Kingdom's Non-oil Private Sector Growth Will Accelerate in 2017

by shariff mohammed | May 03, 2017


A year-on-year increase in total budgeted spending has been announced for 2017, from SR840 billion in 2016 to SR890 billion in 2017. However, looking at the SR930 billion in actual spending from 2016, this represents a decline of SR40 billion. Nevertheless, 2017 should see a substantially lower deficit of SR198 billion (compared with SR326 billion in 2016’s budget). This higher level of budgeted spending continues to highlight the government’s willingness and ability to support the economy, according to Jadwa Research's report on The Saudi Economy in 2017

According to the figures released by government agencies the Saudi economy to continue slowing in 2017, dragged down by negative growth in the oil sector. Non-oil sector growth should rebound but remain subdued. Annual growth in the oil sector will turn negative in 2017, with average oil output expected to decline slightly. This comes as the Kingdom complies with the OPEC production cuts during the first half of 2017. Growth in the non-oil private sector will accelerate from 25-year lows but remain relatively subdued, as the partial impact of fiscal balancing measures is offset by a full-fledged focus by the government on restructuring the private sector support mechanism. As oil prices rebound, the current account deficit will shrink considerably, while the fiscal deficit will fall to single digits. We believe the government will continue to comply with targets specified in the Fiscal Balance Program (FBP 2020), allowing for a smooth adjustment in the fiscal budget while cushioning the impact on growth in the non-oil private sector.

Oil sector growth is expected to fall marginally by 0.3 percent in 2017 compared with growth of 3.4 percent in 2016. The negative growth in the oil sector will be due to a marginal fall in oil production as the Kingdom complies with production cuts during the first half of 2017. Growth in the non-oil private sector is expected to accelerate from 0.1 percent, the lowest since 1990, reaching 1 percent in 2017. We expect a growth of 7.5 percent in the non-oil mining sector which makes it the fastest growing sector in the Kingdom in 2017. The sector is expected to benefit from significant additions. Amongst these projects is the $96 billion phosphate joint venture between SABIC, Ma’aden, and Mosaic. Upon completion in 2017, the project will be one of the world’s largest integrated phosphate complexes. Within the non-oil private economy, ownership of dwellings is likely to also be among the fastest growing sectors, benefiting primarily from major initiatives to promote residential real estate development. Along with government spending, corporate lending and, to a lesser extent, domestic consumption will be the primary drivers of growth in the private sector.

 

A year-on-year increase in total budgeted spending has been announced for 2017, from SR840 billion in 2016 to SR890 billion in 2017. However, looking at the SR930 billion in actual spending from 2016, this represents a decline of SR40 billion. Nevertheless, 2017 should see a substantially lower deficit of SR198 billion (compared with SR326 billion in 2016’s budget). This higher level of budgeted spending continues to highlight the government’s willingness and ability to support the economy. At the same time, a lower deficit reflects the government’s intent to become more efficient and prudent in protecting its fiscal buffers.

According to the report the total spending as supportive to the non-oil economy and it remains important since international and regional events have the potential to damage investment sentiment. We expect the gap between budgeted and actual expenditures to be eliminated, leading to a deficit of SR162 billion (6.2 percent of GDP). The closing of the  overspending gap reflects an improvement in the efficiency of public spending through the Spending Rationalization Office. This represents an important part of the Kingdom's FBP. The financing of the deficit will continue to be a combination of debt issuance and a drawdown of government deposits. This financing strategy has also reduced the extent of foreign reserve depletion, though the deficits in the current account and non-reserve financial account will continue to be pressure points on foreign reserves.

The main risks to our forecast are from the external environment. A significant slowdown in global growth and geopolitical tensions constitute key risks. A sustained period of lower oil prices would lead to a higher-than-forecasted fiscal deficit.  regional political uncertainty will continue to cast a further shadow over the economy and any heightening of tensions will hit businesses and consumer confidence. Any delays of serious reform, particularly those that are the most growth-enhancing areas of the National Transformation Program (NTP 2020) constitute a downside risk to a thriving private sector. Other risks include further delays in government payments o the private sector, which may consequently impact sentiment, capital inflows, and business and household confidence, though this is not likely.


