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Dr. John SfakianakisChief EconomistTel: +966 1 289 1797Email: [email protected]
Turki A. Al HugailEconomic Research AnalystTel: +966 1 289 1163Email: [email protected]
Daliah MerzabanEconomic AnalystTel: +971 4 428 3608Email: [email protected]
February 14, 2010
Bearing the funding burdenSaudi state agency funds plug project financing gap left by banks
Saudi Public Investment Fund and other state entities taking more active role to plug gaps in project financing as bank credit lags
SAMA foreign assets witness December jump, deposits with foreign banks surge 25% in one month as state seeks to keep funds in liquid form
December slump in private sector credit likely seasonal but momentum behind credit revival to remain sluggish
Saudi debt perceived as least at risk of default in the Gulf
With banks and private sector businesses continuing to linger on the sidelines of Saudi Arabia’s infrastructure expansion project, the government appears ready and willing to continue employing its financial clout to keep vital infrastructure projects on track. Involving the private sector in the development plan has been a key government priority for years as part of efforts to strengthen the non-oil economy to reduce reliance on oil exports and create jobs.
But with private investors on their guard, bank credit touching new lows, and the cost of private sector credit still sharply higher than it was prior to the global financial crisis, the government has been compelled to take the lead role in paying for project work. In the past year, the state became the principal financier behind strategic projects across many core sectors, and it looks likely to bolster rather than undercut this strategy during 2010. As the principal investor in the economy, the state is shouldering the recovery effort, after succeeding in keeping the economy from slowing down more than it did in 2009.
In much of the world, including developed countries, governments are trying to better integrate themselves in the economy. Saudi Arabia had already carefully woven the state’s role through a variety of institutional mechanisms over a long period of time. Now, it is using its economic prowess to ensure funds continue pouring into expansion projects. The intention is not to crowd out the private sector but to maintain momentum when private sector participation and credit are not as close at hand as they used to be.
Even private firms are turning to government investment agencies for financing as banks – trying to clean out their balance sheets following some debt troubles suffered by family conglomerates – sidestep new credit requests.
In February, the Saudi Council of Ministers asked the Public Investment Fund (PIF), an arm of the finance ministry, to extend interest-free loans from its revenues to contracts that would expedite the completion of the 450-kilometre Haramain high speed railway project. The estimated SR26 billion railway will connect Jeddah with the holy cities of Makkah and Madinah. In return for its credit extensions, PIF would be compensated in future budget allocations.
2
SAUDI ARABIAECONOMICS
February 2010
Aside from transportation, state-run PIF has moved into a number of crucial economic sectors in Saudi Arabia, announcing in January it would take a 20% stake in Real Estate Financing Co (Refco), which plans to offer home loans in conjunction with the anticipated passage of a mortgage law this year.
PIF’s active role follows revisions to its mandate in January 2009, when the state project lender announced it would provide more project financing to address an imbalance between funding supply and demand. The fund raised the cap on project lending to 40% from 30% of its value and extended loan duration to 20 years from 15 years (including a five-year grace period). An increase in the lending tenor allowed PIF to participate more actively in the power and water sector, where tenors typically extend longer than 15 years. More importantly, PIF raised by 57% the lending limit on each project to SR5.88 billion from about SR3.75 billion.
Petrochemicals giant Saudi Basic Industries Corp (SABIC) turned to PIF – its 70% shareholder – in late December for a SR10 billion private bond placement. SABIC, which plans to use the funds for expansion, had sold bonds to the public in recent years. But risk perception of global markets for all issuers in the Gulf region worsened substantially after conglomerate Dubai World announced in late November it would seek a debt standstill, quashing expectations its liabilities would be backed by a sovereign guarantee.
Not surprisingly, credit default swaps (CDS) of all Gulf countries suffered. Saudi issuers are perceived as the least likely among their Gulf counterparts to default on their debts with CDS Saudi debt a full 59 basis points lower than Abu Dhabi and 11 basis points lower than Qatar by mid-February. Saudi CDS have declined 74% since a February 2009 peak, but are still 19% more expensive than October last year. Markets are naturally pricing a slightly higher risk even for a very solid country like Saudi Arabia. Still, there is wide differentiation of risk in the region and corporate borrowers in less-hit countries like the kingdom should consider tapping the funding market. Companies in countries perceived as more risky will face a tough funding scenario in 2010.
Source: Bloomberg
Saudi issuers seen as least likely in Gulf to default
(Five
-yea
r CDS
spr
ead)
0
600
Abu Dhabi Dubai Oman Qatar Saudi ArabiaBahrain
255075
100125150175200225250275300325350375400425450475500525550575
Source: Bloomberg
Trends in Saudi CDS spreads
0
400
(bas
is p
oint
s)
July 2008 Feb 2009 Oct 2009 Feb 2010
50
100
150
200
250
300
350
3
SAUDI ARABIAECONOMICS
February 2010
Early indications are that a five-year Islamic bond issued by Saudi Arabia's largest property developer, Dar Al Arkan Real Estate Development Co, could be priced at a steep 10-11% yield. These scenarios underpin the crucial role PIF and other state agencies can play in filling a funding gap created by the risk aversion of banks and difficult credit conditions regionally.
