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BALANCING Modernisation with Tradition.

Summary: Saudi Arabia sits atop a fifth of the world's crude reserves. It is the world's top oil exporter and holds significant dollar assets. It is also home to the biggest Arab stock exchange. The country is ushering in change while preserving its centuries-old traditions

Saudi Arabia is an economic powerhouse. In dollar terms its economy is worth $575 billion (as of the end of last year) according to the Riyadh-based Jadwa Investment, making it the largest economy in the region. Saudi Arabia is also a member of the G20, and the dominant player in OPEC.

THE ECONOMY

The economy expanded 6.8 per cent in 2011 amid soaring oil prices. The International Monetary Fund (IMF) forecasts slower growth this year of 3.6 per cent. Although the country's economy and planning minister is far more confident. Mohammed al-Jasser says the Saudi economy will likely slow to six per cent.

"Of course we're still at the beginning, but the signs... are that it will be six per cent if the indicators remain as they now are," Jasser told reporters in Riyadh in March.

Although global energy markets are still buoyant, with crude breaking $128 a barrel earlier this year, economic growth is slowing in China - Saudi Arabia's largest customer.

"If it becomes pervasive then it will affect the global economy and that could affect the demand for our oil and products, but a soft landing seems to be in the offing in China so I'm not worried," he said.

OIL WEALTH

On a recent visit to Qatar, Saudi Oil Minister, Ali al-Naimi, told reporters that the Kingdom was producing 9.9 million barrels a day, about three- quarters of which is exported.

Naimi said that Saudi Arabia could boost output to 12.5 million barrels a day to meet demand but that customers are not interested in buying more than they are now.

"We ask the customers, 'Do you need more?' And invariably the answer is, 'No, thank you,' he was quoted saying.

SUPPLY CONCERNS

Citi, a global financial service company, says concerns regarding global supply continue to exert upward pressure on oil prices, "prompting Saudi Arabia to maintain its highest level of production in over 30 years as the Kingdom repeatedly seeks to reassure markets that it will compensate for any 'real or perceived' shortfalls in supply".

"Although the Kingdom has repeatedly stated its view that physical markets remain well-supplied, and that it is fear and speculation over future supply that is driving prices higher, moves are reportedly afoot to boost supply in the near term in an effort to reduce prices."

A report by Farouk Soussa, Citi's Chief Economist for the Middle East, says it has been widely reported that Saudi Arabia has hired a fleet of tankers to supply up to 22 million barrels of oil to the US, far more than usual. "The EIA said that US imports of Saudi crude surged 38 per cent in the first 10 weeks of 2012. The intent is clearly to ease any perceived supply shortfall, rebuild inventories, and drive down prices."

This has prompted Citi to raise its GDP growth forecast to 7.1 per cent in 2012, from 5.9 per cent previously.

THE ADVANTAGE OF CHAOS

As Soussa points out in his Middle East Macro Monthly Report dated March 29, chaos can have its advantages.

He says that over the past 18 months or so, global economic uncertainties and massive regional socio-political instability have been a serious drag on investor sentiment in the Middle East region as a whole. "The negative news flow has meant that Gulf risk assets have underperformed non-regional peers. We believe this is likely to continue to be the case so long as politics dominate the headlines."

He says it is important to remember that for some of the same reasons, global oil prices have been soaring and that this is resulting in a massive windfall to the Middle East oil exporters of the Gulf (GCC + Iraq). This is generating record domestic spending, investment and economic growth. "Fundamentals continue to strengthen, not just cyclically but structurally as well, and the disconnect with market performance is deepening."

SEA OF CHANGE

Oxford Business Group's (OBG) latest report on Saudi Arabia says the growing population in the country (27.1 million) has increased the need for the government to diversify the economy and to create more employment opportunities for the future generations. "By looking for alternative options for development, the government is preparing for a future when oil export earnings might not contribute as much to GDP as they have in the past."

