Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Saudi Arabia’s Economic Challenges

Currency devaluation, oil price drop, asset valuations & liquidity Samer Ghaddar, CFA

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Saudi Arabia’s Economic Challenges: Currency devaluation, oil price drop, asset valuations & liquidity

Section 1: General Overview Section 2: Overview of the Situation Section 3: The Role of SAMA Section 4: Reserve Assets, Current Account and Budget Deficits Section 5: Monetary Policy and Interest Rate Dilemma Section 6: Private Deposits, Foreign Assets, and the Public Perception Section 7: Credit, Inflation, and Asset Prices Section 8: Can Saudi Arabia Keep the Peg Intact? Section 9: Conclusion

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Section 1: General Overview currency

3.7800

potential for a severe devaluation and

3.8000

this has been apparent in the pricing

3.8200

of the forward contracts of the Saudi

3.8400

Riyal (Chart 1).

3.8600

Markets

have

tested

In 2007–8 there was speculation

SAR 1 Yr. Forward Rate

Chart 1, Proprietary Research

about Saudi Riyal revaluation despite statements from Saudi Arabian Authorities that a currency de–peg or revaluation were not possible. Speculation was apparent in Saudi Riyal forward contracts as well as foreign bank claims on Saudi Arabian Banks. This document will show that Saudi Arabia's current economic situation is not comparable to 2007–8 for a number of reasons. 

What is different this time is that Saudi Arabia is starting from a massive currency reserves that were accumulated during the high oil prices period. In addition, it is also experiencing a quick decline in currency reserves, increased government borrowings from local banks and a twin–deficit, which seems here to stay.



The following key questions will be addressed in this paper: o

2015–6 Saudi Riyal forward contracts point to a devaluation; how imminent is it?

o

What is different this time?

o

Are current events comparable to the liquidity crunch witnessed in 2008–9?

o

What role has the currency peg played in asset market bubbles / crashes and would these issues prevail?

o

Is the Saudi Central Bank able to keep the peg intact?

o

Currently policymakers are consistently stressing that the peg will stay intact; however, the question is, can they afford to keep it?

Samer Ghaddar, CFA. All Rights Reserved, as per the last page of this document

18-Aug-16

the

2014.



3.7600

10-May-16

a topic of public discussion since late

31-Jan-16

devaluation in Saudi Arabia has been

Chart 1, SAR 1 Yr. Forward Rate (Inverted)

3.7400

23-Oct-15

a

15-Jul-15

for

6-Apr-15

potential

27-Dec-14

The

18-Sep-14



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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Section 2: Overview of the Situation

Many analysts have projected a currency devaluation in Saudi Arabia, arguing that the fast drop in currency reserves, widening budget and current accounts deficits (Twin–Deficit) will lead monetary authorities and policymakers to devalue the currency. While the Saudi Riyal is pegged to the dollar, devaluation is technically in the hands of policymakers (Ministry of Finance) and SAMA (Saudi Arabian Monetary Authority) since it is not a fixed exchange rate regime – it is not defined in the constitution as is the case in a currency board system. SAMA has stressed lately that there will be no change to the peg system which indicates that devaluation is not on the table; however, sustained lower oil prices, widening budget and current accounts deficits, trade deficit, the fast drop in currency reserves, and a number of other factors are likely to force authorities to devalue the Riyal. The history/impact of the peg and market perception

Banafe published a paper in Bank of

0.276

International

that

0.274

details Saudi Arabia’s foreign exchange

0.272

intervention. They published an article

0.27

explaining why the peg system of the Riyal

0.268

against SDR was dropped in 1981:

0.266

Settlements

Papers

Chart 2, SAR vs Dollar Index

130 125

USD Index

$/SAR

120

USD Index

0.278

$/ SAR

In 2005, Muhammad Al-Jasser and Ahmed

115 110 105 100 95 90

0.264

85

within the technical framework of the ±7½% margin

Jan-89

Jan-88

Jan-87

exchange rate adjustments were made

80

Jan-86

0.262

Jan-85

“During the 1970s, frequent dollar/riyal

Chart 2, Proprietary Research, SAMA Yearly Statistics 2016

relative to the riyal’s parity of 4.28255 against the SDR, expressed in dollar terms”1 This new mechanism helped the authorities avoid further devaluations in the Riyal since the US dollar witnessed a prolonged rise in the first half of the 1980s1.

