110125 Bsf January Economics

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SAUDI ARABIA

ECONOMICS

January 2011

Dr. John Sfakianakis

Chief EconomistTel: +966 1 289 1797Email: [email protected]

Daliah Merzaban

Economic Analyst

Tel: +971 4 428 3608

Email: [email protected]

Turki A. Al Hugail

Economic Research Analyst

Tel: +966 1 289 1163

Email: [email protected]

January 25, 2011

Splitting the billState eyes private sector, bank revival to press growth

Economic growth to accelerate to 4.2% in 2011, with private

sector growth of 4.2% relieving some of states burden

Banks well positioned to boost lending to the private sector by

9.1% this year, but return to double-digit growth not likely for

another year

High oil prices, project financing, real estate mismatch and

population growth among factors to shore up non-oil sectors

Government to post twin fiscal and current account surpluses

as global energy demand growth continues

Consistent oil price gains in the early part of 2011 have set the stage for a respectable turna-round in Saudi economic activity this year. GDP growth in the worlds top oil exporter lookspoised to accelerate due to a blend of higher crude oil output, state stimulatory spending on

strategic projects and quicker private sector expansion. Whereas in 2010 the government pre-dominately shouldered the burden for financing projects, the private sector is likely to becomeprogressively more engaged in the recovery process this year.

Bank lending should pick up steadily though not significantly, inflationary pressures are ex-pected to moderate on the whole but remain historically elevated, and the government shouldpost sizeable budget and current account surpluses that would enable it to further pay downdomestic debt and augment its foreign assets store.

Underpinning the optimistic outlook is a view that oil prices are poised to hold ground above$80 a barrel. Other than 2008 when prices soared to record peaks near $150, an average priceabove $80 a barrel in 2011 would be the highest annual price recorded this decade. Still, oilproduction, set to rise to 8.48 million barrels per day (mbpd) from 8.2 mbpd in 2010, remains

well below the average 9.1 mbpd produced from 2004 to 2008.

The government will thus rely on its own financial muscle and private sector participation tochannel economic growth along an upward trajectory. Since the onset of the financial crisis,the state has taken up the slack for keeping the economy in motion. In 2010, the governmentsector expanded at its fastest pace in 13 years of 5.9%, far outpacing private sector growthof 3.7%.

Relying on government-led growth would not form a practicable policy in the long term andwe have already witnessed evidence that the state is eager to re-integrate local and globalinvestors in the development process. This will take time, however, and the 2011 Saudi budgethit another record with planned expenditures. The government has nonetheless deliberatelyslowed down the pace of growth in spending allocations to minimise overspending and compel

private businesses to return to the drawing board.While private sector GDP growth is likely to rise to 4.2% this year and to 4.5% in 2012, thesectors rate of growth is still lags pre-financial crisis levels and in our view is not high enoughto generate an adequate stream of new jobs needed to substantially reduce unemploymentand relieve the recruitment strain from government departments.


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January 2011

In the five years to 2008, private sector GDP expanded

5.5% per year on average; between 2009 and 2013 the

sectors annual growth should slow to 4.2%, according to

our estimates. The government is therefore confronted with

a challenge to extensively re-integrate the private sector in

development both through public-private partnerships and

independently. A major overhaul is needed in private sector

job creation for Saudi nationals; in 2009, they accounted for

just 9.9% of total private sector employees.

The public sector continues to act as an employer of last

resort for Saudis; in 2009 it hired 71,900 Saudis while the

private sectors Saudi employment figure fell by 147,576

jobs. The private sector created 821,177 jobs in 2009, ac-

cording to official data, but solely relies on expatriate labour

for expansion, an alarming trend that should be reversed to

accommodate the local job market.

On the monetary policy front, we foresee no changes in in-

terest rate policy as the central bank seeks to encourage

healthy bank lending, but we could see a slight hike in the

benchmark repurchase rate around 2012 as markets nor-malise further.

State still navigating recovery

On the heels of the financial crisis, the Saudi economydecelerated quickly at the end of 2008 and throughout

2009 due to a combination of factors, including the dropin oil prices and global oil demand, and the cancellationor postponement of tens of billions of dollars in expansion

projects. In addition, many local and foreign private sectorcompanies decided to wait out the crisis on the sidelinesand credit markets dried as banks contended with a non-performing loan challenge.

With strong oil prices and better demand from Asia in 2010,the Saudi economy worked at jumpstarting the recovery and 2011 promises to continue cementing this. To sup-port an improvement in the economic climate, the govern-ment has pledged to keep spending at historically highlevels throughout the 2010-2014 five-year plan, including

investment commitments of $385 billion. It continues to

GDP at constant prices 2011 Ratio 2010 Ratio 2011 growth rate

Oil sector 247.01 27.2 238.65 27.3 3.5

Private sector 436.12 47.9 418.57 47.9 4.2

Government sector 216.68 23.8 205.81 23.6 5.3

Import duties 10.39 1.1 10.09 1.2 3.0

Total GDP at constant prices 910.20 873.12 4.2

Source: CDSI, Banque Saudi Fransi forecasts


0

7

(YoY%c

hange)

Private sector GDP likely to pick up pace as government steps a bit back

2010e 2011f 2012f

Agriculture Mining &

Quarrying

Manufacturing Electricity ,

Gas and water

Construct ion Wholesale &

retail trade

Transport,storage

and comms

REAL GDP

1

2

3

4

5

6

Finance,

insurance,

real estate

Community,

social and personal

services

Producers of

government

services


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SAUDI ARABIA

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January 2011

overspend its budget by, in the case of 2009 and 2010,

25.5% and 16%, respectively, to ensure funds get wherethey need to be.

