Saudi Arabia’s economic recovery this year will most likely follow a gradual, steady track. Economic growth should accelerate following a stagnant and difficult year, inflation will remain at manageable but historically high levels and expansion of the private sector is set to take a turn for the better along with credit expansion at Saudi banks. The government, through a stimulatory public spending program, will continue to lead the pick up in the economy as Saudi oil averages around $74 a barrel and low levels of government debt bolster the Kingdom’s fiscal position. A higher oil price environment will enable Saudi Arabia to experience comfortable budget and current account surpluses.
While many key elements are in place to support a recovery in the Middle East’s largest economy, Banque Saudi Fransi (BSF) reducing slightly its 2010 economic growth forecast for the Kingdom to 3.9 percent from 4 percent based on our view that improvements in business activity will be gradual and cautious. The government’s commitment to counter-cyclical fiscal expansion remains solid.
Banks are likely to loosen up on their reluctance toward lending to the public and private sectors, one barrier that choked the private sector during 2009. Last year, claims on both sectors by banks contracted by almost 5 percent, following growth of 30 percent during 2008. This year, banks will have little choice than to lend more as they emerge from a period of challenging revenues and an unfavorable low interest rate environment.
It was not only banks that stifled nonoil private sector growth in 2009; private Saudi companies themselves shelved many projects as international credit became more scarce, and businesses deleveraged and restructured. Assessing the private sector’s appetite to expand is as important as examining banks’ willingness to lend.
The Saudi government last month revised lower its real GDP growth figure for 2007 to 2 percent (from 3.3 percent) and 2008 to 4.3 percent (from 4.45 percent).
Real economic growth in Saudi Arabia has not surpassed 5 percent since 2005. Expansion of the private sector — which was growing by more than 5 percent per year between 2004-2007 — is also down to levels that are not strong enough to support the amount of job creation Saudi Arabia needs in order to cater to a population that accounts for two-thirds of the Gulf total, and is growing around 2 percent per year. The private sector expanded 2.5 percent in 2009 and the bank anticipates growth to rise to 3.7 percent in 2010.
A measured turnaround
The Saudi economy registered better-than-expected growth of 0.15 percent in 2009, while nominal GDP, subject to oil price fluctuations, contracted around 21 percent, according to government estimates. A smaller-than-anticipated decline in oil sector output of 6.4 percent enabled GDP to grow last year as most major world economies fell into recession. The bank had expected a 9.1 percent contraction in the oil sector, which underestimated Saudi Aramco’s investments in oil sector expansion.
The private sector’s investment appetite subsided and overall domestic demand declined, contributing to low nonoil private sector performance. The private sector expanded 2.5 percent down sharply from 4.7 percent a year earlier. International and local credit was scant and prompted many businesses to postpone and cancel projects as they opted to hoard cash.
BSF is cautiously optimistic that 2010 will witness an improvement in the private sector’s performance. The downside risks BSF foresees are linked to both the willingness of banks to provide credit and on the private sector’s willingness to undertake investments. BSF anticipates private sector GDP will expand at 3.7 percent this year, accounting for more than 47 percent of GDP at constant prices. With oil prices standing around $80 a barrel and key global economies beginning to return to growth, Saudi Arabia, a seminal oil and petrochemical products exporter, is likely to benefit from the improvement in global economic conditions. The bank foresees real growth for the Saudi economy of 3.9 percent this year, including a 4.1 percent rise in real oil GDP activity (accounting for 28 percent of total GDP). GDP growth should rise to 4.8 percent in 2011, the fastest pace in six years, once banking sector and business momentum is back in full swing.
BSF expects the government sector to grow by 4.1 percent in 2010, accelerating slightly from its 4 percent growth level last year, as the state continues to take the lead in the economic recovery. Government sector growth above 4 percent has happened only three times in the last 20 years — 2005, 1997 and 1992.
In the 2010 budget, this expansionary stance culminated in a 13.7 percent rise in projected state expenditures to a record level of SR540 billion. The largest budget in Saudi history is designed to encourage private sector businesses to loosen their purse strings and urge banks, awash with liquidity, to jumpstart lending following a slow 2009.
According to government budget projections, which BSF estimates are based on an average oil price of $44 per barrel for Saudi crude, the state’s fiscal deficit will widen to SR70 billion in 2010 after a smaller-than-expected shortfall of SR45 billion in 2009.