Saudi Arabia remains arguably the most important oil producer in the world, it goes on to say. The country contains around 260 billion barrels of known oil reserves. "The Kingdom has managed to accumulate large cash reserves due to years of high oil prices. This has allowed it to continue its economic diversification programme and industrial development even during recessionary years. Recently the mining sector has increasingly been viewed as an area of future growth."

The report adds that due to large reserves of gold, silver, zinc, copper and industrial minerals, especially in the eastern mountains and the north-eastern regions of the country, "mining is expected to become the third industrial pillar of the economy, after energy and petrochemicals."

BANKING

KSA is also home to the second largest sector in the region: Banking. OBG points out the main themes driving the sector:

- Moving back toward a lending posture

- A growing emphasis on long-term loans

- Authorities are working to develop new mortgage law

The report says to remedy the absence of a legal framework, the authorities have been working on the development of a mortgage law, "which is really five separate laws covering different procedures like registration and enforcement".

However, the practicalities of enforcing such a law in a society where foreclosure is still widely considered anathema, have led to delays in final approval. "Still, financial industry figures seem to be united in viewing mortgaging as the next major growth market for the sector," the report says.

Saudi investment bank NCB Capital says despite being the most spoken about legislation in Saudi Arabia, "few developments have been made over introducing the law".

"We continue to believe that even if the mortgage law is passed, it will not have an immediate impact. A key concern is the limited availability of affordable housing and the wide income disparity."

According to an analysis by Credit Suisse published in June last year, mortgages are ultimately expected to add 17-20 per cent to the valuations of Saudi banks, with most of the market divided between Al Rajhi Bank, Arab National Bank and Riyad Bank.

In his monthly report, Citi's Farouk Soussa says the banking sector capacity to provide mortgage lending is "strong".

"2011 saw deposit growth of 12 per cent, outstripping loan growth which moderated to eight per cent by year end. The private sector loans to deposits ratio came down as a result, to around 77 per cent, well below the regulatory limit of 85 per cent and near historical lows," he adds.

Aside from the banking sector, liquidity in the Saudi market from high oil receipts is very likely to be funneled through a proliferation of specialised mortgage lenders once the mortgage law is finally approved, he points out.

FOCUS ON RETAIL LENDING

NCB Capital says it expects strong loan growth to continue this year as banks focus on retail lending. "In our view, government spending and bonus salaries in 2011 will have a 'recurring effect' on balance sheet growth in 2012."

A report written by Farouk Miha, says, "Overall, we expect loan growth of 12.4 per cent in 2012 led by a retail loan growth of 16 per cent."

He adds that government spending will drive economic activity and corporate lending, "We estimate 2012 government expenditures 13 per cent higher than budgeted on revenues of SAR 930 billion ($248 billion), leading to a budget surplus of SAR 150 billion ($40 billion), or 7.1 per cent of GDP."

The continuing expansionary fiscal policy, coupled with low-interest rates should maintain healthy economic growth and boost domestic liquidity, Miha's report states. "We believe the corporate sector will benefit from continuing government support and estimate a corporate loan growth of 11 per cent."

NCB Capital says its top picks are "the established players" such as Al Rajhi, Samba and RIBL due to their attractive valuations and their ability to take advantage of the opportunity in the retail segment. "These names also stand to benefit most from the strong equity market activity," it says.

"We expect lending growth to continue in 2012 with abundant opportunities following a government spending spree initiated in early 2011 which, according to most banks we spoke to, will have a recurringeffect on balance sheet growth. Coupled with sound economic fundamentals, growing population, and elevated oil prices, we expect bank lending to grow 12.4 per cent this year driven by retail lending growth of 16.4 per cent and corporate loan book growth of 11 per cent," Miha adds.

"Overall, the government's commitment to expand economic activity, develop physical infrastructure and enhance human capital formation should lead to increased demand for banking services in otherwise underpenetrated areas. It must be stressed that over 50 per cent of Saudi population are under the age of 30; a burgeoning young population will see their demand for banking services increase as underdeveloped regions 'catch up' with the three main cities of the Kingdom," he concludes.

