“Output gains from the oil sector, along with firm government spending, particularly in terms of capital spending, are the main drivers of a macroeconomic outlook for 2015, which has slightly improved from our previous forecast. Nevertheless, non-oil growth is expected to moderate but remain healthy, supported by stimulative government fiscal policy that aims to broaden and deepen the non-oil economy, stimulate the private sector and deliver substantial improvements to infrastructure, Saudi employment, and education levels—even at the expense of expected fiscal deficits in 2015 and 2016. While the kingdom’s substantial domestic and foreign reserves have been accessed to finance the deficit, the government intends to tap the debt markets for additional support. The recent opening of the Saudi bourse to foreign investment should also provide additional liquidity and support asset prices. Inflationary impulses, meanwhile, remain contained on account of continuing softness in international food prices.
“Saudi oil production in 2015 has surged to levels not seen since 1980. Output has averaged 10 million barrels per day (mb/d) so far in 2015 as the kingdom responds to a rebound in demand. Output of downstream oil products such as diesel, gasoline and jet fuel, for example, (though considered part of non-oil GDP) has also been boosted by gains in refinery runs at the SATORP refinery, which reached full capacity in 2014 and the YASREF refinery, which was commissioned in late 2014 and which delivered its first cargo of refined products earlier this year. Further gains in output are expected in 2015.
“Government spending continues to be the linchpin of the non-oil economy, buffering it from an anticipated slowdown brought about by lower oil prices. Spearheaded by the government’s investment and diversification plan, estimated at $1.1 trillion and which aims to stimulate employment, consumer demand and private sector activity, non-oil sector output is forecast to grow around four per cent in 2015 and 2016, from 5.3 per cent in 2014.
“Key metrics of consumer and business activity such as point-of-sale transactions (POS), the Purchasing Managers’ Index (PMI) and private sector credit growth continue to point to a buoyant, albeit slowing, non-oil sector. The latest data on POS transactions and cash withdrawals showed increases of 10.1 per cent y/y and 7.2 per cent y/y in April, respectively. May’s headline PMI figure of 57.0, while still comfortably above the 50.0 no-change level, was the lowest in a year as non-oil private sector firms noted a softening in output and exports.
“Similarly, private sector credit growth, despite moderating over the last six months, was still a healthy 10 per cent y/y in April in line with steady economic activity. Credit to the construction, commerce and manufacturing sectors, for example, was increasing in the region of 8.0-13.0 per cent y/y at the end of 1Q15, while mortgage and real estate lending, to both consumers and businesses, expanded by a robust 26.9 per cent y/y at the end of 1Q15.
“Addressing the high unemployment rate among Saudi nationals and Saudi youth especially as well as the small proportion of nationals in the private sector has been one of the government’s main priorities in recent years. Labor market reforms introduced in 2011 including the ‘Nitaqat’ program, which imposed ‘Saudization’ quotas on private sector companies, have yielded broadly positive results: the overall unemployment rate among Saudi nationals has declined from 12.2 per cent in 1Q12 to 11.6 per cent in 4Q14; Saudi female participation levels have improved to 17.6 per cent in 2H14 from 14.7 per cent in 1H12; and the number of Saudis employed in the private sector has increased from 10.9 per cent in 2011 to 15.2 per cent in 2013. The rate of employment growth of Saudi nationals in the private sector has been higher than that of expatriates. Meanwhile, compliance with the Nitaqat program has risen to 85 per cent among participating private sector companies, although this represents only 25 per cent of firms registered under the scheme at the Ministry of Labor. The remaining majority of firms are classified as SMEs (small and medium size enterprises), with a much smaller number of employees.
“Efforts to address the problem of youth unemployment (ages: 20-29), however, have been less successful. The unemployment rate remains stubbornly high at 27.8 per cent, and is unlikely to fall substantially without significant improvements in the overall quality of the education system; the skills and competiveness of university graduates need to improve to meet industry and private sector standards.
“The most recent monthly data, for May, showed that inflation in the food and beverages category, the component with the greatest weight of 21.7 per cent in the Saudi cost of living index, and the transportation and restaurants and hotels categories was in the low single digits. International food and commodity prices especially have been relatively subdued, helping to keep a lid on otherwise rising costs in the housing category; housing inflation reached 3.1 per cent y/y in May as the kingdom continues to suffer from a shortage of units thanks to rising demand for affordable housing. We expect headline inflation to slow further, from 2.7 per cent in 2014 to 2.1 per cent this year before rising to 2.6 per cent in 2016.
“Having recorded only its third fiscal deficit since 2002 last year, of 2.3 per cent of GDP, this year and next should see further deterioration in the kingdom finances as a result of lower oil revenues and higher expenditures. The fiscal deficit is likely to widen markedly in 2015, to an estimated -21.0 per cent of GDP as a result of burgeoning capital expenditures and one-time costs relating to King Salman’s accession bonus (worth around $32 billion or 7.0 per cent of non-oil GDP) and the 13th Islamic month in 2015 as well as the military intervention in Yemen. The ultimate bill for the latter is undetermined.
“With their spending elevated, the authorities have clearly expressed their intention to continue to act as the lynchpin of the non-oil economy, cushioning it from the effects of the drop in oil prices—even at the risk of fiscal deficits and some reserve depletion. Reserves, in the form of the government’s deposits at the central bank, were down by 20.4 per cent y/y in to $312.8 billion in April. In percentage terms, the bulk of the drawdown this year has come from the reserve account that the government maintains for capital projects, which declined by 16.7 per cent ($19.5 billion).
“Nevertheless, the authorities look likely to resort to debt issuance (bonds and Sukuk) in order to help finance part of the fiscal deficit. With public debt as low as 1.6 per cent of GDP at the end of 2014—a legacy of years of fiscal surpluses—the government has ample fiscal room to maneuver.
“Saudi Arabia is expected to record a deficit in its current account in 2015 and 2016, of -7.3 per cent of GDP and -4.5 per cent of GDP, respectively. While oil export revenues are likely to be higher than previously forecasted in view of the ramp up of oil production and exports so far in 2015, the decline in oil prices coupled with a still considerable import bill and outflow of remittances and financial aid will weigh significantly on the current account.
“A drawdown in foreign investments and foreign currency deposits abroad in order to finance domestic spending and defend the exchange rate peg has seen the kingdom’s foreign reserves decline by seven per cent y/y to $686 billion last April. Still, with the equivalent of 32 months of imports in reserve and oil prices likely to rise over the next year, the kingdom should possess adequate buffers to ride out the current period of low prices. Furthermore, demand for local currency should get a welcome boost by the opening up of the Saudi bourse to foreign investment.
“Monetary policy has remained accommodative in the context of the currency peg to the US dollar. Mirroring the path of the US Federal Fund’s rate, currently at 0.0 per cent-0.25 per cent, SAMA’s key interest rates, the reverse repo and repo, have remained unchanged at 0.25 per cent and two per cent respectively since late 2009. SAMA is expected to follow the Federal Reserve’s lead and raise its policy rates sometime over the next six to 12 months, albeit with a lag of a few months.
“The Saudi stock market has outperformed regional bourses in 2015, with the general index, the Tadawul All-Share Index (TASI), increasing by 14.5 per cent year-to-date (17 June) to 9,543. The market has seemingly overcome earlier worries about low oil prices and the kingdom’s military intervention in Yemen and instead looked ahead to the potential entry of foreign investors starting from June. Entry of qualified financial investors (QFI) on 15 June should catalyze greater portfolio inflows over time, especially once Saudi equities are included in emerging market indices such as the MSCI.”
Originally published on www.cpifinancial.net