Yet prolonged fiscal expansion would not be healthy forthe country, hence the emphasis placed on private sectorparticipation in the five-year plan. The government is aim-

ing for the private sector to grow 6.6% per year during theplan period, the key thrust behind ambitious growth of 5.2%per year. In our view, these growth projections are virtually

impossible to achieve if current circumstances persist. Wehave seen little evidence of efforts to nurture and organ-ise the small- and medium-sized enterprise sector, which

would be necessary to generate higher rates of growth.

At present, it is government gross fixed capital formation

(GFCF) that has led the way in domestic investments. Be-

tween 2000 and 2010, government GFCF surged eight-fold,

according to our estimates, while private sector GFCF about

doubled. In 2009 state GFCF rose almost 9% as private GFCF

fell 2.2%. Private sector capital formation growth rates are

likely to pick up in the coming two years as companies offer

more expertise and financial support for projects in energy,

utilities and infrastructure. However, state investments will

continue to dominate the funding space.

Oil revival steering growth

Although a cautious atmosphere prevails, the scope for en-

thusiasm is wide due to oil market fundamentals. High oil

Real GDP growth rates 2005 2006 2007 2008 2009 2010e 2011f

Agriculture 1.2 1.1 1.9 0.7 0.6 0.5 0.7

Mining& Quarrying 6.6 -1.1 -4.0 4.2 -7.9 2.2 3.5

Manufacturing 6.9 6.3 5.7 6.0 2.3 5.0 5.1

Electricity, Gas and water 5.4 6.4 4.1 6.7 6.8 6.0 6.2

Construction 4.8 7.3 4.1 1.5 4.7 3.7 4.2

Wholesale & retail trade 4.4 6.1 6.2 6.5 2.5 4.4 4.7

Transport, storage and comms 8.7 9.8 10.2 12.2 6.9 5.6 5.9

Finance, insurance, real estate 6.4 4.6 3.8 2.4 3.7 1.4 2.7

Community, social and personal services 5.1 5.0 2.7 2.4 4.0 3.8 4.3

Producers of government services 3.3 1.9 1.9 2.4 3.8 5.9 5.3

Import duties 5.7 4.1 3.3 2.7 1.8 2.6 3.0

Real GDP growth rate 5.6 3.2 2.0 4.2 0.6 3.8 4.2


Government capital formation makes 8-fold surge between 2000-2010

0

250 29

15

Source: CDSI, SAMA, Banque Saudi Fransi forecasts

(SR,

bn)

(%ofGDP)

Gross fixed capital formation as % of GDPPrivateGovernment

2011f1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010f 2012f

50

100

150

200

17

19

21

23

25

27


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SAUDI ARABIA

ECONOMICS

January 2011

prices translate into robust revenues for the kingdom, buy-

ing it some time to bring round private capital.

Oil sector GDP growth is likely to expand 3.5% this year, up

from about 2.2% in 2010, owing to a rise in production and

persistent growth in global demand. The Energy Information

Administration (EIA) forecasts world oil consumption will

grow 1.45 mbpd in 2011 to 88.02 mbpd, with almost 37%of new demand arising in China. This marks a slowdown

in consumption growth from 2.02 million bpd in 2010 and

yet illustrates an overall positive trend. The EIA anticipates

another 1.6 mbpd of consumption growth in 2012. Saudi oil

production is likely to grow 3.5% this year to 8.48 million

barrels per day, according to our forecasts.

With oil prices now within striking distance of $100 a barrel,

Saudi Arabia is well positioned to reap great advantages. As

of November, the Saudi Arabian Monetary Agency (SAMA)

had accumulated SR1.64 trillion ($433.7 billion) in foreign

assets, taking the stash back to pre-2009 levels. We project

that by the end of 2011, the kingdom will have built its for-

eign assets to $470.8 billion, a record level and more than

98% of GDP.

Real GDP growth for the Saudi economy should climb to 4.2%

this year, including the 3.5% rise in oil GDP activity (account-

ing for 27.1% of GDP). We anticipate GDP growth will rise to

4.4% in 2012, the fastest rate of growth since 2005, once

lending activity returns to normal and private sector compa-

nies take meaningful steps to improve their contributions.

Source: EIA Short-Term Energy Outlook

-2.000

2.000

(Millionbarrelsperday)

Fuel consumption growth seen easing in 2011, China leads

China United States Other

2007 2008 2009 2011f2010

-1.500

-1.000

-0.500

0.000

0.500

1.000

1.500

30

90

(WTI,USD/bbl)

EIA expects oil prices in $80-$90 range in 2011

2010 Mar May Jul Sep Mar May Jul SepNov Nov2011f2009 Mar May Jul Sep Nov

35

40

45

50

55

60

65

70

75

80

85

Source: EIA


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January 2011

Growth of the government sector which accounted for just

under 24% of GDP in 2010 should slow slightly to 5.3%

this year from 5.9% last year, as the private sector relieves

some of its funding burden. Including last year, government

sector GDP growth exceeded 5% only three times in the

past two decades.