A QUESTION OF SUCCESSION

Succession is currently a problem in the House of Saud. The Al Saud family has reigned over Saudi Arabia for centuries (it has held intermittent control since the mid-1700s). But changes in the royal line last year following the death of Crown Prince Sultan in October raised questions about the pace and direction of gradual economic and social reforms aimed at reconciling conservative Islamic traditions with the needs of the young population. Interior Minister Prince Nayef was promoted to King Abdullah's heir, but he is two years off 80 himself.

REFORMS

The King has sought to create jobs for Saudis by restricting foreign workers and liberalising the economy and in a bid to combat Islamist militancy; he has reduced clerical control over education.

Youth unemployment helped drive Arab uprisings elsewhere, but the Kingdom has avoided serious unrest.

Perhaps handout of $110 billion in social spending plans helped.

Economic reform, the area of most progress in the early years of Abdullah's reign, has also slowed. However, changes to the Kingdom's economic team in December may reinvigorate the process. Former Central Bank Governor Muhammad al-Jasser became Economy and Planning Minister. He was replaced by Fahad al-Mubarak, who may give the Central Bank a more market-oriented focus, given his private-sector background.

LAGARDE WEIGHS IN

On a recent visit to Saudi Arabia, IMF Managing Director Christine Lagarde said, "The Saudi economy has navigated the global financial crisis well. Strong economic policies in the preceding years, together with prudent supervision of the financial sector, allowed the government to boost expenditure to support demand during the crisis, and to limit the direct impact on the financial system. Saudi Arabia's policies had an important positive impact on the region and the global economy."

However, challenges still remain, she said. "Access to housing and job creation are clear priorities."

"Accelerating private-sector growth that can generate employment opportunities for Saudi nationals entering the labour market will be key," she added.

NITAQAT PROGRAMME

Citi says the government 'Nitaqat programme' will make a difference to local employment.

"We believe the latest drive to promote local employment (Nitaqat) will achieve significantly better results than previous attempts, given the sense of urgency the Arab unrest has given the question of employment throughout the Arab world."

Reports suggest that companies in Saudi Arabia are increasing their local hiring aggressively, often at the cost of expatriate workers. "Some malpractice is also being reported in the local press, including ghost-hiring, but the programme appears to be having an immediate effect on Saudi employment rates. As Saudis' salaries are higher than expatriates', this will have a dual impact on inflation," Soussa says.

1) It will raise the cost base of local businesses

2) It will support greater domestic demand, particularly as the local population's propensity to save is likely to be lower than that of the expat community

He adds that, "The implementation of unemployment benefits from the end of last year will give a further boost to domestic demand, in our view, and add to inflationary pressures."

According to government statistics, youth unemployment (ages 20-24) stands at almost 40 per cent.

RETURN OF INVESTOR CONFIDENCE

The Saudi stock market has had a strong first quarter. The Tadawul continues to post solid gains (up more than 20 per cent as of the end of March) as average daily volumes doubled. In that period it crossed 7,000 points for the first time since September 2008. Citi believes the Tadawul index has been benefiting from Saudi Arabia's strong economic potential and as well as investor expectations that the Saudi stock market will open to foreign investors this year.

Currently, the stock market is only accessible through total return swaps with local counterparts. "Reports have been emerging in recent months regarding plans by the Capital Markets Authority to allow foreign direct holdings for the first time. A move that is bound to boost the market as new liquidity rushes in", the report concludes. nBME

POPULATION (2010)

27.1 million

70 per cent nationals

30 per cent foreigners

POPULATION GROWTH (2006-2010)

Average annual growth rate: 3.2 per cent (Estimate)

Source: Central Department of Statistics (CDSI)

2012 CPI Financial. All rights reserved.

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Publication:Banker Middle East
Geographic Code:7SAUD
Date:Apr 30, 2012
Words:2292
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