Something to build on: foreign assets in excessSaudi Arabia’s stimulatory fiscal policies are part of the larger countercyclical trend adopted by countries including China, India and a few others, based on healthy internal and external balance sheets and macroeconomic stability. Although the debate over finding the right balance between state involvement in the economy and laissez-faire economics cannot be appropriately articulated here, the Saudi economy has benefited from a fiscally supportive state now more than ever before.
The kingdom has committed to raising its expenditure budget by 14% this year to SR540 billion – almost double projected spending in 2005. Unlike other members of the G20, Saudi Arabia is able to accommodate sweeping increases in public spending without exacerbating its domestic debt
position due to: its substantial holdings of foreign assets; and its ability to replenish them in the relatively high oil price environment that continues to prevail.
After declining for most of last year, the Saudi Arabian Monetary Agency's (SAMA) net foreign assets witnessed a 4.2% jump in December to SR1.52 trillion – 109.8% of the kingdom's 2009 gross domestic product. That marked the biggest month-on-month jump in SAMA net foreign asset holdings since July 2008, when oil prices had touched a peak near $150 a barrel. Oil prices have fluctuated around $75 a barrel for the past three months – a level the government regards as adequate for both producer and consumer nations.
Combined net foreign assets of SAMA and commercial banks, often used as a benchmark by ratings agencies to assess macroeconomic sovereign risk, stood at about 117% of GDP in 2009, up from 95% in 2008 – incomparable in the region and among many G20 nations. The big jump was mostly due to a sharp change in nominal GDP. Net foreign assets also declined by only SR52.6 billion in a year marred by the worst global financial crisis for six decades. Oil export revenues fell 46% in 2009 from record levels in 2008, while net foreign assets saw a very manageable 3.1% decline aided by higher oil prices in the second half.
Source: SAMA
SAMA net foreign assets on the rise
(SR,
bn) (%
)
MAY MARCH 2008 JULY SEPT NOV 2009 MARCH MAY JULY SEPT NOV
500
1700
Month on month changeSAMA net foreign assets
600
700
800
900
1000
1100
1200
1300
1400
1500
1600
-2.5-3.0
-2.0-1.5-1.0-0.50.00.51.01.52.02.53.03.54.04.55.05.56.06.57.0
4
SAUDI ARABIAECONOMICS
February 2010
For years, SAMA has followed a policy of investing its surplus oil revenues into a variety of low-risk assets, with more than 76% of foreign assets invested in foreign securities, a category that includes government bonds like U.S. Treasuries. Very little is invested in equities which, as this global crisis has taught us, are not easy to liquidate when a sovereign needs funds.
However, in the past year, it was SAMA's very-liquid deposits in foreign banks that became the central focus of foreign asset inflows and outflows. While the central bank's investments in foreign securities were relatively steady in the fourth quarter, its deposits with banks abroad jumped
Jan.2007
Jan.2008
Jan.2009
Dec.2009
Source: SAMA
(SR,
bn)
(SR, bn)
SAMA draws on foreign bank deposits
Deposits with banks abroadInvestments in foreign securities
0
400
50
100
150
200
250
300
350
200
1300
300
400
500
600
700
800
900
1000
1100
1200
almost 41%, including a 25% rise in December alone to SR335.7 billion. It appears clear that the government would like to keep funds in an accessible form as it ramps up expenditures this year, projecting a fiscal deficit of SR75 billion. This is in line with the state’s conservative oil outlook for its budget and its ability to draw secondary and tertiary funds from within the country.
During the first nine months of 2009, SAMA drew down its deposits with banks abroad by 37.1%, or SR140.7 billion. Over the same period, holdings in foreign securities declined by a smaller SR83.1 billion, or 7.2%. Keeping in mind the generous cushion of foreign assets and comparatively low
Source: IMF regional economic outlook
Gulf external debt positions
0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75
Qatar
Saudi Arabia
UAE
2008
2009f
2010f
(Gross external debt as % of GDP)
5
SAUDI ARABIAECONOMICS
February 2010
domestic debt to GDP ratio of 16.3%, the government has significant leeway to uphold deficit spending, although we anticipate the kingdom can support its stimulatory 2010 spending plan and turn a surplus of SR77.9 billion.
We continue to regard Saudi Arabia’s position vis-à-vis domestic debt as unique compared with its neighbours in the Gulf and under the G20 umbrella. As a percentage of GDP, Saudi public debt, all of which is domestic, is likely to fall to 13.2% in 2010 according to our forecast and 18% as per the IMF’s forecast. From a macroeconomic perspective, the growth threshold for external debt is considerably lower than for domestic government debt.
By contrast, the IMF foresees UAE external debt standing at 35.6% of GDP this year and Qatar's at 61.4% of GDP. Dubai has weighed down the UAE debt position substantially; outstanding debt of some $100 billion amounts to about 120% of the emirate's GDP. Saudi Arabia has reduced its public debt burden by 63% since 2003 as it took advantage of a high oil price environment. This included a 4.3% reduction in the debt burden in 2009, when economic growth slowed to just 0.2%.
Saudi Arabia has been a credible financial facilitator and supporter, without creating confusion in the market about what is explicitly sovereign backed and what is not. Global markets are, hence, starting to differentiate risk profiles
within the Gulf. Unlike holdings of other regional sovereign funds, SAMA’s foreign assets are managed as a stabilisation fund not as a futures fund. SAMA also releases details of its foreign asset holdings in a monthly report, making it easier to gauge the financial strength of the central bank than it is with other Gulf countries, where sovereign funds release little or no data. Central bank foreign assets elsewhere in the Gulf are very low due to variations in investment policy and outlook.
