Lower oil prices could cause Saudi to curb spending plans
Saudi policy makers can look forward to a promising year ahead, with only a few clouds to unsettle a generally rosy economic outlook.
Age and ill-health issues affecting the senior leadership, and the ensuing uncertainties over the future line of succession, are one clear challenge that will have to be addressed; the likely lowering of the kingdom’s average oil production is another, as this is likely to force a scaling back of gross domestic product (GDP) growth performance in 2013.
The ill-health is a cause for concern, particularly in light of the deaths of two senior princes within the space of a year. “We have lost two of the top four men in the past year and people are now a lot more focused on the generational shift. It is commanding more attention and obviously any uncertainty there would have an impact on the economy,” said one commentator.
On the positive side of the balance sheet, oil prices continue to be supportive of economic activity - unsurprising in the context of an economy where the oil sector still dominates. The latest economic data reveals some impressive growth statistics. In real terms, the Saudi economy grew nearly six per cent in the third quarter of 2012 over the same period in 2011. Though slightly below the 7.1 per cent average seen in full-year 2011, it is impressive nonetheless, especially when compared to the anaemic figures seen in the European economies.
Domestic demand is buoyant, as shown by the latest Saudi British Bank (SABB) Purchasing Managers Index (PMI) data for the month of November, which reveals that new orders continue to expand on the back of investment in education and health infrastructure, utilities, oil, gas and petrochemicals sectors.
SABB’s PMI data said the Saudi non-oil producing private sector continued to report strong growth in output and new orders in November with more than one in four respondents reporting an increase in production. The bank suggests one of the main reasons behind the rise was higher volumes of new orders. Export orders for Saudi companies have remained high thanks to increased Chinese demand for Saudi petrochemicals, which are also now more competitively priced thanks to favourable exchange rate developments.
The private sector has become a more vibrant determinant of overall growth, emerging as the main growth driver in the second quarter of 2012, contributing 3.2 percentage points. In 2011 the private sector grew at 8.5 per cent, with the construction and manufacturing sectors contributing the largest increase.
According to Saudi-based Jadwa Investment, private sector growth remains robust supported by public sector investment, strong domestic demand and rising bank lending.
However, government spending is still the underlying engine of growth and will remain so, said James Reeve, deputy chief economist at Samba Financial Group. “The private sector has reasonable momentum for 2013 (though new orders are perhaps beginning to soften) but the domestic environment might become a bit more challenging in 2014-15 when we expect the government to rein in expenditure more markedly. However, I expect the external environment – basically China’s demand for petrochemicals – to remain supportive.”
Another near-term boost to consumption will arrive in 2013 with an extra month’s salary set to be paid. Samba also sees large infrastructure projects, such as the Riyadh metro, along with ongoing investments in the oil, gas, refining and minerals sectors, as underpinning the vital contracting sector.
Domestic demand will benefit from government labour market reforms and the minimum wage. Fahad Alturki, head of research at Jadwa Investment, said: “Labour changes are going to create jobs for Saudis and increase their incomes and this will support domestic consumption.”
Private sector lending by Saudi banks, which has picked up from the end of 2011, will help support growth. “Year-to-date lending growth is about 15 per cent year-on-year and that is likely to stay given the liquidity and given the strong fundamentals in the domestic market. Rising credit to the private sector is going to support both private sector as well as domestic demand,” said Alturki.
Despite healthier private sector growth, the government is unlikely to become a weaker force in the economy for the simple reason that government spending is the main source of private sector expansion – especially if state oil company Saudi Aramco and Saudi Basic Industries Corporation (Sabic), the two largest corporates in the kingdom – are regarded as the public sector.
“We think government spending growth will ease fairly sharply in 2013-15, and will actually be cut in 2015,” said Reeve. “The fiscal outlook is a lot more nuanced than say five years ago: government spending is now running at about 80 per cent of non-oil GDP (up from about 50 per cent in 2002). This leaves the government vulnerable to even a moderate sustained reduction of oil prices. The government is aware of this and I think will act to put the brakes on spending growth,” said Reeve.
