Saudi Arabia: Economic boom set to continue

After an exceptional year in 2005, Saudi Arabia's economic position is forecast to remain strong in 2006. According to preliminary data, real GDP growth hit 6.5% in 2005, with both the fiscal and current account surpluses reaching record highs and annual average inflation remaining low at 0.4%. Highlighting Saudi Arabia's strengthened external position, S&P updated the kingdom's long-term foreign currency sovereign currency rating to 'A+' from 'A' in April 2006. A higher average oil price in 2006 will ensure the economic performance remains buoyant, alongside increased government spending and investments, although growth is expected to slow moderately owing to the strong base effect, a lower marginal increase in the oil price and higher imports.

The government has announced an expansionary budget for 2006, with spending planned to increase by 19.6% from the 2005 budget. Although this is 1.8% lower than actual spending in 2005, we expect the government to exceed budgeted spending (which is usual for Saudi Arabia). Furthermore, the nearly 20% increase in the 2006 budget is much higher than the planned spending rises in previous budgets, suggesting the actual expenditure will be substantially higher. The main areas to benefit from higher spending include social development (including education and healthcare) and infrastructure. Reflecting these priorities, 26% of the budgeted expenditure is directed towards education and human resource development, a positive development in terms of diversification efforts.

The budget surplus is forecast to increase marginally in 2006. However, this will be limited by the increase in government spending. The budget is based on a conservative oil price of USD 35pb (compared to our forecast of USD 60pb for Brent) and we expect the surplus to be substantially above the forecast of SAR 55 billion in the budget. We forecast a budget surplus of 19.0% of GDP, up from 18.6% in the previous year.

The increase in government spending will continue to add a strong fiscal stimulus to the economy (along with the high oil price), supporting both business and consumer confidence. Furthermore, increased investment and consumption in the economy will result in continued buoyant results for the Saudi corporate sector and will support private sector growth. Private demand in the economy will also be aided by the continued expansion of consumer bank lending, albeit at a weaker rate (the central bank issued tighter rules for personal lending in November 2005).

However, an area of risk has been the fall in the stock market; the index dropped almost a third in February and March and again fell in April. Many Saudis borrowed from the banking sector and invested their savings in the domestic stock market. The strong performance of the index had increased the wealth effect and buoyed domestic demand. However, this risk is partly mitigated by the fact that at the time of writing the index was at the same level as October 2005 and the government has introduced a number of measures to improve sentiment.

The main driver of growth going forward will be investment as a number of mega projects get under way. Capital spending will be boosted by private and foreign involvement in the development of the country's hydrocarbon and power and water sectors. With the strong population growth rate, there is an emphasis to upgrade the infrastructure of the country, such as the building ten independent water and power plants by 2016, with an investment outlay of USD 16 billion.

Infrastructure improvement is also needed to attract FDI, which is crucial for increasing employment opportunities for the population. Other plans include the development of the King Abdullah City, with investment of USD 26.7bn in a huge new residential, industrial and services development to be located close to Jeddah. Work on the development started in December 2005.
Furthermore, government owned Saudi Aramco has announced a number of initiatives ranging from new upstream oil and gas projects to expanding refining capacity. Capital investment in the Kingdom's downstream hydrocarbon sectors alone is expected to reach more than USD 94bn in the five years to 2009. Work is already underway on a number of new oil field projects (which are expected to add some 2.5mbpd capacity by 2009) and Saudi Aramco is in the process of contracting two major new refineries. The refineries will each have a refining capacity of 400,000 bpd.

Despite the strong oil price, the government has forged ahead with its economic reform programme. This culminated in Saudi Arabia joining the WTO in December 2005. Membership to the body will have marked impact on the economy. Domestically, the trade deal will promote the liberalisation process via the opening up of sectors, and increase transparency and predictability in the commercial environment; these factors will support the investment environment. However, competition in the domestic market will increase, as sectors are opened and measures to protect domestic producers are removed. Saudi companies will have to use the transition period improve their productive efficiency to compete with greater international competition.

One key area of the economy that will benefit from the WTO agreement is the petrochemical sector. Positively for Saudi Arabia, the agreement confirmed Saudi Arabia's right to retain low feedstock prices on the grounds that its hydrocarbon resources are a natural advantage and not classed as a subsidy. The Saudi Basic Industries Corporation (Sabic) plans to raise its output of petrochemicals and other products to 51m tonnes in 2006 (from 43m tonnes in 2004) as part of an expansion to 60m tonnes by 2008.

The economic reform program is set to continue in 2006; in March the government Supreme Economic Council (SEC) approved the privatisation of Saudi Arabian Airlines. The carrier had already completed two of its three-step privatisation plan in anticipation of getting the go-ahead. The privatisation programme will help of increase the role of the private sector and deepen capital markets.

The security situation improved in 2005 as a result of government crackdowns against militants and the strong popularity of King Abdullah Ibn Abdulaziz Al Saud's accession to the throne in June. Al-Qaeda's crude attempted attack on the Abqaiq oil and gas processing plant at end-February, highlights the current substantially weakened position of the jihadists and their logistical capability, with the majority of top militants killed. In addition, Saudi Aramco and the government have also greatly increased security around oil facilities. However, the development reiterates the organisations aim to focus the oil sector as a way of targeting the government and the US. Although al-Qaeda in the kingdom is in a state of disarray, the organisation has been very adaptive in the past. That said, while the threat of further terrorist attacks remains, this is unlikely to undermine neither the economic recovery nor the government's commitment to reform.