JEDDAH – Inflation in Saudi Arabia is likely to hover around 3 percent this year, with the recent sharp increase in commodity prices moderating by the 2H2014 and offset by lower imported inflation, the National Commercial Bank (NCB) said in its “Saudi Economic Perspectives 2014-2015” report released recently. The report noted that in 2013, prices edged higher, averaging 3.5 percent due to higher food prices. The liquid state of the economy was supportive of higher consumption expenditure, which drove up local food prices that averaged 5.7 percent Y/Y, higher than 4.5 percent Y/Y registered in 2012. On the rental component, prices maintained a slightly higher pace than 2012, albeit low compared to the 2007- 2011 period by averaging 3.5 percent in 2013. Accelerating the implementation of the mortgage law will positively impact the local real estate market by providing financing to home seekers. Looking ahead, the cost of building materials is not exerting upward pressure on prices, with the average prices for timber, cables, iron and cement falling year-to-date by 1.7 percent, 1.2 percent, 0.9 percent and 0.6 percent, respectively, by the end of February 2014. It is important to note that the robust growth in private credit in general and consumer loans in particular will constitute an upside risk to our forecast for headline inflation. With unemployment at the lowest level since 2009, 11.5 percent by the end of 4Q2013, an expected increase in disposable income will boost private consumption expenditure, which posted a 7.2 percent increase last quarter. However, the dollar-positive effect due to tapering will underpin the headline inflation rate, which will remain in a range-bound movement around 3 percent this year. Moreover, Saudi Arabia's monetary system continues to be awash with liquidity as elevated oil prices and production resulted in higher revenues that underpinned broader economic activities, the NCB report said. On the regulatory front, SAMA's proactive stance contained liquidity risks, ensured compliance with Basel III requirements ahead of schedule and assessed the soundness of local banks via stress tests that reflected lower systemic risks. Additionally, SAMA was keen to ensure price stability for businesses and consumers to benefit from the buoyant economy. Open market operations that mop up excess liquidity have been accelerating and by the end of 2013 SAMA has issued SR179.1 billion worth of T-bills. The conservative policy approach was accentuated by the buildup of net foreign assets, which was supported by the influx of oil revenues. SAMA's net foreign assets under management incrementally increased by SR238.8 billion, 9.8 percent, during last year, reaching SR2.7 trillion by the end of 1Q14. It is widely expected that the majority of foreign assets are invested in USD-denominated fixed-income securities, which provide a stable return albeit lower than other riskier alternatives. The lock-step nature of Saudi monetary policy with the US is an important factor that will support our view of no change to the domestic benchmarks, with SAMA keeping the repo at 2 percent and the reverse repo at 0.25 percent. The sustainable pace of monetary aggregates reduces the risk of overheating the economy. During 2013, the monetary base (M0) recorded its first annual contraction since 2008. The narrowest monetary measure settled at SR343.5 billion by the end of December, slightly lower than 2012's SR350.6 billion. The decline is not representative of a negative situation as the largest component of M0, deposits with SAMA, decreased given local banks' preference to utilize their excess reserves for granting credit. Accordingly, the credit market witnessed another healthy year by expanding at 12.1 percent Y/Y. Additionally, money supply (M3) maintained its double-digit growth, recording 10.9 percent on an annual basis. The local financial system remains liquid with excess reserves settling at 54.2 percent last year. Saudi banks held SR1.4 trillion worth of total deposits by the end of last year that represent more than 70 percent of their total liabilities and continue to provide a stable funding base. The capacity utilization, represented by the loans-to-deposits ratio, dropped to 79.9 percent by the end of last year after peaking in August at 83.1 percent. Interestingly, local banks continued to accumulate net foreign assets that grew by 9.6 percent to reach SR149.3 billion in 1Q2014 after a marginal 2.1 percent increase during 2013. As for the interbank market, NCB expects that SAIBOR to remain around the 100bps level in the short-term due to the healthy cash levels of most Saudi banks. The Saudi banking system capitalized on reforms implemented during the financial crisis and posted record profits in 2013. The vibrancy of the private sector underpinned economic activities, which, in turn, provided opportunities for banks to expand their balance sheets, a scenario that is likely to materialize this year as well. Even though low interest rates kept net interest margins contained, the 12 locally incorporated banks by the end of last year recorded a staggering SR37.6 billion, an annual growth of 7.1 percent, supported by volume-growth in credit. Saudi banks increased their average credit maturities by focusing on long-term loans that recorded a growth of 16.1 percent Y/Y, reaching a total of SR305.2 billion. Additionally, non-performing loans and provisions significantly declined by 21.7 percent and 15.1 percent, respectively, as banks improved their asset quality. The report further said the Saudi financial system has always complied with international standards and SAMA has already started guiding banks towards embracing Basel III standards, propping up capital buffers with capital adequacy levels standing at 17.8 percent well above requirements and as the banking industry increased its share capital recently by 27.5 percent. The report stressed that the Saudi banking system is secured by ample liquidity levels and capital buffers, indicative of a much healthier industry going forward. – SG
