All 831 respondents to Banque Saudi Fransi's (BSF’s) second-quarter (Q2) business confidence survey expect oil prices to remain above $100 a barrel for the coming two quarters, including 76 percent supposing prices will stay above $110 a barrel. Higher oil prices and greater production have enhanced the overall expectation about the business community's growth prospects, with a majority of company executives surveyed charting out plans to increase production and hire new staff in the next six months as the vast majority count on a revival in bank lending.

Still, there has also been a shift in investment attitude coinciding with recent weakness in regional equity markets and political uncertainty afflicting several countries in the region. The survey indicated a move is taking place toward regarding low-risk investments in cash and bonds as more favorable than equity investments. A majority of respondents also expect inflation to rise in the coming period after the government handed out one-time bonuses to employees as part of a sweeping SR485 billion citizen support package unveiled in the first quarter.

The BSF business confidence index rose slightly to 101.7 points in Q2, 2011 from 101.3 points in Q1, 2011, continuing along an upward trajectory initiated in Q4, 2010. The base value of 100 represents the third quarter of 2009, which marked a period of economic weakness following the global financial crisis. The Q2 survey drew on perspectives of top managers across various sectors: Finance, real estate and construction, information technology, petrochemicals and industry, agriculture, tourism, advertising and legal affairs.

It was conducted between March 19 and April 6.

Among the survey's key findings are:

• A substantial 84 percent of business executives foresee an improvement in their companies' profitability over the survey period, up from 80.1 percent in Q1 and 51.4 percent in Q4.

This is the strongest profit outlook since the survey was launched in 2009, reflecting the likelihood of greater private consumption and consumer confidence as oil prices scale 2-1/2-year highs.

• Risk aversion has once again gripped investors, with 44 percent of business leaders ranking cash holdings as the best medium-term investment prospect, ahead of bonds, equities and real estate. This marks a drastic shift from the Q1 survey, when 71.5 percent of respondents chose equities as their top investment pick and none picked cash. This change of opinion corresponds with prevailing uncertainty about the performance of the local equity market.

• Bank lending is not likely to recover quickly in the next six months, with the number of respondents describing the upcoming lending attitude of banks as "very good" or "excellent" falling slightly to 73 percent from 78 percent in the first quarter. Nonetheless, the over all credit outlook has improved markedly in the past year as banks begin to slowly boost the pace of new lending and borrower appetite improves.
 
High oil prices

Oil prices above $100 a barrel quickly became the norm this year as regional political instability drummed up the risk premium related to oil prices, driving Brent crude above $120 a barrel and WTI to nearly $110 - its highest level since the onset of the 2008 financial crisis in the fourth quarter of that year.

When the bank conducted its Q1 survey, most respondents held the view that oil prices would not exceed $90 in the first half of the year. Their perspectives have taken a U-turn since then; not one respondent in our Q2 survey expects oil prices to fall below $100 in the next six months. In fact, some 47.4 percent - the largest proportion of respondents - foresee prices ranging between $110 and $120 a barrel, while another 29 percent expect the price of crude will fluctuate within the $120-$130 band.

Saudi Arabia, which derives almost 90 percent of fiscal revenue from oil exports, has increased crude oil output since January to compensate for a shortfall left by OPEC producer Libya, currently embroiled in a political crisis that has halted oil exports. Global oil prices are a crucial gauge of confidence in the Saudi economy, which we now expect will witness GDP growth of 5.5 percent this year, in addition to posting twin fiscal and current account surpluses.

Against this positive energy price backdrop, it is not surprising that the proportion of survey respondents expecting the Saudi economy's performance to be "much better" in the coming period rose to 87.8 percent, against 76.7 percent in Q1. The remaining respondents said the economy would perform "better". By comparison, as the euro zone debt crisis intensified last summer and oil prices fell below $70 a barrel, only 29.6 percent of respondents had anticipated a "much better" economic outcome.

While economic growth is expected to accelerate this year, the government rather than the private sector will continue to be its biggest driver. In two royal decrees in February and March, King Abdullah committed to investing an estimated SR485 billion of state cash over several years toward multiple initiatives, including introducing an unemployment benefit, paying out bonuses to state employees, raising wages, creating jobs and building homes.

According to our estimates, the one-time bonus alone will cost the government an additional SR52.9 billion this year, which has raised the likelihood for a pick up in private consumption and a consequent rise in inflation. We revised our inflation forecast to 5.6 percent for 2011, from 5.1 percent previously, in view of the new liquidity in private hands.

