The Kingdom of Saudi Arabia is the Gulf heavyweight. Its population, its Gross Domestic Product (GDP) and its oil reserves all more or less match those of the rest of the Gulf Cooperation Council (GCC) countries put together. Robin Amlot reviews the economic outlook for Saudi Arabia
The Saudi monarch's official title, Custodian of the Two Holy Mosques, reflects the cornerstone of the legitimacy of the Al Saud regime the support of clerics and a conservative interpretation of Sunni Islam (often labeled Wahhabism after a leading 18th century cleric, Mohammed ibn Abd al-Wahhab).
Saudi Arabia is the world's leading oil exporter and has the largest proven crude oil reserves. There is no value-added tax and Saudi citizens and businesses pay no tax on income but are liable for Zakat equivalent to 2.5 per cent of net worth. Foreign businesses in the hydrocarbon sector pay tax on a scale between 30-85 per cent. Other foreign operations are subject to corporation tax of up to 20 per cent.
The key driver behind the future shape of the Saudi economy is a young population, rising by 4.8 per cent from 25.194 million at the end of 2006 to 26.424 million at the end of 2008. In fact, some 50 per cent of the population is below the age of 15. This simple fact dictates two key economic necessities for the Kingdom in the medium term the need for more housing and more jobs.
The outlook on Saudi Arabia's 'AA-' (AA minus) sovereign rating remains stable, according to Capital Intelligence, supported by the large net asset position of the government, a strong external balance sheet, and a sound banking system.
The government has used accumulated budget surpluses to reduce debt to relatively low levels and build up financial assets, resulting in a strong balance sheet that can act as a buffer against oil-price driven reductions in cash flows and provides ample room to manoeuvre in the event of other economic or financial shocks.
The general government's net asset position, which includes the external assets of the state pension funds but excludes substantial local equity holdings, was around 90 per cent of GDP at the end of 2008. On the liability side, central government debt (all of which is domestic in terms of issuance and part of which is held by other public sector institutions) is comparatively low at a provisionally estimated 13.5 per cent of GDP at the end of 2008.
Inflation falling
Saudi Arabia is one of the few countries in the GCC to publish monthly inflation data. The rate of inflation is now falling from a record high of 9.9 per cent for 2008. In January it fell to 7.9 per cent and then again in February to 6.9 per cent - its slowest rate in more than 12 months.
The SAR is pegged to the dollar. This, according to an International Monetary Fund Working Paper* means that, "There is little scope for an active role for monetary policy to stimulate or cool economic activities." However, Emirates NBD Capital noted that the February inflation figures followed hard on the heels of numbers showing that money supply growth eased back further during the first month of 2009 with M2 money supply slowing to 14.3 per cent year-on-year at the end of January, down from 19 per cent in December.
The Saudi Central Department of Statistics put the fall in the inflation rate in February down to a sharp decline in food price inflation; food and beverage costs rose 4.6 per cent in February, down from growth of eight per cent a month earlier. However, rent inflation was steady at 20.2 per cent in the year to February compared with 20.3 per cent in January.
Financial brokerage Jadwa Investment forecasts that the overall inflation rate will average 6.7 per cent in 2009 while the median prediction of eight economists surveyed by Bloomberg News suggests 7.5 per cent.
Budget boost
Fiscal pressures have increased in 2009 but are manageable. The 2009 budget foresees a 50 per cent fall in total revenue compared to 2008 and is based on an average oil price equivalent to around $40 a barrel. This is in fact a more conservative estimate than the price factored in by the markets themselves. The average price of oil in 2008 was $97.03 a barrel and the assumed average price based on future markets trading is $50 for 2009 and $60 in 2010.
In fact Saudi Arabia unveiled its largest budget ever for 2009 of SAR 475 billion ($126.8 billion), a 16 per cent increase from 2008. The budget includes ambitious plans to spend $400 billion on infrastructure development over the next five years.
The Saudi government is projecting its first budget deficit since 2002 of some SAR 65 billion ($17.34 billion), around 5.6 per cent of GDP. The eventual outturn could be somewhat higher as actual spending tends to exceed the targeted level. However, Capital Intelligence believes that financing risks are negligible given the size of the government's asset buffer and good appetite for government securities from local banks and pension funds, and the general government is expected to remain a relatively large net creditor.
Saudi Arabia's balance of payments position is also expected to shift into deficit this year, putting downward pressure on central bank reserves. Nevertheless, with official foreign assets in excess of 80 per cent of GDP at end-2008 against a projected current account deficit of 7 per cent of GDP and gross external debt of 17 per cent of GDP, Saudi Arabia's capacity to absorb external shocks is high.
Significantly lower oil prices and a decrease in oil production in line with OPEC commitments will result in a large decrease in nominal GDP in 2009 and contribute to a moderate contraction in real output growth of 1.6 per cent, according to Capital Intelligence's estimates. However, the projected recovery of oil prices for 2010 onwards should return both the budget and current account to surplus.
Asset management
The central bank, the Saudi Arabian Monetary Agency (SAMA), also operates as the Kingdom's investment authority, responsible for managing the country's foreign assets, inside and outside of the Kingdom. SAMA's foreign assets alone had gained nearly SAR 467 billion in the first 11 months of 2008 before recording a decline of some SAR 20 billion in December. Although there have been further falls since, SAMA's current financial position is in sharp contrast to that seen during the 1990s.
SAMA's assets were below SAR 100 billion at end-1998 before the oil price rally turned budget deficits into huge surpluses. In 2008, combined net foreign assets of SAMA and Saudi commercial banks recorded their largest annual increase of nearly SAR 513 billion to peak at SAR 1.68 trillion ($449 billion) and total deposits for all domestic commercial banks stood at SAR 846 billion ($226 billion).
