With a favorable oil price environment of between $70-$80 a barrel continuing virtually uninterrupted so far this year, commercial activities are beginning to shrug off a tough 2009 and business confidence is gradually strengthening. Bank credit to the private sector resumed growth at a guarded pace in January following a contraction in December, according to the latest data, while foreign trade flows are stabilizing and rising, port activity is increasing and inbound tourism looks poised to improve following a slump last year.

Inflation is also picking up pace as an acceleration in food price inflation globally offsets lower rates of rental inflation at home. Saudi rents rose in February at their slowest pace in more than two years.

Three months into the year, however, we foresee some plausible downside risks to our real GDP growth forecast for 2010 of 3.9 percent, if there is no significant uptick in economic activity. This forecast assumes a 4.1 percent expansion in the oil sector which is implausible unless the Organization of the Petroleum Exporting Countries (OPEC) raises crude oil output this year, an action that is unlikely in the near term given the stability of oil prices and the fragility of the global recovery.

OPEC output changes are typically implemented incrementally over a period of months, which would mean that any late-year change in output may not be fully carried out before 2011, stripping down real GDP growth potential for this year. Despite the OPEC output target remaining constant, producers including Saudi Arabia have been raising output since early last year, effectively reducing their level of compliance with OPEC targets, as they seek to cater to rising demand, particularly from Asia, in the global recovery. A continuation of this trend would bode positively for oil GDP, although at lower levels than earlier anticipated.

Our non-oil private sector GDP growth forecast of 3.7 percent also relies on an upswing in bank credit, and could face revisions to the downside should bank lending to private businesses fail to return as quickly as we expect. But the supply story is only one side of the coin; the other side is demand for credit. The private sector is hesitant about seeking credit for new expansion projects, an attitude that must witness a meaningful shift for our growth forecast to be achievable. For the time being, the state has taken on the role as principal financier, as we have argued in the past. We expect a gradual shift in private sector sentiment to take place this year as a greater number of state tenders for infrastructure works in the energy, water, power, and airport infrastructure space are awarded.

For now, we maintain our GDP forecast and our view that bank lending to the private sector will rise 8 percent this year, following a stagnant 2009, with most of the revival in lending likely to happen in the second half of the year. Already, there are signs that banks could begin parting with their excess liquidity through new loans rather than safeguarding them in low-interest deposits with the Saudi Arabian Monetary Agency (SAMA) and abroad, mostly on an overnight basis. After soaring during 2009, commercial bank foreign asset holdings declined almost 11 percent in January from December levels. Meanwhile, commercial and personal checks in value and volume, and point of sale transactions continued to strengthen into 2010, signaling a gradual return in domestic demand.
 
Fair oil price

In the first two months of 2010, WTI oil prices averaged $77 a barrel, and have risen for most of the time above $80 a barrel during the month of March. Saudi authorities have reiterated repeatedly that they are comfortable with oil around $75-$80 a barrel, regarding this price as suitable for both producer and consumer nations. Robust oil prices will enable the Kingdom to balance its fast-expanding budget and finance oil and gas capacity expansion plans. Consumer nations, meanwhile, regard this level as manageable, which has supported a continuation of this price range. Custodian of the Two Holy Mosques King Abdullah said this month the Kingdom would continue to pursue a policy of "moderation" in oil prices.

Supposing there are no significant shocks in the global economy that would disrupt supply, oil prices are likely to remain within the $70-$80 band for the coming months. Our average oil price target is still at $78 for WTI. There could be some downward risks to prices during the second quarter, when demand typically weakens and inventories grow. OPEC has kept its output target steady for more than a year and is likely to keep up with this policy until a significant period of price disturbance unfolds. At its March meeting, OPEC left its output target unchanged and said it wouldn't hold its next meeting until October, making it unlikely OPEC nations will implement changes in oil output this year.

Still, while OPEC targets have been steady since December 2008, the gap is widening between OPEC's target cut and actual output by member states. Crude oil production of OPEC member states rose 0.7 percent in February compared with January, according to OPEC's March oil market report. Production levels in February were up 3 percent from the second quarter of last year, and compliance is now at less than 60 percent of the target.

Oil output for Saudi Arabia, OPEC's biggest producer, averaged about 8.2 million barrels per day in 2009, according to our assumptions, and our initial expectation is that this level will rise to 8.4 million bpd this year. As of February, OPEC's secondary sources put Saudi production at 8.117 million bpd, down from January but 2 percent higher than the first quarter of 2009. Production, hence, has trended upward across producing nations.