Respondents to the Q2 survey shared this view; 52.8 percent of company managers expect inflation will rise in the next six months (against 41.3 percent in Q1). Meanwhile, the number of executives who expect inflation to fall narrowed to 23.1 percent from 37.4 percent, while 24.1 percent expect inflationary pressures to remain the same, similar to the Q1 response.

As inflation rises and the US dollar continues to weaken versus the euro, business executives have altered their view of the likelihood for exchange rate reform. The riyal is pegged to the US dollar at 3.75, and since we launched our survey in the third quarter of 2009, the overwhelming majority of respondents have said they do not expect any change in the exchange rate.

In the Q2 survey, by contrast, some 36.9 percent of respondents answered "yes" or "maybe" to the question about whether they anticipated that authorities would alter the Saudi riyal exchange rate in the next two quarters. In the prior three quarters, none of the respondents expressed any expectation for currency reform, so this is a notable shift.

Still, the majority of respondents, 59.2 percent (against 90.7 percent in Q1), said they foresaw no change in exchange rate policy, which continues to be our view as well.
 
Higher sales

Over the past year, as Saudi Arabia's macroeconomic fundamentals improved so too have the prospects for company sales and profitability. Since our Q3 survey, the proportion of survey respondents anticipating their firms' revenues would rise has climbed gradually from 53.9 percent in Q3 to 81 percent in the latest survey. Some18.1 percent of respondents, meanwhile, expects sales will stay the same.

There are a number of factors fueling the buoyant sales outlook. For one, private consumption has picked up gradually since the start of 2010 with elevated confidence in the economic recovery. The Q1 bonus payouts, furthermore, make it more likely that consumers will pursue big-ticket purchases such as cars or appliances, which would enhance sales of retailers and wholesalers in the short term. In addition, greater government spending and better global energy demand will boost demand for goods and services on the whole.

Under these conditions, company profitability is likely to follow suit, survey respondents said. Some 84 percent of business executives in Q2 expect stronger profit growth over the forecast period (versus 80.1 percent in Q1 and 53.2 percent in Q2 2010).

Anticipation for greater consumer demand has not prompted companies to rush to raise prices, however, the survey showed. The proportion of business leaders who said they would increase prices in the forecast period fell slightly in Q2 to 37.8 percent from 39.1 percent in Q1, although still considerably higher than the 20 percent who gave the same answer in Q4. The number of executives who said they planned to cut prices, meanwhile, fell by almost half to 15.6 percent, while those who intend to keep prices steady increased to 38 percent (versus 32.1 percent in Q1).

Companies are also not planning to build up their inventories in view of the greater consumer demand, after the majority said they would do so in the first quarter. Quite to the contrary, 52.6 percent of company executives said they would set out to reduce inventories in the next six months - the biggest proportion giving that answer since the survey was launched. Alternatively, only 23.2 percent of respondents said they planned to build inventories (against 50.7 percent in Q1) while 19.6 percent expect to replenish inventories to keep them at current levels over the period (versus 10.4 percent in Q1).

This may indicate that companies imported sizeable amounts of goods in the first quarter and would like to gauge consumer demand in the coming months before opting to modify their purchasing programs. The government and private sector bonus payments are likely to have only a short-term impact on demand, whereas small increases in salaries would have a more prolonged effect, the extent of which is difficult to judge at this stage. Companies remain hesitant about the pace of Saudi Arabia's economic recovery since government spending has driven most of the revival rather than a genuine return in private sector demand.

Hesitations aside, business leaders are confident enough in the economic circumstances to commit to investing more money in capacity expansion and new recruitment, the survey showed. A substantial 74.3 percent of businesses expect to raise production capacity in the next two quarters, up from 72.5 percent in Q1 and the best showing in more than a year. This is a signal that private businesses may be looking invest more money in expansion in the coming period in conjunction with state spending outlays.

Managers, meanwhile, are more bullish about hiring than they have been in a year. The proportion of respondents who said they planned to hire staff in the next two quarters advanced to 58.9 percent (against 29 percent in Q1), the highest ratio of business executives to give that response since Q2, 2010.

All but 12 percent of executives, meanwhile, have abandoned a hiring freeze policy, compared with 53.1 percent who planned not to recruit in the Q1 survey.
 
Equities

Volatility on local and regional markets since January has shaken the confidence of business leaders, whose responses to the survey indicate that they are exercising greater caution when it comes to investment decisions.