Muhammad Al-Jasser and Ahmed Banafe (2005). Foreign exchange intervention in Saudi Arabia. Bank of International Settlements Papers No. 24 pp 265-72 1

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

The current account and budget were in deficit for every single year from 1983 to 1995. Total accumulated current account deficit for the period stood at ~ US $ 169 billion, while accumulated budget deficit stood at ~ US $ 180 billion2. In 1986 speculation against the Saudi Riyal peaked due to a number of factors some of which are similar to the economic situation facing the country today. This triggered a devaluation in that year by ~3%; however, the Saudi Riyal devaluation against all major currencies was much higher due to the US Dollar peg. The dollar dropped by ~ 39% from 1985 to 19893 (Chart 2). The speculation against the Saudi Riyal came into place again in 1993 after the Gulf War and in 1998 after the drop in oil prices due to the Asian crisis. In both years SAMA intervened in the forward market3. Between 2002–2014, with the exception of 2009, Saudi Arabia sustained a budget surplus. Throughout this period, money supply as measured by M3 increased by around five times to US $ 460 billion as of December 2014. Since August 2015 the growth in money supply has become negative averaging (0.25%) per month4. The inflationary pressure witnessed from 2004 to 2008 raised the question of the sustainability of the peg to the US dollar. Many economists and policy makers were openly expressing their views that each individual GCC country should revalue its currency against the US dollar or de-peg from the greenback in order to regain control over their monetary policy tools. This led to increased speculation of a currency de–peg and /or currency revaluation of the GCC currencies, mainly the UAE Dirham, Saudi Riyal and the Qatari Riyal. Although policymakers in Saudi Arabia in 2007–08 were clear that a currency de-peg was not possible as they could afford to keep the peg, market participants never ruled out a revaluation. Currency forwards reflected a re-pricing of the GCC currencies of an average range of 3–5% percent, reaching up to 30% in certain cases.

SAMA Yearly Statistics Muhammad Al-Jasser and Ahmed Banafe (2005). Foreign exchange intervention in Saudi Arabia. Bank of International Settlements Papers No. 24 pp 265-72 4 SAMA Yearly Statistics 2 3

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Section 3: The Role of SAMA

Saudi Arabia runs an orthodox central banking system with a mandate to maintain

Chart 3, Money Supply $600.00 Money Supply (M1) $500.00

Money Supply (M2)

the pegged exchange rate, while pursuing price through the supervision of commercial

$300.00

banks5.

$200.00

Billions

stability and overseeing financial stability

Money Supply (M3) $400.00

$100.00

The influx of oil revenues does not directly

Jan-01 Oct-01 Jul-02 Apr-03 Jan-04 Oct-04 Jul-05 Apr-06 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12 Jan-13 Oct-13 Jul-14 Apr-15 Jan-16

$0.00

impact liquidity in the local market. Oil receipts

are deposited at SAMA and credited to government accounts on the liability side of the balance sheet while assets increase through the purchases of foreign currency assets.

Chart 4, GDP vs Money Supply $500.00

$800

$450.00

$700

$400.00

$300 $200

Arabia’s budget threshold, government expenditure declines leading to reduced local

2015

2014

2013

2012

2011

2010

2009

2008

2007

Nominal GDP US $ (RHS)

2016 E

when oil prices decline to below Saudi

$0

2006

$0.00

2005

money supply growth (Chart 3). Conversely,

$100

2004

$50.00

Money Supply M3

Charts 3, 4 Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

liquidity (Chart 4). SAMA manages local liquidity in the banking system through the REPO and Reverse REPO process and local currency treasury bills issuance.

Al-Hamidy (2012), Aspects of fiscal/debt management and monetary policy interaction: the recent experience of Saudi Arabia. Bank of International Settlements Papers No 67, 301

Samer Ghaddar, CFA. All Rights Reserved, as per the last page of this document

$400

$100.00

funding and allowing excessive credit and

5Abdulrahman

$500

Nominal GDP Billions

$150.00

2003

commercial banks access to cheap sources of

$200.00

2002

results in increased local liquidity giving

$250.00

2001

oil prices), higher government expenditure

$300.00

2000

During periods of large capital inflow (high

M3 Billions

$600 $350.00

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Section 4: Reserve Assets, Current Account and Budget Deficits Chart 5, Nominal & Real GDP

Chart 6, Evolution of Reserve Assets

$800

$800

6%

$700

$700

5%

$600

$600

$500

$500

$400

$400

$300

$300

$200

$200

$100

$100

-2%

$0

-3%

Billions

50% 30% 10% -10%

4% 3%

6-month moving avg.

