Global energy demand, particularly from Asia, is
advancing gradually, although the latest projections are for the rate of oil
demand growth to decelerate next year as governments look to unwind fiscal
stimulus packages that have propped up the recovery process. This will have a
direct bearing on the pace of growth of Saudi oil export revenues, which
accounted for more than 85 percent of total state revenues last year.
Oil prices consistently above $75 a barrel have supported
Saudi Arabia's fiscal position and enabled the Kingdom to replenish foreign
assets to $417 billion as of July - the most it has held since early 2009. The
average price of crude for the first nine months of 2010 exceeded $77 a barrel,
and it is likely to flow within a similar channel next year, averaging around
$81 a barrel. Domestically, bank credit growth continues to recover at an
unhurried pace, keeping the onus of financing strategic projects on the
shoulders of government ministries and agencies.
The state overspent its budget targets by more than 25
percent in 2009, according to new data, raising the urgency of re-integrating
the private sector in the coming year to relieve some of the funding burden. A
temperate outlook for oil demand and prices will make it more and more
difficult for the government to balance budgets consisting of sizeable gains in
fiscal expenditures. The state revised upward its fiscal deficit for 2009 to
SR86.6 billion, exceeding its initial estimate by more than SR20 billion.
Banque Saudi Fransi has revised its 2010 fiscal forecasts in light of this
revision and now expects Saudi Arabia will post a small deficit of SR8.4
billion in 2010.
Small deficits are very manageable in the medium term
given the country's very low levels of public debt. However, continuous
overspending cannot be sustained without a constant rise in oil prices.
Inflation in Saudi Arabia is now the highest in the Gulf
region due to rising global food prices, shortages in real estate supply and
growing domestic demand among its 27 million residents.
While the recovery process appears protracted, Saudi
Arabia is betting a good turnaround in private sector growth in the coming
years will lead to a big jump in economic growth rates. In its Ninth
Development Plan, a five-year program of economic targets for 2010-2014, the
government envisions its most-ambitious real GDP growth rates in three decades,
including average real GDP growth of 5.2 percent. Chief contributor to this
growth would be the nonoil private sector, which the government targets to grow
6.6 percent per year, on average, during the five years - taking its share of
GDP to 61 percent from 48 percent.
We have raised our private sector growth forecast for
2010 to 4 percent from 3.7 percent - with growth rising to 4.6 percent next
year. Without a drastic improvement in the encouragement and integration of
small- and medium-sized enterprises, as well as a substantial upsurge in
foreign investment - the private sector will struggle to exceed 5 percent
growth in the coming years.
Oil production
While the government has grand plans to reduce its
reliance on the oil and gas sector to 20 percent of GDP by 2014 (from 28
percent in 2009) - for the time being, oil is king, and state finances will
fluctuate based on global demand and prices. In its five-year plan, the
government expects oil and gas sector GDP to grow just 1.2 percent, on average.
Higher growth rates of 7 percent and 5.7 percent, respectively, are expected
for oil refining and petrochemicals, which are categorized under nonoil GDP.
Saudi oil production is increasing modestly this year,
with most new demand growth coming from Asia. As of August, Saudi oil production
was 8.23 million barrels per day (mbpd), according to the data, up 1.4 percent
from the fourth quarter of last year.
However, average oil production between January and July
was only 8.14 mbpd, according to estimates of the Joint Oil Data Initiative,
below average 2009 output of 8.18 mbpd. We expect oil production will average
8.20 mbpd in 2010, reflecting a 0.2 percent rise over 2009.
As a result of this passive rise in production, we are
reducing our forecast for the oil sector's real GDP growth in 2010 to 2.9
percent from 3.7 percent. The oil sector contracted 6.7 percent in 2009 due to
a drastic cut in OPEC oil output. Prior to 2009, there was a strong correlation
between the rate of growth in Saudi oil production and real oil GDP growth. However,
oil GDP growth rates have tended to outpace growth in per-barrel oil production
since 2004 - with the biggest discrepancy in at least two decades apparent in
2009; Oil production fell 10.8 percent last year but oil GDP declined less than
7 percent.
