Saudi Economy Improves; Inclusion in MSCI’s EM Index Eagerly Awaited

Global index compiler MSCI is expected to announce its much-awaited decision on the Kingdom’s inclusion in its Emerging Market (EM) index in June, which will help the country attract billions of dollars ($10 billion in passive funds, according to Reuters) in its equity market.

Earlier in March this year, FTSE Russell has accorded EM status to Saudi Arabia, while S&P Dow Jones has recently commenced consultation on potential upgrade for the Kingdom.

MSCI will announce its decision on inclusion of Saudi Arabia in its EM index on June 20, 2018. MSCI had added Saudi Arabia to its watch list for inclusion as a potential classification as an emerging market in June last year.

“We believe that extensive capital market reforms undertaken in recent years by the government and MSCI’s confirmation that Saudi Arabia’s upgrade to EM status is unrelated to the Aramco IPO (which has most likely been delayed to 2019) has increased the probability of inclusion. Further, in our view, MSCI may upgrade Saudi Arabia in tranches (like FTSE Russell), as any issues during the initial phase of trades will be addressed/resolved by the Saudi officials.”

Meanwhile, recent SAMA data has showcased signs of improvement in the economy. SAMA foreign reserves have witnessed an annual rise (+1.3% y-o-y) in April for the first time in more than three years, which can be attributed to the recent local and international debt issuances. Further, credit to the private sector rose at the fastest monthly pace in 26 months (+1.4% m-o-m) in April, whereas the banking claims on the public sector edged down (-0.1% m-o-m). Moreover, consumer spending has continued its robust growth, mainly driven by expenditure on entertainment notable in increased spending in ‘Restaurants and Hotels’, ‘Food and Beverage’ and ‘Clothing and Footwear’ segments. Meanwhile, cost of living index has increased at a slower pace in April (+2.5% y-o-y Vs 2.8% y-o-y in March), but SAMA indicated that inflation is expected to pick up in Q2, owing to the rise in consumer demand during Holy month of Ramadan.

IMF in its 2018 Article IV mission to Saudi Arabia stated that the economic growth is likely to pick up over the medium term, owing to ongoing structural reforms in the Kingdom. It added that the government should sustain implementation of reforms and should resist the temptation to increase government spending in line with the rise in oil prices.

Saudi Arabia’s Q1 2018 fiscal deficit stood at SR 34.3 billion compared to SR 26.2 billion in Q1 2017. For Q1 2018, revenue jumped 15.4% y-o-y to SR 166.3 billion, largely supported by non-oil revenue (63.1% y-o-y).

Meanwhile, expenditure grew by 17.8% y-o-y to SR 200.6 billion (Figure 2 & 3). Based on USD68/barrel, we expect 2018 oil revenues to reach SR547 billion as compared to Govt.'s estimated SR492 billion.

Around 20% of the budgeted expenditure has been spent till end of Q1 2018 - that is around SR200 billion has been spent compared to SR978 billion of expenditure planned in 2018 (out of which SR205 billion is related to capital expenditure and SR773 billion is current). As expenditure increases we can expect continued loan growth and economic recovery.

Kingdom raised SR3.95 billion in May via domestic sukuk issuance under the SR-denominated sukuk program. The government sold SR3.35 billion of 5- year bonds, SR350 million of 7-year bonds and SR250 million of 10-year bonds.

Saudi Arabia and Russia are planning to increase oil production in near future in order to make up for the drop in Venezuelan production and the probable impacts of US sanctions on Iran. OPEC oil producers and Russia are scheduled to meet on June 22, 2018 in Vienna. Oil prices are likely to remain volatile but we expect them to be upwards of $60/barrel with WTI-Brent spreads declining as major oil producers increase capex. We believe Global E&P producers will need to accelerate capital spending significantly to meet the anticipated rise in demand.

SAMA foreign reserves increased on an annual basis (+1.3% y-o-y) for the first time in more than three years in April 2018, as the recent domestic and international debt issuances have limited the government’s need to use its reserves in order to plug its fiscal deficit. On a monthly basis, reserves have jumped for two consecutive months in April (Figure 8 & 9). Meanwhile, government reserves with SAMA stood at SR 612.4 billion (including government current account) as of April 2018, registering a monthly rise of 1.2%.

Deposits declined by 0.5% y-o-y (+0.2% m-o-m) in April, whereas credit to the private sector rose 0.7% y-o-y (+1.4% m-o-m; fastest in 26 months) in April. Meanwhile, bank claims on public sector increased 29.8% y-o-y (-0.1% m-o-m) in the same month (Figure 10 & 11).

Banking sector profits climbed 20.3% y-o-y to stand at SR 4,343 million in April (+24.1% y-o-y in March), while on a monthly basis, profits grew by 3.4% in April (+10.5% m-o-m in March). The cumulative banking sector profits for the year stood at SR16,516 million, recording a rise of 11.1% y-o-y. Meanwhile, the non-performing loans have witnessed a steady rise over the past few quarters. Moody’s has indicated that Saudi Banking sector’s Q1 2018 results, which were driven by lower interest expense and provisioning charges, are credit positive for Saudi banks.

Money Supply (M3) edged up 0.2% y-o-y in April to SR1,785 billion, recording the same annual rise as that in March, backed by increase in M1 (+2.7% y-o-y). Meanwhile, as per the weekly money supply data, published by SAMA, M3 may remain broadly stable in May as well.

Consumer spending continued to rise as expenditure on entertainment is increasing. This has been indicated by +17.8% y-o-y rise in the Point-of-sale (POS) transaction in April (+19.8% y-o-y in March), driven by ‘Restaurants and Hotels’ (+30.8% y-o-y), ‘Food and Beverage’ (+26.9% y-o-y) and ‘Clothing and Footwear’ (+11.7% y-o-y) segments. ATM transactions climbed 5.5% y-o-y in April as against the rise of 5.3% y-o-y in March.

Remittances (Personal Transfers) by Saudi nationals jumped 27.2% y-o-y in April (+40.6% y-o-y in March), while remittances by non-Saudi nationals rose by 2.8% y-o-y in the same month (+0.4% y-o-y in March).

Crude oil prices (Brent July futures contract) rose 2.3% MTD in May 2018, due to geopolitical concerns in Iran and economic crisis in Venezuela. Further, the drop in the US crude oil stockpiles also aided crude oil prices. Meanwhile, Saudi Arabia’s crude oil production rose sequentially in April.

Cost of living index (base year 2013) rose by 2.5% y-o-y in April (+2.8% y-o-y in March), owing to slower rise in the ‘Housing, Water, Electricity, Gas’ and ‘Food & Beverage’ sectors. On a monthly basis, the index slipped 0.2% in April, same as that in the previous month. SAMA indicated that the inflation is expected to pick up in Q2 2018 due to higher consumer demand during the holy month.