Economic growth set to slow

18 December 2013

As the impact of the government’s 2011 fiscal stimulus continues to fade, the non-oil sector of the Saudi economy is headed for a slowdown

After sluggish activity in the first half of the year, the kingdom’s third-quarter economic performance suggests a rebound under way in the second half of the year. In real terms, the Saudi economy was 3 per cent larger in the third quarter of 2013 than in the same quarter of 2012, and 1.1 per cent bigger than in the second quarter of this year.

According to an assessment of the quarterly gross domestic product (GDP) figures by Riyadh-based Jadwa Investment, higher crude production pushed the Saudi oil sector to its highest annual growth since the second quarter of 2012. Output averaged 10.1 million barrels a day (b/d) in the third quarter, compared with 9.8 million b/d for the same period in 2012, representing growth of 3.7 per cent year-on-year.

The trade, hotels and restaurants sector was the main driver for weaker growth in the non-oil private sector

Jason Tuvey, Capital Economics

On deeper analysis of the figures, however, the positive news begins to fade. First, the increase in oil production was largely driven by increased domestic crude consumption during the summer months, meaning the kingdom was not earning more export revenues. Second, the non-oil sector slowed in the third quarter, with trade particularly hard hit amid a general slowing of government investment.

Slow growth

Robust external demand for Saudi crude should ensure continued positive oil sector growth in the fourth quarter of 2013 and into 2014. But strip out the hydrocarbons sector from the data, and the kingdom’s economy looks considerably less healthy.

The non-oil sector as a whole grew by just 3.3 per cent year-on-year in the third quarter of 2013, down from of 4.2 per cent in the second quarter. The weak non-oil private sector growth is a particular concern for Saudi policymakers as it represents the slowest pace of performance since 1998, when the economy grew by just 2.6 per cent on the back of oil prices that had sunk close to $10 a barrel.

This time the slower growth, says Jadwa, reflects both normalisation as the impact of the 2011 fiscal stimulus gradually fades away and the new, stricter labour market regulations being introduced. 

The winding back of the stimulus is causing pain at the consumer end of the spectrum.

“The data breakdown revealed that the trade, hotels and restaurants sector was the main driver for weaker growth in the non-oil private sector,” says Jason Tuvey, an analyst at UK consultancy Capital Economics.

“This suggests that consumer spending is struggling. The one crumb of comfort in the new GDP figures is that construction activity has picked up over last year, after concerns about the pace of construction and projects being undertaken.”

Nonetheless, the sluggish non-oil private-sector performance will be a concern, particularly when set in contrast with the 2010-12 period, when it grew by an average 7.5 per cent a year. Retail and wholesale sectors witnessed double-digit growth during that period, as high oil revenues were recycled into the system.

The new GDP data suggests instead that the Saudi private sector will have to adapt to more straightened times. There is an upside, however.

The private sector’s relative buoyancy in recent years had contributed to an increased rate of commercial bank lending that some analysts viewed as feeding a potential credit bubble.

Consumer lending

Saudi credit growth in the past two years has been averaging 15-16 per cent a year, outpacing that of its GCC neighbours. According to local investment firm Al-Rajhi Capital, lending rose 15.7 per cent in the January-August 2013 period, reaching almost SR1.1 trillion at the end of August, with much of this targeted at the consumer sector.

In contrast, lending to the building and construction and transport and communications sectors saw declines of 3.6 per cent and 1.8 per cent respectively in the first six months of 2013.

For some analysts, the rise in credit directed to the consumer sector represents a worrying development. Even though the kingdom’s private sector credit-to-GDP ratio, at 39 per cent, is the lowest in the GCC, the pace at which credit has risen relative to GDP is a cause for concern.

“What’s important is how rapidly credit growth is expanding relative to nominal GDP,” says Tuvey. “If you look at emerging market banking crises, you tend to find that rapid rises in credit relative to GDP – at above 3 percentage points a year – are what is important in trying to predict whether financial stress is imminent.”

