Government sector GDP growth rates in the first half of the year exemplify the fundamental role played by state and quasi-state investors in the economy. Nominal GDP of the government sector expanded 13.5 percent in the first six months, more than double the private sector's rate of growth at current prices. While state-led growth is likely to continue in 2011, we do see the starting signs of greater involvement by the private sector, although its reintegration into economic activity is likely to take place slowly over the next two to three years.
Against a backdrop of a relatively inactive, deleveraging private sector, the government's fiscal expenditures will continue to expand, although we have reason to believe the pace of expansion may slow in the coming years. Authorities are becoming more cognizant of the fact that higher spending raises the risk for fiscal deficits in the medium term, especially as the oil price needed to balance the budget has leapt to $72 a barrel this year. We have raised our state revenue forecast to SR658.9 billion this year as a result of sustained higher oil prices. Following this revision, and a reduction in our expenditures forecast, it looks likely that Saudi Arabia will swing a surplus in 2010 amounting to 2.5 percent of GDP.
Accelerating price pressures due to a combination of global and local factors have characterized 2010. High soft commodity prices, continued real estate supply constraints and imperfect domestic competition came together to nudge Saudi inflation to 6.1 percent in August for the first time in 18 months. Inflation rates dipped back below 6 percent since then, and we anticipate the deceleration in inflation rates will continue in 2011 as a consequence mainly of high base effect adjustments for rents and stabilizing food prices. Although rents are poised to continue climbing month on month, the rate of annual increase is set to decline, thus removing a great deal of the burden on the annual inflation rate. Our forecast of 5.3 percent inflation in 2010 remains intact, and we foresee inflation subsiding in 2011 to 4.7 percent, against a prior estimate of 5.1 percent.
The very guarded pick up in bank credit growth is poised to continue in the coming months, prompting us to reduce our 2011 forecast for growth in bank claims on the private sector to 8.5 percent from 12.2 percent. Momentum behind credit growth is likely to continue to lag until a substantial pipeline of project financing is integrated into bank balance sheets and the private sector moves toward expansion financed through a combination of equity and debt. These trends should start to unfold in the second half of 2011 and encourage a return to double-digit rates of credit growth in 2012 and 2013.
Reduced inflationary pressures and expectations for a stronger US dollar in 2011 will relieve speculation that Saudi authorities will rethink a long-standing policy of pegging the riyal to the dollar. Credit Agricole CIB, our joint-venture foreign partner, expects the euro-dollar to end 2011 at 1.18, signaling a serious trend reversal. Euro weakness is likely to result from the spillover effect from debt-troubled nations elsewhere in the euro zone as well as a robust US economic outlook.
A weaker dollar tends to raise the cost of imports into Saudi Arabia, particularly for food items, but it also increases the appeal of non-oil exports to global customers and makes tourism into the Kingdom, primarily for religious purposes, more affordable for those whose currencies strengthen against the greenback. November's Haj pilgrimage illustrated this strong demand, with preliminary estimates indicating a record number of pilgrim visits. This is bound to have a positive ripple effect on the wider services and hospitality sectors for this year and 2011.
As we stated briefly in our November Monetary Watch, inflationary pressures in Saudi Arabia - now the highest in the Gulf - are poised to decline in 2011, leading us to reduce our inflation forecast for next year to 4.7 percent from 5.1 percent. We anticipate inflation will average 5.3 percent in 2010, higher than 2009's 5.1 percent.
The primary downward pressure should stem from falling rental inflation. The rent and utilities index, which comprises about a fifth of the index, is likely to record average inflation of 9.5 percent this year, although next year we see the rate falling to 6.7 percent. While we still expect moderate month-on-month gains in rental inflation, the annual rate of rental inflation is likely to decline during 2011 due to the higher base effects. In 2009, rental index inflation averaged 14.3 percent, down from about 18 percent in 2008.
We are also anticipating a slowdown in home furniture inflation, and in other expenses and services, which together comprise more than 20 percent of the index. The largest weighting in the Saudi cost of living basket is food and beverages, accounting for almost a third of the total. Food price trends are somewhat more difficult to predict because they depend on movements in global commodity prices, and may also be influenced by fluctuations in the US dollar. When the dollar is weaker, this raises the cost of importing food into Saudi Arabia, heightening imported inflation. A stronger US dollar in 2011 and some softening in food commodity prices should be anticipated, although food inflation rates will likely hover in a similar range as this year. Any decline in food price inflation will be slight given price stickiness.
