Saudi capital market key to powering corporate investments
The Saudi Arabian government is focused on economic reform. Its Vision 2030 plan sets out various paths to diversify away from hydrocarbons via programs, initiatives, and budgetary allocations. This has led to significant project announcements across various corporate sectors.
PIF Is The Main Force Behind Vision 2030
Public Investment Fund (PIF) has US$620 billion of assets under management (AUM; Q1 2022) and is a catalyst for Saudi Arabia’s economic transformation. The fund has identified 13 strategic sectors to prioritize to best support the national economy. These are aerospace and defense; automotive; transport and logistics; food and agriculture; construction and building components and services; entertainment, leisure, and sports; financial services; real estate; utilities and renewables; metals and mining; health care; consumer goods and retail; and telecom, media and technology. To fulfil Vision 2030, PIF and its portfolio companies aim to help grow Saudi Arabia’s annual non-oil GDP by about 7%. PIF’s latest fiveyear strategy is to:
Invest a minimum of US$40 billion annually in domestic projects and investments;
Contribute US$320 billion to non-oil GDP cumulatively through its portfolio companies;
Increase AUM to more than US$1.07 trillion; and
Create 1.8 million direct and indirect jobs by the end of 2025.
Vision 2030 includes several ambitious goals and investment expectations. Its key goals are:
Raising the private sector’s contribution to GDP to 65% (40% currently); Increasing the contribution of FDI to GDP to 5.7% (from 3.8%); Increasing the contribution of non-oil exports to GDP to 50% (from 16%); Reducing the unemployment rate to 7.0% (9.7% as of Q2 2022); and Being among the top 10 competitive economies in the world.
These 2030 targets are ambitious. Even if they are not fully met, we expect the country will make some progress. The productive capacity of the non-oil economy could potentially increase as a result.
The government plans to transform the financial, health care, housing, and infrastructure sectors, among others. It also wants to focus on human capital and sustainability. It launched the National Investment Strategy (NIS) in 2021 to empower investors, offer investment opportunities, provide financing solutions, and enhance competitiveness. The NIS will launch several initiatives over the coming years, with more than Saudi riyal (SAR) 12 trillion to be invested in the national economy during 2021-2030. The Shareek plan to increase private-sector companies’ domestic investments is expected to inject SAR5 trillion; PIF is set to contribute SAR3 trillion; and the remaining SAR4 trillion will likely be generated by investments facilitated by the NIS. The economy will also receive SAR10 trillion of government spending over the next eight-to-10 years and a further SAR5 trillion from private consumption and investment. This brings the total injection to SAR27 trillion (US$7 trillion) in the next decade. The political will to invest remains strong. We anticipate the vast majority of investments will be off the government’s balance sheet and therefore will not weaken its fiscal position (see “Saudi Arabia ‘A-/A-2’ Ratings Affirmed; Outlook Remains Positive On Strong Fiscal And Economic Growth Dynamics,” Sept. 16, 2022). However, we consider that these strategic domestic investments will reduce PIF’s liquid assets.
Large Investments Will Not Immediately Affect Saudi Corporates’ Credit Quality
Investments in various corporate sectors could promote growth and increase business opportunities for companies. But this will not automatically lead to us to assess them as having stronger business risk profiles, a factor in our ratings. To assess an entity’s business risk we look at its profitability and competitive advantages, not just its investments in ambitious projects--which could ultimately prove detrimental to cash flow generation and entail additional operating risks, especially if outside its core business. Similarly, rapid growth in projects that are not or only moderately profitable could increase leverage and weaken cash flows in high capital expenditure (capex) cycles, and weigh negatively on our assessment of a company’s financial risk profile. However, if a company establishes a track record of adhering to sound and transparent financial policies, we could reassess its financial risk profile assuming its credit metrics sustainably improve. We also assess an entity’s liquidity management, transparency of foreign investments, and its risk management including how skilled senior staff are at managing transformational development.
We do not anticipate imminent rating actions on Saudi corporates--as they carve out significant capex budgets over the next two-to-five years--given their healthy balance sheets and strong liquidity. Over time, however, we will reassess our ratings as projects are executed.