Substantial fiscal outlays have supported growth. The 2011

budget includes expenditures of SR580 billion for 2011, al-

though we expect actual expenditures of closer to SR676

billion indicating 16.6% overspending. The states 2010fiscal surplus, at SR108.5 billion or 6.7% of GDP, was more

than double our forecast. We anticipate the surplus fall to

SR93 billion, or 5.2% o GDP, this year due to a 4.6% in-

crease in revenues to SR769 billion.

Reinforcing the private sector

The private sectors growth rate will be motivated by higher

oil price environment, increased demand for petrochemi-

cals and continued state stimulatory spending. Private

sector companies spent much of the past two years de-

leveraging and regrouping, and many of them should beginto pursue expansion again this year.

This will necessitate that they obtain some funds from

banks and from equity and bond markets all of which

should be accommodating. Numerous sovereign and cor-

porate issuers have already exploited better bond pricing as

yields declined.

This month, the civil aviation authority indicated a plan toissue $4 billion of Islamic bonds to help finance airport projects. Saudi International Petrochemical Co also wants toraise at least $400 million this quarter to finance the firstethyl acetate plant in the region, while in December SaudiElectricity Co. (SEC) finalised a 15-year Islamic financingworth $1.33 billion to fund projects designed to build powergeneration capacity.

We expect that state firms will work to involve private com-panies more thoroughly in their projects. SEC for one, is

hoping the private sector will contribute about $24 billionof the $80 billion projected investment bill it envisions willbe necessary to boost power generation capacity to at least70,000 megawatts by 2020 from 50,000 MW now.

Following is a discussion of some of trends we foresee tak-ing place in Saudi Arabias key non-oil private sectors thisyear.

Finance

The finance sector has suffered from low rates of growth

in recent years and 2010 did not diverge from this trend.Up to November, cumulative bank profits reached SR24.22billion, down 10.8% from SR27.15 billion in November of2009. Net earnings of Saudi banks have fallen in each yearsince 2006 after soaring 185% between 2004 and 2006.Cumulative bank profits at the end of 2010 were lower thanthey were in 2005 when profits of banks leapt 54% from

the year earlier. The low interest rate environment has en-

croached on bank profitability.

Finance sector growth drops along

with bank profits

0.0

7.0

10

40

2004 2005 2007 20092006 2008 2010*

(SR,

bn)

(YoY%change)

Source: SAMA

Finance, insurance GDP growthCumulative bank profits

1.0

2.0

3.0

4.0

5.0

6.0

15

20

25

30

35

* Up to November

Credit growth turnaround slow

-5

40

300

1000

2005 2007 20092006 2008 2010* 2011f 2012f

(SR,

bn)

(YoY%change)

Source: SAMA, Banque Saudi Fransi forecasts

YoY % changeCredit to private and public sectors

0

5

10

15

20

25

30

35

400

500

600

700

800

900

* Up to November


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SAUDI ARABIA

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January 2011

Bank asset growth has also fallen markedly in Saudi Arabia.

As of November, total bank assets grew 2.3% from the end

of 2009 positioning banks for their slowest rate of asset

growth since 1990. Between 2005 and 2009, bank assets

grew 16.8% per year, on average.

Given the weak statistics, it is no wonder the finance sec-tors GDP growth rate slowed to just 1.4% in 2010, ac-

cording to initial estimates. That is below the 3.7% growth

recorded in 2009 and is the slowest pace of expansion for

the sector since 1998. By comparison, the finance sectors

growth rate was as high as 6.4% in 2005 at the peak of

bank profitability.

Then, the 2006 stock market crash revealed the vulner-

ability and exposure of Saudi banks to equity investments

and banks profits and the sectors growth took a hit. The

equity crash and the financial crisis, which compelled lend-ers in the kingdom to take large provisions to guard against

bad debt, have obliged banks to rethink how they do busi-

ness, and particularly to whom they lend funds. Private sec-

tor lending fell in tandem from double-digit growth ratesin most years of the past decade to a slight contraction in

2009. Bank lending failed to gain considerable momentum

in 2010, touching a lower-than-expected 6%.

We do not expect to witness a return to double-digit rates

of loan growth before 2012, with a fuller recovery in 2013,

as a stream of project financing deals bolsters the balance

sheets of banks. Meanwhile, lenders have focused more

attention on their retail businesses. The number of newbranches opened in 2009 and 2010 was 19-fold higher

than 2005 at the peak of bank profitability.

Despite persistent caution, we expect a good turnaround

in credit growth this year as there is adequate pent up de-

mand to support growth in bank claims on the private sec-

tor of 9.1%, including private sector credit growth of 8.8%.

Total bank credit, including to state enterprises, should

grow 8.6%. These factors support our finance sector GDP

growth forecasts of 2.7%.