The core financierWhat is apparent from Saudi bank private sector credit data in the past year is that without state funds, many crucial expansion projects would be held up for months waiting for lenders to slacken strict lending policy. Despite very low interest rates in Saudi Arabia and elsewhere, a pickup in lending has not happened with as much strength as many policymakers had hoped.
Bank claims on the private sector declined 1.9% month-on-month in December, effectively erasing all of the gains in bank credit since July. Private sector credit in Saudi Arabia had witnessed monthly contractions for most of the first part of 2009, after having soared 28% in 2008 from the year earlier and more than tripling since 2003.
The downturn in bank credit was not simply linked to corporate transparency issues surrounding the debt
Source: SAMA
Private sector credit contracts slightly after boom
(SR,
bn) (%
)
2005 2006 2007 2008 2009 Jun Dec
400
750
Reverse repo ratePrivate sector credit
0.0
5.0
425
450
475
500
525
550
575
600
625
650
675
700
725
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
6
SAUDI ARABIAECONOMICS
February 2010
troubles of business families. It began months before the Saad Group-Algosaibi debt issue emerged in May 2009, stemming from risk aversion among local and global banks propagated by the post-Lehman global credit crunch.
We regard December's big drop in private sector credit as seasonal and particular– banks took sharp fourth-quarter provisions against expected non-performing loans in an effort to start 2010 with a cleaner slate. Private businesses, meanwhile, paid off outstanding debt as creditors and lenders closed end-of-year books. Banks wanted to show better financial results and pressured private entities to close pending credit facilities.
Paying off debts is healthy, but we need to ask whether private sector appetite exists for fresh lending once this cycle is over. In our view, banks’ reluctance extend new loans has reached a trough and they will begin to lend.
However, should the contraction stem from reluctance in the private sector this could have important implications for the pace of the recovery this year. Lack of credit availability is the principal reason why economic recoveries tend to be much slower and more protracted than normal. Policymakers in Saudi Arabia have long recognized this danger and they have done their bit to facilitate liquidity and lending. Banks and the private sector have to do their part.
Source: SAMA
M2 money supply growth slumps
5
31
(YoY
% c
hang
e)
2007 Apr Jul Oct 2008 Apr Jul Oct Apr Jul Oct2009
79
11131517192123252729
M3 growth rateM2 growth rate
Source: Official data of respective countries
Gulf inflation rates stabilise, edge higher
(YoY
% c
hang
e)
-10
14
-8
-6
-4
-2
0
2
4
6
8
10
12
* Kuwait, Qatar, Bahrain rates represent year-end inflation* Qatar 2009 data is quarterlyUAE Saudi Arabia Qatar Kuwait Bahrain Oman
2002 2003 2004 2005 2006 2007 2008 2009 Feb Mar MayApr Jun Jul Aug Sept Oct Nov Dec
7
SAUDI ARABIAECONOMICS
February 2010
Money supply growth in Saudi Arabia has also been subdued in recent months, in many ways reflecting the contraction in bank loans. Annual growth in broad money (M3) slowed for a third month in December to 10.7%, while M2 growth stood at a low 6.5%, contracting from the month earlier. The main source of the decline in M3 can be attributed to the contraction in bank lending and its negative impact on the monetary transmission mechanism. Money supply is also impacted by anaemic growth in time and savings bank deposits which, because loans are subsequently deposited back into the system, mirrors the decline in outstanding loans. The trade off is that declining money supply helps mitigate upward pressure to inflation, which hovered at 4.2% in December, similar to its level in the prior five months. We do not expect much variation from this level during 2010, with inflation averaging 4.3% for the year.
We expect the risk aversion gripping Saudi banks is only going to let go slowly this year, and until it does, new projects under way will have to find alternative, more cost-effective mechanisms for funding, which we discuss below. As we have stated in the past, credit growth is likely to accelerate toward the second half of the year, with a full-year rise in claims on the private sector at 8%, compared with a contraction of 0.04% in 2009, the first annual decline in at least 15 years. In the event that 8% credit growth is not reached, our private sector baseline forecast would need
Source: SAMA, Banque Saudi Fransi forecasts
(SR,
bn)
(USD per barrel)
Saudi Arabian foreign assets resume uptrend
Average oil priceSAMA net foreign assets
20
110
2002005 2006 2008 2009 2010f 2011f2007
1800
400
600
800
1000
1200
1400
1600
30
40
50
60
70
80
90
100
to be revised, placing downward pressure on the final GDP figure. Banks are, nonetheless, liquid; their foreign asset holdings jumped 37% in the year to December. While credit growth momentum is easily lost, it is not easily recovered, as we have seen in Saudi Arabia and among developed markets.
In our view, private Saudi entities have not in most cases taken on unmanageable amounts of debt that would hinder their future growth. Rather, they are seeking to de-leverage, leading to a noticeable decline in short-term borrowing (less than one year) versus a rise in medium-term (one to three years) and long-term (more than three years) lending. Saudi businesses continue to be profitable and competitive, indicating that they will gradually return to credit markets later this year to finance expansion, albeit at a slower pace. Bank claims on the public sector, down 25% year on year, rose 1.2% month on month in December and has shown signs of a pick up since October 2009.
