Saudi Arabia’s range of macroeconomic indicators suggest an economy well insulated from regional economic pressures. Its 2010 budget was expansionary and public sector infrastructure spending is still rising.

The project finance market is definitely more competitive now than it was six months ago

James Reeve, Samba Group

None of the kingdom’s 12 commercial banks have reported annual losses nor been forced to seek state financial support. The seven initial public offerings successfully launched in the first quarter of 2010 further indicate a revival of investor sentiment and a recovery in private economic activity is starting to bed in, with rising imports and stronger retail growth.

Commercial bank lending to the private sector in April was 3.2 per cent higher than a year earlier, the fourth successive year-on-year rise. Lending to the private sector increased by 0.7 per cent month-on-month, with the kingdom’s loan-to-deposit ratio rising to its highest level in over a year. The value of letters of credit opened by the private sector in April was among the highest recorded in two years.

Internal crisis

These indicators show how far the economy has come during a year that saw oil prices collapse and lending to the private sector all but dry up. But not only was the Saudi economy affected by global credit conditions, it also had to deal with the defaults of two prominent Saudi family business empires, the Saad Group and AH Algosaibi & Brothers, which revealed debts of more than $20bn in mid-2009.

Inflationary impact should fall as the year progresses. I’m not overly concerned about inflationary pressures

Paul Gamble, head of research, Jadwa Investment

But, after 18 months in which business activity was underpinned by government spending, the positive macroeconomic indicators seen in early 2010 give greater confidence that the Saudi private sector is in a position to grow.

High government expenditure drove the Saudi economy in the downturn. It is intended to deliver a counter-cycle of expansion, which will raise corporate performance and encourage banks to start lending again. The impact is now being felt, say analysts.

“The project finance market is definitely more competitive now than six months ago and spreads have fallen sharply. More general corporate loan growth is also picking up, although banks are insisting on more disclosure and collateral than in the past,” says James Reeve, an economist at Samba Group.

One reason for the expansion in credit growth is the absence of new financial problems in the private sector. Fears that the Saad/Algosaibi saga would yield further revelations of impaired corporate exposures have not yet been realised, which has reassured local banks – if not their foreign counterparts, who continue to give Saudi Arabia a wide berth.   

The Saudi fiscal position remains comfortable, despite the increase in state expenditure over the past couple of years, with a small budget surplus anticipated this year on the back of improved hydrocarbons income. Jadwa Investment Bank forecasts a fiscal surplus of 4.5 per cent for 2010.

Despite some oil price weakness in May – oil prices fell 24 per cent from $86.2 a barrel on 3 May to $65.2 a barrel on 26 May – average oil prices are still close to the Saudi ‘sweet spot’ of $75 a barrel.

There will be some pressure on the public purse as state spending efforts continue. However, this policy is only meant to kick-start economic activity. Once private sector confidence improves, the government should start to relax its high-spending programmes.

“Many of the projects commissioned last year will only be rolled out in 2010, so capital spending will likely be higher in 2010 than 2009. I expect some cooling of expenditure growth in the second half of 2011,” says Reeve.

Spending programme

Finance minister Ibrahim al-Assaf announced in January that the government was likely to continue its large-scale public spending programme in 2010 in order to help support the domestic economy. It envisages public spending will reach SR540bn ($144bn), 14 per cent higher than the amount budgeted in 2009.

The Saudi government has approved 652 contracts valued at SR40bn during the first four months of 2010. Al-Assaf, speaking at the Global Competitiveness Forum in Riyadh, said there would be a curb in spending “at some point in the future”, but that 2010, in his opinion would be a year in which a continuous stimulus to the economy was provided.

“The finance minister announced a figure for capital expenditure at the Euromoney conference in May that was a lot bigger than we anticipated, which suggests the possibility that the budget deficit for 2009 could be revised up. This would have a knock-on effect on this year’s forecast,” says Paul Gamble, head of research at Riyadh-based Jadwa Investment. “But, whatever the deficit is, it will be manageable, because the country’s reserves were back up to $412bn at the end of April.”

Bank lending has picked up, but it is still primarily government spending that is the main economic driver. This policy will not be prematurely ended by early signs of an upturn in private credit.

“If the Saudi government were to start aggressively cutting back on spending, it would send a pretty negative signal. But we don’t think any reduction in capital spending will be that great,” Gamble adds.

Despite the stimulative impact of this spend, economic growth will not match the explosive rates witnessed during the boom years of 2003-08. However, the kingdom’s GDP performance is still comfortably ahead of its peer group. The International Monetary Fund, in its regional economic outlook released in May 2010, forecast real GDP growth at 3.7 per cent in 2010, compared to just 1.3 per cent in the UAE. The figure for Saudi Arabia is a significant rise on the 0.15 per cent GDP growth registered in 2009.

Private sector growth

This performance will be underpinned by a better non-oil private sector performance. Significantly, Jadwa forecasts that Saudi oil sector real GDP growth of 3.8 per cent this year will be matched by non-oil private sector growth, also at 3.8 per cent. 

Construction is proving one of the strongest-growing sectors, with a backlog of large projects that were revitalised last year after a series of delays as the authorities retendered major economic schemes to capture lower materials and labour costs. Budget spend is centred on enhancing physical and social infrastructure. Water, agriculture and related infrastructure were awarded the largest increase in budget outlays, rising 30 per cent.  

Another infrastructure sector receiving renewed capital investment is transport and telecommunications, on which spending in 2010 is to rise by 24 per cent to SR24bn. Work gets under way this year on 6,400 kilometres of new roads on top of the 35,000km that were already under construction.

 With a $412bn reserve cushion and robust oil prices, the Saudi economy is well insulated from the global economic chill. It nevertheless faces a range of challenges, the most immediate of which is a rise in inflation.

The Saudi consumer price index rose 4.9 per cent in April, the highest level for 10 months, largely driven by a rise in food and commodity prices, as well as rental costs. Yet the kingdom is unlikely to experience an inflationary spike on a par with 2007-2008, given that the dollar – to which the riyal is pegged – has strengthened against the euro.

“Most food and other commodity prices were at their low point in March-April 2009. The subsequent rise in prices reflects the economic recovery since then, and the inflationary impact should fall as the year progresses. For example, rental inflation was below 10 per cent for the first time in over two-and-a-half years in April, so I’m not overly concerned about inflationary pressures,” says Gamble.

Another concern is fallout from the Eurozone debt crisis, with equity markets feeling the impact of negative investor sentiment. The Saudi stock exchange shed 14 per cent in May.

The EU was the destination of 11 per cent of Saudi exports, worth $33bn in 2008, so any downturn in European growth will have a knock-on effect for the kingdom, although – temporarily at least – a weaker euro is, on balance, a positive factor for the Saudi economy.

The euro crisis will cause some serious thinking in Riyadh’s corridors of power. The attractions of a single Gulf currency may be reassessed, including the institutional structures behind it.

Financial reserves

Saudi Arabia is keenly aware of the precarious international financial situation. The fact that sectors, such as petrochemicals, most exposed to the global economy, have experienced the starkest losses on the stock exchange shows that Saudi Arabia is firmly locked into the global economy, despite its advantageous financial reserves position.

This is not a year for economic superlatives. As Riyadh steadies its course for respectable GDP growth near 4 per cent, the government will be looking to next year to allow the private sector to play its part in driving growth and provide a solid and sustainable foundation for future economic development.