Speaking at a lecture in Riyadh in March, Saeed Al Shaikh, Saudi Shura Council member and Chief Economist at the Saudi National Commercial Bank commented, "SAMA has always followed a conservative investment policy as most of its assets are concentrated in safe US treasury bills away from volatile stock markets and restructured products... This has enabled SAMA to preserve the value of its net foreign assets and kept it in a much better position than the other Gulf investment organizations, which have accumulated nearly 40 per cent of their assets in financial markets.
"As a result of these massive financial resources, I believe Saudi Arabia can handle the crisis even if it continues into 2011. These resources could also partly be used to cover the Kingdom's public debt of around 13.5 per cent of the GDP... If all the assets are used, then the debt will be eliminated and there will be a surplus of 40 per cent of the GDP."
A recent opinion poll conducted by SABB suggests that the majority of the Saudi business community is not expecting the GCC single currency to materialize until 2012 despite protestations reported in the Saudi Arabic language daily Al Jazeera from GCC Secretary-General Abdul Rahman Al Attiyah that the 2010 deadline remains in force. The bank commented, "Most of the respondents [77 per cent] say they do not expect the union to take place by that date, against a slightly lower response [73 per cent] in the previous Index report."
The opinion poll also shows that the Saudi business community does not expect any revaluation of the SAR. The survey was conducted by SABB as part of its quarterly index on private sector sentiment about the Saudi economy.
New central banker
A cabinet reshuffle by the Custodian of the Two Holy Mosques, King Abdullah bin Abdul Aziz Al Saud, saw Hamad bin Saud Al-Sayyari, who had been Governor of SAMA since 1983, replaced by his 54-year old deputy, Vice Governor Dr. Muhammad Al-Jasser. Al-Sayyari, the longest-serving central banker had overseen a substantial transformation of the financial sector during his tenure. The governorship of SAMA carries the rank of Minister, which means that Al-Jasser will also sit in the Saudi Cabinet.
Al-Jasser, an alumnus of San Diego State University and the University of California, held a number of posts in the Saudi Ministry of Finance and the International Monetary Fund before joining SAMA in 1995.
Given his long service as Al-Sayyari's deputy, no radical change in macroeconomic policy is expected although a more proactive stance from the new Governor is likely. At an economic conference in Riyadh in February, the then Vice Governor was clear in stressing that "there was a dismal failure of regulatory oversight" in the financial services markets in the US and Europe.
He contrasted this failure with Saudi foresight, "In the good days, we rebuilt our reserves and paid down debt so we could cushion the economy and spend more than we are taking in during the bad times. Now our reserves will come down. We were accused of micro-managing. They said that SAMA was intrusive when we said 'slowdown'. Now they want to kiss our foreheads. We never ceased believing that regulation must be part of the financial markets. The private interest of bankers must be guided like traffic. The rules must be applied to prevent excessive risk taking."
SAMA has taken a series of measures to ensure more liquidity for banks, including cuts in the repo rate, most recently to two per cent from 2.5 per cent in January while the reverse repo rate was slashed to 0.75 per cent from 1.5 per cent. The cuts, on 19 January 2009, took the repo rate to its lowest since mid-2004 and the reverse repo to an all-time low.
The risks to sovereign creditworthiness from the banking system remain fairly low. John Sfakianakis, Chief Economist at SABB said, "Unlike the speculative real estate lending that was witnessed in some parts of the Middle East, Saudi banks have adhered to a balanced and conservative loan book." The sector is strongly capitalized and well-regulated, and at 42 per cent of GDP at end-2008 commercial bank credit to the private sector is not high. Banks' reliance on external funding is limited at about nine per cent of total assets, and the net foreign asset position of the sector is positive.
Saudi corporate profit margins fell in the fourth quarter of last year after companies started to feel the impact of declining oil prices and the overall economic slowdown, according to Global Investment House (GIH). Overall profitability decreased by 7.57 per cent in 2008. Among sectors, banking and the petrochemical sector amount to 65 per cent of total corporate profitability.
The Saudi banking sector remains an attractive destination for financial institutions worldwide. However, fourth quarter (Q4 2008) results negatively affected the overall performance of the year.
The listed Saudi banks recorded profitability growth of 1.6 per cent in the first nine months of 2008. However the picture changed in 4Q08 with the banks either actually realizing losses or increasing provisions against declines in investments portfolios. This lead to a profitability decline of 1.1 per cent for 2008 as a whole with consolidated net profit of SAR 24.1 billion in 2007 declining to SAR 23.9 billion in 2008. In contrast, listed Saudi banking assets continued to grow posting an annual increase of 25.7 per cent, closing 2008 at more than SAR one trillion.
Nevertheless, the overall good asset quality of the Saudi banking sector has been maintained with well provisioned balance sheets. GIH believes that, "Supportive domestic economic measures, together with positive developments in the global financial arena, coupled with the banks' restructuring plans and efforts to lower dependence on revenues from equity markets provide a window for modest performance by the banking sector in 2009."
The Economist Intelligence Unit (EIU) notes that strong state regulation, through SAMA protects the banks from exposure to risky liabilities. The government is unlikely to allow any of the Saudi-owned banks to fail. The banks themselves maintain a relatively strong level of provisioning for bad debts. The EIU says, "Although individual and business connections will be important in any lending decision, even those individuals or businesspeople of high personal standing will be subject to the requirement for proof of direct access to collateral to back up the loan."
The authorities have taken steps to ensure adequate levels of liquidity in the system, but credit growth is likely to ease in the months ahead. Capital Intelligence believes there is likely to be some weakening in asset quality as the domestic economy slows and this could give rise to additional provisions and put pressure on profitability. Nevertheless, the banking sector as a whole appears to be capable of withstanding a moderate deterioration in the operating environment.
© Banker Middle East 2009