8
SAUDI ARABIAECONOMICS
February 2010
2010 oil market outlookThe outlook for oil prices is already cast with high volatility, ranging from $70 to more than $80 per barrel. Volatility and downside risks to prices will continue so long as the dollar strengthens, oil demand fails to be as strong as anticipated and the global economy follows a gradual, fragile recovery path. With the balance of risk more on the downside for now, it will be difficult in our view for oil prices to average above $78 per barrel in 2010. WTI’s 2009 average was $62 per barrel. The price would have to rise 37% this year, the largest annual gain since 2000, if it is to average $85 – an implausible scenario given current dynamics.WTI averaged $78.4 in January, while Argus crude stood at $76.4 before falling to $70.9 as of February 9.
We do not regard the Energy Information Agency’s (EIA) outlook for average oil at $80 as achievable unless geopolitical concerns unfold in the wider Middle East that are difficult to predict. While we maintain our forecast for oil to average $78 a barrel in 2010, we will examine downside risks that may cause us to revise this lower later in the year. Inventory levels have piled up considerably and demand will need to pick up for stocks to return to historic levels.
A comeback in global oil demand at the end of 2009 might not be enough to put much upward pressure on oil prices this year. Oil demand may not rise enough to persuade OPEC to raise output since the market is well-supplied and compliance among member countries is a potential concern. Indeed, if current supply conditions prevail, an OPEC production cut cannot be discounted, should oil prices linger below $70 per barrel for a prolonged period of time.
If oil prices fluctuate between $70-$80 there is little reason to expect a pre-emptive OPEC production cut. This price level supports Saudi Arabia in attracting necessary investment to build future capacity. In January, the International Energy Agency (IEA) cautioned that global upstream spending, including acquisitions, was budgeted to fall by over $90 billion, or 19%, in 2009 – the first decline in a decade. Saudi Arabia’s investment position has been clearly articulated by Minister of Petroleum and Mineral Resources Ali Al-Naimi, who said recently: “Everyone is looking at this price [$70-$80 per barrel]. And everyone is saying this is great. And more importantly, economic growth is not being hampered. That is why I said this is almost a perfect price.”
Saudi Arabia’s oil and refined products exports are unlikely to witness any geographical shifts in 2010. The majority of Saudi oil was exported to the Far East (52.7%) according to the latest data from 2008, with the United States the destination of 20%. Of refined products, the Far East again received the bulk (53.4%) of exports, followed by Europe at 8.2% and the Mediterranean 7.4%. Oil exports to China and Japan, as well as South Korea, form an important part of Saudi exports to the Far East. Saudi oil comprised 20.5% of total Chinese oil imports in 2009, up 10% from 2008. Chinese oil firms are set to boost their imports of Saudi oil by 12% this year, including about 200,000 barrels per day to Saudi Aramco’s 25% affiliate Fujian Refining & Petrochemical Co. Japan’s oil imports from Saudi Arabia declined 6.6% between 2008 - 2009 as overall oil imports fell 12.8%; the kingdom is the single-largest exporter of oil to Japan, covering 30% of its needs 2009.
9
SAUDI ARABIAECONOMICS
February 2010
Keeping projects on targetWhile the global economic crisis has affected the way projects are financed, the government's goal is that tighter credit conditions will not disturb the projects themselves.
In a clear articulation of this policy, the government announced last May that a SR22.5 billion power and water desalination plant at Ras Azzour in eastern Saudi Arabia would no longer be designated as an independent power and water project (IWPP) – a mechanism the government introduced to promote the inclusion of private sector firms in the utilities sector. Saudi Arabia re-tendered the project in November, stipulating it would be financed entirely by the government in order to reduce project costs.
The role of PIF and other state agencies has become accentuated as a result of the government’s interest to
ensure progress on all fronts of the infrastructure spectrum, even for projects initially designated to the private sector.
The government in its 2010 budget allocated SR48.3 billion to be disbursed to specialised credit institutions, including PIF, SIDF, the Real Estate Development Fund, Saudi Credit and Savings Bank, Agriculture Development Fund and Government Lending Program. The anticipated allocation is 20% higher than the 2009 budget and five-fold more than 2005.
The King Abdullah Economic City is one such private investment mega-project underway along the Red Sea north of Jeddah. The city includes an industrial zone, a sea port and residential community, and is estimated to require investments topping SR100 billion. Emaar Economic City, the Saudi-listed developer of the mega-project, has faced delays in delivering housing and business units, as well as with its expected mega port, due to lack of investor appetite.
In the event that a state agency extends a financing facility to Emaar Economic City, which some anticipate will happen in order to avert further project delays, this would mark further evidence of public funds being used to back projects of strategic importance, even if they do not fall directly under the aegis of the state. We expect to see this trend continue due to the high cost of private sector borrowing and risk aversion among banks.
State-run utility Saudi Electricity Company (SEC) obtained a SR2.6 billion, 15-year soft loan from PIF in July 2009 for projects it is undertaking in the Saudi capital, Riyadh.
Source: SAMA, Banque Saudi Fransi forecasts
Private sector GDP growth poised for pickup
0.0
7.5
(YoY
% c
hang
e)
1990 1992 1994 1996 1998 2000 2002 2004 2008 2010f2006
0.51.01.52.02.53.03.54.04.55.05.56.06.57.0
Government sector GDPPrivate sector GDP
Source: Saudi Aramco
Oil exports by region
Far East53%
Europe5%Mediterranean
7%
United States20%
Other15%
Source: General Administration for Customs of China
Chinese oil imports by country
Russia12%
Saudi Arabia34%
Angola26%
Iran18%
Sudan10%
10
SAUDI ARABIAECONOMICS
February 2010
The state’s Public Pension Agency (PPA), meanwhile, is developing the King Abdullah Financial District at a cost of SR29 billion.