In recent months, data of the Food and Agriculture Organization show some food prices, particularly sugars and cereals, are on the rise again, although there is evidence that food prices are near peaks and are unlikely to face significant upward pressure in 2011. Saudi Arabia's food price index broadly tracks trends in the FAO food price index, albeit much more moderately. Sustained higher food prices globally are likely to be offset by the stronger dollar, and while we expect food inflation to rise in the first part of 2011, it should ease during the second half of next year. Food and beverage inflation in 2011 is likely to be slightly lower than the projected 6.2 percent average we foresee for this year, although the index has varied widely in recent years based on global circumstances. In 2008, food and beverage inflation averaged around 15 percent and fell to 2 percent in 2009.
Money supply growth in the Kingdom, traditionally a contributor to inflation, is beginning to pick up due to greater lending and economic activity in general, although remains far from levels that we expect would lead to a build up in inflationary pressures. In September, M3 money supply growth was 5.1 percent, compared with between 10 percent and 27 percent in every month between 2005 and the end of 2009. By comparison, M3 money supply growth averaging 5 percent this year and 9.6 percent next year, according to our forecasts, would have a much less-pronounced impact on inflation rates.
Nominal GDP showed solid performance in the first half of the year, according to quarterly data released by the Central Department of Statistics & Information. GDP at current prices grew 24 percent year on year in the first six months of 2010, according to the numbers, due primarily to a 42.5 percent jump in oil sector GDP, which comprised more than half of the total nominal figure for the period.
Oil prices in the first half of 2010 averaged $78.46 a barrel - up 52 percent from an average of $51.7 a barrel in the same period a year earlier. Still, with Saudi oil production in the first six months falling to 8.13 million bpd from 8.19 mbpd a year earlier, according to figures of the Joint Oil Data Initiative (JODI), the impact of high oil prices on real oil GDP will be negligible.
Nonetheless, the nominal GDP numbers also indicate a good comeback in nonoil private and government sector GDP, which are the main components driving real GDP growth this year. Private sector GDP growth in the first half came in at 6.5 percent in current prices, while the government sector's current price GDP growth came in at 13.5 percent, according to the data.
The government did not release real GDP growth data for the same period, although analysis of the correlation between real and nominal GDP growth trends in recent years does indicate fairly strong real GDP expansion for both the private and government sectors in the first six months. In the five years to 2009, the average median correlation between real and nominal private sector growth was 70%, while for the government sector it was 57 percent. Applying these ratios to the first-half numbers yields real growth rates of, roughly, 4.5 percent in the first half for the private sector and 7.7 percent for the government sector.
Annual growth rates are likely to have slowed in the second half, mainly because of a higher base effect; the performance of the Saudi economy began picking up in the second half of 2009 and the first part of 2010. Since then, momentum has stagnated. Banque Saudi Fransi maintains its forecasts for 4 percent real growth of the private sector for 2010 and 4.6 percent for the government sector, although government sector expansion may be higher due to the state's inclination to steer the recovery process by investing in strategic projects.
As a percentage of GDP (at current prices), the bank expects Gross fixed capital formation (GFCF) to reach 26.8 percent this year up slightly from 2009 levels, which is positive for business activity. It is clear that the government has outpaced the private sector in driving investments to spur economic growth. Private gross fixed capital formation fell in 2009 by 2.2 percent, while the government sector's capital formation rose 8.9 percent, according to SAMA data. As a percentage of GDP, nonoil private sector investments rose to 11.9 percent in 2009 from 9.6 percent in 2008. BSF expects the ratio rise to 13.2 percent this year and should climb again to 13.6 percent in 2011. GFCF as a percentage of GDP is still lower than rates attained in other emerging markets, which have tended to surpass 30 percent during crucial growth phases. Authorities are, however, taking crucial measures to boost capital investments.
With state investments leading the way, the burden on public fiscal balances is clear. The government announced in November it would not phase out an inflation allowance that had raised salaries of state employees by 15 percent over the last three years. The allowance was meant to be removed after this year - but due to continued high inflation the Finance Ministry has decided to keep it intact, costing the government an estimated SR33 billion a year (inclusive of public sector employees and pensioners). Overall for this year, the bank has revised down its state expenditures target to SR618 billion as we expect additional expenditures will be billed forward.
BSF anticipates the government will slow the pace of budget expansion in 2011 and unveil a budget later in December including announced expenditures of not more than SR590 billion, up from SR540 billion this year, a 9.3 percent increase. Budgeted expenditures in 2010 budget were 13.6 percent bigger than 2009, which itself was 15.9 percent bigger than the year- earlier budget. This slowdown in budget expansion is necessary and prudent following years of overspending budget targets by more than 20 percent.
In 2009, the Saudi government overspent its budget targets by 26 percent. Such exorbitant overspending is not sustainable over the long term.
