More than 80 percent of respondents to Banque Saudi Fransi's first quarter (Q1) business confidence survey foresee oil prices persisting above $80 a barrel in the coming two quarters, including 44 percent expecting prices above $90. Oil price fluctuations directly influence business sentiment in Saudi Arabia since the state derives more than 85 percent of revenue from exports of crude oil. The higher price backdrop is likely to impel greater lending by the Kingdom's banks, which were extremely reluctant to extend credit last year despite having ample liquidity, the survey showed.

The BSF business confidence index rose to 101.3 points in Q1, 2011 from 100.2 points in Q4, 2010, and is substantially higher than the 99.4 points it scored in Q1, 2010. The base value of 100 represents the third quarter of 2009. The Q1 survey - which drew on perspectives of top managers in finance, real estate and construction, information technology, petrochemicals, tourism, advertising and legal affairs - was conducted between Dec. 23 and Jan. 8.
 
Highlights of survey

Business executives displayed confidence that the lending attitude of banks is poised for a considerable upturn in the next six months. Some 78 percent of respondents described the upcoming lending attitude of banks as "very good" or "excellent", more than double the number who offered the same answer in Q4 2010. Defrosting the credit market and improving borrower appetite are among the key hurdles before the private sector's recovery.

A substantial 76.7 percent of business leaders expect the Saudi economy will perform "much better" in the next two quarters, up from 41.9 percent who gave that response in Q4, 2010. That is the strongest macro-economic outlook among businesspeople since the survey was launched in 2009, reflecting optimism as oil prices fluctuate around more than two-year highs.

Confidence in equity market investments improved markedly among businesspeople, with almost 75 percent of respondents expecting positive performance in shares in the first half of this year, up from 34.5 percent in Q4, 2010. Petrochemical and banking shares are most likely to gain from the ripple effects of robust oil prices, the survey showed.
 
Oil price strength

In Q4, 2010, almost 26 percent of business leaders continued to be vigilant in their oil price outlook bearing in mind the fragility of the global recovery, and said they expected oil prices would not surpass $75 a barrel, including some who eyed oil below $65. Following two months of recharged oil prices - averaging $84 a barrel in November and $89 in December - executives have abandoned this hesitation. In Q1, 2011 survey, only 3 percent of business leaders think oil prices will fall below $75 in the next six months.

The largest proportion of respondents, 44 percent, foresee prices ranging between $90 and $100 a barrel, while another 37% expect the price of crude to fluctuate within a $80-$90 band. The oil price is a key indicator of confidence in the Saudi economy. In the Q3, 2010 survey, when euro-zone debt default fears gripped financial markets, a majority of respondents expected prices would drop below $75 a barrel, including more than a third predicting a decline beneath $65. This colored pessimism in company financial performance and hiring plans, and dimmed investment prospects across the board.

But oil prices outperformed in the following months and enabled the government to post a surprising fiscal surplus of SR108.50 billion for the year, according to state estimates released last month. High oil prices have enabled Saudi Arabia to replenish its store of foreign assets to pre-financial crisis levels above SR1.6 trillion, giving it plenty of room to maneuver a budget including record expenditure projections of SR580 billion this year. A full 78 percent of respondents to the survey expect the state will continue overspending its budget forecasts in 2011. State overspending reached 25.5 percent in 2009 and 16 percent in 2010.

Government spending has been the key driver of economic growth since the onset of the financial crisis. In 2010, government sector GDP growth hit 5.9 percent, a 13-year peak, while private sector growth rose only slightly to 3.7 percent from 3.5 percent a year earlier. Business leaders are confident the economic recovery will continue to build momentum this year; some 76.7 percent of respondents (against 41.9 percent in Q4, 2010) said macroeconomic performance would be "much better" in the next two quarters. The remaining respondents said the economy would perform "better".

Greater economic activity is not likely to feed inflationary pressures, however, the survey found. Inflation in the Kingdom has declined slowly since hitting an 18-month high of 6.1 percent in August. Inflation hit 5.4 percent in 2010, with pressures likely to slightly ease this year due to comparatively lower rental inflation although food inflation should remain elevated due to global food price pressures. In the Q1 survey, 37.4 percent of respondents said they expect the inflation rate will fall in the next six months, up from 28.5 percent who said the same in Q4, 2010. Meanwhile, the number of executives who expect inflation will rise narrowed to 41.3 percent (against 57 percent in Q4, 2010), and 21.3 percent thought the rate would stay at current levels (versus 14.5 percent in Q4, 2010).

