Aug 07 2011
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Saudi Arabia's growth expected to reach 6.5% this year
Saudi Arabia might be somewhat less concerned than previously about the impact of changes in its crude output levels thanks to significant gains in output of natural gas liquids (NGLs). These NGLs, which are sold at a premium, can be produced with impunity as they fall outside the OPEC regime.
According to PFC, Saudi NGL output is likely to reach 1.7 million bpd in 2011, an 8 percent gain on 2010.
These increases in crude and NGL output will see hydrocarbons GDP rise by 9.5 percent in real terms this year-the fastest rate of growth since 2003, when crude output was ramped up during the US invasion of Iraq.
The oil sector will provide the government with a solid platform for a year of exceptional fiscal stimulus. The Samba report was already anticipating a year of firm government spending even before Custodian of the Two Holy Mosques King Abdullah's announcements in February and March of an additional combined SR460 billion of spending or 24 percent of our forecast for GDP. Some of the elements in the spending package - housing for example - will take years to fully roll out; however, other features, such as the two months' additional salary for public sector workers, have already been disbursed.
Consequently, according to Samba around SR195 billion of the pledge will be spent this year. This will push total spending up to a colossal SR840 billion in 2011 (43 percent of GDP) or more than a third higher than the previous year (in fact, more than twice the level recorded as recently as 2006).
It seems likely that spending will edge down next year-the economy would find it difficult to digest another increase after such a surge in 2011-but it will remain high in historical terms at around 39 percent of GDP. Indeed, it seems to us that government spending has shifted up a gear and is likely to stay in a rough 40-45 percent of GDP range, up from around 30-35 percent in the previous decade.
The Samba report said sustained increase in government spending witnessed since the beginning of 2009 has been of enormous support to private sector confidence. This can be measured from both demand (consumers' spending) and supply (output and investment by Saudi firms). Looking first at demand, it is clear that Saudi consumers have stepped up spending quite markedly this year. Data for May put the three month moving average of points of sale transactions (which are a proxy for retail sales) up 44 percent year-on-year in value terms - a trend that seems likely to harden as Saudis continue to spend their salary windfalls.
Most of this spending will "leak out" into imports, which do not count towards GDP growth.
Nevertheless, a good deal of spending will find its way towards locally-produced goods and services-especially the latter, since these are often "non-tradable" (real estate services, accountancy, office cleaning, taxi rides, etc). Further support for the consumption outlook comes from demographic factors, notably population growth (recently revised up to 3.4 percent for 2005-10) and growing urbanization.
Businesses have also been busy. The most detailed series for corporate activity comes from the Markit purchasing managers' index (PMI). These data are based on a survey of purchasing managers in around 400 Saudi firms, weighing a number of factors such as the level of output, new orders, purchases, input prices, employment, inventories, and suppliers' performance on a month-to-month basis. A number above 50 denotes expansion of activity, while below 50 signals a contraction.
The overall index has been trending down so far this year. This is unsurprising given regional political concerns, which have acted as a drag on private investment to a certain extent. Nevertheless, the index remains well above the 2010 average, and edged up again in June (to 62.8), with respondents continuing to paint a picture of robust expansion in output, new orders, and employment. Most of the new orders have come from the government, according to respondents, though export demand (mainly for petrochemicals and steel) has also hardened. The increase in employment is particularly encouraging, with 20 percent of respondents saying that staff numbers at their firm had increased in May compared to April (employment data were unavailable for June). The bulk of new hires are likely to have been expatriates, who tend to save more and spend less, but new legislation may encourage firms to tap deeper into the Saudi national market.
All this points to robust overall economic growth in 2011. According to the Samba report real growth will reach 6.5 percent this year, the highest level since 2003, and comparable to the rates seen in the most dynamic emerging markets. Next year some moderation in growth to 4 percent is expected. However, this largely reflects the leveling off of crude oil output; the nonoil sector should continue to thrive, growing by 5.2 percent (down from 5.4 percent in 2011). A recovery to 4.5 percent overall growth is envisaged for 2013 as the nonoil sector continues its 5 percent-plus rate of expansion and oil output edges up once more. GDP per head is set to reach around $18,300 this year, climbing to $19,300 by 2013. GDP per head has doubled in less than ten years.