In the meantime, however, budgets are easily financed with rich foreign asset reserves which, due to higher oil prices, the Kingdom has been in a position to enlarge this year. In the first nine months of the year, Saudi Arabia's central bank added SR61 billion to its net foreign asset holdings, taking them to SR1.58 trillion, the highest since February 2009. At that time, the central bank was drawing down foreign assets to pay for its growing budget during a period of low oil prices. Sustaining big budgets does not pose a major concern in the short-term because it is part and parcel with the government's current five-year development plan to stimulate the economy and create the right backdrop for the private sector to operate.
Still, mushrooming expenditures - which have tripled since 2002 - will raise the oil prices needed to balance Saudi budgets. In the early part of the decade, the Kingdom had traditionally based its budget on very conservative oil price assumptions that made it easy to post respectable surpluses. But budget breakeven oil prices have risen rapidly along with state expenditures in the last few years and are now very similar to the actual oil price. According to our estimates, the budget breakeven price of oil for this year's budget is around $72 a barrel - compared with $66 a barrel in 2009 and $52 a barrel in 2008. Next year, the budget breakeven price could rise again to more than $75 a barrel - giving the Kingdom very little room to maneuver should oil prices weaken from current levels.
At the current pace of government spending, the breakeven price of oil could rise to $98 a barrel by 2017. Current high state spending could be replaced by spending that creates additional multiplier benefits and a trickle down that has cross-sector reach.
A revival in oil prices during 2010 has played a role in ameliorating the state's fiscal position and reviving domestic demand, but it is unlikely to render much of a rise in real oil sector economic growth. While energy demand globally, and particularly from Asia, has climbed this year, Saudi Arabia's oil production levels are not following suit, leading us in October to reduce our real oil GDP growth forecast to 2.7 percent.
According to data of JODI, Saudi oil production in the first nine months of 2010 averaged 8.13 mbpd, which is actually lower than the same period last year, when the Kingdom produced 8.19 mpbd of crude, on average. This leaves little scope for growth in oil GDP in 2010. Our forecast for oil GDP growth of 2.7 percent this year stems from a view that the government integrates investments in oil infrastructure into its calculation of oil GDP at constant prices.
OPEC has cited a pick up in oil demand in the third and fourth quarters, particularly due to better-than-expected oil demand in OECD countries which prompted the organization to revise its world oil demand growth forecasts upward by 0.19 mbpd, or 1.6 percent, to 1.32 mbpd. Developing countries account for 83 percent of that total, including a 6.4 percent climb in demand from China, according to OPEC estimates in its monthly Oil Market Report. OPEC also upwardly revised 2011 projections for oil demand growth to 1.36 percent in 2011, driven mainly by 5.1 percent growth in China and 2.1 percent in developing countries of Asia, Latin America, the Middle East and Africa.
The Kingdom is a key beneficiary of strong oil demand growth from Asian clients since about 54 percent of exports in 2009 were destined for Asia, up from 45 percent just nine years earlier. The bank anticipates Saudi oil sector GDP growth will accelerate to 3.7 percent in 2011.
Greater energy demand from Asia has been a key catalyst for better export flows during 2010 following declines in much of 2009. Nonoil exports, too, are on the rise, according to preliminary data of the Central Department of Statistics & Information. In the first nine months of 2010, CDSI data show nonoil exports climbed about 16 percent compared with the same period a year earlier. Final foreign trade data tend to vary, but the CDSI trends show a pick up that can be attributed to enhanced petrochemical and plastics sales. In September, the latest data available, nonoil exports grew 15.3 percent from the year earlier. The bank anticipates total exports, including oil and nonoil, will rise 16 percent this year to $223.4 billion (SR837.77 billion), and climb another 10.4 percent next year.
Growth in imports, on the other hand, has been more muted, with import flows into Saudi Arabia declining in value in August and September compared with the corresponding months in 2009. Preliminary CDSI data show a small decline of 1.8 percent in imports over the first nine months. In view of these weaker - than - expected data, BSF has reduced its total imports forecast for 2010 to $90.7 billion from an earlier $95.4 billion. This marks a near 5 percent rise in total imports during 2009, reflecting its expectation for a pick up in imports in the final months of 2010, and an additional 10 percent gain in 2011.
With improved export earnings this year, the country's current account surplus has recovered following weakness during 2009, including current account deficits in the first and second quarters. The Saudi current account surplus rose to SR74.5 billion in the first quarter of this year, the highest since the onset of the financial crisis in the third quarter of 2008, SAMA data show. Given the strong Q1 performance and slower import activity, BSF is raising its current account surplus forecast for 2010 to SR154.15 billion ($41.1 billion), or 9.5 percent of GDP - almost double last year's surplus.
Balance of payments data also show growth in workers' remittances did not lose steam in 2009. About 8.4 million expatriates officially live in Saudi Arabia, or almost a third of the total population. Another 500,000 to one million expatriates overstay their visas. In the first quarter, expatriates remitted SR26.7 billion home, up 12.8 percent from the fourth quarter.
