Riyadh’s massive fiscal stimulus has helped stabilise the economy and restore confidence among the kingdom’s business community
With its economy still almost entirely dependent on crude oil sales – oil receipts make up about 90 per cent of both government and export revenues – Saudi Arabia was never going to entirely avoid the fallout from the global recession.
As oil consumption fell in line with the decline in global demand for goods and services, the oil price tumbled from its record high of $147 a barrel in July 2008 to less than $40 a barrel by the end of the year, before recovering to about $75 a barrel in the second half of 2009.
To compound matters, the kingdom had to drastically cut oil production in the second half of 2008, from a 27-year high of 9.7 million barrels a day (b/d) in July 2008 to 8.1 million b/d by January 2009, to slow the slide in oil prices. In addition, domestic credit in Saudi Arabia started to dry up towards the end of 2008, as a result of tightening global liquidity.
Saudi Arabia’s limited exposure to the global financial markets was the economy’s only saving grace. “Local banks and the sovereign body have always pursued a very conservative investment philosophy and do not dabble in derivatives,” says Zahid Khan, chief economist for Riyad Capital, the investment banking arm of the local Riyad Bank.
Nevertheless, the local credit market has been increasingly constricted, resulting in slower consumption. By early 2009, the Saudi authorities were in emergency response mode, and their response was to spend. The 2009 budget was the kingdom’s largest ever, with expenditure rising 18 per cent on 2008 levels to SR475bn ($126.7bn).
Riyadh’s stockpiles of cash, accrued from years of high oil prices, will support this massive fiscal stimulus. At the end of 2008, the kingdom’s net foreign assets totalled $449bn and its foreign exchange reserves were about $30.6bn. With the drop in oil receipts in the second half of 2008, the country’s central bank, the Saudi Arabian Monetary Authority (Sama), started drawing down these assets. By the end of March 2009, Sama’s net foreign assets had fallen to SR1.54 trillion, from SR1.64 trillion at the end of 2008. Much of the cash was pumped directly into the economy to boost liquidity.
At the same time, Sama initiated a series of interest rate cuts. Five such interventions came between October 2008 and February 2009. In November 2008, Sama cut the repo rate – the rate at which it repurchases government securities from commercial banks – by 50 basis points to 5 per cent, lowering the rate to 2.5 per cent the following month.
The combination of strong fiscal stimulus and a looser monetary environment have ensured that the Saudi economy remains solvent. “There is no doubt the fiscal stimulus has kept the economy going,” says Paul Gamble, head of research at Riyadh-based Jadwa Investment. “It was a stimulus package that was long in the planning and, with its focus on infrastructure, was well targeted.
Khan agrees, saying that public spending in Saudi Arabia has always been central to the economy and that, in this instance, the “fiscal stimulus has been especially important. Private sector demand evaporated and public demand was left holding the baton”.
By the end of April this year, Saudi Arabia’s economy looked to have stabilised. The oil price was picking up, local liquidity was rising and confidence was returning. This was reflected in the performance of the stock exchange. From opening the year at just over 5,000 points, the Tadawul All Share Index (Tasi) fell to 4,130 points by March but rallied to 5,472 points by the end of April.
But another crisis was looming. In May, Sama froze bank accounts associated with two local family conglomerates, Saad Group and Ahmed Hamad al-Gosaibi & Brothers, as fears rose about their financial position. By June, both had defaulted, raising alarm among local and regional banks. The direct impact on local banks was limited, as Sama said it was prepared to provide financial support to exposed local banks. However, confidence again tumbled and the credit markets tightened up once more.
No banks have failed as a result of the problems at the Saad or Al-Gosaibi groups, however, and Khan says “fears of contagion from the Saad-Gosaibi crisis proved overblown”.
Gamble agrees, saying “the domino effect that many anticipated after Saad never materialised”. Indeed, bank lending to the private sector grew in the second half of this year. Private sector borrowing fell from a record high
of SR714.2bn in November 2008 to SR694.1bn by the end of May this year. However, by the end of October, it had recovered to a new record of SR715.5bn.
The rise in borrowing and underlying confidence has been supported throughout the year by an increasingly loose monetary environment. By the end of September, the three-month inter-bank lending rate had been reduced to just 0.2 per cent, down from 4.29 per cent a year earlier.
Liquidity has also been boosted by the rally in the oil price in the latter half of the year. In the year to the end of June, the oil price averaged $51.82 a barrel, according to the Energy Information Administration, a division of the US Department of Energy. But in the five months since then, the oil price has averaged $70.53 a barrel.
As a result, Sama has been able to stop drawing down on its foreign assets and, instead, started building them up once more. In October, they rose for the first time in a year, edging up to SR1.46 trillion.
These shifting dynamics have helped brighten the outlook for the Saudi economy for the coming year. “While there are some sectors in the Saudi economy still concerned about the availability of finance and prices of raw materials, these concerns are relatively lower than the past quarters,” said Said al-Shaikh, chief economist of the local National Commercial Bank (NCB), on 10 November when announcing the latest result of the bank’s Business Optimism Index.
Al-Shaikh noted that the role played by the Saudi authorities has been central to the more positive outlook. “There is no doubt that the continued support provided by Sama to the banking sector, along with the expansionary fiscal policy adopted by the kingdom, have both played a pivotal role in raising the level of optimism of the business community,” he said.
Jadwa forecasts that government spending will remain the key factor behind domestic demand and Gamble says “growth next year will be chiefly domestically generated”.
This is not to negate the importance of external factors, however. The oil price should ensure buoyant revenues but, more importantly, the anticipated global economic recovery should support growth in Saudi Arabia’s non-oil exports.
While a resurgent global economy could lead to higher import costs, as demand rises around the world, Gamble says there is sufficient slack in the Saudi economy to prevent a domestically driven increase in inflation for some time. This slack is most noticeable in the oil industry. Production has fallen since last year – from an average of 8.9 million b/d in 2008 to 7.91 million b/d in the 10 months to the end of October, according to the International Energy Agency – but capacity has increased. In June, Saudi Aramco announced that it had completed its recent expansion scheme and the country’s total production capacity stood at 12.5 million b/d.
While this provides the country with a significant strategic buffer, it also imposes a huge opportunity cost on Saudi Arabia of about $15m a day, in potential oil sales not being made. This is on top of the estimated $70bn it cost the country to build the additional capacity in the first place.
By bearing this cost, Saudi Arabia demonstrates the responsibility that it is now prepared to assume in supporting the global economy. This discipline buys it far-reaching global influence, not least in the G20 group of leading economies, of which it has been a member since 1999. “Saudi Arabia takes its role in the G20 very seriously and the health of the global economy will be central to its [oil] production decisions,” says Gamble. “It will gradually increase production as global economic fundamentals improve.”
Riyadh’s preparedness to suppress its oil production to support the wider market will result in underperforming domestic growth next year. Riyad Capital forecasts growth in gross domestic product of 3.1 per cent in 2010, up from an expected contraction of 1.5 per cent in 2009.
Jadwa is slightly more bullish, anticipating growth of 4.1 per cent against a 1 per cent contraction this year. But both clearly agree that, after a year of turmoil, the Saudi economy is now on the brink of recovery.
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