Saudi Arabia's economic recovery this year will most likely follow a gradual, steady track, Banque Saudi Fransi said in its latest research paper on the Saudi economy. Dr. John Sfakianakis, chief economist of the bank, said the Saudi economic growth should accelerate following a stagnant and difficult year. Moreover, inflation will remain at manageable but historically high levels and expansion of the private sector is set to take a turn for the better along with credit expansion at Saudi banks. The government, through a stimulatory public spending program, will continue to lead the pick up in the economy as Saudi oil averages around $74 a barrel and low levels of government debt bolster the Kingdom's fiscal position. A higher oil price environment will enable Saudi Arabia to experience comfortable budget and current account surpluses. While many key elements are in place to support a recovery in the Middle East's largest economy, “we are reducing slightly our 2010 economic growth forecast for the Kingdom to 3.9 percent from 4 percent based on our view that improvements in business activity will be gradual and cautious.” The government's commitment to counter-cyclical fiscal expansion remains solid. Banks are likely to loosen up on their reluctance toward lending to the public and private sectors, one barrier that choked the private sector during 2009. Last year, claims on both sectors by banks contracted by almost 5 percent, following growth of 30 percent during 2008. This year, banks will have little choice than to lend more as they emerge from a period of challenging revenues and an unfavorable low interest rate environment. It was not only banks that stifled non-oil private sector growth in 2009. Private Saudi companies themselves shelved many projects as international credit became more scarce, and businesses deleveraged and restructured. Assessing the private sector's appetite to expand is as important as examining banks' willingness to lend. “In our view, the private sector's eagerness to invest and grow is intact, albeit at more cautious levels than 2008. We are cautiously optimistic that 2010 will witness an improvement in the private sector's performance, although we do not expect the sector will grow at trend levels. The downside risks we foresee are linked to both the willingness of banks to provide credit and on the private sector's willingness to undertake investments. We anticipate private sector GDP will expand at 3.7 percent this year, accounting for more than 47 percent of GDP at constant prices. With oil prices standing around $80 a barrel and key global economies beginning to return to growth, Saudi Arabia, a seminal oil and petrochemical products exporter, is likely to benefit from the improvement in global economic conditions.” The report forecast real growth for the Saudi economy of 3.9 percent, this year, including a 4.1 percent rise in real oil GDP activity (accounting for 28 percent of total GDP). GDP growth should rise to 4.8 percent in 2011, the fastest pace in six years, once banking sector and business momentum is back in full swing. The report said the government sector - which accounts for just above a fifth of GDP - will grow by 4.1 percent in 2010, accelerating slightly from its 4 percent growth level last year, as the state continues to take the lead in the economic recovery. Government sector growth above 4 percent has happened only three times in the last 20 years - 2005, 1997 and 1992. To support an improvement in the economic climate, the government has pledged to keep spending at historically high levels throughout the current five-year plan (2009- 2013), including investment commitments of $400 billion in building infrastructure and oil and gas output expansion. It continues to overspend its budget by, in the case of 2009, 16 percent. In the 2010 budget, this expansionary stance culminated in a 13.7 percent rise in projected state expenditures to a record level of SR540 billion. The largest budget in Saudi history is designed to encourage private sector businesses to loosen their purse strings and urge banks, awash with liquidity, to jumpstart lending following a slow 2009. According to government budget projections, which we estimate are based on an average oil price of $44 per barrel for Saudi crude, the state's fiscal deficit will widen to SR70 billion in 2010 after a smaller-than-expected shortfall of SR45 billion in 2009. Beyond the general risk aversion that is gradually beginning to loosen its grip, there has been a noticeable downturn in productivity in both the government and private sectors in the recent past that requires examination. Lower productivity levels could explain part of the reason why economic growth rates have lost some momentum the last four years, including in 2007 - 2008, the height of an oil price rally that supported a regional economic boom. The Saudi government last month revised lower its real GDP growth figure for 2007 to 2 percent (from 3.3 percent) and 2008 to 4.3 percent (from 4.45 percent). Real economic growth in Saudi Arabia has not surpassed 5 percent since 2005. Expansion of the private sector - which was growing by more than 5 percent per year between 2004 - 2007 - is also down to levels that, “in our view, are not strong enough to support the amount of job creation Saudi Arabia needs in order to cater to a population that accounts for two-thirds of the Gulf total, and is growing around 2 percent per year.” The private sector expanded 2.5 percent in 2009 and we anticipate