As governments around the world moved to invest in their own economies to prevent them falling even deeper into recession during 2008-09, Saudi Arabia took the biggest fiscal stimulus measures in the Group of 20 (G20) industrialised nations, according to the Washington-headquartered International Monetary Fund.

Government spending as a percentage of Saudi Arabia’s gross domestic product (GDP) increased from 30 per cent in 2008 to 40 per cent in 2009. Government expenditure increased from SR520bn ($140bn) in 2008, to SR550bn in 2009, and is forecast to touch SR621bn in 2010, says the local affiliate of France’s Credit Agricole, Banque Saudi Fransi.

Said al-Shaikh, chief economist at local National Commercial Bank, also points to the growing role of government investment agencies as part of the government’s stimulus package. The state-backed Public Investment Fund, for example, has increased the size of contributions it can make to a project’s cost from 30 per cent to 40 per cent of total project value. It has also extended loan tenors from 15 to 20 years, as private sector lenders try to reduce the length of their exposures.

Other government funding bodies, such as the Saudi Industrial Development Fund, have enjoyed a 21 per cent increase in their budget allocation from the government. The 2010 budget gives these funds a total of SR48.3bn.

State equity

“More significantly, government institutions are financing projects through larger shares of equity holdings,” says Al-Shaikh. A key example of this is the Ras al-Zour independent water and power plant, which was transferred from being 32 per cent government owned, to being entirely government financed after the chosen private sector developer encountered funding issues.

Also, state-backed Saudi Arabian Mining Company increased its equity investment in the development of an aluminium project with the US-based Alcoa. Other measures to help stimulate the economy include interest rate cuts by the Saudi Arabian Monetary Agency (Sama), and the reduction in reserve requirements for banks.

The state has taken on an active role in keeping the economy moving, which helped avoid a recession

John Sfakianakis, Banque Saudi Fransi

The question now facing the kingdom is distributing this vast stimulus package, and turning economic policy into productive activity.

After several years of robust growth, 2009 marked a significant slowdown in the economy. At around 0.2 per cent real growth, the kingdom grew at its slowest rate since 2002. The kingdom also suffered a sharp slowdown in private sector appetite for funding development projects.

“The foreign assets of commercial banks rose more than $18bn in 2009. This suggests that all of the $10.9bn that the government deposited into domestic banks, plus a bit more, was reinvested in foreign securities or used to pay off foreign liabilities,” says Mahdi Mattar, chief economist at Dubai-based investment bank Shuaa Capital.

In addition, cash deposits with Sama rose by about 65 per cent in 2009 and private sector credit growth slowed to around zero. Loans to government and quasi-government companies declined almost 25 per cent.

Crisis response

In response to the slowdown in bank lending, the government stimulus was quickly put to work. John Sfakianakis, chief economist at Banque Saudi Fransi, estimates that about one third of the $400bn spending programme the government outlined in late 2008 has been spent. A significant portion of the spending plan is intended to stretch from 2009 to 2013.

“The state has taken on an active role in keeping the economy moving, which helped the country avoid a recession,” says Sfakianakis. The government became the principal financier behind strategic projects during 2009, he says.

“Government stimulus is having a tangible affect on the real economy. As the principal investor in the economy, the state shouldered the recovery effort, and succeeded in keeping the economy from slowing down more than it could have in 2009,” Sfakianakis adds.

But it is not just the fiscal stimulus that is buoying the economy. One Riyadh-based banker says: “There are definitely signs that activity is picking up as a result of government spending plans. But there is also a desire to capitalise on falling engineering procurement and construction (EPC) prices by launching projects now, while development costs are cheaper.” Both these factors are combining to create a healthy pipeline of development projects in the kingdom.

Shuaa Capital estimates the total value of infrastructure projects in the kingdom is $440bn, and sponsors are expected to seek more than $30bn of project finance during 2010 alone.

Private credit recovery

The problem for Saudi Arabia remains the private sector. Credit growth is not expected to return until late 2010, with some analysts saying it may take longer. “Only towards the end of this year do we see credit loosening enough to allow private investment growth to gain traction,” says James Reeve, senior economist at local Samba bank. “One of the key problems is that international banks are still largely out of the Saudi market.”

This is because of the defaults last year on about $20bn of debt by two large Saudi conglomerates, the Saad Group and AH al-Gosaibi & Brothers. The failure to resolve the debt issues at these two businesses has weighed heavily on international banks’ willingness to lend. Meanwhile, local banks have become risk averse in the face of rising non-performing loans and concerns about other corporates. Bankers say several other large loans have had to be restructured or rescheduled as a result of the financial crisis and the slowdown in the economy.

Without a return to credit growth, the economic recovery will not be sustainable. “The main hurdle before a rapid acceleration in economic growth remains the lending attitude of banks, which is only slowly picking up pace,” says Sfakianakis. “In the meantime, the government is shouldering the funding burden and taking advantage of lower material prices to reduce project costs. But a private sector pick-up is an essential component of a successful stimulus programme.”

The consensus forecast from analysts is for the Saudi economy to grow by about 4 per cent in 2010, with stronger growth forecast for 2011. This is assuming that the banking sector starts lending again by the end of the year. Further financial shocks would sap some of the strength from that recovery.

With the rest of the $400bn investment programme spread out over the next three years, the state is prepared to maintain its role as a driver of the economy. However, as the private sector recovers, the state is expected to gradually reduce its economic participation. Sfakianakis expects private sector appetite to return in full in 2011. This will coincide with a gradual reduction in the ratio of government spending to GDP, falling from 40 per cent in 2010, to 37 per cent in 2012, according to Reeve.

In 2010, the government is projecting a budget deficit of SR70bn, but Banque Saudi Fransi forecasts that even with an expected overspend on the budget, higher oil prices will leave the government with a SR78bn surplus.

That will give the country firepower to continue reducing debt and financing the diversification of its economy. This will be welcome as the state had been dragged back into areas such as financing power and water schemes in 2009, which the private sector had been doing successfully, preventing it from concentrating on pushing ahead with industrial diversification in its bid to tackle unemployment.

The last year has demonstrated that as much as Riyadh has the financial resources to step in and support its economy without relying on the excessive borrowing that others in the G20 have been forced to adopt, it lacks a strong and diversified private sector to take over as government spending recedes.

Missed opportunity

Developing that will be a key challenge for the government, and a means for measuring how successful fiscal stimulus measures have been in the long term. As a result of stimulus measures, the government non-oil sector now accounts for 24 per cent of real GDP, the highest level since 2002. Private sector non-oil GDP growth slowed from 4.8 per cent in 2008 to just 2.5 per cent last year

If Riyadh has targeted its spending plans wisely, it will have created the infrastructure for a thriving private sector to lead growth in the country and provide jobs for a new generation. If not, it may have missed out on an opportunity to capitalise on a build up of reserves from the oil boom and low construction costs to prime the economy for years of growth, well after the $400bn has been spent.