We do not foresee any change to SAMAs exchange rate

policy in 2011. The U.S. dollar remains well below the key

Bank asset growth slowest since 1990

0

1500 26.0

-2.0

Source: SAMA

(SR,

bn)

(YoY%change)

GrowthBank assets

1990 1992 2000199819961994 2002 2004 2006 2008 2010*

100

200300400500600700800900

10001100120013001400

0.0

2.0

4.06.08.0

10.012.0

14.016.018.0

20.022.024.0

* Up to November

Banks pushing retail business amid slower

sector-wide growth

0.0

7.0

0

120

(Newb

ranches)

(YoYGDP%change)

Source: SAMA

Finance, insurance GDP growthNew branches opened

1.0

2.0

3.0

4.0

5.0

6.0

20

40

60

80

100

2004 2005 2007 20092006 2008 2010*

* Up to November


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SAUDI ARABIA

ECONOMICS

January 2011

1.50 mark vis--vis the euro, last crossed in late 2009 when

oil prices were about $20 lower than they are now. Hence,

we do not anticipate the return of speculation on a change

in currency policy. Interbank rates have remained mostly

steady during 2010. The three-month interbank offered rate

stood at 0.75% in early January, little changed on the year.

Interest rate policy is likely to remain static this year, al-though SAMA does have some freedom to modify rates in-

dependent of U.S. policy. It has been more than two years

since the Fed reduced rates to 0-0.25%; interest rates in

the United States and other advanced economies are likely

to remain unchanged this year.

Construction

Growth of Saudi Arabias construction sector fell to 3.7%

in 2010 from 4.7% in 2009, according to the initial esti-

mates. With the scale of construction taking place on theground, the sectors growth appears underestimated and

the rate could be revised upward as the year progresses.

Cement sales grew 13% in 2010, slightly slower than the

16% growth recorded in 2009.

We project an upturn in construction activity in 2011 sup-

porting growth of 4.2% as more real estate projects reach

fruition as builders take steps to bridge the gap between

supply and demand. Work on major infrastructure projects

in energy, utilities and infrastructure also carries on across

the country. In the holy city of Makkah, billions of dollars are

being funnelled into residential and hotel projects to cater

to growing religious tourism. The Royal Mecca Clock Tow-

er across from the Grand Mosque in Mecca is just one of

many such ventures in the holy city, where an abundance of

cranes are now erected in the vicinity of Islams holiest site.

Construction activity is principally backed by state infra-

structure spending and a deficit in available housing. Inits 2010-2014 development plan, the government targets

construction of one million housing units, or about 200,000

per year. With the market undersupplied, real estate prices

faced upward pressure last year. The BSF H2 real estate

survey showed the median price of a large apartment in 12

Saudi districts surveyed climbed 4.7% from the first half

of the year, while villa prices were up an average of 9.5%.

Similar price trends can be expected in 2011 as the de-

mand-supply mismatch continues and investors prepare for

the launch of Saudi Arabias much-delayed mortgage law.

Manufacturing

Saudi Arabias manufacturing sector made a good come-

back in 2010, growing 5% after real GDP expansion slowed

to just 2.3% in 2009, the lowest rate of growth since 1991.

Manufacturing utilises comparative advantages in labour,

energy and capital inputs.

The return in domestic and global demand for petrochemi-

cals helped reinvigorate the sector in 2010. Profits of Saudi

Basic Industries Corporation (SABIC) surged 46% in the

2010 manufacturing GDP growth recovers from 18-year low

20

120 16

0

Source: SAMA

(SR,

bn)

(YoY%change)

GrowthManufacturing GDP

1991 1993 2001199919971995 2003 2005 2007 2009 2011f

30

40

50

60

70

80

90

100

110

2

4

6

8

10

12

14


8/148

SAUDI ARABIA

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January 2011

third quarter and 27% in the fourth quarter, above expecta-

tions as sales volume for plastics and petrochemicals im-

proved and energy prices rose broadly. In the year to No-

vember, petrochemical exports soared more than 60% and

plastics exports more than 45%, according to preliminary

CDSI non-oil export data. Profits of all listed petrochemical

firms almost tripled last year.

This year should witness a similar scenario. The petro-

chemical sector is likely to reap the benefits of higher en-

ergy prices and the continued demand growth from Asia.

We anticipate manufacturing GDP growth will climb to

5.1% this year. From 2004 and 2008, manufacturing GDP

expanded 6.3%, on average, so the improvement this year

would not yet take it back to pre-financial crisis levels.

At home, output will get a boost from the giant, SR20.6 bil-

lion Maaden phosphates plant as commercial production

starts in Q3 2011. Located at Al Jalamid, the phosphate

mine and beneficiation plant will produce 3 million tonnes

per year of di-ammonium phosphate fertiliser, representing

about 10% of global demand.

Wholesale and retail trade

Wholesale and retail trade GDP growth should speed up to

4.7% this year from 4.4% in 2010 as a consequence of bet-

ter consumer demand. The sectors GDP expanded more

than 6% in each of 2006, 2007 and 2008, before growth

slowed to just 2.5% in 2009. Consumer demand in Saudi

Arabia is much more price sensitive than is the case in most

-30

110

(YoY%c

hange)

2010 non-oil exports improve with oil prices

2007 Apr Jul Oct 2008 Apr Jul Oct 2009 Apr Jul Oct 2010 Apr Jul Oct

-10

10

30

50

70

90

Source: CDSI Growth in non-oil exports

-30

50

(YoY%c

hange)

Imports recovery slowly from 2009 drop

2007 Apr Jul Oct 2008 Apr Jul Oct 2009 Apr Jul Oct 2010 Apr Jul Oct

-20

-10

0

10

Source: CDSI Growth in imports

20

30

40


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SAUDI ARABIA

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January 2011

Gulf countries, although it rests on a solid foundation of a

population exceeded 27 million representing almost 60%

of the total Gulf population. As a consequence of this, and

the populations young age demographic, consumer de-

mand has continual potential to expand.