The predominant view, then, is that economic conditions will improve without any consequently large elevation in price pressures. The results also imply that executives do not expect a great deal of pressure from imported inflation related to fluctuations in the US dollar, to which the Saudi riyal is pegged. The dollar has gained recently versus the euro and other global currencies, relieving speculation that authorities might re-evaluate the currency policy. Of survey respondents, 90.7 percent said they did not expect any change in the Saudi riyal exchange rate over the forecast period.
 
Companies upbeat

Following two years of struggling to enhance profit growth, business leaders foresee a decisive shift in the coming six months as many of them look to raise prices and build inventories to prepare for better consumer demand, the survey found.

A substantial 80.1 percent of respondents to the survey expect healthier profit growth in the coming two quarters (against 51.4 percent in Q4, 2010). That is the strongest expectation since the survey's launch in Q3, 2009, and marks a swing in optimism for a broader economic recovery. Three-quarters of executives (versus 66.2 percent in Q4 2010) are anticipating their companies' revenues will rise over the period, while 23.9 percent think they'll stay the same and only 0.9 percent expect sales to decline. The result is still below the 88.6 percent who expected higher sales in the Q2, 2010 survey, underpinning a sense of hesitation that remains at the back of managers' minds.

Still, many business leaders are confident enough about the return in domestic demand that they plan to raise prices in the coming six months. Some 39.1 percent said they would do so (against 20 percent in Q4, 2010), although another 32.1 percent said they would err on the side of caution and hold prices steady (down from 54.6 percent in Q4, 2010). A good proportion of businesses, meanwhile, continue to plan price cuts - 28.8 percent gave that answer, up from 25.4 percent in Q4, 2010.

Asked about what they planned to do with inventories in the next two quarters, a majority of 50.7 percent said they would boost inventories (against 37.2 percent in Q4, 2010), while 10.4 percent expect to replenish inventories to keep them at current levels over the period (down from 22.1 percent in Q4, 2010). Holding more inventories in stock is a sign that businesses think consumers in the country will have greater purchasing power this year. It is also a signal that import flows could improve this year following lower-than-expected growth of less than 1 percent last year.

A decent number of businesses remain wary, however, with 27.3 percent saying they would reduce inventories over the period (versus 31.3 percent in Q4, 2010). The private sector remains hesitant largely due to the gradual pace of revival in domestic investments and private consumption.

While they may have some scruples, business leaders are betting that regional and Asian demand will enable the Saudi economy to outperform. A substantial 72.5 percent of businesses plan to raise production capacity over the next two quarters, by far the highest outcome in a year. This could signal that private sector businesses, which have held off on new investments as they deleveraged in the past year and a half, are looking to recommence funding in expansion. The latest data show nonoil exports grew 12.3 percent year on year in November to SR10.9 billion while imports climbed 4 percent to SR28.4 billion, comparatively high growth for the year.

Businesses are very hesitant about recruitment, however. The proportion of respondents who said they planned to hire staff in the next two quarters fell sharply to 29 percent in Q1 from 54.9 percent in Q4, 2010. That is the lowest result in more than a year and emphasizes that executives' confidence remains clouded with caution. While none of executives surveyed planned to lay off any staff in the next two quarters, 53.1 percent plan to maintain a freeze on hiring over the period, up from 34.2 percent in Q4, 2010.
 
Outlook on loans strong

Lackluster credit growth rates over the past year have made it difficult to imagine any substantial catalysts that could jumpstart bank lending to the private sector. Annual growth in claims on the private sector rose just 3.7 percent in November, according to the latest central bank data, reflecting both resistance among banks toward lending and companies toward investing in new projects.

There has nonetheless been a noticeable improvement in the outlook for credit growth among survey respondents in the past year, including a sharp upturn in the Q1, 2011 survey. The proportion of business leaders to describe banks' lending attitude as "excellent" jumped sharply to 33.5 percent in Q1 from 11.5 percent in Q4, 2010 and just 5.1 percent in Q3, 2010. Almost half of respondents, 44.5 percent, described banks' lending attitude as "very good", nearly double the Q4, 2010 result. The outlook has, therefore done a complete about-turn from a year ago. In Q1 of 2010, a whopping 58.6 percent of respondents had described banks'lending attitude as "not good".