The lack of strong OPEC output compliance makes sense given the dynamics of the world economy at present, coinciding with a cautious recovery in the global economy, especially in Asia. In the latest monthly, OPEC predicted a rebound in world economic growth to 3.4 percent this year, following a 0.9 percent contraction in 2009. Developing Asia would be the main contributor to this gain, with GDP growth in China expected to exceed 9 percent this year, while the Indian economy expands at 7 percent. On the other side of the spectrum, GDP growth in OECD countries is unlikely to surpass 1.7 percent, OPEC said.

Should prices remain steady and oil demand stay strong, OPEC producers have little incentive to adopt greater compliance with the producer group's output target. OPEC's current projection is that world oil demand should grow by 0.9 million barrels per day in 2010 to average 85.2 million barrels per day, following a contraction of 1.4 million bpd last year. It raised its demand projection slightly from January based on robust oil demand from Asia, Latin America and China. However, it said world oil demand was "highly dependent" on the course of government-led stimulus plans and would fluctuate depending on whether the US economy will have the strength to pull up from the recession before stimulus plans begin to fade.

The slowdown in demand last year, as well as a slump in prices, did lead producers to curtail investments in the oil sector, which witnessed a substantial drop in 2009 and had an overall negative impact on real oil GDP growth. It is estimated that oil sector investments declined by around 35 percent in 2009 compared with the year earlier. A Saudi Aramco official recently cited global economic circumstances as a reason behind its decision not to add oil rigs to its existing 96. Saudi Aramco had an estimated 129 rigs were in use at the end of 2007 and early 2008.

The International Energy Agency (IEA) in March revised up its global oil demand outlook to 86.6 million barrels per day in 2010, compared with 85 million bpd in 2009. Asian oil demand has been picking up quickly, buoyed by China and India. Oil demand in Asia is likely to rise about 4 percent in 2010, according to IEA estimates, compared with almost stagnant demand in Europe and North America.
 

Foreign trade flows are a useful indicator for domestic demand appetite and trends in global trade. World imports in the fourth quarter grew 8.5 percent from third-quarter levels, according to the latest World Trade Organization (WTO) data. The pace of annual decline in imports also eased considerably in the last three months of the year, falling just 1 percent from the year earlier, compared with annual drops of 26.3 percent and 32.9 percent in the two prior quarters. Asian countries supported the advancement in trade numbers, with imports rising an annual 5.8 percent in the three months, WTO data showed.

A pickup in imports was also noticeable in Saudi Arabia, a major importer of foodstuffs, cars, building materials and electronic goods to cater to its desert climate and population of about 25 million. December was the best month of 2009 for both imports and non-oil exports, according to data of the Central Department of Statistics and Information (CDSI). Imports during December rose almost 25 percent from November levels to SR31.7 billion, including a 32 percent rise in both machinery and electronic imports and transport equipment to SR8.99 billion and SR6.39 billion, respectively.

CDSI data, which are preliminary, indicate full-year imports stood around $86.7 billion, down almost a fifth from 2008 levels. Our forecast was for imports to drop to $89 billion in 2009, reflecting a slowdown in domestic demand that accompanied subdued economic growth conditions in the region and globally.

Cargo arriving to and leaving from Saudi Arabia's eight ports also slowed in 2009, although a pickup has been notable since the final months of last year. A total of 58.25 million tons of cargo were discharged from Saudi ports in 2009, down 14.6 percent from the year earlier, Saudi Ports Authority data show. The main factor behind this decline was the 27.2 percent drop in shipments of construction materials, which comprised 18.1 percent of total cargo arriving in the kingdom last year.

While the state kept up its stimulatory state spending program in 2009 as part of plans to invest $400 billion to build infrastructure in the five years to 2013, many projects were postponed as developers sought to renegotiate contractor terms following a drop in material costs. In addition, private sector companies focused their attention on de-leveraging rather than expansion, also putting pressure on demand for building materials.

The downturn in consumer demand was evident in the fall in new car sales; vehicle shipments arriving at Saudi ports declined 20 percent in 2009 while consumer goods fell 5.3 percent. By contrast, food shipments, comprising 32 percent of total cargo moving into Saudi Arabia through its ports, climbed 0.2 percent in 2009, thus cushioning the overall decline.