The drastic shift in the investment risk attitude has the greatest implications for Saudi Arabia's equity market, which tumbled to a near two-year low in early March, but has since recovered 26 percent. Market weakness this year is linked to regional political instability following successful popular revolutions in Tunisia and Egypt that have spread to a number of countries across the region, including Libya and Yemen.

These regional circumstances have fueled uncertainty despite the rise in oil prices, survey results show. Asked which single asset class they expected would provide the best medium-term investment returns, a majority of survey respondents chose low-risk, low-yield investments in cash and bonds.

The biggest proportion of business leaders at 44 percent picked cash as their best investment bet, followed by bonds at 21.6 percent, equities at 17.6 percent and real estate at 16.8 percent. This marks a sharp shift from Q1, when 71.5 percent of company leaders placed their bets on equities, and only 7.5 percent chose bonds and none picked cash.

Reflecting the uncertainty and doubt that prevail, the most-common response to the question of how the equity market would perform in the next six months was "negative". Some 34.9 percent gave that answer, up sharply from 8.1 percent in Q1. Meanwhile, only 18.8 percent expect the stock market will rise (down from 74.7 percent in Q1) and a sizeable 30.8 percent were unsure about the route the bourse would take in the forecast period.

Among equity sectors, most investments that do take place will focus on petrochemical names, according to survey respondents. Some 50.7 percent of survey respondents chose petrochemicals above cement, banks and telecommunications sectors as their most-preferred equity sector, almost unchanged from Q1. Saudi Arabia's petrochemical index was hit by the Q1 market rout, but still managed to rise 2.1 percent during the quarter compared with an advance of 15.6 percent in Q4.

Banks have fallen out of favor with respondents, only 18.1 percent of whom expect banking shares have the best upside potential in the next two quarters, less than half the ratio that gave the same answer in Q1. The Tadawul banking index slipped 0.5 percent in the first quarter. Meanwhile, cumulative bank profits for the first two months of the year were down 4.2 percent, according to preliminary central bank data.

Cement shares gained favor, meanwhile, with 22.7 percent of managers choosing the sector as their most-preferred in the next six months, compared with 2.3 percent who said the same in Q1. The cement index rose 1.8 percent in Q1.

The anticipated gain in cement shares may be linked to an expected rise in domestic demand for building materials as the government begins to roll out an SR250 billion plan to build new homes for its citizens, announced in Q1. While new home building should pick up in the coming five years as a result of the new cash commitments, the short-term implications for bringing down property prices are limited, the survey showed.

A majority of respondents to the Q2 survey said they expect real estate prices to rise in the next two quarters, with 52.8 percent giving that answer (up from 49.4 percent in Q1) - the highest proportion since the survey was launched.

Supply bottlenecks are therefore likely to continue in Saudi Arabia's under-supplied property sector. Of the survey respondents, 23.1 percent anticipate prices will fall and 24.1 percent foresee them staying the same.
 
Loan growth

Private sector credit growth picked up pace for a third month in February to almost 6 percent year on year, according to the latest central bank data. While bank lending remains subdued compared with double-digit levels achieved prior to the financial crisis there has been a notable turnaround over the past year in the lending attitude of banks over the past year. The proportion of business leaders to rate the lending attitude of banks as "excellent" rose to 39.4 percent in Q2 (versus 33.5 percent in Q1), up markedly from a third-quarter trough of 5.1 percent.

Nonetheless, bank lending growth continues to be lackluster and most of the development projects under way in the Kingdom are being financed using state cash rather than bank loans. Private sector loan demand is picking up moderately, although survey responses showed there is still a way to go before the credit market stabilizes. The proportion of business leaders to describe banks' lending attitude as "very good" fell to 33.7 percent in Q2 from 44.5 percent in Q1, while those who said it was "not good" rose to 12 percent of the total from 10 percent in Q1.

Meanwhile, a vast majority of respondents, 75 percent, said banks had tightened loan approval requirements "substantially" in the past year - higher than the 62.6 percent who gave the same answer in Q1.

A low interest rate environment continues to create a backdrop conducive for banks, which are highly liquid, to seek out greater lending opportunities. Some 52.2 percent of respondents said they expect no change in key interest rates in the next two quarters (against 65.4 percent in Q1). Only 10.2 percent of respondents anticipate rates will rise.
 
— John Sfakianakis is chief economist at Banque Saudi Fransi, Riyadh.