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Mar 23 2009

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Saudi Arabia economy: Outlook - Budget forecast to record deficits

Given the deteriorating global economic outlook, and the difficulty of attracting foreign investment or credit, the government will increase its role in financing the development of the country's infrastructure and industry, in order to shore up growth. The Saudi Arabian Monetary Agency (SAMA , the central bank) has said that US$400bn of public investment (including oil sector investment) is planned over the next five years. With inflation abating, SAMA will focus on maintaining liquidity. The state will continue to guarantee bank deposits and (implicitly) borrowing by parastatals. The authorities may also raise subsidies and other transfers, mindful of the potential political fallout of a slowdown in growth. The government will continue to seek foreign investment into several new "economic cities", but may need to provide new public financing or scale back some of its plans, particularly for the schemes in more remote areas, which are partly motivated by political and social concerns. Providing economic benefits to its nationals is one of the state's claims to legitimacy.

The state will maintain a monopoly in crude oil production and will cut annual average oil output substantially in 2009 in an effort to shore up prices. Nonetheless, it will press ahead with a large-scale expansion of crude and refining capacity. The government is also developing a rail link between the east and west coasts, ramping up spending on health and education, and planning to invest in food production abroad (as domestic crop production is reduced to save water). In the longer term, the government will encourage greater competition in several sectors formerly monopolised by the state, including power generation, air transport and telecommunications. There will be further, gradual privatisation of state-owned enterprises, usually through flotations on the local stock exchange, which redistribute wealth while allowing the state to remain the largest shareholder—but this process will slow in 2009 given the subdued state of the stockmarket and the liquidity constraints on many local investors. The role of the non-oil private sector will broaden, but largely on the back of government contracts or partnerships with parastatals, especially while private financing is scarce.

Policy implementation will be mixed, given the lack of co-ordination between ministries and the inefficiency of the overstaffed bureaucracy. One of the drawbacks for business will remain the "Saudiisation" quotas on the proportion of expatriates a firm can hire.

The Saudi budget is forecast to record deficits in 2009-10, for the first time since 2002. For 2009, the government has published another expansionary budget, suggesting that it is willing to incur a deficit in order to shore up economic growth (although budget projections are only a rough guide to actual outturns). Based on its oil price and production estimates, the Economist Intelligence Unit now projects that the central government budget deficit will be 8.7% of GDP in 2009 and 7.6% of GDP in 2010, assuming that spending increases by an average of 6% a year. Subsidised credit institutions including the Public Investment Fund will supplement spending by the central government. Alternatively, the government could opt to cut spending in order to maintain a surplus, but this would slow economic growth and would be more politically difficult than incurring a small budget deficit. New taxes would also be controversial, although some other Gulf Co-operation Council (GCC) states are considering introducing a value-added tax.

After several years of rapid growth, the pace of expansion of the broad money supply (M2) is expected to slow sharply in 2009-10, owing to lower oil export earnings, slower government spending growth and the impact of the global liquidity squeeze on local financial institutions. In 2009 we forecast that the drop in oil prices will lead to a contraction of the narrow money supply, as happened in 1998. As inflationary pressure abates and concerns about an economic slowdown mount, SAMA is likely to maintain its repo (repurchase) rate, which influences commercial lending rates, and its reserve requirements at low levels in 2009, and further cuts cannot be ruled out. Assuming that monetary tightening in the US resumes in 2010, SAMA is likely to begin raising rates again that year. Given the dollar peg, Saudi interest rates must broadly track US rates, but SAMA has some flexibility to decide which rates it cuts and by how much. Bank lending has begun to slow following several months of strong growth. SAMA may inject more liquidity into the banking sector in the form of deposits in an effort to stimulate lending.

SOURCE: Country Report