RIYADH: As the global economy has entered its deepest recession since the early 1930s, we would find it surprising if business confidence remained unscathed in Saudi Arabia. Market psychology in an economy is often as important as market demand and we think that in part, the slowdown witnessed in the market place is due to declining confidence.
Saudi businesses and their owners are impacted by global events. We think that businesses are bracing for a slowdown in 2009, which is not unfounded, but the causes are not uniquely local. Businesses and particularly their owners are impacted in one important way affecting confidence in the economy: Unlike any other economic slump the world has faced, this one has substantially impacted on the networth of Saudi businessmen. The uniqueness is that there is nowhere to hide as local and regional markets have been severely battered and international equities are at best anemic.
Stock market
The 2006 stock market fall in Saudi Arabia impacted mainly on small retail investors, whereas the 2008 plunge affected the large player. These investors were using plentiful local and international credit in anticipation of high returns. Even when the market went through an initial fall in early 2008, many large businessmen leveraged themselves in anticipation of euphoric returns later in the year. The drop in the stock market in 2008 has witnessed a SR1.02 trillion being wiped off values, which has acutely affected the networth of large businessmen. This negative wealth effect made a large segment of the business community become much more careful. Hence, many businesses are putting off expansion plans as uncertainty puts downward pressure on confidence.
However, psychology is not the only determining factor for confidence in the economy. Demand is another component that builds on the level of confidence. We continue to think that demand is declining. Consumers are not as exuberant as in the first half of 2008 and are showing signs of becoming price-thrifty.
Auto industry
We think that many consumers expect prices to fall in the domestic market, especially for big-ticket items. Auto industry is one of them as consumers expect prices to fall due to falling auto sales abroad. Both US autos and Japanese car agents (which form the bulk of the market) have noticed a decrease in sales (both December 2008-January 2009), with only one exception currently being Toyota Saudi Arabia. The market is not always right though. Unit costs for autos will increase, not decrease, as margins will decline due to a fall in the economies of scale advantage following an overall fall in total production. In fact, many automobile manufacturers are instituting price increases. The appreciation in the Japanese yen is also negatively impinging on the final import cost. Saudi auto agents could also face more competition from second-hand and new car imports by non-official agents, as per WTO (World Trade organization) agreement.
Consumers seem to also be less willing to spend as much on consumer electronics as there is a perception, we think, that prices will also fall.
Oil prices
Lower oil prices are taking their toll on confidence. Last time we conducted our survey, oil prices were ranging between $48 and $55 as the global economy was bracing for a slowdown in oil demand. By December WTI closed at $31 and many expected that the worst was yet to come in terms of commodity prices. World oil demand is contracting more than expected this year. Recently, OPEC said global demand would fall by 580,000 barrels per day in 2009, whilst its previous forecast was for demand to contract 180,000 barrels. OPEC’s predictions of falling demand are less pessimistic than that of the IEA (International Energy Agency) which also recently said that consumption in 2009 would fall by 980,000 barrels per day. The OPEC cuts have brought some results but the only tool available to avert a further drop in oil prices will be to rein in more production and adhere to quota discipline which could be out of character for some countries. However, we maintain our thinking that oil prices would be exaggerated on the way down, just as they were on the way up during the summer of 2008. High volatility in oil prices will be maintained but we also hold to our forecast of average WTI of $44 per barrel for 2009.
Inflation
As mentioned, we think that inflation will come down more substantially than the consensus view. Given the 2008 final inflation data and also January 2009 inflation data (7.9 percent) we forecast average inflation of 5.8 percent for 2009. We think that inflation will begin to decline more aggressively in Q2 which could have a greater impact on confidence levels, both with businesses and consumers. However, we don’t think that prices will enter a huge deflationary downward spiral, but that they will stay above historical trends. Real estate prices will come further down in the coming months, especially commercial office space due to an oversupply and lower demand as the private sector slows down.
We think that confidence in the Saudi economy would have dipped more aggressively had it not been for an expansionary 2009 budget that is beginning to be felt as increased government spending. This spending has a delayed effect in the real economy, but we think it will become more widely felt in the months to come. We think that the government has already approved SR8 billion above and beyond the announced budget. And we are still at the onset of 2009. Also, we note that in the month of December alone SR14.4 billion were deposited by SAMA (an increase of almost 1,000 percent) on behalf of government organizations with the local banks.
The spending that the government is carrying out, however, is unique in many ways, as it involves no deficit financing. In contrast, the US and many euro zone economies, fiscal stimuli are carried out through debt issuance. Saudi Arabia has very little debt and its spending is based on deploying surplus funds that have been piled up in the “good days” of the third oil boom. Based on our discussions with Saudi businesses there is a “wait and see” attitude to the actions the government will take to boost confidence in the economy.
The Saudi government will not go bust as its finances are better than most OECD (Organization for Economic Cooperation and Development) countries, although some Saudi companies could face more challenging times ahead.
We think that the debate about banks’ liquidity should be refocused. We think that banks are liquid in that sense and far more liquid than many regional banking systems. While banks can’t lend an infinitum, we believe that there are three interrelated trends unfolding in the banking system:
• Banks are more risk averse
• Banks want to observe the private sector’s ability to meet its obligations
• Private-sector borrowing appetite is decreasing
Bank lending
We are not of the opinion that banks are failing to lend because banks have “run out of money.” This is the false assumption and a misinformed one. Actually banks’ deposits with SAMA in December 2008 have jumped to SR41.1 billion from just SR930 million in October 2008, mostly in the form of reverse repo transactions with the central bank.
We think that sustaining loan growth and appetite in 2009 at the pace of 2008 will not be possible, given that the risk matrix has changed for both borrowers and lenders alike.
We also think that the end of the “mine is bigger” boom that many in the GCC experienced is negatively impacting on business perceptions in Saudi Arabia, as a result of possible ripple effects that might be felt in the Kingdom. But we think that these negative impressions could soon turn out to be positive as Saudi Arabia appears to be a value proposition with strong demographics, local demand, geography, no real estate bubbles, negligible sovereign local debt exposure and foreign assets that have increased rather than dissipated.
Labor market
The labor market seems to be on a general hiring freeze or witnessing some layoffs, which businesses are reluctant to record. This is quite telling about private-sector expectations, given that the non-oil private sector grew at 4.3 percent y-o-y during one of Saudi Arabia’s highest level of budgetary overspending. We do think that businesses, especially in the financial services sector as well the private sector at large, are in the process of restructuring business operations. We have already noticed that the expatriate labor market is contracting but only gradually.
We also think that a small number of nationals have been made redundant but its extent will depend on the degree of private sector appetite to downsize considerably its labor force.
The limited hope in the 2010 common GCC currency is also of no surprise to us.
Finally, businesses have decided to be conservative after having incurred losses in all corners of the world. They are not unique in looking for safety in cash and bonds. We think that the stock market’s poor performance does negatively impinge on business confidence, but we wonder how would businesses view the economy if the stock market had stabilized at 10,000 with oil prices in the mid-$30s. We dare say that confidence would appear more positive if the local stock market was higher. We think that this is the time for private and public actors to work together. If we were to define succinctly what we think are the most important steps that would help create confidence:
• The government should maintain its spending and, at the same time, maintain its payments to the private sector on time
• For its part, the private sector needs to retain its money in Saudi Arabia and re-invest profits in their businesses locally
• Finally, we think that despite the downturn we are now witnessing, there is still some light at the end of the tunnel.
(John Sfakianakis is chief economist at SABB (Saudi British Bank.)