This indicates that the government is including other
factors - perhaps investments in oil infrastructure and non-crude oil
hydrocarbon products - into its oil GDP calculation. It is for this reason that
we still anticipate growth of 2.9 percent in the oil sector in 2010, supported
mainly by domestic energy market investments. Lower oil GDP growth aside, we
expect the non- oil private sector will grow 4 percent and the government
sector 4.6 percent. We have slightly reduced our 2010 GDP growth forecast to 3.8
percent from 3.9 percent.
Oil demand
Oil demand growth in the first half of the year was
faster than anticipated, mostly due to government stimulus packages rousing
economic growth and spurring demand globally. The tables could be turning,
however, as states begin to phase out stimulus spending and this reveals
structural weaknesses in some global economies.
"Now that the current round of government stimuli
appears to be winding down, demand growth in the second half of this year is
likely to return to the initially projected growth levels, assuming that no
further government support is forthcoming," OPEC said in its September
Monthly Oil Market Report. "As a result, oil demand could weaken over the
remainder of this year. In fact, the impact of the slowing economic recovery on
oil demand is already evident as growth in oil consumption is slowing down and
has even turned negative in some parts of the world."
Still, world oil demand in the second half is forecast to
grow by more than 1.0 mbpd, led by China, the United States and the Middle
East. Decent growth in demand from Asia benefits Saudi Arabia, which has
diversified its exports away from the West in recent years in favor of Asia.
Some 11 percent of Saudi exports - which more than doubled in value between
2003 and 2009 - were destined for China in 2009, up from 4 percent in 2003.
Asia, which accounted for 45 percent of Saudi exports in 2003, last year
received 54 percent, while the European Union's share of Saudi exports fell to
9 percent from 15 percent over the period.
OPEC projects global oil demand in 2010 should grow 1.24
percent, primarily the result of a 2.3 percent rise in demand from developing
countries and 5.6 percent growth in demand from China. 2010 oil demand in OECD
countries to fall 0.05 percent from last year. But demand growth rates in 2011
are likely to weaken, according to OPEC's latest forecasts. Global demand
growth would fall to 1.22 percent as demand in Western Europe contracts and
North America's expands less than 1 percent. Even in China, demand growth is
seen slipping to 4.9 percent and that of developing countries in Asia, Latin
America, the Middle East and Africa to 2.05 percent.
Inflation rising
One worrying trend for the Saudi economy is the
acceleration in inflation to above 6 percent in August - the highest rate in
the Gulf. While annual rental inflation continues to decelerate, food price
inflation has been accelerating quickly this year due to a number of factors
globally and domestically.
In August, the Food and Agriculture Organization (FAO)'s
food price index rose after holding steady for much of 2010. The advance was
primarily due to gains in the cost of sugar, cereals, cooking oils and meat.
Saudi Arabia relies heavily on food imports to feed its population of 27 million,
particularly as it moves toward phasing out certain water-intensive
agricultural industries as wheat cultivation. Imports of food accounted for 15
percent of total imports in 2009. The country is, therefore, vulnerable to
shifts in global commodity prices. The other dynamic propelling food prices is
domestic. Imperfect competitive forces in the country mean retailers may be
slower to pass on cost savings to consumers than they are to pass on increases.
Anecdotal evidence shows that domestic animal feed prices, especially barley,
have risen more than 110 percent over the past three months, to SR55 per bag
from SR26, compounded by consumer hoarding.
Rental inflation, while declining year on year, has
nonetheless continued to accelerate month on month and will remain a key factor
behind historically high inflation rates. Annual inflation in the rent, fuel
and water index has fallen consistently in the eight months to August, and this
trend is likely to continue. Inflation of 8.9 percent in the index in August is
the lowest since mid-2007. We expect monthly rises in rents to continue, with
anecdotal evidence pointing to more aggressive increases in rents by the end of
the year, as well as higher real estate prices more generally. The annual rate
of rental index inflation is unlikely to fall below 7-8 percent in 2011.
