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.
Oil market
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.
When the financial crisis hit, inflation was in double digits for the first time since the 1970s. It peaked at 11.1 percent in 2008.
At that time, the two main drivers of inflation were global food prices and local rents. Since then, the collapse in commodity and transportation prices have erased the price increases in imported food, and price easing of imports across the board was aided by a strengthening dollar in the initial months of the crisis.
Rental price inflation, which is purely a local phenomenon resulting from a shortfall of housing supply, has continued, but at a lower rate. Inflation in early 2010 is running at around 4 percent. This decline is one of the positive aspects of a steadier rate of growth in a post-crisis economy in contrast to what was becoming an overheated economy before the crisis hit. “We expect that inflation will stay subdued over the next couple of years as the economy recovers,” said Brad Bourland, chief economist of the Riyadh-based Jadwa Investment.
The crisis caused sharp gyrations in the value of the dollar. First it rose for a period as a result of global flight to safety — people were worried and wanted to hold cash denominated in dollars. This reversed a multi-year trend of dollar decline and took some related pressures out of the market. For example, the rapid dollar appreciation, lower inflation and greater bank risk aversion snuffed out lingering speculation against the dollar-riyal exchange rate peg — a major popular and market issue before the downturn. Once investors began to regain confidence early in 2009 and moved from dollar cash holdings into “risky assets,” such as stock market investments, then the dollar resumed its decline. It stands now about where it was before the crisis began. “We have not yet seen a return to market pressure on the exchange rate peg, but this would certainly reemerge if the dollar continues its decline,” Bourland added.
Observers are divided currently on whether the dollar will weaken or strengthen in 2010; movements will depend on how the recovery proceeds in the US versus other major currency regions.
Stock market
Perhaps the key lesson for the Saudi stock market is that movements in Saudi share prices are being driven by a more complex set of forces. Not so long ago this market was seen as an “oil play” — as oil prices went, so went the stock market. Today the market is no longer isolated from what is happening on global stock markets. During the period of extreme financial stress, the Saudi stock market was very highly correlated with other global markets and even now the relationship is fairly strong.
The still-small but growing entry into the market of foreign investors is affecting some, but not all, segments of the market — mainly petrochemicals and banks, said the Jadwa report released on Monday.
The tighter relationship with global markets also reflects the increasingly globalized nature of many Saudi companies and the deepening and broadening of financial links between the Kingdom and the rest of the world. Particular local and regional developments, such as the high-profile defaults also come strongly into play. Finally, with a growing number of listed companies, improved transparency and the growth in equity research, the earnings season after the end of each quarter has become as much a driver of price movement here as anywhere.
Trade flows
Trade flows globally and locally were seriously impacted by the recession, with both non-oil exports and imports falling for the first time in a decade.
While much of the decline was the result of lower prices, volumes were also down for products such as petrochemicals, where the Kingdom has built a highly competitive world-class industry. Even sectors of the Saudi economy that are not export-oriented did not escape, as consumers reacted to falling share prices, tougher access to credit, and global uncertainty by restraining spending.
Bourland said: “It is hard to track consumer spending in Saudi Arabia, but one data series we think is a good guide is point of sale terminal transactions. These are reported monthly and reflect local purchases carried out using debit cards, so it is an incomplete picture because it does not capture cash transactions, but it indicates the trend.”
Growth in point of sale terminal transactions slipped throughout the first half of 2009 to a long-term low in June, but picked up notably in the final quarter.
Imports of consumer goods were down by 6 percent in volume terms over the first eleven months of last year; for vehicles, the decline was 20 percent.
Broader economy
The Saudi economy has proved quite resilient to the global recession. Government policy played a very supportive role. The government was prudent in building up large reserves that could be drawn down during troubled times and was fairly aggressive in its response to the financial crisis. Interest rates were cut quickly and sharply, support given to the banking sector when needed and spending was raised.
The policy response ensured that the economic environment was healthy, but could not prevent the drag on economic performance caused by weak consumer and business confidence, which was affected as much by the global as the local news flow, the report said.
The impact of the crisis on Saudi Arabia highlights that the integration of the Kingdom into the global economy now runs well beyond the oil market. Slumping commodity prices, extreme currency volatility and a plunge in world trade had important effects on the economy, though not all were negative. In particular, two key economic policy issues during much of 2008 — rising inflation and pressure on the exchange rate — were overcome. In both cases, the issue was created and resolved by movements in the global economy and global markets, highlighting the limitations to the effectiveness of local government policy.
“The tighter links between the Kingdom and the global economy are not going to fade. However, just as the crisis emphasized how exposed Saudi Arabia is to developments in the global economy, it also raised the Kingdom’s standing, through its inclusion in the G20, for example, which gave it a seat at the main forum for global economic policy, and through its obvious membership in the club of fast-growing emerging market countries,” Bourland added.