Trade flows out of Saudi Arabia improved markedly in 2010,gaining 23% on the year earlier, when export revenues had

tumbled almost 40%. Strong oil revenues and the rise in

non-oil trade mentioned earlier should give export revenues

another 6.6% boost in 2011, our forecasts show. Saudi ex-

ports are highly dependent on the price of and demand for

oil; oil exports accounted for 86% of total estimated export

revenues of $236 billion last year. Oil export revenues are

set to grow 4.5% in 2011 after expanding 24.6% in 2010.

Non-oil exports, meanwhile, should maintain growth of

around 13.2% in 2011, on par with expansion in 2010.

Imports have taken longer to recover. In 2010, initial esti-

mates show imports advanced less than 1% from 2009. We

anticipate that 2011 import flows will moderately improveas retailers and wholesalers build inventories in order to

meet growing domestic demand. A majority of company

leaders who responded to our Q1 Business Confidence sur-

vey said they would raise inventories in the next two quar-ters.

The states expansion plans also necessitate a greater vol-

ume of building material and machinery imports this yearas construction projects progress. In the first 11 months of

2010, there were 24.9% more new letters of credit issued

against the import of goods than the year earlier. Imports

are likely to track private consumption patterns in 2011 andas a result, we forecast imports will rise to SR97.4 billion

this year, almost 12% above SR87 billion in 2010.

With higher imports, slower export growth and a continualrise in workers remittances, Saudi Arabias current account

surplus will likely fall slightly in 2011 to SR236.81 billion,

or 13.2% of GDP, from a higher-than-expected surplus of

SR260.9 billion in 2010 (16% of GDP). In the foreseeablefuture, we do not expect the current account surplus to ex-

ceed 24% of GDP as it did in each year between 2005 and

2008.

Current account surplus to remain elevated in

2011-12

0.0

30.0

0

600

(SR,

bn)

(YoY%change)

Source: SAMA, Banque Saudi Fransi forecasts

As % of GDPCurrent account balance

20042003200220012000 2005 2007 2010e2009 2012f2011f2006 2008

5.0

10.0

15.0

20.0

25.0

100

200

300

400

500

0.0

10.0

(YoY%c

hange)

Private sector in focus after government steered 2010 growth

2012f2011f2010e20092008200720062005200420032002

2.0

4.0

6.0

8.0

Real GDP Private sector Government sectorSource: SAMA, Banque Saudi Fransi forecasts


10/1410

SAUDI ARABIA

ECONOMICS

January 2011

Electricity, gas and water

The electricity, gas and water sector has continued to sus-tain economic growth of upwards of 6% throughout thefinancial crisis due to a government commitment to buildpower generation and water desalination capacity. Expan-sion at constant prices was 6% for the sector in 2010, thefastest rate of growth for any sector, and we except thegrowth rate will rise to 6.2% this year.

High annual population growth rates and the escalation ofindustrial production have led to a rise in domestic demand

for utilities of about 8% per year in recent years, and growthshould resume at 7.6% per year through to 2032.

Peak power demand jumped 85% in 1999-2008 andthe kingdoms power demand could grow to more than120,000 megawatts by 2032 from capacity of about 50,000MW now. In the fourth quarter, the new Riyadh PP10 powerplant should come on-stream, its first phase totalling 799MW poised to enter commercial operation in mid-2012,adding a further 941 MW by mid-2013. Available water percapita, meanwhile, dwindled by almost a quarter in the pastdecade, which has necessitated a push to boost water de-salination capacity.

We estimate public and private sectors will need to investSR1 trillion to build capacity in power and water through2032 just to keep up with demand. Measures to curtailoveruse are therefore crucial. In July 2010, SEC raised tar-iffs for commercial and industrial users by 9.6%, while ex-cluding residential users from the change. The company isstill selling electricity 3.5% below production cost. Similarfee adjustments can be expected in the future as the state

seeks to rationalise the use of power, water and fuel do-mestically.

Transport, storage and communications

The transport and communications sector is likely grow5.9% this year, having been the second-fastest-growingprivate sector last year, at 5.6%.

The telecoms sector has expanded quickly in recent yearswith the introduction of two mobile phone operators to

compete with the incumbent Saudi Telecom. Home to morethan 27 million people, the Saudi market offers the great-est subscriber potential in the Gulf region, in addition totremendous roaming revenues generated in relation to themillions of people who visit the kingdom to perform the hajjpilgrimage or lesser umrah pilgrimage.

Third operator, Zain Saudi Arabia, widened its network cov-erage last year and built its customer base to more than8 million, about 2 million more than it had a year earlier.Etihad Etisalat (Mobily), the second operator, also posted arecord profit in Q3, up 41% on the year, while incumbentSaudi Telecoms Q3 profit also surpassed expectations.

Transport projects have, meanwhile, been a top priority forthe government, which allocated SR25.2 billion of its 2011budget to transport and telecommunications investments,up 5% from 2010 allocations. The plan includes a strategyto lay down 6,600 kilometres of new roads, build four newairports and rebuild the King Abdulaziz International Airport.