Potential rating upside could emerge if these large investments have a positive effect on business trends, improve a company’s EBITDA in a sustainable way, and strengthen its leverage metrics. We will be looking at a company’s ability to take a disciplined approach to project selection, to focus on returns and not only on volumes, and to adapt its risk management frameworks as its business grows. For government-related entities (GREs), the potential for increased support from the government could lead to higher ratings. We currently have three rated GREs on positive outlook in line with our outlook on Saudi Arabia because we expect they would receive various degrees of extraordinary support if in distress (see “Outlooks Revised To Positive On Three Saudi Corporates Following Similar Action On Sovereign; Ratings Affirmed,” March 31, 2022).
Saudi Arabia’s Strong Growth Is Spurring Investment
We anticipate Vision 2030 will drive the fiscal outlook for Saudi Arabia with PIF and other government agencies setting the pace of investment, followed by private local companies.
Investment will likely remain fairly high as a percentage of GDP (gross fixed capital formation was 24% at Q2 2022). Efforts to drive non-oil growth via foreign direct investment (FDI) and mega projects should also support GDP growth. We view the country’s business fundamentals as supportive with relatively high oil prices yielding a revenue windfall and allowing the government the fiscal room to continue its large capex plans (see “S&P Global Ratings Revises Its Oil And Gas Price Assumptions On Supply/Demand Fundamentals,” Nov. 18, 2022).
High oil prices have helped Saudi Arabia’s strong recovery in 2022, but growth will slow in 2023 because of supply cuts agreed under OPEC+. Aside from high oil prices, increased oil production and robust non-oil momentum also helped grow the economy this year. GDP increased for the sixth consecutive quarter, growing 8.6% year-on-year in the third quarter of 2022, according to the flash estimates published by the General Authority for Statistics. Saudi Arabia is set to become one of the world’s fastest-growing large economies in 2022. We expect real GDP growth in excess of 7.0% this year. We estimate a return to fiscal surpluses at 6.3% of GDP in 2022 and 3.5% in 2023. With the Brent oil price expected to average about $100/bbl in 2022 and remain elevated through 2023, we expect the current account to record significant surpluses this year and next. We estimate the current account surplus to reach a very large surplus of 13.7% of GDP in 2022, the highest since 2013. We expect the surplus to moderate to 5.9% on average over 2023-2025 as oil prices taper.
Rising inflation and interest rates haven’t yet made a dent, but would weigh on growth if they linger. Despite the effects of the Russia-Ukraine conflict on global food and fuel prices, inflation in Saudi Arabia is lower than the global average and is forecast to remain under control because of administrative price controls on fuel and food, as well as the peg to the relatively strong U.S. dollar. Following the Fed’s Nov. 2 decision, Saudi Arabia’s central bank raised its repo rate by 75 basis points to 4.50%. We expect interest rates to broadly move in tandem with the Fed’s rates, which we forecast to peak at 4.75%–5.00% by March 2023. The peg to the dollar has historically helped anchor inflation and has upheld the predictability of Saudi Arabia’s monetary arrangements, especially when oil prices have been volatile. We forecast inflation at 2.5% in 2022, before rising to 2.7% in 2023 and averaging 1.9% in 2024-2025. Inflation averaged 2.0% in the first half of 2022 and around 2.9% in the third quarter, led by rises in education, hotels, and food items in the CPI basket. We expect interest rate hikes to affect the private and general household sectors more than government-related activities given expected high but tapering oil prices.
Saudization and women’s participation in the work force present opportunities for economic growth, with new jobs to be created under Vision 2030. The total population was 34.1 million in 2021 (mid-year; according to General Authority for Statistic estimates) of which males accounted for 56.8% of the total population and females 43.2%. We expect the population to expand as the number of Saudi nationals increases and more foreign workers arrive to support construction and infrastructure development. The focus on labor-oriented sectors such as retail, tourism, entertainment, and housing will also create new business and investment opportunities and attract foreign talent. We expect the government to continue its ambitious Vision 2030 diversification program via investment in the non-oil economy; the “Saudization” of the workforce (replacing expatriates with Saudis); increasing female participation in the workforce; improving the business environment; and pursuing socioeconomic liberalization. Reform efforts have given women increased access to the labor market but have struggled to create sufficient jobs for the fast-growing and young population (38% of the population is younger than 35). Despite significant changes in recent years, more than 60% of the female workforce is still outside the labor market and most men are employed by the public sector (according to the Ministry of Economy and Planning: Quarterly Economic Report, Q3, 2022).
