Sustained government spending and resurgent oil prices have brought a speedy return to growth for Riyadh. The challenge will be finding the capacity to deliver its spending plans
Forecast inflation of 5.4 per cent in 2010 will increase to 5.7 per cent in 2011
Strong government spending throughout the financial downturn and a recent upturn in oil prices mean that the impact of the global downturn is proving more short-lived in Saudi Arabia than in most economies across the world. Although real gross domestic product growth slowed to an estimated 0.6 per cent in 2009, from 4.2 per cent in 2008, it is likely to rebound to 3.8 per cent in 2010 and 4.2 per cent in 2011, according to figures from the local Banque Saudi Fransi.
The principal downside risk for the Saudi economy, however, remains its dependence on oil
In contrast to the aftermath of the last oil price boom in the 1970s, when rapid growth was followed by a deep economic downturn as oil prices collapsed, the most recent surge in hydrocarbons earnings was accompanied by a husbanding of resources that has enabled Riyadh to spend its way back into good economic health. In 2009, capital expenditure totalled SR180bn ($48bn), almost three times the SR71bn spent in 2006.
Public spending in Saudi Arabia
“Saudi Arabia’s fiscal policy in the past 10 years has been very sound, so they have had the fire-power to employ counter-cyclical fiscal policies, which they were unable to do in the 1970s and 1980s,” says Reinhard Cluse, senior economist for Europe, Middle East and Africa at Swiss investment bank UBS.
This expansive fiscal policy has continued in 2010, with overall government expenditure forecast to increase to SR617.6bn this year, compared with SR596.4bn in 2009, according to Banque Saudi Fransi. Although the pace is likely to slow next year, public spending will remain the backbone of the kingdom’s growth in 2011. Public spending is expected to increase by 6.8 per cent in 2011, according to the local Samba Financial Group.
|Saudi economic growth (percentage)|
|Real GDP growth||4.2||0.6||3.8||4.2|
|Non-oil private sector real GDP growth||4.6||3.5||4.0||4.6|
|Oil sector real GDP growth||4.2||-6.7||2.7||3.7|
|*=estimate; **=forecast. Source: Banque Saudi Fransi|
“Public investment seems to have developed its own momentum,” says James Reeve, an economist Samba. “There has been a lot in 2010, and it will continue in 2011, perhaps not at the same rate, but certainly robust. It will be the main driver of growth in 2011 and 2012.”
In contrast to the latter part of 2008 and most of 2009, when oil prices dropped below the level required to balance the books, spending in the next two years is expected to be supported by rebounding hydrocarbons revenues. The kingdom is set to generate a budget surplus of 2.7 per cent in 2010 and 3.7 per cent in 2011, compared with an estimated deficit of 6.7 per cent in 2009.
On 7 December, oil prices hit a 26-month high of more than $90 a barrel, and the US’ JP Morgan is projecting spot sales in excess of $100 a barrel in 2011. Not all analysts are so bullish, but few believe prices will drop below $70 a barrel. Samba projects an average price for West Texas Intermediate, the benchmark crude on the US market, of $82 a barrel in 2011 and $90 a barrel in 2012. Ali al-Naimi, the Saudi minister of petroleum and mineral resources, recently stated that Opec is comfortable with oil prices of between $70-90 a barrel, this is slightly above the previously-stated band of $70-80 a barrel.
“Higher oil prices will unlock a virtuous circle of increased foreign exchange reserve accumulation, higher liquidity and better credit generation that should boost economic growth and lift equity markets, which have been disappointing,” says Cluse.
Saudi oil production
There are still risks associated with the link between oil revenues and economic growth. Riyadh’s increased spending has pushed up the oil price it needs for its budget to break even by almost $40 between 2006-10, to an estimated $70, according to Banque Saudi Fransi. “Saudi Arabia’s oil price sensitivity is one of the highest in the Gulf,” says Cluse.
The kingdom’s oil production is likely to be flat in the coming year. “It looks as if Opec will keep quotas unchanged, so we are unlikely to see much growth in oil output in the first half of 2011, even though prices are at the top of the range that Opec says it is comfortable with,” says Charles Seville, associate director of sovereign and international public finance at the US’ Fitch Ratings.
But reduced spending by state-owned oil company Saudi Aramco means that revenue transfers from the oil sector to the treasury could increase in the short-term. “Aramco’s oil production capacity building is being wound down and although it is now focusing on gas infrastructure, there should be more money around for the government,” says Reeve. “Aramco handed over just 71 per cent of its export revenues in 2009, but in 2010 this is likely to grow to about 79 per cent and increase slightly again in 2011.”