Below is a breakdown of some of the key trends the bank expects in nonoil economic sectors this year:
Finance
Finance sector GDP growth rates continued their declining trend in 2008-2009 as both bank profit and asset growth registered weak performance. The growth rate dropped to 2.8 percent in 2008 and 1.8 percent in 2009. Last year, in particular, bank lending to the private sector slowed to a crawl. Despite being awash with liquidity, bank claims on the private sector rose only 2 percent, down from 27 percent expansion a year earlier. Total domestic credit growth (including lending to public entities) fell about 5.4 percent last year.
As risk appetite among banks cautiously returns this year, the bank expects the finance, insurance and real estate sector will grow 3.8 percent in 2010, more than double its rate of growth last year.
BSF does not expect any change to SAMA’s (Saudi Arabian Monetary Agency’s) exchange rate policy in 2010.
Construction
Saudi Arabia’s construction sector grew 3.9 percent in real terms in 2009 — faster than growth of 2.2 percent registered a year earlier. This is partly a reflection of the knock-on affect of government infrastructure spending. In bank’s view, a lot of work remains to address growing demand for housing which BSF estimates, given prevailing conditions, at 255,000 residential units per year for the next five years. The kingdom’s real estate sector is still suffering from a shortage of housing units, a fact that has shielded it from the sharp price corrections experienced in neighboring countries, particularly the United Arab Emirates. The demand for new housing will continue, steered by the indigenous population.
Manufacturing
In 2009, manufacturing sector GDP growth slowed sharply to 1.7 percent from almost 6 percent in 2008. This decline in output is understandable given the general deceleration in the domestic economy, in addition to a slowdown in demand for goods, particularly petrochemical products, globally. The value of petrochemical and plastics exports from Saudi Arabia, for instance, fell 21.5 percent between January and September of 2009, according to preliminary data of the Central Department of Statistics (CDSI). The bank anticipate the manufacturing sector’s output will rise to 4.1 percent in 2010 as petrochemical output increases on the back of higher oil prices and new production volumes reach fruition.
Wholesale trade
Wholesale and retail trade is likely to witness GDP growth rates of 3.6 percent this year, compared with 1.97 percent in 2009, according to BSF estimates. Saudi Arabia’s exports are highly dependent on the price of and demand for oil. Oil exports accounted for 85 percent of a total estimated $153 billion in 2009. Nonoil exports, primarily petrochemicals and derived products, have performed well over the past few years in line with global demand and the Kingdom’s competitive advantage. However nonoil exports were not isolated from the global economic downturn, falling about 16 percent in 2009.
Letters of credit against the import of items such as food, automobiles and machinery are likely to track the performance of private sector expansion and private consumption. The bank expects imports, which fell 21 percent to $80.3 billion in 2009, to climb to $94.7 billion in 2010.
BSF anticipates that Saudi Arabia’s current account surplus will rise to SR98.7 billion this year, or 6.2 percent of GDP, compared with SR76.7 billion last year on the back of higher oil income.
Electricity
The electricity, gas and water sector grew 3.4 percent in 2009, down from an expansion at constant prices of 6.7 percent a year earlier, and we expect this sector to grow by a solid 4.3 percent this year. As demand for utilities rises in the coming years, greater government and private funds will be allocated to efforts to improve output and address growing demand. In 2008, electricity generation grew 5.7 percent, and domestic demand for utilities is growing by 8% per year.
Transport
BSF expects the transport and communications sector to grow 4.8 percent this year, having been the fastest-growing sector last year, at 6 percent. The Saudi telecoms sector has expanded quickly with the introduction of two mobile phone operators to compete with the incumbent Saudi Telecom Co. in recent years. Zain Saudi Arabia, the Kingdom’s third mobile phone operator, reached 6 million subscribers in November, and total Saudi mobile phone subscriptions exceeded 41 million at the end of the third quarter.
Agriculture
Agriculture GDP is likely to grow 0.5 percent in 2010 according to our estimates, up from growth of 0.2 percent last year. While the rate appears low at first glance, it is in line with the state’s policy of moving away from agricultural production toward importing key commodities, including wheat. Saudi Arabia is giving up a 30-year program to grow its own wheat as part of a government strategy to change its water usage habits by phasing out water-intensive crop production.
Inflation
After soaring to a record 9.9 percent in 2008, inflationary pressures subsided in 2009 due to slower domestic demand, lower global commodity prices, a retreat in food prices and a decline in domestic rents. The circumstances created deflationary trends in some Gulf countries, particularly Qatar, although we do not foresee a substantial decline in inflation in Saudi Arabia this year. BSF expects Saudi annual inflation to average 4.3 percent this year, compared with 5.1 percent in 2009.
(To be concluded)
(John Sfakianakis is group general manager and chief economist at Banque Saudi Fransi, Riyadh)
