106.2 - against a base value of 100. Over time, fluctuation of the index figure will indicate changes in business sentiment from quarter to quarter.

Strong Business Growth

Business confidence is expected to remain very strong over the coming two quarters. From our survey of 609 companies across diverse industry sectors, 87 percent of respondents expect improved performance from their businesses in Q2 and Q3. Overall, the business environment continues to be very robust and is expected to gain momentum, while the economy is expected to grow in line with the boom, which is now giving way to what is seemingly a period of more sustainable growth. Significantly, not a single survey respondent predicted weak business growth for Q2 and Q3.

Oil Prices

Fifty-four percent of the businesses SABB surveyed expect the oil price to rise above $90 a barrel (WTI) in the next two quarters, while some 13 percent believe the price will fall below $90 and 33 percent expect the price to remain at the same level. Although we recently stated that we expect the oil price (WTI) to average $78 in 2008, prices currently remain very buoyant and have hit a record high above $101. Indeed, there has been evidence in the past week that investors (speculators) are moving back into oil and other commodities, which could now lead to oil prices testing the $104-$107 range in the not-too-distant future. Net long positions on NYMEX (New York Mercantile Exchange) have increased, despite uncertainty in the US economy, and the overall demand for oil remains strong.

Inflation

Price rises are a concern for nearly half of all the businesses we surveyed, with 48 percent expecting inflation to have a negative impact on their business. In theory, when firms (and their employees) anticipate such an impact, they will seek higher prices (and wages) - although a local perception that prices are rising faster than the published inflation rate is common in virtually all countries. Already, 33 percent of respondents state that they will pass on higher costs to the end user through increased prices, which will impact on inflation during the year. However, Saudi Arabia's price pressures are still far from the ongoing double digit inflation being witnessed in Qatar and the UAE, which makes the Kingdom a more affordable location for business.

Saudi Riyal

Currency matters are an issue for local businesses, but the survey responses surprised us. With 73 percent of respondents expecting the riyal to remain pegged against the US dollar for the next two quarters, only 37 percent of businesses anticipate a revaluation during that period - far lower than anecdotal evidence suggested prior to our survey. Saudi Arabian Monetary Agency's (SAMA's) steadfast denials have helped assuage market concern about a revaluation, at least for the time being.

Real Estate

The impact of rising real estate prices is a worry for many Saudi businesses - and is an issue we have been monitoring carefully over the past year. In the survey, 63 percent of respondents said they expect the cost of real estate to have a negative impact on their business in the next two quarters. However, some 8 percent of the companies we surveyed are in the real estate sector and another 15 percent in construction - so these businesses view the rise in property prices as having a positive impact on their bottom line.

Labor Market

It is not surprising to note that companies are facing labor supply constraints. The demand for Saudis with the required skills, as well as for skilled and unskilled expatriates, continues to rise. Labor supply problems seem to persist, despite a 30 percent increase in foreign recruitment, according to the latest data from the Ministry of Labor. Among our survey respondents, 41 percent reported that their organizations do not have all the required staff and another 26 percent expect to be very insufficiently staffed in Q2 and Q3. Only 22 percent of respondents see their businesses as adequately staffed.

Borrowing and Interest Rates

Businesses are very optimistic (73 percent) about the lending attitude of banks in the Kingdom. Bank lending to the private sector in 2007 (loans, advances and overdrafts) increased by 22 percent, as against 10 percent in 2006. It should be no surprise that money supply has seen high double-digit growth - since bank credit to public enterprises is increasing, with limited crowding-out effect as public-sector lending accounts for a meager 6.3 percent of all bank credit.

Businesses also expect interest rates (SIBOR) in Saudi Arabia to fall over the next two quarters, consistent with the decline in SIBOR rates since September 2007.

Investment Opportunities

Because of its subjective nature, the question of investment prospects was not included in our statistical calculations for the index, but responses in this area do throw light on how businesses view market opportunities.

Real estate is seen as the preferred investment option in Saudi Arabia over the next two quarters, followed by investment in local equities. Forty-six percent of respondents showed a preference for real estate and 42 percent for equities.

(Dr. John Sfakianakis is chief economist at SABB. He is based in Riyadh.)