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Non-oil growth to moderate in 2014 & 2015

The government has intensified its enforcement of workforce nationalization — known as “Saudization” — in order to tackle high unemployment amongst nationals. The past year has seen renewed impetus in the “Nitaqat” labor reform program, or quota system, which aims to replace expatriate workers with Saudi nationals in the private sector. Expats account for almost 90% of total private sector employment. It is hoped that increased hiring of higher-paid Saudis will provide a boost to income levels and consumer spending in the long run.

A wide crack-down on illegal foreign workers led to the expulsion of more than 1 million expatriates in 2013. Those deported had failed to regularize their legal status during a seven-month amnesty period which ended in November 2013. Some immediate impact on domestic consumption levels was inevitable, but the extent might have been mitigated by the fact that most deportees represented low-skilled labor with a higher propensity to save and remit. 
Yet, disruptions to economic activity have already been felt in the expat-intensive sectors — namely construction and retail trade. The construction sector in particular accounts for around half of total non-Saudi employment in the private sector. Data on the Saudi cement market show a year-on-year contraction in sales during 4Q2013 and 1Q2014. Moreover, the shortage of low-cost labor is already reported to have delayed construction projects and raised costs. This has also raised concerns over the government’s infrastructure development plans and the potential bottlenecks that could emerge.

Non-oil growth moderates

Growth in the non-oil sector moderated to 4.9% in 2013 — its slowest rate since 2009 — as labor market disruptions impacted activity in the private sector. (Chart 1.) Overall growth also slowed to 3.8% from 5.8% in 2012. Meanwhile, oil-sector GDP saw a small contraction as Saudi Arabia cut output in order to support oil prices at close to $100 per barrel in light of rising supplies and weaker global demand.
We expect non-oil growth to continue to ease to around 4-5% in 2014 and 2015, given an easing in private-sector activity and a moderation in the pace of government spending. Nevertheless, the implementation of large government projects should provide underlying support for steady growth in non-oil GDP. Meanwhile, we project oil-sector output to continue to fall by some 2% in 2014, before stabilizing in 2015. 

Consumer sector and domestic demand show signs of softening
Recent data point to a softening in the consumer sector. Growth in bank lending to the private sector has eased back from a peak of 17% in mid-2013 to a 2-year low of 12% in February 2014 — still a very firm pace. Additionally, growth figures for point-of-sale (POS) transactions and ATM cash withdrawals have trended lower through 2013 and early 2014; growth in the value of POS transactions averaged 18% in 2013 down from 25% in the previous year, while growth in the value of cash withdrawals has fallen into negative territory twice in the past year.

The latest PMI figures suggest that activity in the non-oil private sector may have weakened, though it remains in expansionary mode. The PMI index logged its lowest average reading on record in 2013. And despite trending upward in 4Q2013 and at the start of 2014, the index fell back to a 5-month low of 57 in March. Within the overall index, both the output and new orders components fell for three months in a row, while the employment component contracted for only the second time in the reading’s history — signaling weaker domestic demand in recent months.   

Pace of government spending slows
Saudi Arabia’s fiscal surplus shrank to 7% of GDP in 2013 on lower oil revenues. In order to improve fiscal sustainability, the pace of government spending is expected to moderate over the next few years. But despite slower expenditure growth, the surplus is projected to continue to shrink to around 5% of GDP in 2014 and 2015 as oil prices slip and revenues decline. 

Inflationary pressures may emerge

Inflation is expected to pick-up next year as a result of the recent labor market policies and a shortage of affordable housing. Limited progress to-date in the construction of new housing means that rental inflation may remain elevated. Meanwhile, the workforce nationalization program could have a knock-on impact on prices as firms pass on the resulting higher wage costs to consumers. We expect inflation to average a moderate 3.0% this year on softer food prices, before rising to 4.0% in 2015.

Stock market rallies to 5-year highs

The Saudi stock market has continued to rally in early 2014, following significant gains made last year. The index advanced to its highest level since mid-2008. In March 2014, the market was up by a whopping 33% from a year ago and 11% higher since the start of the year, boosted by Fitch’s upgrade of the country’s ratings.

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