The consensus is that government spending growth will be softer than in recent years, though most observers say the government will broadly maintain the expansionary fiscal policy seen since 2008. Budgetary revenues are predicated to contract to SR1096 billion in 2013, down from SR1189 billion in 2012. Jadwa sees spending rising by just over SR50 billion to SR897 billion, leaving a fiscal surplus equivalent to eight per cent of GDP – lower than the 14 per cent level expected for 2012.
There are compelling demographic reasons for the government to sustain spending, with an annual population growth rate at 3.4 per cent and stresses on existing infrastructure that is at bursting point in key areas.
“It’s more important to look at the budgeted level of spending than the change in spending. Government spending is very high and will remain the main driver of the economy in 2013.” said Paul Gamble, an analyst at Fitch Ratings.
Reform efforts in recent years have succeeded in reducing the linkage between the oil price and the level of fiscal spending, and progress has been made on diversifying the economy, notes the IMF approvingly in an assessment of Saudi Arabia published last September. The decline in the link between fiscal spending and oil revenues has yielded significantly lower volatility in fiscal spending.
While oil production will remain the engine of growth, rising Iraqi and US production and demand worries related to weak economies in the West is likely to see reduced output for the kingdom in 2013.
The latest figures show that Saudi Arabia pumped 9.5 million barrels per day (b/d) in November 2012, well down on the 30-year peak of 10.1 million bpd seen in June 2012. Most analysts see production in 2013 averaging around 9.5 to 9.7 million bpd.
Samba expects overall GDP growth is set to fall to 3.9 per cent in 2013 from an estimated 5.7 per cent in 2012, largely reflecting the cut to oil production. Lower oil production will offset the healthy growth in the non-oil sector of five to six per cent.
“We think that oil output will be cut by about three per cent in 2013. Gas output will continue to expand, but overall real hydrocarbons GDP is likely to contract by around two per cent. We think that the non-oil sector will expand by about 5.8 per cent next year, but the topline GDP growth figure will probably ease to around 3.8 per cent,” said Reeve.
Lower oil prices will also persuade the authorities to dampen production. However, there may be factors that will push up prices, such as stronger growth in emerging markets.
“Non-OECD growth will keep global oil demand positive and Saudi Arabia is likely to keep oil production relatively higher than in 2011, but of course it’s going to be lower than in 2012,” said Jadwa Investment’s Alturki.
The IMF is urging the authorities to pursue targeted investment alongside labour market reforms in order to facilitate a more dynamic private sector and stimulate job creation for nationals outside of the public sector. Training and skill-acquisition programmes will take centre stage, with the key measures such as the jobseekers’ allowance (Hafiz) and the refined version of Saudisation, Nitaaqat, aimed at increasing the number of Saudi nationals in the private sector. The government hopes progress will be made through 2013 in boosting jobs.
The mortgage law, finally passed by the Council of Ministers in July 2012, is also likely to come into full effect in 2013 and provide support to the real estate markets. According to Standard Chartered Bank, the law will provide consumers with purchasing power that did not previously exist, in a market that is racing to build the housing stock needed for an estimated five million Saudis who will be entering the work force between now and 2025.
The government has broken ground on a project to build 1.25 million new homes by 2014, making $4 billion available to undertake the project. However it may be too early to factor in a substantial economic bounty just yet. “The mortgage law needs to be tested, particularly the foreclosure process. Until then, the law is not going to have a huge economic impact, but I’m sure companies are gearing up for it,” said Gamble.
Overall, there appear to be few noxious economic surprises in store for the kingdom. Stronger progress on employment generation is perhaps the most pressing issue facing the government, but the kingdom’s fundamentals remain generally sound, and sustained non-oil growth, precipitated by the greater willingness of banks to lend to the private sector, is an added bonus as the kingdom attempts to diversify its still hydrocarbons-dominated economy.