Saudi Arabia: Economic boom set to continue (page 1 of 2)

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.