70%

Total Reserves Billion US $

90%

-50% Change Real GDP Change Nominal GDP Real GDP US $ (RHS) Nominal GDP US $ (RHS)

-70%

$0

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

-90%



1% 0% -1%

Jan-01 Oct-01 Jul-02 Apr-03 Jan-04 Oct-04 Jul-05 Apr-06 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12 Jan-13 Oct-13 Jul-14 Apr-15 Jan-16

-30%

2%

Reserve Assets

Oil revenues created enormous trade

Monthly Change (6-month Moving avg.)

surplus for Saudi Arabia between 2006–2014 to reach an accumulated level of US $1.1 trillion, while reserve assets peaked in mid–2014 at US $ 745 billion6 (Chart 6). Reserve assets have been dropping since July 2014 at an average monthly

$500 $450 $400

rate of 1% (Chart 6). Remarkably,

$350

growth rate of reserves decelerated

$300

since 2011 to reach a consistent negative growth rate since 2014 (Chart 6).

Chart 7, Evolution of Money Supply M3

M3 (LHS) Change M3

40%

$200

30%

$150

20%

$100

10%

$50

0%

Dec-00 Sep-01 Jun-02 Mar-03 Dec-03 Sep-04 Jun-05 Mar-06 Dec-06 Sep-07 Jun-08 Mar-09 Dec-09 Sep-10 Jun-11 Mar-12 Dec-12 Sep-13 Jun-14 Mar-15 Dec-15

-10%

since 2014 while Money Supply growth did not start declining until 2015, which increases our concern of a potential exacerbated drop in GDP growth rates

6

SAMA Annual Statistics Report 2016

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70%

50%

$250

GDP growth rate has been negative

(Chart 4 & 5).

80%

60%

$0



100% 90%

Billions



Chart 5, SAMA Monthly & Yearly Statistics July 2016, World Bank Data & IMF Data Charts 6, 7, Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

Chart 9, Revenues vs Expenditure

Chart 8, Budget Surplus/ ( Deficit)

35%

$350

30%

Billions

$150 $100

25% Surplus/ (Deficit) LHS Surplus/ (Deficit) % GDP

20%

$300

$350

Billions

$200

August 31, 2016

$300 Total revenues

$250

$250 Expenditure

15% 10% 5%

$0

$200

$200

$150

$150

Billions

$50

0% -$50

-5% -10%

-$100

$100

$100

$50

$50

$0

$0

2014

2016 E

2012

2010

2008

2006

2004

2002

2000

1998

1996

Chart 10, Current Account vs Reserve Assets Yearly chng. $200

$150

Reserve Assets 2015

2014

2013

2012

-$50

Is the twin-deficit a new trend, or is it a

-$100

Saudi Arabia recorded a budget deficit of US

Current account Reserve assets Charts 8, 9, 10, Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

$ 17.5 billion in 2014, US $ 96.5 billion in 2015 and is projected to be US $ 63 billion in 2016; 2.3%, 14.5% and 9.5% of GDP respectively (Chart 8). 

2016 current account deficit is expected to be comparable to 2015 based on available Q1 2016 data which was ~ US $ 18 billion8 (Chart 10).



The last time we saw such a prolonged period of twin deficit was between 1983 and 1995. During this time period reserve assets dropped by a total of US $ 63 billion and the currency was devalued by ~ 11%7.

7

SAMA Annual Statistics Report 2016

8

SAMA Monthly & Annual Statistics Report July 2016

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$50

$0

-$100

one-off? 

$100

-$50

2011

$0

2006

level ever reached7 (Chart 10)8.

2010

reached US $ 53.4 billion, also the highest

2009

$50

2008

Simultaneously, the current account deficit

$100

2007

surpassing US $ 96 billion (Chart 8).

$150

Current Account

reached an all-time high in nominal terms,

Billions

In 2015, the budget deficit in Saudi Arabia

2016 E

Twin Deficit, Devaluation in the Making?

1992

2014

2016 E

2012

2010

2008

2006

2004

2002

2000

1998

1996

1994

-20%

1992

-$150

1994

-15%

-$150

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Chart 11, Current account % GDP

20%

150%

governmental expenditure of 33% of

15%

100%

10%

50%

5%

0%

0%

-50%



-5%

8).