Global Economic Outlook

Global economic growth has been steady, but unremarkable in the last few years, with 2017 growth rates not expected to show a huge improvement. According to International Monetary Fund (IMF) data, global GDP averaged 3.3 percent year-on-year, between 2012 and 2015, and is expected at 3.1 percent in 2016, improving mildly to 3.4 percent in 2017. According to the same IMF forecasts, the US, as has been the case in recent years, will be the major proponent of growth amongst the advanced economies. Canada and the Euro zone are expected to show more consistent, if somewhat slower growth. Meanwhile, the UK joins Japan as the weaker element amongst the major advanced economies. Emerging market (EM) growth in 2017 is expected to improve from 4.1 percent in 2016, to 4.5 percent in 2017, but will still be sizably slower than the 2010-15 average of 5.4 percent. Whilst the Chinese economy is expected to slow, this will be a more gradual decline. On a more positive note, India is expected to pick up the mantle of fastest growing major economy for the next few years.

As the IMF highlighted in the recently published World Economic Outlook (WEO), the above forecasts are subject to significant uncertainty. The most obvious risk is tied to the policy stance of the new US presidency, and with it, a potential knock-on effect on both the domestic and international economy. In addition, uncertainty tied to negotiations over the UK’s decision to leave the European Union (EU), not only points to potentially slower economic growth, but also runs the risk of increasing political discord, which could produce a full blown economic crisis in Europe, with global implications.


Emerging markets:

Latest IMF forecasts point to an improvement in EM growth in 2017 for the second consecutive year. Growth is expected to rise to 4.5 percent, compared with 4 and 4.1 percent in 2015 and 2016. The jump in 2017 year-on-year growth is due to an improvement from Russia and the Latin American region, both of which are expected to return to positive growth rates in 2017. Although this is an evident improvement for EMs, a number of risks remain which could pull down overall growth. Mounting debt levels remain a concern, and with expected acceleration in US interest rates in the year ahead, EMs could see a rise in debt servicing/borrowing costs or increased capital outflows. Also, although China’s economic situation stabilized in 2016, there are still major risks ahead as the government attempts to prevent a bubble forming in the property sector.

EM debt has grown rapidly in the last few years, with total external debt of 41 EM countries rising from $4.5 trillion in 2008 to $7 trillion at the end of 2016. During this period, EMs have also witnessed healthy growth rates, but whilst global economic growth rates have moderated recently, total external debt has not. In the context of further hikes in US interest rates during 2017, the concern is that many EMs may also be forced to raise interest rates in order to prevent large capital outflows. In November 2016, just prior to the US Fed’s fund rate hike, net capital outflows from EMs reached their third largest monthly total since the global financial crisis, with around $448 billion leaving ten EM countries in the year-to- November 2016 (Figure 6). If EMs do raise interest rates, this will inevitably push up borrowing costs across all sectors, which could be of particular concern to the non-financial corporate sector, where debt levels have risen rapidly in the last few years.

Chinese concerns remain:

The prospect of a sharp slowdown after more than a decade of rapid growth in China has receded and the economy appears to be on a more stable footing. GDP is expected to reach 6.5 percent in 2017, down marginally from 6.7 in 2016, according to the IMF. China’s foreign reserves currently amount to a massive $3.5 trillion allowing the government to maintain fiscal stimulus and infrastructure expenditure to stimulate the economy in the short-term. That said, risks still remain, with specific concerns related to the emergence of a bubble in the real estate sector. Recent data shows that property prices in many of the big cities in China have accelerated in the last year. For example, both Beijing and Shanghai’s residential property prices rose by around 20 percent year-on-year in Q3 2016, versus an average of 1.8 percent in the capital cities of five emerging Asian countries. The steep rise in property prices has been bought about by a number of factors, including; the lack of urban land made available for development, Chinese capital controls which make it difficult for citizens to invest abroad, thereby encouraging property acquisitions as investments, and the existence of low retail deposit rates by banks. As result of all these factors, sales of residential properties have followed an upward trend since 2010, and so too have household debt levels. Although the government has recently made buying a property much harder, by raising the percentage of cash down-payments and cracking down on shadow bank lending, there is still a risk of a stock market type correction occurring in the property market. Such a correction in the sector would be far more detrimental to the economy than the stock market equivalent, since construction, and associated sectors, are estimated to contribute around 15 percent per annum to China’s GDP.