Which sectors are likely to do well? Construction and contracting firms will continue to benefit from robust public infrastructure investment, especially in refining, power, transport and education. As ever, Saudi Aramco will be a major source of contracts, and Saudi contractors - particularly in the Eastern Province - are awaiting a more sustained flow of gas-related contracts as we move through the year.
Saudi contractors do face some challenges: The increasing involvement of Chinese firms-which tend to source all material and personnel themselves - and the introduction of new caps on expatriate labor for example, but in general the sector should continue to thrive.
Petrochemicals firms should also continue to do well, with East Asia's demand for basic chemicals apparently insatiable. Nevertheless, they too face challenges, such as possible moves to raise the price of gas feedstock (as well as the more general scarcity of gas). The feedstock issue points to some narrowing of the field in the medium term, with Saudi Aramco best placed to take full advantage.
With Saudi consumers spending briskly, the Samba report said retail sector (including restaurants) should also continue to do well. However, performance is likely to vary, with medium-to-large outlets continuing to flourish, but "hypermarkets" still struggling to gain traction. Meanwhile, smaller outfits might find the Nitaqat employment quotas burdensome. In terms of malls, existing outlets are doing well, but there is overcapacity in the sector, and substantial fresh investment is unlikely this year.
The Samba report said headline rate of inflation in H1, 2011 has not been as strong as we were anticipating and we have lowered our overall forecast for average inflation this year. Nevertheless, price pressures are still present and are set to build again in the second half of 2011.
There are three main drivers of inflation in Saudi Arabia: International food prices; trading partners' inflation; and domestic rents. Taking each of these in turn:
The outlook for global food prices is always uncertain, given the vagaries of global weather and the pronounced impact that drought or flood can have on international grains prices.
It is clear that trading partners' inflation, which could also be described as general imported inflation, is already an issue. The Markit PMI shows a sharp pickup in input prices for Saudi firms, which remain heavily dependent on imports of raw materials and other commodities for their production.
Rents will provide the main domestic driver of price pressures. King Abdullah's focus on expanding the domestic housing stock will pay dividends, but only in the medium term; for the moment, the domestic economy is expanding at more than 5 percent, while the existing housing stock remains largely static. Consequently, rents are likely to continue to rise.
The Samba report said the rate of inflation to fall back to 5.6 percent in 2013 as additional housing stock begins to come on line, which should help to calm rental inflation. A tighter global interest rate environment and stronger dollar should also help cool imported inflation
The outlook for the fiscal position remains comfortable, at least from the "top line" perspective. Crude oil revenue is set to rise by 33 percent this year, following last year's 47 percent gain. Crude revenue is expected to flatten out in 2012-13, but overall revenue should be boosted by growing contributions from other hydrocarbons sources, such as NGLs. Non-hydrocarbons revenue sources, such as fees and charges, are also likely to grow in line with the buoyant domestic economy.
Structurally, however, the fiscal position is not so positive. Expenditure growth over the past decade has been pronounced, averaging 13 percent a year during 2002-11 versus just 2 percent in the previous ten-year period. This growth has increased the dependence on oil revenue, a relationship that is best captured by the increase in the nonoil fiscal deficit. The nonoil fiscal deficit as a percentage of nonoil GDP has increased from around 25 percent in 2002 to a projected 82 percent in 2011. Clearly, an oil-based economy will always have a large nonoil fiscal deficit, but the rapid deterioration in this position is of concern since it increases the vulnerability of the government to any pronounced and sustained downturn in oil prices, the report said.
To a large extent, the current-account outlook mirrors that of the fiscal account. Robust oil export earnings will allow substantial current-account surpluses in the region of 14 percent of GDP over the next three years, allowing a further build-up of net foreign assets, which is expected to reach about $700 billion by end-2013 (120 percent of GDP). As with the fiscal channel, the balance of payments remains vulnerable to a sharp and sustained downturn in oil prices given the sustained growth of import spending over the past decade (16 percent annual average growth). Nevertheless, the stock of NFA provides a substantial buffer to maintain balance of payments equilibrium should the need arise.
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