-10%

At an average of US $ 45 per barrel in

-15%

2016 E

2016 & US $ 237 billion in 2017 (Chart

2015

expenditure to be US $ 227 billion in

2014

GDP, we would expect governmental

2013

1992–2015

250%

2012

Assuming

2011

average



2010

200%

2009

25%

2008

2017?

2007

30%

2006

How does the budget deficit look in 2016 &

-100% -150% -200%

Current account to GDP

2016, total government revenues

% Change in Current Account Deficit

would stand at US $ 163 billion implying a budget deficit of US $ 63 billion or 9.5 % of GDP, a conservative estimate. 

At an average of US $ 55 per barrel in 2017, the budget deficit would be ~ US $ 46 billion or 6.5% of GDP (Charts 8 & 9).

How does the current account deficit look in 2016? 

Current account deficit reached ~ US $ 18 billion in the first quarter of 2016 and is expected to remain at the same level for the remaining 3 quarters of the year implying a similar current account deficit for 2016 as 2015 (Chart 11).



Reserve assets dropped by ~ US $ 53 billion in the first 7 months of 20169 and are projected to drop by ~ US $ 85 billion by the end of this year. Chart 12, SIBOR vs Public Debt



250

Billions

Impact on the local interest rate and public debt

2.50% SIBOR 3 month 2.00%

200

1.50%

150

1.00%

100

0.50%

50

0.00%

-

The widening budget deficit since 2015 has led the government to borrow locally, which has driven up

Charts 11, 12, Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

9

SAMA Annual and Monthly Statistics Report July 2016

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Jun-16

Dec-15

May-15

Nov-14

Apr-14

Oct-13

Mar-13

Aug-12

Jul-11

Feb-12

Jan-11

Jun-10

(Chart 12).

Dec-09

measured by the 3 month SIBOR)

May-09

interest rates by around 100 bps (as

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA



August 31, 2016

As rates increased the private sector total borrowing started to drop, which is a typical crowding out effect.



The stubbornly high current account deficit and the lower government spending has led to a drop in Money Supply as presented in Chart 7.

What does this mean? In terms of total spending, Saudi Arabia’s budget is around US $ 227 billion, or 33.7%10 of GDP and the current account deficit is at ~US $ 50 billion. Since oil exports represent the majority of exports in the country and are the primary source of FX, the current account deficit is expected to continue to grow as oil prices decline. Extrapolating year to date monthly reserves gives a projected 2016 drop of reserves in the range of US $ 80 120 billion. In the short term, policymakers are likely to deal with the FX reserves drain by increasing public debt. Since Debt / GDP ratio is low at 8%, Saudi Arabia has capacity to increase this ratio to around 50% (mainly through foreign debt), which is around US $ 270 billion. In parallel, policymakers will seek to transform the economy to increase non-oil exports and allow foreign direct investment to fill the gap in the balance of payments in anticipation of the medium term when all monetary policy tools are exhausted.

10

Propriety research & estimates

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Section 5: Monetary Policy and Interest Rate Dilemma

Chart 13, Credit to GDP & Growth rate 70%

Chart 14, SIBOR vs LIBOR

25%

3%

20%

3%

SIBOR 12M

15%

2%

Libor USD 12 month

10%

2%

5%

1%

0%

1%

-5%

0%

65% 60% 55% 50% 45% 40% 35%

Monetary policy and interest rate dilema Saudi Arabia’s interest rates are linked

50%

to the US rates, as the USD is the anchor

45%

This can be counterproductive as the local economy and the U. S. economy do not necessarily have the same growth engines. 

Jul-16

Sep-15

Feb-16

Apr-15

Nov-14

Jan-14

Jun-14

Aug-13

Oct-12

Mar-13

May-12

Jul-11

Dec-11

Sep-10

45% 40%

Private Sector Credit to GDP

35% 30%

Private Sector Credit Growth RHS

25%

40%

20% 15%

35%

10% 30% 5% 25%

0%

20%

-5%

Dec-93 Jan-95 Feb-96 Mar-97 Apr-98 May-99 Jun-00 Jul-01 Aug-02 Sep-03 Oct-04 Nov-05 Dec-06 Jan-08 Feb-09 Mar-10 Apr-11 May-12 Jun-13 Jul-14 Aug-15

currency to which the Riyal is linked to.

