Political upheaval in North Africa, Bahrain and Yemen has rattled domestic financial markets. The initial reaction to turmoil in Egypt was mild, with just a slight and short-lived dip in the Tadawul All-Share Index (TASI). However, serious violence in neighboring Bahrain, followed quickly by similar events in Libya was more unsettling as the TASI had shed around 7 percent from its mid-January peak. In addition, CDS spreads on Saudi debt in late February had more than doubled from their end-December level. Forward rates and swaps for the Saudi riyal also came under some mild pressure.
Nevertheless, the fall in the equity market should be kept in perspective. The 7 percent decline is only half of that registered during the Greek debt crisis of April-May 2010, when the TASI shed 14 percent peak-to-trough, the Samba report said.
Meanwhile, preliminary figures released by the Ministry of Finance show that the Saudi economy grew by 3.8 percent in real terms in 2010, up from 0.6 percent in 2009. It says that the government sector grew by 5.9 percent, while the private sector expanded by 3.7 percent. This fits with the broad patterns of consumption and investment witnessed in 2010, namely the continuation of the public sector investment push, weak private sector investment growth, and a strong rebound in private consumption.
Data from MEED Projects illustrate the strength of the public sector's investment drive. Public sector contract awards for projects in execution in the nonoil sector amounted to $38 billion in 2010, up from $31 billion in 2009, a 12 percent increase.
There was a notable pickup in activity in the second half of the year, with contract awards more than three times the value of those recorded in the first half. Investment in power continues to feature heavily, but civil construction projects - such as university facilities and transport infrastructure - have accounted for a growing share of spending. As for private investment, this was weak for much of the year, but showed signs of recovery in the final quarter. Investment in petrochemicals led the way, with $4.9 billion worth of contract awards in the fourth quarter.
According to Samba, the pickup in private investment fits with the latest HSBC purchasing managers' index (PMI) for the Saudi private sector. The PMI, which monitors output, new orders, input and output prices, employment etc, increased to 63.8 in January - from 61.3 in December-putting it at its highest value since the survey began in August 2009 (any number above 50 denotes expansion in orders etc). In order to meet current and expected demand, Saudi private sector firms took on new staff, raised buying activity and built up inventories in January, according to the survey. The price of inputs also accelerated, driven mainly by higher raw materials prices, stemming in part from both higher global demand and unfavorable exchange rate movements. Nevertheless, output prices gained more slowly, suggesting that margins might be narrowing somewhat.
There are good reasons to think that the pickup in private investment will be sustained in 2011. Having endured a miserable 2009, listed petrochemicals firms saw profits rebound by over 150 percent in 2010. Samba expects Asia to remain the key driver of petrochemical demand in 2011, based on robust economic growth, and the fact that consumption per capita still lags the developed world by some margin. This positive demand outlook suggests that even though plenty of supply will enter the market in the first half of 2011-both higher run rates at plants that debuted last year and new facility start-ups-the demand-supply balance is still set to improve as we move through the year and into 2012 (particularly if there are delays to the start-ups, as has often been the case in recent years).
The outlook for the construction sector is less clear-cut. Some construction firms are involved in real estate development, and experienced weak demand and restricted credit during 2009 and 2010, resulting in thin and falling profits for listed firms. The sector clearly has enormous potential given the pent-up demand for housing and the Kingdom's youthful demographic profile, the Samba report said.
However, prospects are likely to remain constricted until issues such as the lack of a broad-based mortgage market, the scarcity of buildable land, and restrictions on off-plan sales are resolved.
However, construction also includes the contracting sector - much of which is unlisted - which has benefited hugely from the surge in government investment spending. This segment should continue to see strong growth in 2011, especially given the pipeline of gas, petrochemicals, refining and industrial contracts to be awarded by Saudi Aramco.
The bank report said retail sector enjoyed a strong 2010 with the profits of listed firms up 34 percent. This sector has been supported by high levels of government spending on salaries and subsidies, and by high (and comparatively stable) oil prices, which have bolstered sentiment. Points of sale transactions, which account for around 20 percent of retail activity, were up 28 percent by value in 2010.