In January, the government called on Saudi Aramco to build the proposed 250,000-400,000 barrels per day Jizan refin-ery, initially slated as an independent project, after the proj-ect tender attracted only two bids from local oil companies with no interest from global players. With state backing, the refinery is more likely to achieve a 2015 target start date. The refinery is part of the broader Jizan economic city un-veiled in 2006, which has received less private investment than initially hoped. The project aiming to industrialize the undeveloped Jizan province in southwestern Saudi Arabia, is strategically important for the country due to rising de-mand for refined products in the Jizan region and beyond.
What does this mean for the private sector?One drawback of the government's stimulatory spending plan that we have raised in the past is that it has not adequately passed down benefits to the kingdom's small and medium-sized private enterprises (SMEs). Still, this trend toward using the state as the primary financier for projects should not be viewed as a detrimental for the kingdom's privatisation effort. Over the past year, we estimate there has been a 43% surge in government-financed projects awarded to the private sector.
We expect the state will take a greater role in financing only on a case-by-case basis, where it regards a failure to intervene could lead to project delays or drive up costs in a way that does not make economic sense. This policy should gradually shift once there has been an amelioration of the credit conditions – i.e. banks resume lending at reasonable levels and the cost of credit for private sector partners becomes manageable. However, we do not expect an immediate pickup in bank lending during 2010, necessitating the continued role of the state in supporting projects and at times supplanting the lack of private investments.
Over the past few years, PIF has provided significant
financing to various projects. In 2008, the fund extended around SR3.8 billion for Ma’aden’s phosphate project and another SR3.8 billion each to various petrochemical projects of Kayan, National Chevron Philips, Yansab and PetroRabigh. The Sharq petrochemical project received SR1.8 billion from PIF, which also provided funds to Sipchem and Ibn Zahr.
Other government agencies, most notably the Saudi Industrial Development Fund (SIDF), have financed projects along with PIF. SIDF lends up to SR600 million for individual projects, a cap raised from SR398 million a few years ago. SIDF funding for Kayan has amounted to nearly SR2 billion, along with another SR506 million to Ma’aden and Sipchem.
These two government funds have in many cases supported expansion plans of private companies during the turbulence of the past year and a half. Unable to get loans from local or foreign banks, many companies have sought alternative financing avenues. In January, SIDF extended loans to Nama Chemicals Co, which received SR210 million, and Saudi Cables Co, which secured SR160.5 million for financing a power cable plant.
Al Abdullatif Industrial Investment Co, a carpet maker, also negotiated a SR91 million loan from the SIDF last summer to help it raise production, while in April National Shipping Co agreed on an SR1.05 billion Islamic loan from PIF to enable it to expand its fleet of tankers.
Private sector players have, meanwhile, managed to access some bank credit facilities in recent months. Saudi Aramco and Total last month concluded a SR22.5 billion bank lending facility designed to partly finance the construction of an oil refinery at Jubail. It is widely anticipated that some of the remaining SR22.5 billion of the project's cost would be covered by PIF. Engineering contractor Arabian Bemco Contracting Co also signed a SR1.25 billion contract financing facility in February to fund a Qurayyah Power Plant upgrade.
Meanwhile, we are witnessing a shift in how some state-owned companies, such as SEC, seek financing for projects. SEC has allowed banks to bid for more than one contract within the same project, such as the P11 power project. This differs from a prior policy of allowing banks only one bid each, thus fostering greater price competition and adapting to challenging conditions globally.
11
SAUDI ARABIAECONOMICS
February 2010
Tadawul outpaces Dow in 2010, but correlation intactThe Saudi stock market witnessed a strong rally in the fourth quarter, polishing the three-month period off with a rise of 8.1%, having surged as much as 16.2% from the start of September to a 2009 high on October 25. The strong profit performance of Saudi Basic Industries Corp (SABIC) underpinned this rally along with a robust growth outlook for the kingdom’s petrochemical producers.
Expectations that banks will resume lending at higher levels during the course of 2010 should provide some ammunition to the market this year. But the short-term view on the market is marked by hesitation, mainly because investors and traders are taking cues from global economic indicators and world markets, where recovery remains fragile.
The high correlation of the Saudi market with global markets, specifically the Dow Jones Industrial Average, is continuing, although the Saudi market has outpaced the Dow in 2010, rising 2.1% in January versus a fall of 3.5% on the Dow. Correlation between the two markets was high up to January 19, when the Dow hit its strongest point since October 2008 on the heels of the collapse of Lehman Brothers. The Saudi market also gave up some gains as the Dow plunged 6.2% by the end of the month, but its downturn was not as severe, largely due to some robust corporate earnings.
Foreigners, meanwhile, are more interested in Saudi shares, with swap agreements surging 150% in January from December levels to SR1.03 billion. Total foreign swap agreements between March 2009 and January 2010 included SR9.8 billion of shares bought and SR7.1 billion of shares sold. In January, foreign swap agreements accounted for 1.6% of total shares purchased, the highest level since October.