The increase in lending could begin to translate into an increase in non-performing loans

Senior Gulf-based economist

Saudi Arabia’s credit-to-GDP ratio has risen by about 4 percentage points of GDP over the past year, and if measured over the past decade, it has grown by about 30 per cent.  According to Tuvey, no emerging market that has experienced such a rise has not also experienced a banking crisis.   

“Personal lending has been riding a wave of strong economic performance and higher disposable incomes,” says a senior Gulf-based economist. “The increase in lending could begin to translate into an increase in non-performing loans (NPLs).”

Structural change

However, Saudi banks are sufficiently well insulated to withstand a serious deterioration in loan quality, with NPLs at less than 2 per cent of total loans. Capital adequacy ratios are high at 20 per cent and the government has sufficient resources to recapitalise banks, were a serious crisis to hit.

The more serious danger is if banks were to suddenly restrict credit. Rapid credit growth has helped fuel strong growth in the non-oil sector for past year or so, and if credit were to suddenly become more restrictive, that would have a negative impact on the non-oil sector.

Not all commentators share the view that the kingdom is facing a credit bubble. “Private sector credit-to-GDP is not even 40 per cent, according to the World Bank, compared with say 130 per cent in China. Credit probably needs to play a greater role, not smaller,” says James Reeve, a senior economist at the local Samba Financial Group.

Rather than a credit bubble, Saudi Arabia may be experiencing a change in the structure of credit, through factors such as the increase in mortgage lending. “Banks are putting more money into the economy than before, but they are doing it slightly differently than had been the case,” says the Gulf economist.

In any case, the credit bubble – if it is one – may well have run its course. Bank loan growth to the private sector was down to 13 per cent in October, at SR1.1 trillion, the slowest rate of expansion since May last year, according to figures from the central bank.

The winding back of government stimulus measures focused on consumer spending will help to remove the threat of a credit spike. The 2014 state budget – details of which are expected to be realised before the end of December – may see more restrictions on public expenditure.

Budgeted spending will be smaller than this year’s actual outlays, but actual spending in 2014 will probably represent a retrenchment. Samba Financial Group now expects central government capital spending to be cut in 2014-15, not just reined in.

The main fiscal challenge is getting spending under control. “The authorities need to rein in subsidy spending, in particular, but all areas of government expenditure could do with some rationalisation,” says Reeve.

According to the 2013 budget, the government planned expenditure of SR820bn, a rise of nearly SR130bn on the budgeted figure for 2012. Actual spending is likely to have been higher and this will have added pressure on public finances.

Samba forecasts that the fiscal surplus for 2013 will be SR193.1bn, equivalent to 6.9 per cent of GDP, down from SR329.5bn or 12.1 per cent of GDP in 2012. The bank sees the balance reducing further in 2014, to SR99.5bn, before moving into the red in 2015, when a SR84.9bn deficit is expected.  

The 2014 budget is unlikely to contain too many surprises, but there will be nuances to reflect some of the changes percolating through the economy.

“The Saudi authorities will want to show somewhat greater earnestness on issues like education and training and there’s a potential for more money to be diverted into labour market measures, partly to assuage people’s fears, partly to try to make it easier for companies to have access to qualified Saudis at a time where they are expected to shed expatriate staff,” says the Gulf economist. 

Fading oil boom

With the scaling back of stimulus measures, and a more conservative fiscal stance, most analysts see economic growth weakening in coming years. Samba sees 2014 real GDP growth at 3.8 per cent, before falling to 3.1 per cent the following years. This is well down on the Chinese-style growth rates of 2011, when real GDP grew by a robust 8.6 per cent.

The oil boom that allowed the government to comfortably dip into coffers to boost consumer spending is starting to fade. Locals may have to get used to less rapid economic expansion in the next couple of years and a retrenchment of private sector activity. But compared with the challenges other Middle Eastern economies are facing, this is no cause for panic.

Key fact

Lending rose 15.7 per cent in the January to August period, reaching almost SR1.1 trillion at the end of August

Source: Al-Rajhi Capital

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