The Saudi Economy in 2015
We expect a fall in the current account surplus in 2015 because of lower oil export revenues. The surplus is forecast to decline to 3.7 percent of GDP, down from 10.8 percent of GDP in 2014 (Figure 28). In dollar terms, the surplus is expected to decline to $27 billion, almost a third of its level in 2014, and its lowest since 2009. Relatively moderate growth in non-oil exports is not expected to provide a strong support to overall exports due to weak external demand. We forecast non-oil exports to grow by 4.8 percent compared with an average annual growth of more than 10 percent in the last five years. Imports are expected to grow by 5.4 percent in 2015, rebounding from negative growth of 2.4 percent in 2014. The invisibles balance, which consists of flows of remittances, incomes, and payments and receipts for services, will maintain a large deficit.
Oil revenues constitute 80-85 percent of total export revenue, so the decline in oil production and prices we are forecasting for 2015 will cause a 15 percent fall in total exports. We expect total exports to decline to $272.3 billion in 2015, down from an estimated $320.6 billion in 2014 (Figure 29). The gradual recovery in the global economy is expected to dictate the trend of non-oil exports. We expect demand for petrochemical and plastic products to remain weak in the first half of the year, but gradually improve toward the second half. The decline in oil prices is likely to increase pressure on Saudi petrochemicals in the short-term, given that lower oil prices would reduce the competitive advantage of Saudi petrochemical companies relative to their international competitors. Petrochemicals and plastics already account for more than 60 percent of the Kingdom’s non-oil exports.
While we still expect a continuation of strong demand for imports owing to the ongoing infrastructure work and a robust domestic consumption; the negative sentiment associated with a low oil price environment is likely to limit upside growth of domestic consumption. We think, however, that as the government maintains its expansionary fiscal policy, which was highlighted in the 2015 budget (see next section), economic activity will remain robust, maintaining positive growth for imported products.
We expect workers’ remittances –the main source of outflows from the invisibles account- to continue to grow, but at a slower pace.
Factors that support slower growth include tighter restrictions on visa issuance as part of the broader labor market reforms, which has already led to a sharp decline in new visas issued (Figure 30). We think that while the number of foreign workers should not rise as high as it did in recent years, payments to foreign companies providing construction and related services will be the main source of the growth in outflows in 2015. Foreign providers of other services, such as communications, insurance, and financial services will be the main source of growth in outflows in the longer-term as the economy expands. We also expect that the government services account will record much lower deficits in 2015, owing to an expected reduction in the level of external financial aid and assistance granted to other Middle Eastern countries. The deficit in the government services account is expected to reach an all time high in 2014 following record quarterly deficits during the year (Figure 31).
The main source of non-trade revenues will continue to be returns on the government’s investment portfolio, the bulk of which is being invested in sovereign bonds, primarily US. We expect the gradual increase in the US Federal Fund rate in the second half of 2015 (see box 3) will have a positive effect on the returns to the portfolio.
The 2015 budget foresees continued increases in spending to another historical high of SR860 billion, underscoring the government’s determination and ability to support economic activity despite the prevailing subdued oil price environment. It further highlights the strong focus on economic diversification as spending on physical and social infrastructure has been kept high. However, we believe the 2015 budget numbers remain conservative judging by the underlying assumptions on oil prices and historical patterns of government overspending (Figure 32).
That said, the Kingdom has budgeted for a first fiscal deficit since 2011, amounting to SR145 billion in 2015, compared with a balanced budget in 2014. With uncertainty still clouding the outlook for the global oil market, the budget foresees a contraction in revenues by 16.4 percent and only marginal growth in expenditures (0.6 percent) compared to last year’s budget. At least in the short term, we think that financing this deficit is not a problem, as it can be managed by drawing down the stock of foreign assets built up in recent years. At the end of November net foreign assets at the Saudi Arabian Monetary Agency (SAMA) stood at $736 billion (SR 2,760 billion). The huge stock of assets that the government can call on gives Saudi Arabia an advantage over most other oil producing countries in alleviating the impact of lower oil prices. That means it can push ahead with strategic projects such as key infrastructure development including transport, housing, oil, power and water and support the private sector where necessary.
The revenue projection remains conservative, although less so than in previous years. We believe that a price of $56pb for Saudi export crude (around $60pb for Brent) and production of 9.6mbpd of which 2.6mbpd is consumed domestically is consistent with the revenue projections contained in the budget. We expect both revenues and expenditures in 2015 to be above the budgeted level and forecast a budget deficit of SR167 billion (6.1 percent of GDP) based on an oil price of $79pb for Brent. The oil price level necessary for revenues to balance our forecast level of government spending, known as the fiscal breakeven oil price, is $93.6pb for Saudi export crude (equivalent to around $97pb for Brent). This is based on our assumed production of 9.6mbpd and an oil export/revenue transfer ratio of 89 percent. We think that forthcoming increases in domestic gas production should take some of the burden from oil as the fuel for domestic energy consumption next year. This, however, remains subject to a non-negligible downside risk if there is further delay on the 2.5 billion cubic foot per day Wasit project. A number of media reports highlighted that the projects will not reach full capacity until the fourth quarter of 2015, almost a year behind schedule.