The outlook for the sector remains positive: The government has responded to regional unrest by announcing large increases in social spending. Oil prices are also expected to track higher, and expectations of an improved stock market performance should support discretionary spending.
The improving health of the private sector is not yet reflected in private sector credit growth. Bank lending to the private sector increased by just 5.7 percent in 2010 - a clear improvement on the stagnation witnessed in 2009, but a weak performance by historical standards, and only just positive in real terms. The modest growth in credit largely reflects soft demand: Unlike in previous construction booms, private contractors are in many cases receiving advance payments from government and therefore have less call for bridging finance. In addition, traders and manufacturers are still working down their inventories built up before the onset of the financial crisis.
Nevertheless, the outlook is for much firmer credit growth in 2011. Most banks are extremely liquid, with an average loan-deposit ratio of just 80 percent at end-December. With the provisioning cycle having peaked, and private (and public sector) demand likely to harden this year, the sector is gearing up for double-digit growth in lending in 2011.
Growth in credit to the public sector has been more robust, with a 15 percent gain registered in 2010. This reflects the fact that the public sector remains the main motor of the recovery, and that banks have been more willing to lend to public sector firms, which are underwritten by the vast resources of the Saudi state. The main beneficiaries have been those firms engaged in basic infrastructure and services, such as Saudi Electricity Company, the Saline Water Conversion Corp., and Saudi Arabian Airlines, as well as Saudi Aramco. Nevertheless, loan growth has been volatile: Only in the second half of the year has lending showed consistent strength, reflecting the pattern of contract awards noted above.
The Samba report said bank deposits grew modestly in 2010, by just under 5 percent from 11 percent in 2009. On one level it is surprising that there was any growth at all given persistently negative deposit rates (-5 percent in December), but the increase stems largely from strong gains in public sector wages, as well as limited alternative investment options. Still, depositors shifted more of their holdings away from time and savings accounts toward demand deposits - a trend that has been visible for the past couple of years, but one that became more pronounced in 2010 as Saudis shifted a greater share of their income toward consumption.
Consumer price inflation eased to 5.3 percent in January, down from 5.4 percent in December, and a recent peak of 6.1 percent registered in August of last year. The decline was attributable mainly to a drop in the food price index, which reflected lower prices for two staples (potatoes and tomatoes).
High food prices could feed into Saudi inflation in two ways. The first, most obviously, is through higher food import prices, which could well become apparent in the coming months. Second, food price inflation could have second round effects by stoking inflationary expectations, particularly in emerging markets, where inflation is already high. This in turn could force authorities in emerging markets to raise interest rates and allow exchange rate appreciation. Saudi Arabia, with its peg to the US dollar, could therefore suffer from a generalized increase in import prices from key emerging market trading partners, such as China.
The other main component of the inflation basket, rents, accelerated on a month-on-month basis, though the year-on-year rate of increase continued to track lower. Samba expects year-on-year rental inflation to begin gathering pace again this year as more robust private investment growth pushes up demand for expatriates. Higher government spending on wages and subsidies will also contribute. Overall, the bank therefore expects Saudi inflation to accelerate to an annual average of 5.7 percent this year, with significant risk that it will overshoot, the report said.
Finally, Saudi Arabia's balance of payments position strengthened in 2010. Official data show that SAMA's (Saudi Arabian Monetary Agency's) net foreign assets increased by $35 billion to $440 billion, equivalent to 101 percent of 2010 GDP. This marks a reversal of the situation in 2009 when a large deficit on the financial account of the balance of payments led to a drawdown in official foreign assets of just under $33 billion.
SAMA breaks down its foreign assets into broad categories, and these have not changed very much over the past five years. The majority, around 70 percent, is held in the form of foreign securities, which are understood to be largely US treasuries. Just over a quarter is held in cash, while the revaluation of SAMA's gold holdings has seen its share increase to around 3 percent, the Samba report said.
