High govt: spending will be main engine of Saudi growth

RIYADH: The Saudi economy is expected to improve in 2010. Growth will pick up, credit will become more readily available and the government budget will return to surplus. High government spending will be the main engine of growth, with the private sector making a greater contribution as credit conditions improve. A reviving global economy should keep oil prices around their current levels and will increase demand for the exports.

Lack of confidence was an important factor holding back the Kingdom’s economy in 2009. This was reflected in a fall in bank lending, restrained corporate and consumer spending and a subdued stock market. Economic data suggest that confidence has begun to improve and Jadwa Investment expects a virtuous circle in which this feeds into higher spending, boosting corporate performance, lifting share prices and encouraging banks to lend. As a result, real growth of the non-oil private sector is forecast to rise to 3.8 percent; total real GDP growth is projected at the same level.

The key issue for economic policymakers will be maintaining an environment that supports this recovery. The report, prepared by Jadwa Investment Research Department, therefore thinks that government spending will be in excess of the high level set out in the budget and that interest rates will remain very low. These simulative policies are not expected to have negative consequences elsewhere in the economy. Higher average oil prices and production should generate sufficient additional revenue to ensure a budget surplus. In the event of a deficit, it would be comfortably financed using the Kingdom’s huge stock of foreign assets.

As bank lending will only slowly respond to low interest rates, inflation will not be a problem, though at an average of 4.5 percent it will be high on an historical basis. The report anticipates that inflation will pick up over the first few months of the year, before gradually declining from the second quarter. Rents will remain the main source of inflation in the Kingdom, though the spike early in the year will be the result of external factors. With interest rate needs broadly aligned between the Kingdom and the US, Jadwa does not anticipate significant speculative pressure against the exchange rate peg.

Although the economic recovery will gain momentum, activity will be less vigorous than in recent years as the legacy from the economic and financial turmoil lingers. The global economic recovery does not appear built on solid foundations and once stimuli are removed, growth is likely to be weak. Within the Kingdom, bank lending practices have permanently changed and credit growth will remain well below the level of the boom years to 2008, constraining the private sector. Government spending is central to relatively healthy economic outlook, but after years of strong growth it is likely to require an oil price in excess of $70 per barrel to balance the budget.

Economic outlook

The global economy entered 2010 in far better health than it started 2009. A depression has been avoided and growth has resumed across the world, but it has taken extraordinary measures to get to this situation. Government spending has shot up, interest rates have been cut to exceptionally low levels and unprecedented measures have been taken to support the financial system. These policies are unsustainable. The unwinding of these stimuli and need for longer-term adjustments to consumption patterns mean that once the initial boost to the global economy fades, growth over the next few years will be tepid.

The global recovery that is underway will be pretty strong until the middle of the year. The factors behind this are supportive fiscal and monetary policy, the rebuilding of stocks, rising corporate profits boosting investment and housing not being such a big drag. Economic growth will moderate in the second half of 2010 as the policy stance moves to restraint, inventory replenishment runs its course, deleveraging continues, low capacity utilization restrains investment and emerging economies supply their own demand; tighter financial regulation could be additional burden.

Risks to this weak outlook are on the downside. The withdrawal of policy has to be careful; too soon and it brings the risk of a double-dip recession, too late raises the prospect of inflation and currency depreciation. Political pressures also pose a major risk. Growth is unlikely to be at a pace necessary to dent unemployment and with elections due this year in several leading economies greater protectionism is a possibility. Seventeen of the G20 members have introduced protectionist measures since they pledged not to do so in late 2007. There are still serious problems within financial sector. More needs to be done to clean bank balance sheets (to date, only around half of the $3.4 trillion in write-downs projected by the IMF have occurred) and there is an increasing divergence in performance between weak and strong banks. Ongoing fallout from the crisis, such as recent problems in Dubai and Greece, also remains a risk.

The oil market

Assuming no major shocks to the global economy or events that would disrupt supply, the report expects the recent stability in oil prices to continue. Our forecast is for WTI to average $75 per barrel in 2010 (equivalent to $71 per barrel for Saudi crude). Average Saudi oil production is forecast to be 8.3 million barrels per day, up by 2.3 percent from its estimated average for 2009.

— Global oil demand is expected to rise during 2010 as the global economic recovery continues. Emerging markets will remain the main source of consumption growth. Leading developed economies still face deep problems and their growth momentum will ease in the second half of the year once the impact of stimulus policies fades, restraining their demand for oil.

— Non-OPEC supply is projected to rise slightly owing to higher output from the former Soviet Union and Latin America.

Financial flows are likely to have less impact on oil prices in 2010. The need for investors to use oil as a hedge against the — dollar should diminish as we expect the dollar to be relatively stable. The likely introduction of new rules by the US Commodity Futures and Trading Commission to curb speculation should also reduce the impact of financial flows.

The Kingdom is likely to respond to these trends by gradually raising production in the first part of the year in response to higher demand. Other OPEC members are expected to do likewise and the Kingdom will probably be more cautious than most in order to hold prices around current levels. Production is likely to be kept unchanged in the second half of the year as the pace of global economic growth slows. Saudi Arabia will be mindful of its role in the G20 and will increase production in the event that prices head toward a level that would threaten the fragile global economic recovery.

Economic growth

Economic growth is forecast to rise to 3.8 percent this year from 0.15 percent in 2009. Growth will be lifted by improved performance from both the oil and non-oil sectors. For the oil sector, the expansion reflects higher production in line with a stronger global economy. Growth in the non-oil sector will result from an easing of credit conditions, high government spending and low interest rates, all of which should generate a broad revival in confidence. Transport and telecoms and power and water are forecast to be the fastest growing sectors.