-6

18

(YoY%c

hange)

Inflation remains historically high, but pressures ease

2012f20102008200620042002200019981996199419921990

Inflation rate Rental and utilities index Food indexSource: CDSI, Banque Saudi Fransi forecasts

-4

-2

0

2

4

6

8

10

12

14

16


11/1411

SAUDI ARABIA

ECONOMICS

January 2011

Saudi Arabia further plans to increase its grains storage ca-pacity by 550,000 metric tonnes within three years to guardagainst price rises. Presently maintaining stock of 1.4 mil-lion tonnes, the kingdom would add capacity at ports in theKing Abdullah Economic City, Yanbu and Dhiba under thisscheme.

Agriculture

Agriculture GDP is likely to grow 0.7% in 2011 accordingto our estimates, compared with about 0.5% last year. The

kingdom continues to be a sizeable producer of foodstuffs,but the agriculture sector has not grown as swiftly as itused to due to a state policy to phase out certain water-intensive agricultural production, such as wheat. As SaudiArabia moves toward importing key commodities includingwheat, the agriculture sectors GDP will continue to growonly marginally and possible contract.

Community, social and personal services

This sectors growth is likely to rise to 4.3% in 2011 from anestimated 3.8% last year, according to our forecasts. Healthand social affairs is a crucial policy focus for the govern-ment, which raised its allocation for these areas of spendingby 12% in the 2011 budget to SR68.7 billion. The fundingwould go toward building new hospitals and primary carecentres in addition to financing various socially relevant ac-tivities, such as funding poverty reduction programmes andbuilding sporting clubs and social welfare offices.

Saudi Arabias services industry also derives benefits fromreligious tourism. Last years hajj pilgrimage attracted arecord number of pilgrims. Some 2.79 million people per-formed hajj, up 20.6% from the year earlier, including 1.8million non-Saudi residents, according to CDSI data.

Inflation

Inflationary pressures continue to stem from domestic trig-gers, including rent and higher goods and services costs,and elevated global food price inflation. After hitting an

18-month high of 6.1% in August, inflation moderated andaveraged 5.4% in 2010, three percentage points above theyear earlier. Price pressures are likely to ease slightly thisyear due to comparatively lower rental inflation, althoughfood price inflation could remain elevated due to globalprice pressures.

We expect annual inflation to average 5.1% this year, his-torically high for a country that experienced average infla-tion of 0.8% between 1990 and 2006. Inflation does notpose the same degree of societal risks that it did in 2007and 2008, when it reached double digit levels for the first

time in three decades at a time when the purchasing powerwas weak due to U.S. dollar frailty. In November, the gov-ernment announced it would not phase out an inflation al-lowance that had raised salaries of state employees by 15%over the last three years in order to help them cope withrising prices, without consequently stoking inflation.

The states stimulatory spending programme has not cre-ated notable inflationary pressures in goods, services andwages because state investments have complementedthe lack of private sector investment, rather than compet-ing with it. Saudi Arabia has benefitted from excess labourand services capacity in the region, where some othereconomies faced more severe slowdowns.

Food inflation comprising almost a third of the cost of liv-ing basket is likely to hover around 6.9% in 2011. Globalprices for wheat, corn and rice rose 26% between June andNovember 2010, pushing their index to an all-time high inDecember, according to the Food and Agriculture Organi-sation (FAO). Prices of cereals, particularly wheat, rose inH2 2010 due to severe drought and fires in major wheatproducers Russia and Ukraine, while Canada was also hit

with bad weather.

Foreign assets back to pre-2009 levels

30

150

1000

1700

(SR,

bn)

(USD/bbl)

Source: SAMA, Thomson Reuters

Average oil priceSAMA net foreign assets

1100

1200

1300

1400

1500

1600

40

50

60

70

80

90

100

110

120

130

140

2 01 0 Mar Ma y J ul S ep N ov2 00 9 Mar Ma y J ul S ep No v2 00 8 Mar Ma y J ul S ep N ov


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Rice crops, a staple for Saudi consumers, are also facing

difficulties, prompting the FAO to give a less optimistic

forecast for global rice production in November than it did

in June. The FAO expects global rice trade to decline 2%

in 2011 as major exporters, including Pakistan, Cambo-

dia, Egypt and Vietnam, face supply constraints. This could

translate into higher prices domestically. Aside from global

factors, the dynamics of wholesale food production and dis-

tribution have contributed to market imbalances.

Inflation could get some downward pressure from the otherexpenses and services category, accounting for 14% of the

index. Gold and jewellery comprise a large weighting in this

basket and should undergo a corrective phase as global in-

flationary concerns subside.

Rent and utilities inflation, about a fifth of the index, should

fall to 7.8% in 2011 from 9.5% last year, continuing on a

declining trend since inflation in the index peaked at almost

20% in mid-2008. Given the markets inadequate supply,

upward revisions are plausible. In our latest business con-

fidence index, however, business executives said they ex-

pected inflation rates to decline in the coming six months.

Domestic debt

One unforeseen feature of this years budget announce-

ment was the states reduction of public debt in 2010 to

SR167 billion from SR225.1 billion a year earlier. As coun-

tries the world over grapple with rising debt-to-GDP ratios,

Saudi Arabia reduced its debt ratio to 10.2% from 16% a

year earlier. In 2003, the debt-to-GDP ratio was 82%.

