Saudi growth to be ‘driven’ by non-oil sector over 2020-2022

Budget deficit expected to improve to 4.6% of GDP in 2019

After bottoming out in 2016 at 0.2%, non-oil growth improved gradually to reach 2.5% y/y in 1H2019, helped in part by expansive public spending including on the government’s Private Sector Stimulus Plan. We expect this trend to continue, forecasting non-oil growth at 2.2% to 2.5% over 2020-2022. Our assumption that government spending will not be on an increasing trend in the coming years (which is also indicated in the recently-released official 2020 budget) may cap non-oil growth rates.

After contracting for three consecutive years, the construction sector is expanding again on the back of several large-size projects in Riyadh, as evidenced by a pick-up in project awards in 2019 and double-digit annual increases in cement sales since June 2019. Another growth driver is mortgage financing, which had soared by 33% y/y as of end-September. Other positive indicators are a steady double-digit y/y increase in new private sector import letters of credit (LCs) since mid-2019 and a PMI (58.3 in November) that is the highest in more than four years.

On the downside, manufacturing has exhibited the weakest activity in many years, with negative growth in 1H2019. In addition, corporate credit growth remained muted at 1% y/y by the end of September. For non-oil growth to pick up from current levels, it is vital to see an improvement in corporate credit.

As for the oil sector, although OPEC+ deepened the oil production cuts at its recent December meeting,

KSA still has some space to gradually increase production towards its new OPEC+ quota, given its current over-compliance. Hence, we forecast slightly positive oil GDP growth in 2020 & beyond, following the expected 2.9% drop in 2019; we project an average headline growth of 2% over the forecast horizon. After consumer prices witnessed deflation in 2019 (-1.2% expected), mainly on falling housing rents, we forecast a normalization in inflation going forward, to around 1.6%-1.7%, as the non-oil economy expands, energy subsidies are pared back again and as housing rents pick up. We expect the broadly flat government spending, moderate non-oil growth, & the relatively high but falling unemployment rate are factors that will restrain runaway inflation.

Balancing the budget by 2023 looks unlikely

The budget deficit is expected to improve to 4.6% of GDP in 2019 before deteriorating to 7% in 2020 mainly on lower oil revenues. Our budget deficit forecast for 2020 is higher than budgeted by the government (6.4% of GDP) mainly driven by our slighty higher government spending assumption. Beyond 2020, we expect moderate revenue growth coupled with a broadly flat spending to improve the budget deficit to 5.2% of GDP in 2022, but it is unlikely that the budget will be balanced by 2023 as targeted in the revised Fiscal Balance Program.

We also believe that the authorities’ self-imposed 30% debt/GDP ceiling may need to be relaxed; government debt is forecast to reach around 33% of GDP in 2022. Going forward, the official budget will probably understate the level of total government spending since the Public Investment Fund is expected to play an increasingly larger role in the domestic economy. Aramco’s IPO proceeds ($25.6 billion) and possible additional stake sales in the future will support higher government spending.

Current account (CA) is forecast to remain in surplus

After weakening in 2019 on lower oil exports, we forecast the CA to remain positive at around 4%-5% of GDP to 2022. We project higher non-oil exports in the medium term in line with Vision 2030 targets & lower drag from workers’ remittances resulting from continued Saudization policies, which will support the CA. In the broader BOP, while FDI improved somewhat recently, it is still low at 0.5% of GDP in 1H2019. A stronger FDI is crucial for non-oil growth to pick up from current levels.

Geopolitics and oil prices are the main downside risks

The two main downside risks to our Saudi outlook are lower-thanforecast oil prices and a major increase in regional geopolitical risk. While the Saudi economy continues to depend overwhelmingly on oil prices, any major worsening in geopolitics could impact business investment and consumer confidence. Domestically, reform suspension or roll-back is a main downside risk – as is the failure to create more private sector jobs for Saudis. Despite significant numbers of expats leaving the private sector since 2017 there has been no meaningful increase in Saudi private sector employment levels.