But there has also been a massive drop in trading volumes and the value of shares changing hands on Tadawul, which averaged about SR15 billion per week during the first month of 2010 – less than the value of shares traded in a single day before the 2006 stock market crash. Traders are not pumping in fresh liquidity but rather switching the same funds between stocks, wary about taking risks as they assess global economic news.
Recent punishments leveled by the Capital Markets Authority on some traders, regarded to be major market players, has effectively weeded out many speculators. In our view, current liquidity levels reflect that trading in the market is being driven more by fundamentals and less by speculators. Traders with a daily or weekly outlook are entering the market mostly seasonally, particularly before and after the quarterly earnings season when there is an upturn in activity.
Source: Reuters
Saudi market outpaces Dow in 2010 but correlation intact
(Tad
awul
) (Dow)
2007 201020092008
4000
13000
Dow Jones Industrial AverageTadawul
4000
15000
5000
6000
7000
8000
9000
10000
11000
12000
5000
6000
7000
8000
9000
10000
11000
12000
13000
14000
12
SAUDI ARABIAECONOMICS
February 2010
Conclusion: Shouldering the burdenBoosting private sector involvement in Saudi Arabia's non-oil sectors is a crucial and necessary part of the kingdom’s future expansion. Growth in private sector GDP slowed to 2.5% in 2009 and while we foresee it climbing by a higher 3.7% this year, it remains far from levels recorded in 2004 - 2007 that surpassed 5% annually. Such lower levels of private sector expansion are not sufficient to keep up with the demands of an ever-expanding national labour workforce.
Meanwhile, government sector GDP has been growing more quickly, accelerating to 4% in 2009 from 3.7% in 2008. We expect the growth rate will rise again this year to 4.1%. The government has stepped in to keep the economy from avoiding a recession in 2009 and encourage growth momentum in 2010.
The public sector has absorbed a great deal of the new job entrants in recent years, but with the young Saudi population demographics the private sector will have to do its part. That the public sector is now the biggest employer for Saudis has averted a labour induced recession and a deep consumer depression in 2009. It has offered enormous social protection for Saudis since private firms did embark on periodic layoffs, mainly of non-nationals, in 2009. This, however, does not absolve anyone from creating employment mechanisms for nationals in the private sector.
Between 2004 and 2009, new entrants into the labour market reached around 220,000 per year, according to Ministry of Economy and Planning data. While it had been anticipated that the number of employed Saudi nationals over this period would rise to 4.75 million from 3.5 million, by the end of 2008, the total Saudi employed labour force reached only 3.75 million.
Saudi Arabia's Shura Council, an advisory body that reports to King Abdullah, agreed to a proposal in February to pay out monthly allowances for young unemployed Saudis of at least SR1,000 per year until they find jobs. In January, the advisory council also approved a 5% increase to pensions paid to retired public employees. These and other social welfare programmes will amplify the pressure on the government to keep public spending at historically high
levels, underpinning the need to have the private sector shoulder more of the burden.
The signals are promising that conditions for the private sector to excel will improve through the course of 2010, although not exceptionally. According to our estimates, the kingdom's export revenues will rise almost 19% this year and import flows should gain 18% in keeping with greater economic activity.
Recent letters of credit data also provide scope for cautious optimism. Private sector imports financed through commercial banks (settled LCs) rose to SR15.72 billion in December – the highest level of 2009. New LCs, meanwhile, were 2.6% higher than they were a year earlier, a good signal that appetite among businesses in general is improving. The discrepancy between settled and new LCs is likely the result of businesses settling accounts in the month of December. We will be watching for signs for a pick up in new LCs and credit allocations.
Creating an environment where SMEs are able to better tap bank credit is a vital part of reducing dependence on large family businesses. With greater SME involvement, private sector growth momentum would not suffer as sharply from economic downturns as the one witnessed in the past year. Aside from credit allocations, SMEs, too, should modify their organisational and administrative structures to enable them to gain better access to credit. These longer-term goals are vital in shifting the balance of influence in favour of private sector participants.
2007 June 2008 June 2009 June 2010
Source: Reuters
Dollar likely to extend broad gains
70
91
7271
737475767778798081828384858687888990
2009 2010June
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Global economic challenges in 2010In 2010, the global economy is likely to witness two tracks of growth, with the developed world (U.S., Euro-zone, Japan) on one track and key emerging markets (China and India) on the other. This does not mean that the two blocks have decoupled or that one will remain unaffected by the performance of the other. There are different challenges that each block and country faces. The challenge for the developed economies, particularly the United States, is that massive deficits resulting from recession-fighting fiscal stimulus could cause upward movements in yields at some point. The world is witnessing a different crisis, and in the post-crisis period not everything will be easily predictable. The developed economies will have to discover the right balance between investing enough (capital investments) to kick start a real economic recovery without accruing unbearable debts. Simply, reducing investments that could have long-term benefits and multipliers for the sake of debt during a crisis is not easy.
The Euro-zone is likely to continue to battle for the foreseeable few months with credit worries and rising government deficits in Greece, Ireland, Portugal and Spain.
The risk that Greece will default (we don’t think it will) or declare bankruptcy will need to be addressed either internally or extra-territorially, much as Dubai’s debt problems were resolved by involving its wealthier neighbour, Abu Dhabi. But no bailout is without its own set of rules or costs for each recipient. A bailout or solid support is looking less like a choice and more like a necessity. Markets will search for signs of a snowball effect into wider Europe and stronger Euro-zone economies will have to demonstrate their resolve and ability to support deficit-burdened and credibility-stricken Greece, Portugal and Spain in an open and transparent way.