The move was an attempt by the government to dem-onstrate the extent of its fiscal health even as it pursues

record budget expenditures. All Saudi government debt is

domestic, held by the two state pension funds and local

banks. We anticipate the government will continue to ser-

vice public debt this year, reducing its burden to SR145 bil-

lion, or 8.1% of GDP.

Outlook and challenges

With a strong oil price backdrop, 2011 promises to be a

positive year for the Saudi economy, one marked by solideconomic growth rates, manageable inflation and twin fis-cal and current account surpluses.

In 2012, the economy should encounter a more promisingoutcome, with real GDP growth accelerating to 4.4%, in-cluding expansion of 4.5% of the private sector as the gov-ernment sector pulls back further. Bank credit growth to theprivate sector would return to low double-digit levels androbust oil prices and greater global demand would neces-sitate a gain in crude oil production, leading to smaller butsizeable fiscal and current account surpluses amountingto 4.1% and 11.3% of GDP, respectively. We also foreseeinflationary pressures easing further in 2012, according toinitial indications. With improved lending and faster moneysupply growth rates, the central bank should be comfort-able in raising its repurchase rate by 50 basis points for thefirst time in three years.For the time being, a reluctant private sector and disinclinedbanks have placed enormous pressure on state enterprisesto mobilise funds in order to plug the financing gap. The

states aggressive spending programme has provided abackdrop for private sector momentum, but private firmshave not yet regained their place in the development pro-cess.

In this regard, a great deal needs to be done to revive thesmall and medium-sized enterprise (SME) segment, whichshould be instrumental in any economic recovery. The gov-ernment should devise strategies to encourage SMEs andenable them to become beneficiaries of public funding,which has tended to profit only a small number of very big

private sector players.

In its five-year plan, Saudi Arabia set as one of its objec-tives the need to nurture and organise the SME segmentthrough a series of state and private initiatives designed toboost the segments contribution to non-oil GDP. Withouta drastic improvement in the encouragement and integra-tion of SMEs, the private sector will struggle to exceed 5%growth in the coming years, although such growth rates arenecessary to create jobs, the most serious challenge facingthe economy today.


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Key Saudi Arabia Economic Indicators

2002 2003 2004 2005 2006 2007 2008 2009 2010e 2011f 2012f

MACRO-ECONOMIC INDICATORS

Nominal GDP (USD bn) 188.6 214.6 250.3 315.3 356.2 384.7 476.3 375.8 434.7 478.6 519.3

Nominal GDP (SR bn) 707.1 804.6 938.8 1,182.5 1,335.6 1,442.6 1,786.1 1,409.1 1,630.0 1,794.9 1,947.5

YoY % change 3.0 13.8 16.7 26.0 12.9 8.0 23.8 -21.1 15.7 10.1 8.5

Real GDP growth rate, % 0.1 7.7 5.3 5.6 3.2 2.0 4.2 0.6 3.8 4.2 4.4

Non-oil private sector real GDP growth rate, % 4.1 3.9 5.3 5.8 6.1 5.5 4.6 3.5 3.7 4.2 4.5

Government real GDP growth rate, % 2.9 3.1 3.1 4.0 3.1 3.0 3.7 4.4 5.9 5.3 4.7

Oil sector real GDP growth rate, % -7.5 17.2 6.7 6.2 -0.8 -3.6 4.2 -6.7 2.2 3.5 4.0

Inflation, YoY % change 0.2 0.6 0.3 0.7 2.2 4.1 9.9 5.1 5.4 5.1 4.8

GDP per capita (USD) 8,774 9,744 11,111 13,640 15,041 15,868 19,200 14,809 16,039 17,279 18,286

BUDGETARY INDICATORS

Total government revenue (SR bn) 213.0 293.0 392.3 564.3 673.7 642.8 1,101.0 509.8 735.0 769.0 798.3Total government expenditure (SR bn) 233.5 257.0 285.2 346.5 393.3 466.2 520.1 596.4 626.5 676.0 718.0

Deficit/surplus (SR bn) -20.5 36.0 107.1 217.9 280.4 176.6 580.9 -86.6 108.50 93.0 80.3

Budget balance, % of GDP -2.9 4.5 11.4 18.4 21.0 12.2 32.5 -6.1 6.7 5.2 4.1

Domestic debt (SR bn) 558.0 660.0 610.6 459.6 364.6 266.8 235.0 225.1 167.0 145.0 137

Domestic debt as % GDP 78.9 82.0 65.0 38.9 27.3 18.5 13.4 16.0 10.2 8.1 7.0

FOREIGN TRADE INDICATORS

Total export revenues (USD bn) 72.3 93.0 125.7 180.4 210.9 233.1 313.4 192.2 236.3 249.9 268.5

Oil export revenues (USD bn) 63.6 82.0 110.4 161.6 188.2 205.3 281.0 163.1 203.2 212.4 227.3

Total imports (USD bn) 29.6 38.3 43.5 53.8 63.0 81.5 100.6 86.4 87.0 97.4 112.0

Current account balance (USD bn) 11.9 23.3 49.3 90.0 98.9 93.3 132.3 22.8 69.6 63.1 58.8