One effort to ease rental inflation will be the
government's planned construction of one million housing units to meet 80
percent of demand from 2010-2014, as outlined in the Ninth Development Plan.
The plan stipulates that the government will provide 266 million square meters
of land to the public and private sectors for housing projects. We regard
allocation of public land for private and public housing development as the way
forward.
Interest rates
Other than food and rents - together comprising about 44
percent of the consumer basket - inflation in goods and services and home
furnishings have been quite high this year and are adding impetus to
accelerating inflation rates. The cost of other goods and services (13 percent
of the consumer basket) rose 8.5 percent in August - faster than food
inflation. Personal goods prices alone rose 23.2%.
Given the broad range of factors contributing to
inflation, we find it unlikely that the headline rate will abate in the coming
months and we forecast inflation accelerating to 5.3 percent in 2010, up from
5.1 percent last year, with risks to this forecast slightly to the upside.
Saudi Arabia is now suffering from the highest rates of inflation in the Gulf
region, where Qatar continues to experience year-on-year deflation due to a
housing market slump that saw the rental index decline more than 15 percent in
July.
Despite accelerating inflation and the recent weakness in
the dollar vis-à-vis global currencies, we do not anticipate the debate over
whether Gulf states should revalue their currencies will resurface.
The Saudi Arabian Monetary Agency (SAMA) has emphasized
that it will not change interest rates for the foreseeable future. Doing so
would not, in any case, have much bearing on inflation given that money supply
growth remains extremely subdued at just 2.3 percent in July - a far cry from
growth rates exceeding 20 percent in 2008, when inflation peaked at 11 percent.
The question is what will happen to inflation once money supply growth gathers
some steam and aggregate demand picks up substantially. We expect broad money
(M3) growth to average 7 percent in 2010 and 10.3 percent in 2011, levels that
are unlikely to stoke a good deal of inflationary pressure.
This justifies the central bank's policy of keeping
interest rates low - 0.25 percent for the reverse repurchase rate and the
repurchase rate at 2 percent. SAMA's stance continues to be one centered on
motivating banks to increase lending. Annual growth in bank claims on the
private sector rose to 4.9 percent in July, from no growth in December. Credit
growth, however, remains sorely below the double-digit levels seen between 2007
and early 2009.
Expenditure estimate
To keep funding pouring into strategic infrastructure
projects in oil and gas, transportation and utilities, the government has been
providing soft loans to companies involved as a substitute for financing from
banks or debt markets. Bond markets appear to be loosening up to a certain
degree, with a number of regional sovereign and corporate issuers turning to
the market again. In late September, debt-ridden Dubai issued a $1.25 billion
sovereign bond, and its tallest tower developer Emaar Properties separately
announced plans for a $375 million bond.
Arab Petroleum Investments Corp., meanwhile, is seeking
to issue a benchmark Saudi riyal bond. We expect a gradual revival in bond
markets toward the end of 2010 to meet the refinancing needs of sovereign and
state-linked corporate issuers.
Domestically, Saudi Arabia has succeeded at keeping its
projects pipeline moving ahead through various state-financing initiatives. The
Kingdom's share of total Gulf projects has been growing steadily since the
first quarter of 2009 as the United Arab Emirates shelved hundreds of billions
of dirhams worth of its plans to contend with a recession and housing market
crash. The value of total Saudi projects underway in September 2010 was almost
$695 billion, according to MEED data, a full 30 percent of total Gulf projects.
The Kingdom had accounted for 24 percent of projects in March 2009.