The prospect of running deficits will likely lead to a slowdown in most monetary indicators. The psychological impact of a deficit as well as deterred spending would play a role in the projected slowdown.
In addition to fiscal developments, interest rates are finally expected to increase in 2015 following an end to the lengthy easy monetary policy set by the US Federal Reserve since the outset of the 2008 financial crisis. The Fed is expected to raise its benchmark funds rate as a new tightening cycle sets in. As a result of the exchange rate peg and the open capital account, interest rates in the Kingdom need to mirror those in the US. SAMA would therefore raise its policy rates at some point in the second half of 2015.
SAMA’s key policy reverse repo rate was left unchanged at 0.25 percent for the sixth consecutive year, while the repo rate remained 175 basis points above the Federal Funds Rate (Figure 33). As mentioned in the GDP section, the Saudi economy maintained an expansionary stance during 2014 with high liquidity levels, stable credit growth , and muted inflationary pressures. Year-to-November money supply grew by 8.3 percent compared to 9.4 percent growth during the same period last year while credit to private sector increased by 12.5 percent year-on-year, continuing its double digit growth rates (Figure 34). SAMA continued to utilize open market operations –particularly SAMA bills- to actively manage excess liquidity in the system (Figure 35).
Box 3. Outlook for US & Saudi interest rates
The Federal Reserve is expected to gradually raise its benchmark federal funds rate by mid-2015, as a new tightening cycle sets in for the US economy. The expected increase should come following positive economic developments as well as the conclusion of the Fed’s asset purchase tapering process last December. Positive developments in the US included a fall in the unemployment to a six- year low at 5.8 percent by the end of 2014, as well as encouraging data on household spending and business investment.
The prospect of increasing interest rates in the US means that the Kingdom will have to adjust its own policy rates in order to maintain the fixed exchange rate. While this will translate into lower demand for domestic credit which would eventually reduce the potential growth of the non-oil sector; we think that SAMA will be cautious in responding to such changes in interest rate. This is particularly important given the current decline in oil prices which itself is likely to have a cooling effect on the domestic economy. We thus do not expect the spread between Saudi and US policy rates to be lower than it has been since 2008. On the upside, we think higher rates would limit the upward pressure on some domestic sectors that have led to unjustified increases in asset prices.
That said, previous incidences show that interest rate pass-through effects had proven to be minimal on demand for credit, and have usually meant little in the face of a robust private sector fuelled by an expansionary fiscal policy. Nevertheless, sectors that are likely to experience the greatest impact are those with the highest credit to their respective GDPs (Figure 36), with construction being one of the sectors close to reaching capacity constraints. Our projections for the Saudi policy repo and reverse repo rates by the end of 2015 are 2.75 percent, and 1 percent respectively.
The sluggish global economic recovery and falling import costs due to a strengthening US dollar means that risks of external inflationary pressure in the Kingdom are firmly on the downside, with an interest rate hike on the horizon likely to put further downward pressure on prices. However, the main sources of inflation should continue to be food prices and housing. Food accounts for 22 percent of the total basket of goods and services that make up the Kingdom’s Consumer Price Index (CPI). The Slow progress in government housing initiatives means that the shortage in supply of homes should persist through 2015, and thus continue to put upward pressure on home prices and rents. Overall, we expect muted inflationary pressures leading an average headline inflation rate of 2.6 in 2015 (Figure 37).
In 2015, we expect a slower increase in credit and money supply growth, mainly due to a psychological response to a number of domestic and external factors. The broader economic factors – mainly lower oil prices and the prospect of government deficits– are likely to play a role in the cooling off of domestic economic demand and activity. We believe that higher interest rates will not have a major implication on credit growth given the low pass-through effect.
About Jadwa Investment
Jadwa Investment is a Saudi Closed Joint Stock Company with headquarters in Riyadh.
The company was incorporated on August 21, 2006, when the Saudi Arabian Capital Markets Authority (CMA) granted Jadwa all 5 licenses to operate as a full service Shariah-compliant investment bank in the Kingdom under the license number 37-6034.
Jadwa offers wide-ranging investment services that support both individual as well as corporate financial goals. With a proven track record in asset management, financial advisory, mergers and acquisitions, and researched brokerage, Jadwa is a comprehensive financial services firm.
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We strive to deliver the highest levels of client service, and are focused on creating value for our clients, whether that be generating alpha for investors in our award-winning funds, or helping our corporate clients in executing complex corporate finance transactions.
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