growth to rise to 3.7 percent in 2010. State fiscal expenditures are the highest they have ever been, which has gone a long way toward thrusting the economy forward. The ability of government funds to trickle down into the economy and support the private sector is still not taking place as effectively as the government might anticipate in its effort to spur the private sector's role in the future. Small and medium-sized enterprises have not yet been major beneficiaries of the public funds pouring into the economy. The Kingdom is handing out major oil, manufacturing and petrochemical expansion contracts to big private sector players, which in itself should create a multitude of indirect business for banks, small and mid-segment contractors, building materials companies and traders. This could act as the backbone for nourishing the growth of small and medium sized establishments. A great deal can be done to revive the small and medium-sized contracting sector which has largely disappeared since the mid-1980. The size of current construction projects provides potential for a trickle down into the subcontracting segment. Still, after rising for most of the decade, productivity among private sector enterprises is slipping. Productivity improvements are a key catalyst for sustainable economic growth. Higher productivity increases national welfare and improves competitiveness of companies and national economies. It allows for growth without inflation and pulls together the proper backdrop for social spending. The report pointed out that productivity is - in the long run - the only sustainable engine for job creation for the private sector. The Saudi economy registered better-than-expected growth of 0.15 percent in 2009, while nominal GDP, subject to oil price fluctuations, contracted around 21 percent, according to government estimates. A smaller-than-anticipated decline in oil sector output of 6.4 percent enabled GDP to grow last year as most major world economies fell into recession. The private sector's investment appetite subsided and overall domestic demand declined, contributing to low non-oil private sector performance. The private sector expanded 2.5 percent down sharply from 4.7 percent a year earlier. International and local credit was scant and prompted many businesses to postpone and cancel projects as they opted to hoard cash. The 2009 private sector growth rate was, as a result of this reticence, the lowest in 14 years. Some businesses were wary, trying to meet credit obligations as the global credit crisis widened and stock markets collapsed. Even real estate transactions came to a standstill by the second quarter, keeping prices of prime real estate virtually unchanged as few investors opted to buy or to sell. Automobile sales, one barometer of consumer demand, fell more than 25 percent in some months during the first half of the year. A revival in demand for cars later in the year pared full-year sales declines to about 7 percent. GDP at constant prices 2010 The report expressed optimism about the oil price environment as well as in the growth in global energy demand, particularly from Asia. The Energy Information Administration (EIA) forecasts world oil consumption will grow by 1.1 million barrels per day in 2010 to 85.2 million bpd. The bank report forecast that government revenues should reach to SR699.2 billion and expenditures SR621.3 billion, enabling the state to produce a surplus of SR77.9 billion. “We anticipate the private sector's rate of growth will get impetus from these trends as key sectors benefit from the higher oil price environment and an improvement in global demand for petrochemicals.” A pick up in domestic demand is also likely to follow, prompting retailers and wholesalers to import more stocks to meet a rise in demand for goods and services. As risk appetite among banks cautiously returns this year, the finance, insurance and real estate sector will grow 3.8 percent in 2010, more than double its rate of growth last year. Furthermore, the pace of credit recovery will accelerate by the second half of 2010, leading to healthier loan-to-deposit levels at Saudi banks. Banks will not, however, gallop to support the private sector this year. The report also forecast that claims on the private sector by Saudi banks should rise 8 percent in 2010, from 2.1 percent in 2009, a small gain on what we earlier expected and in line with our cautious expectations in improvement in the non-oil economy in the coming quarters. A fuller credit recovery to unfold in 2011 as private sector appetite becomes more robust. Private sector claims next year are likely to rise almost 13 percent. The report noted that the Dubai debt situation has not had a meaningful impact on banks and we regard their direct exposure to be limited. The Saudi Arabian Monetary Agency (SAMA) has aggressively maintained low tolerance on cross-border bilateral lending facilities. Private investors' exposure to regional property markets, however, is not negligible and the direction of these markets will impact investment portfolios. Interbank rates remained steady in the past two months, with the three-month interbank offered rate at 0.77125 percent in early January - almost on par with its level in November and not far above a historic low breached last summer. SAMA is not likely to apply aggressive monetary constraints for most if not all of this year. Tighter monetary policy measures, including raising interest rate rises, could follow if inflationary pressures mount fast.