The extent of overspending taking place among government
departments to support this expansionary stance has become exceedingly clear in
the latest data. State expenditures last year reached SR596.4 billion,
according to SAMA's 2009 annual report released in September. That is almost 26
percent above state expenditure projections for the 2009 budget of SR475
billion. In December, the Finance Ministry had estimated in its 2010 budget
statement that state expenditures reached SR550 billion in 2009, so the
government discovered a full SR46 billion of spending that had taken place in
2009.
Prior to the budget release, we had forecast expenditures
of SR578.9 billion for 2009. As a result of the revision in actual data this
September, we are revising our 2010 state expenditure forecast to SR648
billion, reflecting our expectation that government departments will overspend
their allocations by about 20 percent this year. It is likely that the
government's initial expenditure estimates, to be released in December, will
underestimate the level of overspending that has taken place, which has
happened in recent years. The government has issued strict warnings to
departments to rein in spending, but it will likely take a few years before the
level of over-spending reaches acceptable levels of closer to 10 percent.
Overspending
The government has been able to sustain high levels of
overspending in recent years due to its substantial cushion of foreign assets,
much of which was accumulated during an oil price boom supported by strong
production between 2003 and 2008. Over that period, SAMA's net foreign assets
grew more than 10-fold to SR437.9 billion in 2008 from SR41.9 billion at the
end of 2002.
State stimulatory spending effectively prevented the
Saudi economy from contracting in 2009 as recession gripped the world. The
government sector grew 4.4 percent that year, helping achieve overall GDP
growth of 0.6 percent. During the year, SAMA drew down its foreign assets by
7.5 percent as sought funds to finance an abundant spending program being
undertaken by the government to stimulate the economy.
The government is interested in building an efficient and
more-productive economy over the long-term, but its spending patterns to demand
caution. Current expenditures almost doubled between 2000 and 2009 to SR416.59
billion. Over the same period, the ratio of current expenditures to total
spending has fallen to under 70 percent in 2009 from 92.2 percent in 2000 due
to the nine-fold rise in capital expenditures to SR179.8 billion in 2009. While
capital expenditures can be phased out should the government face difficulties
balancing its budget in the longer term, it is more difficult to reduce current
expenditures - a good proportion of which includes mushrooming wage bills at
various government ministries, such as the recent Armed Forces salary increase.
Higher state expenditures will make it difficult for the
government to turn budget surpluses in 2010 and 2011 unless there is a decent
turnaround in energy demand globally. As of now, we forecast government
revenues of SR639.6 billion in 2010, up 25 percent from 2009 but not enough to
support a fiscal surplus this year. We expect a small deficit of SR8.4 billion
amounting to 0.5 percent of GDP. Initially, the government could post a
provisional surplus in December because, as we discussed earlier, the final
expenditures figure is not generally released until the third quarter. Next
year, we foresee government revenues of SR682.3 billion against expenditures of
SR704 billion, thus yielding an SR21.7 billion budget deficit amounting to 1.2
percent of GDP.
Sustaining small deficits as these does not pose a
problem for the government. Up to July, SAMA held SR1.564 trillion ($417.1
billion) in net foreign assets, up almost 3 percent from December levels and 9
percent from levels a year earlier. SAMA net foreign assets exceed 100 percent
of GDP while the country's public debt this year would account for less than 13
percent, according to our estimates. As early as 2004, debt-to-GDP exceeded
foreign assets to GDP.
The five-year plan
Saudi Arabia has no plans to reduce steam powering the
economy with projections of SR1.44 trillion in expenditures to support the
2010-2014 targets under its Ninth Development Plan, the details of which were
unveiled in August. Just over half of this allocation will go toward developing
human resources, which includes all levels of education. Nearly 40 percent of
the annual education budget goes toward teacher retraining programs, which are
necessary to improve the quality of primary and secondary education.
