Saudi Special Report: Shifting Sands

INSIDE THE ECONOMY

Record levels of government spending will continue to provide support for Saudi Arabia’s non-oil economy after a slowdown in the hydrocarbons sector last year.

Public sector investment is estimated to rise by 15 per cent from 2012 to $266.6 billion as the government directs funds towards the construction of residential, educational and health facilities and improves transport infrastructure.

The total government expenditure will be equivalent to 31 per cent of GDP compared with an average of 30.4 per cent in the last ten years. This will ultimately also boost confidence and private sector activity.

The improved outlook for value-added petrochemicals and Saudi’s plans to reduce dependency on hydrocarbon markets suggest that the investment will be sourced more broadly than in the past.

A slowing oil market dragged on gross domestic product (GDP) in 2012, although not as badly as first feared.

According to the latest figures, GDP fell to 6.8 per cent from 7.1 per cent in 2011. This compared to forecasts from Riyadh-based Jadwa Investments of a drop to 3.1 per cent.

Lower oil production will cause total real economic growth to slow in 2013 though, and combined with lower oil prices, will reduce the budget and current account surpluses. High government spending will remain the engine of the non-oil economy this year.

Non-oil private GDP growth is forecast at 6.3 per cent in 2013 compared with a 4.9 per cent average for the last ten years, and this willingness and ability to support the economy will be important in the short-term as international and regional events dampen sentiment and potentially damage the economy.

The main economic risk is from the situation in the Eurozone and fiscal uncertainty in the US. The fluid regional political situation will continue to make foreign investors wary and impact the sales of companies that export to the region; it also brings the risk of stock market and oil price volatility.

But the most up-to-date economic data highlight that the economy has maintained a robust performance in line with the recent GDP growth figures.

Indicators of consumer spending, such as point of sales transactions and cash withdrawals from ATMs, point to healthy growth during the year. Cement sales, a good gauge of construction activity, are 10 per cent higher than they were last year.

Meanwhile, the performance of listed companies continues to improve albeit at a slower pace than previous years.

Central bank data shows that bank lending rose consistently during 2012 with net credit issued reaching $33 billion, the highest level since 2008. In an environment of very low interest rates and low investment returns available elsewhere, banks are likely to put more emphasis on lending to smaller business.

ENERGY

As the largest producer in the Organisation of the Petroleum Exporting Countries, or OPEC, Saudi plays a significant role in how the global oil prices play out.

As a result, a cut in oil production to the tune of five per cent in December was seen as a move to push up the global price of crude. However, in response, Saudi has declared that the cut was imposed following weak demand from Asian economies. The government is increasingly shifting its export focus towards Asian economies after moves by the US, formerly the chief oil importer, to progressively seek self-sufficiency in oil from shale formations.

That said, the Kingdom increased its oil output by 5.5 per cent year-on-year in 2012 to offset the drop in Iranian production (15.7 per cent year-on-year), as well as to meet the rising domestic demand (seven per cent year-on-year).

With Iraq and North America production on the rise, OPEC current production being above its quota and troubles in the advanced economies hitting demand, it is forecast that production will be cut in 2013 by 2.3 per cent year-on-year to 9.6 million barrel per day.

It is likely that the oil sector will contract by 1.5 per cent in 2013, lower than the decline in oil output given the project work taking place in the sector.

Most of this work is concentrated on exploring and developing the Kingdom’s gas reserves including Karan gas field and the recently announced Midyan natural gas field.

Into next year, there are hopes that the outlook for the US and EU will improve, though government austerity, banking sector caution and high unemployment will keep growth low. Emerging markets will continue to lead the way and will pull up oil demand. Oil supply is also forecast to be up, both from OPEC and non-OPEC producers. With the political situation in the Middle East stabilising, it is likely that the risk premium on oil prices to gradually fall, and as a result forecasts for Saudi export crude will slip to an average of $96.2 per barrel (equivalent to $100 per barrel for Brent).

In April, Barclays became the last of the big banks active in commodities to abandon its bullish stance on oil prices in the face of rising US oil output and sluggish global demand.

Any future improvements in the global economy or elevated oil prices will provide a reasonable environment for the Kingdom’s economy, but its domestic activity will remain dependent primarily on elevated government spending. Work on the housing program will accelerate and infrastructure improvement will continue. This should contribute to a solid performance by the non-oil private sector. Real GDP growth is forecast to reach 3.6 per cent, with oil production contraction leading the oil sector to down by 1.4 per cent.