So far, 2010 is slowly turning the page on a rough 2009. Saudi Ports' data for January show a 14.8 percent year-on-year rise in total cargo arriving to and discharged at ports. The bank anticipates imports will rise to about SR94.7 billion in 2010, with scope for upward revision if import flows continue strong momentum.

Letters of credit (LCs) data also illustrate the upturn in commercial activity in the past few months, with new letters of credit taken against imports up 28.6 percent in January from December. New LCs were 12.9 percent higher than January 2009, according to SAMA data.

Leading the advance were machinery imports financed using letters of credit, which gained 47.4 percent in January from a year earlier. Saudi companies are also importing more building materials as numerous state and joint venture projects begin construction. LCs opened for building material imports, which slumped 41.3 percent in 2009, jumped 48 percent in January from the same month a year earlier.
 

Saudi exports are also looking stronger than they were just six months ago, tracking gains in world trade, which recorded a 10.3 percent advance in fourth-quarter export compared with the third quarter, according to WTO numbers. World exports in the three-month period rose 3.9 percent year on year, against an annual drop of 25.5 percent drop in the third quarter. European and Asian exports lent the most impetus to world trade, witnessed annual gains of about 4 percent in the fourth quarter.

For Saudi Arabia, nonoil exports were also robust in December, rising 15.9 percent from November to SR10.14 billion for the month, as petrochemical exports soared 43.5 percent month on month to SR3.14 billion and plastics exports jumped 17 percent to SR2.85 billion, both the biggest monthly values for 2009.

The preliminary CDSI data indicate that full-year nonoil exports amounted to SR101.36 billion in 2009, down about 16 percent from a year earlier. Some 83 percent of Saudi Arabia's export revenues last year were derived from the sale of crude oil to markets abroad. Due to substantial oil output curbs, lower oil prices and a slump in global demand, Saudi oil export revenues fell almost 46 percent last year from record levels in 2008 Along with oil export revenues of SR573.4 billion, total exports reached approximately SR674.7 billion last year, down 43 percent from 2008, according to our estimates.

Saudi ports loaded 84.1 million tons of cargo for export during 2009, down 3 percent from the year earlier, the decline mainly paced by lower refined products exports, which dropped 6 percent in the 12-month period. Refined products accounted for 51.5 percent of total loaded cargo at all Saudi ports last year. Petrochemicals

shipped from Saudi ports, on the other hand, climbed 9.4 percent, while food and industrial products were almost unchanged, each declining 0.8% from the year earlier.

With better prices and stronger crude oil demand prospects this year, the bank expects a 23 percent rise in oil exports this year to $188.5 billion, bringing it back to about 2006 levels.
 

A reasonable contributor to Saudi Arabia's nonoil economy, the tourism sector was hit in 2009 due to global recessionary pressures, lower domestic demand and fears about the spread of the H1N1 flu. About half of tourist trips to the kingdom take place for religious purposes, including pilgrims visiting the holy cities of Makkah and Madinah, usually to perform the annual Haj pilgrimage and Umrah, the lesser pilgrimage that takes place throughout the year.

Inbound tourist nights dropped 30 percent and total inbound tourist trips declined 26.2 percent in 2009, preliminary data of the Tourism Information and Research Center (MAS Centre) show. Total internal tourist visits, which includes domestic tourists, fell 14.1 percent, slightly below our forecast for a drop of 15 percent in tourist numbers during 2009. Inbound tourists also spent 17 percent less in 2009 than they did during 2008 at SR30.14 billion, due to lower tourist numbers and drops in the cost of accommodation, among factors that attracted many tourists to holy cities known for steep hotel costs. Domestic tourist nights were up 3 percent in 2009, according to MAS.

The tourism sector's GDP fell a substantial 22.5 percent to SR1.37 billion, accounting for 6.9 percent of nonoil GDP, preliminary 2009 MAS data show. The National Committee for Haj and Umrah indicated this month it expects an upswing in religious tourist visits during 2010, projecting a 15 percent rise in pilgrim traffic this year. It said there was an 8.9 percent rise in pilgrim traffic last year. We find the forecast reasonable and attainable given global economic recovery dynamics, particularly in Asia, where the largest proportion of pilgrims reside.
 

 
The greatest uncertainty about when the recovery will accelerate in the Kingdom continues to be the revival of bank credit, which remained subdued in the first month of 2010. Bank credit to the private sector grew a monthly 0.2 percent in January following a contraction in December. Credit to the government, meanwhile, fell 0.2 percent - both data reflecting a combination of continued hesitation among banks to extend new credit and the propensity of private sector companies to wait on the sidelines as they focus on deleveraging, not expansion.