The Saudi population is growing quite quickly, reaching
27.1 million this year according to revised figures following a country-wide
census. The Kingdom's official unemployment rate rose in 2009 to 10.5 percent
from 9.8 percent for Saudi nationals, which highlights the urgency of spending
to develop the non- oil economy and spur job creation. By the end of the plan
period, the government wants to almost halve unemployment among nationals to
about 5.5 percent. This will be a daunting task without improved quality of
primary and secondary education and promotion of the private sector, which
alone should bear the burden of generating new employment opportunities for
Saudis. Higher education alone demands SR200.18 billion in spending in the
five-year period, according to state estimates. Health care requires another
SR242.7 billion.
"The preparation of the Ninth Development Plan
coincided with a crushing financial and economic global crisis. Despite the
burden imposed on all countries by the crisis, the development program embraced
by the plan reflects the kingdom's determination to continue accelerating the
development process," the government said.
Spending commitments on education must focus both on
quantity and importantly, quality. About 31 percent of the Saudi population
includes expatriates, many whom fill gaps left by the national population for
skilled professionals. Saudi Arabia moved up seven places to 21st in the World
Economic Forum Global Competitiveness Report - the second highest ranking in
the region after Qatar. But the Kingdom ranked a low 74th in health and primary
education and 51st for higher education and training. "Both these areas
... are of high importance to Saudi Arabia given the growing numbers of its
young people who will enter the labor market over the next years," WEF
said of challenges it foresees for the Kingdom.
Too ambitious?
Through these spending outlays, Saudi Arabia is targeting
5.2 percent average annual GDP growth rates in the five years to 2014. If
achieved, this would be the most-ambitious economic growth since the 1970s oil
boom. Five-year average real GDP growth has not exceeded 5 percent since
1975-1979. The government is counting on the non-oil sector to support its
projections. The crude oil and natural gas sector is expected to grow only 1.2
percent, on average, for the next five years - although that excludes oil
refining and petrochemicals, which the government groups in with non-oil
sectors.
Under the plan, the private sector's GDP would expand an
average 6.6 percent per year over the plan period, raising its share of GDP to
61.5 percent by 2014 from 48 percent in 2009. The private sector would be the
main engine in the economy, with the oil and gas sector's share of GDP
declining to 20 percent from 28 percent and the government sector to 17 percent
from 23 percent. Achieving these high levels of private sector growth could
prove difficult. Between 2005 and 2009, a period of rapid expansion and high
oil prices prior to the global financial crisis, private sector growth averaged
4.95 percent. It has not exceeded 6 percent for a plan period since the 1970s.
Growth between 6 percent-6.5 percent annually is needed to create enough jobs
to bring labor equilibrium for Saudis in the coming years. Government sector
GDP growth is also faster than any plan period since 1980-1984.
The government is targeting real GDP growth of greater
than 7 percent per year, on average, in many nonoil sectors - building and
construction; utilities; trade, restaurants and hotels; financial services; oil
refining; manufacturing and community and personal services. Over the same
period, expansion in the oil and gas sector is expected at just 1.2 percent per
year, while the government services sector grows 4.8 percent.
Among the plans objectives is to nurture and organize the
small- and medium-sized enterprise sector. It wants to implement government and
private initiatives to develop the sector and boost its contribution to non-oil
GDP.
Setting its expectations high does not mean the targets
will be fully achieved or that they cannot be achieved. Saudi Arabia missed its
real GDP target under the 2004-2009 development plan by 1.5 percent. Real GDP
grew an average of 3.1 percent during that five-year period, below a 4.6
percent target. The plan also envisioned Saudi unemployment falling to 2.8
percent by 2009 - whereas it rose to 10.5 percent. One thing that is certain is
the government is ready and willing to keep fuelling the economic recovery and
envisages that in the near future, the private sector will reciprocate.
Moreover, policymakers are aware of the challenges facing Saudi Arabia: job
creation, education, economic diversification, sustainable growth and domestic
energy inefficiencies. Public and private stakeholders need to work together to
develop nation-wide solutions.
(John Sfakianakis is chief economist at Banque Saudi
Fransi, Riyadh.)