The Oil Market in 2017

The first few weeks of the oil market in 2017 are a marked contrast to a year ago. In January 2016, intense competition amongst OPEC members, massive global oversupply, and the anticipated return of Iranian crude oil exports, following the lifting of sanctions, saw Brent oil prices drop to multi-year lows. In January 2017, oil prices are much more stable, at around $55 per barrel (pb), with little deviation from this level in the last two months. This stability in prices is mainly due to the coordinated action by OPEC and some non-OPEC members to cut 1.8 mbpd, or 2 percent of global oil supply, during the first half of 2017. Early indicators suggest that key OPEC producers are complying with cuts. Preliminary crude oil export data for Saudi, Iran, Iraq, Qatar, UAE and Kuwait, which account for 75 percent of total OPEC output, are down by a 9 percent month-on-month.



Assuming that cuts at agreed levels continue until mid-2017, we would expect to see oil markets balancing more aggressively by Q2 2017, when the deal expires. In fact, oil markets could fall into deficit by 200 thousand barrels per day (tbpd) in Q2 2017, compared with a surplus of 1.5 million barrels per day (mbpd) without cuts. This forecast is, however, based on discounting two major risks which could delay balancing. The first of these risks relates to OPEC. Whilst the above preliminary January data shows genuine commitment from key OPEC producers, non-compliance remains a big risk, with the risk growing the longer the cuts go on. A crucial test in OPEC compliance is likely to come around March/April time, when global oil prices tend to rise following a period of refinery maintenance. The danger is that as prices rise, the economic incentive to cheat, especially for financially troubled producers such as Iraq and Venezuela, will become more appealing. Any production above agreed OPEC ceilings is likely to bring about reciprocal action from both OPEC and non-OPEC producers, resulting in higher output all round.

Another equally significant risk is present through a swift rebound in US oil production. The rise in oil prices following the OPEC agreement saw rises in key oil indicators from the US as well. Aside from a rebound in the oil rig count, US producers have also taken out a record number of contracts on short positions against the US crude oil benchmark WTI, thereby protecting themselves against a drop in prices. Consequently, US oil production has seen sizable revisions in recent months. According to the latest US Energy Information Agency’s (EIA) Short-Term Energy Outlook report, US oil production is forecasted to be 630 tbpd higher than its January 2016 forecast, which amounts to roughly half of the proposed OPEC cut of 1.2 mbpd. More significantly, even if OPEC fails to fully implement its own cuts, and oil prices consequently decline, US producers will still be able to expand output since they have locked in current prices levels for at least six months through hedges. In this context, we do not see a sustained rise in oil prices beyond current levels, and we have therefore stuck to our Brent oil forecast of $55 pb in 2017.


Saudi Economic Growth

In 2016, the Saudi economy expanded by 1.4 percent, slowing notably from 4.1 percent in 2015. This represents the slowest growth rate since 2002, when overall GDP expanded by 0.1 percent. A smaller increase in oil production, by 2.4 percent, meant a slower oil sector growth at 3.4 percent. Meanwhile, annual growth in the nonoil private sector was nearly flat at 0.1 percent. Based on our outlook for the current year, we forecast overall economic growth to slow further to 0.2 percent in 2017, owing to negative growth in the oil sector, while non-oil sector growth should accelerate but remain weak.

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