The road will not be an easy one for the Europeans in 2010 and markets will continue to be jittery throughout the year. The latest data out of the Euro-zone reveal a more pessimistic future regarding southern economies given the need for aggressive consolidation. Southern economies suffer from chronic competitiveness problems. On an annual basis, the Euro-zone contracted 2.1% while the EU shrank 2.3%.The Greek economy contracted 0.8% on a quarterly basis, Portugal’s output was unchanged following two solid quarterly increases, Spain’s economy, still in recession, contracted 0.1%, and Italy – where the ratio of public debt to GDP is close to Greece – shrunk 0.2%. That should put additional downward pressure on the euro, but we do not regard the dollar as structurally strong. Since currencies are all about a game of relativity (dollar is strong relatively to the euro for now), among the weak currencies the market perceives the dollar to be the strongest due to flight to quality, while regarding the greenback as the only reserve currency.
However, France and Germany would see a pickup in growth during 2010 that should give positive comfort to Euro-zone economies. Germany will regain its position at the head of the recovery as it benefits from a strong competitive position. France is also on a good recovery path together with the Netherlands. The United Kingdom economy will witness a tough 2010 as the public finances, high unemployment, weak activity and the high level of consumer debt are a challenge for any government after the looming elections. For the short term, the pound could come under pressure but that could be an advantage further ahead to the country’s competitive position.
The United States appears to be on gradual but jobless recovery even as the unemployment rate fell to 9.7% in January from 10% due to a 541,000 rebound in the household survey measure of employment. A huge number of people have opted to exit the job market, which makes the latest jobs figure circumspect. We continue to anticipate that the U.S. economic recovery will fade later this year as consumption growth remains subdued, and unemployment and underemployment remain high. Home foreclosures in the U.S. this year are estimated by some
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1 Reinhart, Carmen M., and Kenneth S. Roggoff. 2010 “Growth in Time of Debt.” American Economic Review Papers and Proceedings.
to reach between 2.5 - 3.5 million which will compound consumer distress. U.S. credit growth might not recover quickly; it was only after World War II that the economy started to witness strong credit growth following the 1930s depression. In a recent study of the link between different debt levels and economic growth over the past two centuries, countries exhibiting gross public debt exceeding 90% of annual economic output tended to grow more slowly. For developed countries above the 90% mark, average annual growth was about 2 percentage points lower than for countries with public debt of less than 30% of GDP. 1 Gross government debt in the United States, for example, stood at 85% of GDP in 2009 and will reach 108% of GDP by 2010, according to IMF projections.
With the U.S. fiscal deficit remaining steep, high state spending will need to be curtailed and/or taxes raised, both of which could place downward pressure on economic growth in the coming years. The environment could become more challenging and volatile for U.S. equities in 2010 than it was in 2009 due in part to the rising dollar. The dollar value of European earnings of U.S. firms falls when the dollar rises. The economy is still not creating net new jobs and growth is set to slow in the not so distant future as boosts from the inventory cycle and fiscal stimulus dissipate.
Political quarrels in the U.S. Congress will add to the uncertainty. The Federal Reserve is in no hurry (unlike the ECB) to raise interest rates while the labour market remains very weak, and fiscal stimulus that brought back risk appetite and some asset inflation winds down. The major beneficiaries of the ongoing reduction in risk appetite will be the dollar and government bonds, at least for the foreseeable future. Inflation in the Euro-zone and the United States will not be a forefront concern, but in our view fiscal prospects do not look very auspicious after 2010, which will begin to have a bearing on prices. But the question still remains how can the United States continue to credibly borrow more than $1 trillion every year when U.S. public and private cumulative debt hovering around 350% of GDP; the outlook on growth may not be very bright.
China’s economy should witness strong growth this year while inflation is of concern. The recent move by the government to raise reserve requirements offers adjustments to liquidity that we don’t think are leading the economy to overheat. The danger for China is that policy stimulus is not sustained and the global rebound is not extended to support its export growth. The domestic stimulatory measures taken to support urban consumption do provide some reason for optimism. The Indian story is still one of growth, but prevailing inflationary pressures in 2010, especially wholesale prices, are of concern especially as food prices are at the forefront.