Current account as % of GDP 6.3 10.8 19.7 28.5 27.8 24.3 27.8 6.1 16.0 13.2 11.3

EXCHANGE RATE (=USD1)

Saudi riyal 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75 3.75

BANKING INDICATORS

Bank claims on private sector, year-end % change 10.0 11.0 37.4 38.9 9.2 21.4 27.1 -0.04 6.6 9.1 11.1

Total private credit, year-end % change 12.4 11.3 37.0 38.9 9.8 20.6 27.9 -0.6 7.3 8.8 10.2

Total bank credit, year-end % change 12.3 17.2 34.5 36.2 9.8 19.7 25.2 -1.1 8.4 8.6 9.5

Broad money M3, YoY % change 14.7 6.9 18.8 11.6 19.3 19.6 17.6 10.7 5.0 9.7 10.4

SAMA net foreign assets (USD bn) 41.9 59.5 86.4 150.3 221.1 300.9 437.9 405.3 438.0 470.8 499.1

Repurchase Rate (year-end) 2.00 1.75 2.50 4.75 5.20 5.50 2.50 2.00 2.00 2.00 2.50

SAVING & INVESTMENT INDICATORS

Gross fixed capital formation, % of GDP 18.1 18.4 16.7 16.5 17.5 20.5 19.5 24.7 23.9 24.8 26.5

Non-oil government investments, % of GDP 2.6 2.9 3.2 4.6 4.4 5.8 6.2 8.5 8.7 8.6 8.4

Non-oil private investments, % of GDP 13.8 12.9 11.6 10.0 9.7 10.1 9.6 11.9 11.0 10.9 10.7

Gross domestic savings, % of GDP 37.1 41.8 45.9 51.3 50.1 48.5 52.8 37.1 41.8 42.3 40.9

Government savings, % of GDP -0.9 6.0 14.0 23.6 26.2 20.5 40.7 6.6 12.1 16.5 17.8

Private savings, % of GDP 38.0 35.8 31.9 27.7 23.9 28.0 12.1 30.5 27.6 23.5 24.3

DEMOGRAPHIC INDICATORS

Population (in millions) 21.5 22.0 22.5 23.1 23.7 24.2 24.8 25.4 27.1 27.7 28.4

Non-Saudi 5.8 6.0 6.1 6.3 6.4 6.6 6.7 6.8 8.4 8.6 8.9

Unemployment rate (%) Saudi 9.7 10.4 11.0 11.5 12.0 11.0 9.8 10.5 10.5 10.7 10.9

Non-Saudi 0.8 0.8 0.8 0.8 0.8 0.4 0.4 0.3 0.4 0.4 0.3

OIL INDICATORS

Argus Sour Crude Index (ASCI) 59.4 66.4 93.8 60.4 76.0 79.4 82.1

Average oil price (WTI) (USD/barrel) 26.3 31.3 41.3 56.6 66.1 72.3 100.2 62.1 79.0 82.5 85

Average Saudi oil price (USD/barrel) 23.4 26.8 34.5 49.5 60.5 68.1 93.4 61.4 76.0 79.0 81

Crude oil production (million bpd) 7.09 8.41 8.90 9.35 9.21 8.82 9.20 8.18 8.19 8.48 8.75

STOCK MARKET INDICATORS Nov. 2010 Dec. 2010

Tadawul Stock Index (TASI) (period-end) 2,518.1 4,437.6 8,206.6 16,712.6 7,933.3 11,038.7 4,803.0 6,121.8 6,310.0 6,620.8

Source: Saudi Arabian Monetary Agency, other Saudi Arabian government authorities, Banque Saudi Fransi forecasts


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Disclosure appendix

Analyst certification

The analyst(s), who is primarily responsible for this report, certifies that the opinion(s) on the subject security(ies) or issuer(s)and any other views or forecasts expressed herein accurately reflect their personal views and that no part of their compensation,was, is or will be directly related to the specific recommendations or views contained in this research report.

This report is designed for, and should only be utilised by, institutional investors. Furthermore, Banque Saudi Fransi believes an

investor,s decision to make an investment should depend on individual circumstances such as the investor

,s existing holdings

and other considerations.

Additional disclosures

1 - This report is dated as at 25 January 2011.

2 - All market data included in this report are dated as at close 24 January 2011, unless otherwise indicated in this report.

3 - Banque Saudi Fransi has procedures to identify and manage any potential conflicts of interest that arise in connection withits Research business. A Chinese Wall is in place between the Investment Banking and Research businesses to ensure thatany confidential and/or price-sensitive information is handled in an appropriate manner.

Disclaimer

This report is prepared for information only. Where the information contained in this report is obtained from outside sources,Banque Saudi Fransi believes that information to be reliable. However, Banque Saudi Fransi does not guarantee its completenessor accuracy. The opinions expressed are subject to change without notice and Banque Saudi Fransi expressly disclaims anyand all liability for the information contained in this report.

The report only contains general information. It should not be construed as an offer to sell or the solicitation of an offer topurchase or subscribe to any investment. The specific investment objectives, personal situation and particular needs of any

person have not been taken into consideration. Accordingly, you should not rely on the report as investment advice. NeitherBanque Saudi Fransi nor any of its affiliates, their directors, officers and employees will be liable or have any responsibility ofany kind for any loss or damage that may be incurred as a result of the information contained in this report.

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