Increased sales of natural gas liquids (NGLs) are also helping to offset limited growth in crude sales. “Oil production was anaemic this year and given the international market it will be flat next year,” says Reeve. “But this will be slightly offset by a ramping up of NGLs, which are outside Opec quotas. We expect hydrocarbons growth of about 2.5 per cent in 2010 and in 2011.”
Growth forecasts for Saudi Arabia
Growth in the non-hydrocarbons sector is expected to be 4.5 per cent in 2010 and 4.8 per cent in 2011, according to Samba, due to a combination of the government’s expansive fiscal policy and an upturn in consumer spending. “Based on retail sales and import spending figures, after a stagnent 2009, Saudi consumers have been spending again in 2010,” says Reeve. “We expect imports to grow by 25 per cent in 2010 and by 13 per cent in 2011. While in 2010, a lot of the growth was due to public sector construction imports, in 2011 it will increasingly be private sector consumer goods, such as cars and white products.”
In contrast to public spending, growth among private businesses remains weak. “This year has been a year of retrenchment in the Saudi corporate sector,” says Reeve. “There’s not been a lot of capital expenditure in the private sector, which helps explain why private sector credit has been weak. It’s been due to a lack of demand, not a lack of supply.”
Banks’ attitude to lending remains cautious, but there are indications of a warming market. Private sector credit growth fell from 34.9 per cent in the second quarter of 2008, to 0 per cent in the fourth quarter of 2009, according to figures from UBS. But it has edged up to 4.4 per cent and 3.6 per cent in the second and third quarters of this year. “Credit is growing pretty slowly, but if you look at the annualised rate over the last quarter it’s beginning to accelerate,” says Seville.
Lending is likely to be focused on government projects, due to their low-risk profile and their dominance of the market. “Foreign banks are feeling their way back into the market after a fairly unpleasant experience in 2009 with corporate defaults and the economic downturn,” says Reeve. “They are more confident about lending to public sector projects and there’s not a lot of room for private investment on the industrial side.”
Opportunities for private investment in the real-estate market are also few and far between, due to a government ban on off-plan sales and the protracted wait for the introduction of a mortgage law, which has been years in the planning, but still shows no sign of implementation. “A lot will hinge on the mortgage law because it would free up private sector investment, but there doesn’t seem to be any immediate likelihood of it being passed,” says Reeve. “There are still quite a lot of regulatory oversight issues that need to be resolved.”
The lack of activity in the property market is also one of the main contributors to persistently high inflation in the kingdom. Forecast inflation of 5.4 per cent in 2010 will increase to 5.7 per cent in 2011 and to 5.9 per cent in 2012, according to Samba. “Rents are growing at nearly 10 per cent a year,” says Seville. “There’s a shortage of properties for nationals to move into. The mortgage law is supposed to spur construction growth for housing, but changing the law won’t necessarily mean there will immediately be a flow of mortgages.”
The principal downside risk for the Saudi economy, however, remains its dependence on oil. “There’s a huge stock overhang in the global oil market, non-Opec oil supply is increasing, and Opec discipline [on production quotas] is fraying,” says Reeve. “Prices are increasing because the financial markets believe the global market will eat up the overhang. But the fundamentals are worrying. Demand will increase, but there’s a huge amount of oil in the market that needs to be run down.”
Saudi Arabia reserves
But even in the worst case scenario, Saudi Arabia will be insulated from low oil prices by its huge reserves. Government deposits in the banking sector were worth almost SR990bn in September, according to Samba. Even if oil prices fell to $25 a barrel and the government maintained its current level of spending, it would be 2013 before it would need to start issuing domestic debt; and if spending were cut by as little as 1 per cent, the kingdom could last until 2015 before such action were necessary, the financial group says.
If oil prices remain buoyant, as expected, the kingdom will have ample liquidity to fund its planned infrastructure spending programme. In August, Riyadh approved its ninth five-year development plan, in which it intends to invest $385bn between now and 2014, in addition to the annual government budget. Financing the plan is unlikely to be a problem. But the sheer scale of the programme will strain the kingdom’s capacity to deliver on its targets. “When you consider that all the spending has to go on properly planned projects, spending has been raised surprisingly quickly,” says Seville. “There’s a capacity issue.”
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