Saudi strength set to drive regional recovery

The GCC's largest economy shows signs of returning good health as key credit and monetary figures improve. That should provide a stimulus for its neighbours.

Consumer spending is on the rise in the kingdom in what is seen as a good sign for the Gulf.

As the second half of the year unfolds, the contrasting performances of the region's economies are becoming more discernible. Most striking are the stirrings of a recovery in the GCC's largest economy Saudi Arabia, which carries implications as well as some lessons for the rest of the GCC.

The latest monthly bulletin from the Saudi Arabian Monetary Agency (SAMA) showed that key monetary and credit variables are recovering in contrast to the largely dormant situation prevailing in the rest of the GCC. Admittedly Qatar still has the strongest money supply growth in the region by some way with 24 per cent in June compared with the same month last year but this is to do with the relatively unique circumstances there related to the development of the natural gas sector.

The latest SAMA monthly bulletin for June showed that the broadest M3 money supply measure (cash and all forms of deposits) in Saudi Arabia rose 3.4 per cent compared with the same period last year. This was up from 2.3 per cent in May and broke eight consecutive months of annual declines going back to September. Narrower measures of M2 and M1 money growth were even more impressive at 6.9 per cent and 21 per cent, respectively, for the same period even though foreign asset purchases levelled off slightly.

The monetary base, or the stock of money in the economy, also rose by 6.7 per cent in June compared with the same month last year. Although the rise in M3 is still relatively modest, the upturn is an indication that economic activity in Saudi Arabia is picking up. Saudi inflation, meanwhile, was up 5.5 per cent in June compared with the same period last year, a far cry from the situation that prevails in the rest of the region, but still contained enough to prohibit a pre-emptive monetary policy tightening by the central bank.

By contrast, inflation in the UAE is running at 1 per cent, in Kuwait it is 2.8 per cent, Oman 3.1 per cent, Bahrain 2.3 per cent and Qatar still has deflation of minus 2.8 per cent. As a consequence of such contrasting inflation rates monetary policy is far more expansionary in Saudi Arabia than it is elsewhere in the Gulf. As interest rates across the Gulf, except in Kuwait, are anchored by their currency pegs to the US dollar market interest rates are, for the most part, close to central bank policy rates and accordingly much lower than the rates of inflation.

Such "negative real interest rates" are appropriate when economies are seeking to grow, as they are today, because the interest rates charged by banks provide no disincentive to borrow money. However, in practice this structure of negative real rates is not uniform across the region. In the UAE, for example, the relationship between interest rates charged by banks and the policy rates set by the Central Bank have diverged over the past year, reflecting the legacy of past leverage in the banking system going back to the boom years. Banking sectors in other countries are similarly hampered by property excesses to varying extents, something Saudi Arabia largely avoided.

In the UAE's case, real interest rates are positive with nominal rates higher than inflation, thereby discouraging businesses and consumers from borrowing. Whereas three-month real deposit rates are now minus 5 per cent in Saudi Arabia, in the UAE they are more like plus 2 per cent. As a result the liquidity that has been pumped into the UAE financial system by the authorities is still not circulating properly through the broader economy and credit growth remains lacklustre.

The latest bulletin released by the UAE Central Bank showed credit growth is still not returning. Loan growth remains stuck at 3.3 per cent in June compared with the same period last year, with deposit growth even lower at 2.4 per cent. The picture does not appear to be much better in Saudi Arabia with private-sector bank credit also rising by 3 per cent annually in June, unchanged from May and still a long way from the double-digit levels of 2007 and 2008. However, with the Saudi banks having healthier loan-deposit ratios of 80.6 per cent, the lowest in the region, compared with 100-per-cent-plus in the UAE and elsewhere, the scope would seem to be greater for private credit growth to recover faster and for the kingdom, ultimately, to lead the region's recovery.

Also, the relatively subdued private-sector credit situation does not reflect the full extent of economic activity in Saudi with much of the activity there reflecting robust public-sector spending by the government. Oil prices averaging US$75 per barrel provide a strong fiscal backstop, allowing the government to continue spending on public works and infrastructure programmes while at the same time rebuilding its budget surplus.

The finance ministry announced that the Saudi government approved contracts for 1,420 projects through the first half of this year worth 71.5 billion Saudi riyals (Dh70.03bn), with the majority of those being construction developments. In April, plans were announced to develop six industrial cities to help the economy diversify away from oil dependence and to create jobs to address the needs of its rapidly growing youth population. SAMA has also been able to replenish its stock of foreign assets in recent months as a result of the rebound in global oil prices, gaining $35.87bn (Dh131.76bn) from the end of last year to $414.9bn at the end of June.

In terms of the translation of monetary trends into proper economic activity, the evidence is still relatively limited in terms of hard data (a common problem across the region) but Saudi Arabia does publish relatively up-to-date point-of-sales transactions data that do give some sense of consumer spending trends in the kingdom. SAMA reported these transactions climbed by 4.4 per cent in June compared with the previous month, following an 8.3 per cent advance in May compared with April. Sales jumped to 6.54bn riyals up from 6.26bn riyals in May, while the number of transactions rose 1.1 per cent in June after a 5.9 per cent gain in May.

On an annual basis, point-of-sale transactions soared 43.6 per cent in value and 34.1 per cent in volume, testifying to the improvement in consumer confidence during the past year. When combined with strengthening external demand for its oil products, it seems increasingly likely that the largest economy in the region will see GDP grow by a respectable 4 per cent this year, rising to 5 per cent next year. After it slowed markedly last year, in common with the rest of the region, the omens are appearing increasingly favourable for the kingdom to develop some positive momentum and at a hefty 42 per cent of regional GDP this momentum should serve to pull the rest of the GCC higher as well.

Tim Fox is the chief economist at Emirates NBD and this piece is taken from his "Global & Regional Monthly" publication