Source: Government data of respective countries
2009 deficit-to-GDP ratio comparisons
0
14
(%)
IrelandGreece Portugal Saudi Arabia Spain United States
2
4
6
8
10
12
Source: Reuters
Dollar rises vs euro as Europe debt woes mount
1.24
1.54
1.29
1.34
1.39
1.44
1.49
2009 June 2010
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Key Saudi Arabia Economic Indicators2002 2003 2004 2005 2006 2007 2008 2009e 2010f 2011f
MACRO-ECONOMIC INDICATORSNominal GDP (USD bn) 188.6 214.6 250.3 315.3 356.2 384.7 475.1 369.2 422.5 478.2
Nominal GDP (SR bn) 707.1 804.6 938.8 1182.5 1335.6 1442.6 1781.6 1384.4 1584.2 1793.3
YoY % change 3.0 13.8 16.7 26.0 12.9 8.0 23.5 -22.3 14.4 13.2
Real GDP growth rate, % 0.1 7.7 5.3 5.6 3.2 2.0 4.3 0.15 3.9 4.8
Non-oil private sector real GDP growth rate, % 4.1 3.9 5.3 5.8 6.1 5.5 4.8 2.5 3.7 4.6
Government real GDP growth rate, % 2.9 3.1 3.1 4.0 3.1 3.0 3.7 4.0 4.1 3.8
Oil sector real GDP growth rate, % -7.5 17.2 6.7 6.2 -0.8 -3.6 4.2 -6.4 4.1 5.2
Inflation, YoY % change 0.2 0.6 0.3 0.71 2.21 4.13 9.91 5.1 4.3 4.8
GDP per capita (USD) 8774 9744 11111 13645 15040 15870 19149 14880 17028 19275
BUDGETARY INDICATORSTotal export revenues (SR bn) 271.7 349.7 472.5 677.1 791.3 874.4 1175.4 691.6 768.7 832.1
Oil export revenues (USD bn) 63.6 82.0 110.4 161.6 188.2 205.3 281.0 152.9 188.5 201.9
Total government revenue (SR bn) 213.0 293.0 392.3 564.3 673.7 642.8 1101.0 505.0 699.2 762.3
Total government expenditure (SR bn) 233.5 257.0 285.2 346.5 393.3 466.2 520.1 550.0 621.3 694.5
Deficit/surplus (SR bn) -20.5 36.0 107.1 217.9 280.4 176.6 580.9 -45.0 77.9 67.8
Budget balance, % of GDP -2.9 4.5 11.4 18.4 21.0 12.2 32.6 -3.3 4.9 3.8
Domestic debt (SR bn) 558.0 660.0 610.6 459.6 364.6 266.8 235.0 225.0 209.0 186.0
Domestic debt as % GDP 78.9 82.0 65.0 38.9 27.3 18.5 13.4 16.3 13.2 10.4
Total imports (USD bn) 29.6 38.3 43.5 53.8 63.0 81.5 100.6 80.3 94.7 109.2
Current account balance (SR bn) 44.5 87.2 184.9 337.5 371.0 350.0 502.7 76.7 98.7 159.8
Current account as % of GDP 6.3 10.8 19.7 28.5 27.8 24.3 28.2 5.5 6.2 8.9
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
BANKING INDICATORSDomestic credit growth, % 10.8 13.6 20.9 21.6 6.5 19.7 28.6 -6.1 9.5 13.2
Bank claims on private sector, YoY % change 10.0 11.0 37.4 38.9 9.2 21.4 27.1 -0.04 8.0 12.7
Broad money M3, YoY % change 14.7 6.9 18.8 11.6 19.3 19.6 17.6 10.7 13.9 12.1
SAMA net foreign assets (USD bn) 41.9 59.5 86.4 150.3 221.1 300.9 437.9 405.3 445.9 498.2
Repurchase Rate (year-end) 2.00 1.75 2.50 4.75 5.20 5.50 2.50 2.00 2.00 3.25
SAVINGS & INVESTMENTSGross fixed capital formation, % of GDP 18.1 18.4 16.7 16.5 17.5 20.5 19.6 24.8 24.5 26.7
Non-oil government investments, % of GDP 2.6 2.9 3.2 4.6 4.4 6.4 6.2 15.2 13.8 14.1
Non-oil private investments, % of GDP 13.8 12.9 11.6 10.0 9.7 6.6 8.3 10.2 10.7 12.6
Gross domestic savings, % of GDP 37.1 41.8 45.9 51.3 50.1 48.5 52.8 35.5 41.8 43.2
Government savings, % of GDP -0.9 6.0 14.0 23.6 26.2 20.5 40.7 9.8 19.1 23.4
Private savings, % of GDP 38.0 35.8 31.9 27.7 23.9 28.0 12.1 25.7 22.7 19.8
DEMOGRAPHIC INDICATORS*Population (in millions) 21.5 22.0 22.5 23.1 23.7 24.2 24.8 25.5 26.2 26.8
Unemployment rate (%) Saudi 9.7 10.4 11.0 11.5 12.0 11.0 9.8 10.0 10.3 10.6
Non-Saudi 0.8 0.8 0.8 0.8 0.8 0.4 0.4 0.5 0.4 0.4
OIL INDICATORSArgus Sour Crude Index (ASCI) 59.4 66.4 93.8 60.4 76.0 82.0
Average oil price (WTI) (USD/barrel) 26.3 31.3 41.3 56.6 66.1 72.3 100.2 62.1 78.0 84.0
Average Saudi oil price (USD/barrel) 23.4 26.8 34.5 49.5 60.5 68.1 93.4 58.1 74.0 80.0
Crude oil production (million bpd) 7.1 8.4 8.9 9.4 9.2 8.8 9.2 8.2 8.5 9.1
Source: Saudi Arabian Monetary Agency, other Saudi Arabian government authorities, Banque Saudi Fransi forecasts
* Demographic indicators in the January 2010 report were incorrect due to a publication error. These are the correct forecasts.
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Disclosure appendixAnalyst certificationThe 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 disclosures1 - This report is dated as at 14 February 2010.
2 - All market data included in this report are dated as at close 12 February 2010, 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 with its Research business. A Chinese Wall is in place between the Investment Banking and Research businesses to ensure that any confidential and/or price-sensitive information is handled in an appropriate manner.
DisclaimerThis 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 completeness or accuracy. The opinions expressed are subject to change without notice and Banque Saudi Fransi expressly disclaims any and all liability for the information contained in this report.
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