JEDDAH: Now that the global economy has begun to recover from the worst recession since the 1930s, what insights can we derive from the past year and a half for the Saudi economy?
The high degree of connectivity between the Saudi economy and the rest of the world was made abundantly clear. Impacts were felt not only through gyrations in the oil market, the dollar and global trade, but also in the banks, stock market, inflation and consumer spending and saving habits within the Kingdom. The important global role of Saudi Arabia was highlighted by its membership in the G20, the forum of the world’s 20 largest economies charged with formulating fixes for global problems, according to a report released on Monday by the Riyadh-based Jadwa Investment.
Centrality of credit
Perhaps the most important unexpected impact is that the stress point for Saudi Arabia in this recession turned out to be more related to credit than oil. Oil prices tumbled over the second half of 2008 recording a peak to trough decline of 80 percent. However, the recovery was rapid. Oil prices doubled from their December lows in five months and, in early 2010, have traded with quite low volatility between $75 and $85 per barrel. The lower oil prices did not significantly harm government finances, and the impact on the broader economy was muted by strong and consistent government spending. The government built up a huge stock of foreign reserves at SAMA (Saudi Arabian Monetary Agency) during the very high oil prices of the previous years and had embarked on a multi-year ramped-up spending program before the financial crisis hit. Drawing down these reserves allowed the government to maintain its near-term expenditure plans regardless of the downturn in oil prices.
In contrast, Saudi credit conditions were affected much more than we had thought would be the case as the crisis unfolded. Initially it appeared that Saudi banks were among the best positioned in the world to weather the storm. Saudi banks had minimal exposure to the “toxic assets” of the West. They went into the downturn with strong capital adequacy, and the absence of local securitizations — the packaging and reselling of loans — meant Saudi banks were in direct touch with their borrowers and seemed better able to manage their credit risks.
Islamic banking, a large segment of the market, by its nature had avoided high leverage, structured packages of conventional loans and investment in conventional financial institutions, said the Jadwa report, prepared by chief economist Brad Bourland.
Saudi banks, in common with those throughout the world, tightened credit standards and slowed lending in the final quarter of 2008 owing to concern about their exposures to plunging asset prices and the health of borrowers, notably other banks. “Aggressive action from SAMA quickly allayed these concerns and with other global banks gradually on the mend, we thought conditions were right for Saudi bank lending to bounce back during the second quarter of 2009,” the report added. But in May 2009, two high profile corporate defaults rattled the system, raised questions about the severity of the write-offs needed, the quality of Saudi bank credit risk management, and the possibility of other major Saudi corporate defaults.
This led to a several-months stretch of contraction in Saudi bank lending to the private sector, just as lending elsewhere in the world was gradually recovering, or in the case of other emerging markets such as China, soaring.
Problems accessing credit and broader concerns about the health of banks and other private sector companies dented confidence even though the fundamentals — strong oil prices, high government spending, declining inflation and a recovering global economy — all pointed to a healthy and rebounding economy. Local stock market performance lagged both emerging and global markets from May 2009.
The events of 2008 and 2009 highlighted the unpredictability of oil prices. In 2008, oil (WTI) started the year at $98 per barrel, rose to $147 per barrel in July, then ended the year at $44 per barrel. No forecaster could rationally foresee, let alone accurately predict, this extreme volatility.
“So, although we and our peers provide oil price forecasts, a lesson from the crisis is to be wary, especially of headline-grabbing forecasts,” the report said.
What is clear is that there has been a fundamental change in the market equilibrium price for oil. After spending most of the 1980s and 1990s hovering around $20 per barrel — higher during supply disruptions, lower during periods of oversupply — oil seems to have a new market balanced price of somewhere between $50 and $80 per barrel. This fundamental step change began to manifest itself in 2003 with sharp growth in emerging market demand, especially Chinese. The new level was stress-tested by the recession with the first global contraction in oil demand in decades occurring in 2009.
Bourland said whatever the new equilibrium price turns out to be, it certainly is no longer $20 per barrel. Oil prices within the new higher range provide a comfortable level of funding for the government of Saudi Arabia and those of many other oil producers, particularly in the GCC (Gulf Cooperation Council). Even though government spending went up notably in 2009 in the Kingdom and oil production was well-below capacity, oil revenues were still such that just a small budget deficit was recorded.
Some of the new higher price is simply oil adjusting to hold its value against a persistently declining dollar. Since the end of 2003 oil prices are up by around 140 percent, while the dollar (on a trade-weighted basis) is down by 25 percent. The bulk of the price rise is clearly due to the surge in demand from emerging markets. An important impact of the global crisis, recent years of higher oil prices and increasing environmental protection policies is the peaking of oil demand in OECD (Organization for Economic Cooperation and Development) countries.
“Oil demand in the OECD may never again return to the level of 2008, and the dynamics between emerging market and OECD demand and sources of new supply will determine the longevity of the current balanced market price,” Bourland said.
(To be concluded)