Yet evidence of this shift in attitude is wanting in official data; claims on the private sector were up by 5.7 percent in November compared with year-end 2009, and that month private sector credit actually contracted from October levels. Still, business leaders are likely placing hopes that continued government spending will sift through into a larger number of project financing deals in the coming year. They also anticipate private businesses will re-enter an expansion phase in the coming months, which will necessitate that they turn to banks to provide part of the funding mix.

A low interest rate environment continues to support lending. Some 65.4 percent of survey respondents in Q1 said they expect no change in key interest rates in the next two quarters (against 55.5 percent in Q4, 2010). Only 7.4 percent expect rates to rise between 10 and 20 basis points.
 
Risk appetite

Encouraging and stable economic conditions are prompting business executives to increase their propensity for risk in the investment decisions they take this year. Asked which single asset class they expected would provide the best medium-term investment returns, the vast majority pointed to the equity markets. Gains in Saudi stocks are correlated, among other things, to fluctuations in oil prices, and investors tend to favor holding shares when the outlook for crude oil is positive.

Investors are much more comfortable taking risks with their surplus cash than they were at any point last year. The ratio of business leaders who described equities as the best medium-term investment prospect rose sharply to 71.5 percent in Q1 from 43.9 percent in Q4, 2010 and just 15.4 percent in Q3. Real estate investments came in second place, but fell out of favor, with only 21 percent of respondents naming it the best investment bet (versus 35.9 percent in Q4, 2010).

That companies are more likely now to park capital in higher-yielding, riskier investments was clear from the survey results on bonds and cash holdings. None of those surveyed said cash would provide the best returns in the next six months - down from 48 percent in Q3 at the height of concerns over the fallout of the euro-zone debt crisis. Only 7.5 percent of respondents, meanwhile, listed bonds as their favored investment (against 10.9 percent in Q4 2010 and 21.7 percent in Q3).

Saudi Arabia's main index, Tadawul, ended 2010 at a 7 1?2-month closing high after gaining more than 5 percent in the prior five weeks. Managers expect this positive performance will not lose steam, according to the survey. Some 74.7 percent of respondents expect the stock market will gain ground in the coming two quarters, up from 34.5 percent in Q4, 2010. Another 8.1 percent expect stock market declines over the period while 14.2 percent foresee share prices remaining static.

The general optimism in equity investments likely stems from the view that company profits will make a comeback due to higher oil prices and improved domestic demand. Petrochemical shares were listed as the most-preferred sector by 51.4 percent of surveyed executives (against 41.6 percent in Q4 2010), while banking stocks took 42.9 percent of the votes (against 45.5 percent in Q4 2010).

Earnings of petrochemicals giant Saudi Basic Industries Corp. (SABIC) mirror the oil market closely, and expectations for improved demand in Asia, coupled with higher prices, should bode well for the company's earnings this year. In the fourth quarter, Saudi petrochemical shares surged 15.6 percent, and jumped more than a fifth during the whole of 2010, thus vastly outperforming the general index.

Investors are, meanwhile, keen to see the banking sector's bottom-line performance improve as banks take less-aggressive provisions to guard against bad debt and gradually increase lending. Survey respondents expect banking shares have upside potential after the Saudi banking index fell 2.2 percent in the fourth quarter. The banking index rose 7 percent in 2010, slightly underperforming the general index. The ratio of respondents favoring other equity sectors, meanwhile, fell to 2.4 percent (against 6.7 percent in Q4, 2010) for telecommunications and 2.3 percent (versus 2.8 percent in Q4, 2010) for cement, the survey showed.

Real estate investments also lost some favor to equities as investors expressed contrary views on their outlook for the property sector's performance this year, the survey showed. Some 49.4 percent of respondents expect real estate prices will rise in the next six months, up from 38 percent who gave the same answer in Q4, 2010. Still, a substantial 39.8 percent anticipate prices will fall - thus highlighting confusion surrounding the route property prices will follow in 2011. Investing in real estate, particularly commercial land holdings, has long been regarded by Saudi businesspeople as a prime investment choice.

The cost of prime commercial land slumped 17 percent between the second half of 2008 and the first half of 2010, according to our latest real estate survey. In H2, commercial land prices rose by 1.6 percent on average compared with H1, although prices were still down 5.2 percent from the year earlier. Some 10.8 percent of respondents in the Q1 business confidence survey are expecting no change in real estate prices, down from 17.8 percent in Q4, 2010.
 
 
- John Sfakianakis is chief economist at Banque Saudi Fransi, Riyadh.