Money supply numbers also demonstrated the cautious atmosphere. Growth in broad money, measured as M3, slowed for a fourth month to 8.3 percent in January, a decline in 2.3 percent from December levels. M2, which measures money held in cash, checking and savings accounts, also fell 0.6 percent month-on-month in January. The annual growth rate was steady at 6.5 percent, having declined steadily from peak growth rates above 22 percent in mid-2008. The money multiplier fell to 4.03 in January from 4.14 in December. It will be difficult to expect money supply to make significant increases without an improvement in bank lending.

The contribution of money supply growth to inflationary pressures is and should remain minimal for the short term, with the key driver of inflation continuing to be rents and, more recently, the acceleration in food price inflation.

Rental inflation slowed to 12.6 percent in February from 13.8 percent in January, marking the lowest pace of annual inflation in rents since August 2007. Rents began accelerating quickly in the second half of 2007 until they peaked at 23.7 percent in July 2008. Supply bottlenecks are very slowly being rectified in the Kingdom's residential real estate market, but it will take years before a mismatch in demand and supply for property is bridged.

Despite the decline in rental inflation, Saudi Arabia's inflation rate jumped to 4.6 percent in February, the highest level since June, due to the increase of food and beverage inflation to 4 percent, the highest level in a year. Data of the Food and Agriculture Organization (FAO) show global food prices have been on an upward track since the summer, although they eased slightly in February. For the time being, we are sticking to our forecast that annual inflation will fall to 4.3 percent this year from 5.1 percent in 2009, with risks to the upside depending on the pace of increase in global commodity prices, the performance of the dollar versus other currencies and the real estate supply situation at home.
 

With bank credit conditions subdued, it unlikely that SAMA will revise interest rates this year. The central bank has kept its repurchase rate at 2 percent for more than a year and its reverse repurchase rate at 0.25 percent since June. Keeping rates low has done little to hearten bank lending, with lenders preferring to keep their excess cash with SAMA or in foreign bank deposits in 2009. Commercial bank deposits held with SAMA's reverse repo window jumped 37 percent last year, the same rate of growth recorded in banks' foreign asset holdings.

SAMA will find support for its dovish stance in US policy. The US Federal Reserve pledged in March to keep interest rates near zero for an extended period of time. By pegging its currency against the US dollar, Saudi Arabia closely mirrors the Fed's monetary policy moves.

The choke on bank credit in 2009 at Saudi banks was not a matter of tight liquidity conditions but a reflection of both risk aversion among banks and de-leveraging among private sector companies adjusting to economic conditions that caused an economic boom in Gulf Arab nations to unravel quickly.

There are early signs that banks could be loosening their stronghold on extra cash. In January, commercial banks drew down their foreign assets by 10.9 percent from December to SR187.92 billion, following four straight months of gains. Bank deposits in SAMA's reverse repo window also slipped 0.6 percent in the month to January, SAMA data show, while bank deposits in SAMA's statutory and current deposits climbed over the same time frame.

Repatriation of bank capital could be linked to a host of reasons, including loan-to-deposit management and balance sheet management; banks could be bringing capital back to deploy it in the domestic market.

SAMA data also signal some return in domestic demand has taken place. Total commercial and personal checks, registered a 7.1 percent year-on-year rise in January to SR41.65 billion - down from a 2009 high in December of SR64.5 billion.

Meanwhile, the number of point of sale transactions rose 12.8 percent in January from the year earlier, their value jumping by 20.8 percent to SR5.08 billion.
 

Provisions taken by Saudi commercial banks more than doubled last year to SR22.08 billion from SR9.99 billion in the previous year, according to bank financials posted on the stock market website (Tadawul). National Commercial Bank, Saudi Arabia›s biggest bank, accounted for 21 percent of total provisions taken by the Kingdom's 12 commercial banks. The highest proportion of provisions were taken in the fourth quarter - 90 percent more than Q3, and triple the level of Q1 provisions. Banks are guarding against possible bad loans, with non-performing loans more than doubling in 2009 to SR25.8 billion compared with 2008. The level of defaults on loans was highest at NCB, reaching SR5.42 billion, followed by Al-Rajhi Bank at SR3.87 billion, then SABB, where NPLs reached SR3.53 billion.
 
— John Sfakianakis is group general manager and chief economist at Banque Saudi Fransi, Riyadh