Jadwa had anticipated that oil prices would be the main source of weakness in the Kingdom’s economy last year, with prices falling by nearly 60 percent over the final six months of 2008. However, oil prices quickly recovered to comfortable levels and the government drew down reserves to finance its spending. Instead, it was access to credit that held the economy back. Defaults by two local firms and concerns about the health of the private sector caused banks to adopt a very cautious attitude to lending. Bank lending to the private sector fell in 2009, the first annual decline since 1990.

Lending is set to pick up this year. The absence of new public financial problems within the private sector has reassured the banks, who appear to have become more comfortable with their exposures. Even though local banks set aside over SR7 billion in 2009 to cover losses, all were profitable. Furthermore, they remain very liquid. Bank deposits in excess of the statutory requirement at SAMA (Saudi Arabian Monetary Agency) were at an all-time high of SR98.3 billion at the end of December. However, lingering uncertainty within the banks and the possibility of other corporate defaults (many companies have large amounts of short-term debt that needs to be rolled over) means that lending growth will not return to pre-crisis levels.

Prospects for raising capital through the equity and sukuk markets have also improved in line with better market conditions. Over 50 IPOs (initial public offerings) have been announced for 2010. However, there will be little financing forthcoming from foreign banks. General risk aversion among foreign banks was heightened by an opaque partial settlement of the debts of one of the defaulting local companies that appeared to exclude foreign creditors. The debt standstill announced by Dubai World in December further tarnished the image of the region in the eyes of many foreign banks.

Growth in lending should boost business sentiment and performance, lifting share prices, which in turn will bolster consumer confidence. More credit and higher confidence should ensure that the private sector is able to take greater advantage of a very supportive economic policy framework. Interest rates are expected to remain very low and government spending is forecast to rise further this year. Government spending will continue to provide the main stimulus to the Saudi economy. In addition to the direct boost it gives to sectors such as construction, there will be efficiency savings throughout the economy as more government projects are completed (for example, better roads lower transport costs).

Recent economic data give signs of a revival in the economy that is starting to build momentum. Most of the indicators we track have turned up since the third quarter. Notably, point of sales transactions are growing at double-digit annual rates for the first time since mid-2008 and the results of listed companies for the fourth quarter were generally positive. Lending to the private sector rose in each of the four months to November, though these gains were unwound by a large fall in December.

Given this generally improving backdrop, growth in all sectors is forecast to rebound in 2010. Jadwa expectations for growth in the key sectors of the economy are as follows:

— Growth in the oil sector is forecast to be above the 2.3 increase in oil production as growth will be boosted by the project work occurring in the sector. Over the five years to 2009, the oil sector grew by an average of 1.8 percentage points more than oil production; in 2009 the difference was 5.7 percentage points.

— Manufacturing growth is expected to recover from an 18-year low in 2009. Although last year was a difficult one for the global petrochemical industry, Saudi Arabia increased its market share owing to the very low input costs enjoyed by the Kingdom’s producers. Nonetheless, weak demand meant that the commencement of production at some petrochemical facilities was pushed back. With the global economy reviving, demand for petrochemicals should pick up. Large new facilities scheduled to commence or ramp up production include Saudi Kayan, Yansab and Sharq, PetroRabigh and the Sahara/Tasnee joint venture. Rising natural gas prices reinforce the advantage of Saudi-based producers, who pay a fixed rate of $0.75 per million British thermal units (mbtu); in North America the Henry Hub natural gas price has nearly doubled since September and is at its highest for over a year of $5.6/mbtu due to recent cold weather. Elsewhere in the manufacturing sector, growing demand from Asia should boost plastics production and cement producers will benefit from the ongoing construction work within the Kingdom.

— The construction sector will be one of the main beneficiaries of continued large government investment spending. There will be a full year of work on several very large projects that were started last year after delays owing to retendering in order to lock in lower raw material costs. Improving credit availability for the private sector should allow a recovery in smaller-scale construction activity later in the year.

— Telecoms and transport is expected to remain the fastest growing sector. Growth has been led by rising mobile phone penetration. With penetration at 162 percent at the end of the third quarter, the pace of this growth will slow. Data services, Internet provision and the activities of the new entrants to the fixed line market should take on some of the momentum. Transport growth should pick up as a result of higher foreign trade volumes and the revival in the domestic economy.

— Stronger growth in consumer spending will boost the wholesale and retail trade sector. Unlike in many other parts of the world, Saudi Arabia has not been affected by widespread redundancies or pay cuts, meaning that the weaker retail sales during 2009 was the result of uncertainty and the effect of stock market losses. The impact of both of these factors should fade this year. The sector should also benefit from greater tourist arrivals. The number of Umrah pilgrims was up by 9 percent last year (to 3.38 million) even though concerns about H1N1 are thought to have deterred many people from traveling.

— Activity in the finance sector should rise this year as banks become less averse to lending and greater business confidence leads to more transactions. There is growing speculation that the mortgage law will soon be passed. The law has been imminent for several years and even if it is approved there is unlikely to be a major short-term impact (though it will have important long-term implications). Rising use of insurance services will support growth in the sector.

— Ongoing government investment and greater usage stemming from a revival in industrial activity and a higher number of residential units should result in strong growth in the power and water sector. The sector has been prioritized by the government and the necessary infrastructure is being built up rapidly to cope with an annual demand growth of around 7 percent per year. The allocation for the water sector has been the fastest growing in the budget in recent years, nearly doubling between 2007 and 2010.

The main project opening in 2010 is the Jubail independent water and power project, which will add about 7 percent to total power generating capacity in addition to 800,000 cubic meters per day of desalinated water.

Article Courtesy Arab News