Despite Their Strong Capitalization, Saudi Banks Can’t Fund All Vision 2030’s Projects
Saudi banks have contributed significantly to a key Vision 2030 objective--increasing home ownership to 70% by 2030 (60% in 2020). Mortgage lending has been the main engine of growth for Saudi banks over the last few years, with total mortgages hitting SAR503.2 billion as of June 30, 2022, compared with SAR140.3 billion at Dec. 31, 2018. As the market matures and interest rates continue to rise, origination will likely lose momentum in the next 12-24 months. However, as contracts
for Vision 2030 projects are awarded, corporate credit lending should start to contribute more meaningfully to banks’ lending growth. Overall credit growth will moderate relative to 2019-2022 but stay strong at over 10%.
Rapid credit growth, together with weaker deposit creation, resulted in tighter liquidity earlier this year. The central bank reportedly injected SAR50 billion in late June and we expect such support would again be forthcoming if needed (see “SAMA Support For Saudi Banks Eases Near-Term Liquidity Needs,” June 29, 2022). This shows, however, that the banking system alone cannot handle all the financing needs related to Vision 2030. As of June 30, 2022, banks’ loan to deposit ratio (calculated by S&P Global Ratings) reached 100.4%. We expect banks to resort to alternative funding strategies absent significant deployment of oil revenues via the banking sector. Less supportive market conditions mean that access to external funding will be more expensive and divesting from existing fixed-income instruments will crystallize unrealized losses.
Saudi Debt-Capital Markets Have An Important Role
Vision 2030’s investment program continues to drive funding requirements, while the authorities are also pushing to deepen local debt and equity markets and increase FDI. The Saudi Stock Exchange, Tadawul, is the largest equities market in MENA by market capitalization and trading volumes. The 2019 Saudi Aramco IPO was a major step and we have since seen several Saudi entities tap the equities market. This year, as of Nov. 24, 2022, 15 companies have undertaken an IPO and raised around SAR26 billion (US$7 billion) while 16 companies have done so on the parallel market (Nomu) raising SAR11 billion (US$3 billion) in addition to ETFs and CEFs. Saudi debt markets, like others around the world, have been less active due to uncertainties about rising interest rates and inflation, but we expect long-term issuance trends to be positive. Indeed, the magnitude of contemplated investments, notably from the corporate sector, will necessitate debt issuance as a complement to the banking sector and a way to attract foreign debt investors. This spells a big change for Saudi corporates, with most currently relying on the banking sector or other direct/indirect government funding. Tadawul is focused on diversifying the industries represented on the stock exchange in line with Financial Sector Development Program directives. It is working with the Capital Market Authority of Saudi Arabia to simplify processes and attract local and international issuers by improving market functionality and efficiency, expanding access, strengthening corporate governance, and increasing transparency. This aligns with Vision 2030’s goal of creating a sophisticated and advanced capital market.
We expect growing capital markets transactions, particularly as more GREs are listed on the stock exchange. In July 2022, for example, Crown Prince Mohammed bin Salman announced plans for an IPO of Neom on Tadawul as early as 2024. Neom is going to be a large smart city built in north western Saudi Arabia on the coast of the Red Sea. It will reportedly cost about SAR1.2 trillion (US$320 billion) during its first construction phase, which runs until 2030. PIF is said to be financing half the project while the rest will likely be externally funded, including through the IPO. In our view, any difficulties in sourcing adequate external funding, and at a reasonable cost, could impede the pace of development or threaten profitability prospects, as the viability of the whole project and its long-term returns are still to be demonstrated.