Feb-11

Chart 15, Private Sector Credit to GDP & Growth Rate 60% 55%



Apr-10

Dec-93 Jan-95 Feb-96 Mar-97 Apr-98 May-99 Jun-00 Jul-01 Aug-02 Sep-03 Oct-04 Nov-05 Dec-06 Jan-08 Feb-09 Mar-10 Apr-11 May-12 Jun-13 Jul-14 Aug-15

20%

Nov-09

Total credit Growth Rate RHS

25%

Jan-09

30%

Jun-09

Total Credit / GDP

In mid–2015 Saudi Arabia’s interbank lending rate (benchmark used by commercial banks for lending – “SIBOR”) and the LIBOR started to

Chart 16, Credit to GDP & Credit Growth Rate 25%

diverge as presented in Chart 14. 20%

From 2009 to 2015 there was excessive credit creation, high money supply growth – credit doubled in the same period to reach US

15%

80% Public Sector credit % GDP Public Sector Credit Growth RHS

10% 0% 5%

lending rates in the same period since LIBOR / SIBOR differential rate was low (Chart 14). Samer Ghaddar, CFA. All Rights Reserved, as per the last page of this document

-20%

0%

-40%

Dec-93 Jan-95 Feb-96 Mar-97 Apr-98 May-99 Jun-00 Jul-01 Aug-02 Sep-03 Oct-04 Nov-05 Dec-06 Jan-08 Feb-09 Mar-10 Apr-11 May-12 Jun-13 Jul-14 Aug-15

The main reason behind this was low

40%

20%

$400 billion (Chart 13). 

60%

Charts 13, 14, 15, 16 Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

11 | P a g e

Saudi Arabia Macro Analysis Samer Ghaddar, CFA



August 31, 2016

And negative real rates, rates after deducing inflation.

3.00%

Chart 17, SIBOR Rates

2.50%



SIBOR 3M

Currently we are in the middle of a contracting business cycle and credit and Money Supply growth rates have gone into a downward trend (Charts

SIBOR 6M

2.00%

SIBOR 12M

1.50%

1.00%

15, 7). While lending rates are up due



Stress in the banking system is on the rise, as measured by the total amount of reverse REPO agreements which

Jun-16

Feb-16

Jun-15

Oct-15

Feb-15

Jun-14

Oct-14

Feb-14

Jun-13

Oct-13

Feb-13

Jun-12

Oct-12

Feb-12

Jun-11

Oct-11

Feb-11

Jun-10

Chart 18, Credit Public vs Private Sector $60.0

$50.0

have been spiking since mid–2015 as presented in Chart 19.

Oct-10

0.00%

Feb-10

(Charts 12, 17).

0.50%

$450 Credit to Public Sector

Billions

to increased public sector borrowings

$400 $350

Credit to Private Sector (RHS)

$40.0

$300 $250

$30.0 $200 $150

Billions

$20.0

$10.0

Billions

Jan-15

Jan-13

Jan-11

Jan-09

Jan-07

Jan-05

Jan-03

Jan-01

Jan-99

Jan-97

Jan-95

Chart 19 Repo Transactions $4

$3

$3

$2

$2

$1 Repo Transactions $1

Charts 17, 18, 19, SAMA Monthly & Yearly Statistics July 2016

Jan-16

Jun-15

Apr-14

Nov-14

Sep-13

Jul-12

Feb-13

Dec-11

Oct-10

May-11

Mar-10

Jan-09

Aug-09

Jun-08

Apr-07

Nov-07

Sep-06

Jul-05

Feb-06

$0

Samer Ghaddar, CFA. All Rights Reserved, as per the last page of this document

$50 $0

Jan-93

$0.0

$100

12 | P a g e

Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Section 6: Private Deposits, Foreign Assets, and the Public Perception

general public in Saudi Arabia has

3%

experienced a downward trend

2% 1%

-1%

increasing FX deposits resulting in

-2%

10%

-3%

5%

-4%

Oct-15

Feb-14

Dec-14

Jun-12

Apr-13

Oct-10

Aug-11

Feb-09

Dec-09

Jun-07

Apr-08

Oct-05

Aug-06

Feb-04

the first quarter of 2016 (Chart 20).

Dec-04

0%

Jun-02

-5%

Apr-03

foreign deposits peaking at 20% in

15%

0%

mid–2015, depositors started the 6-month average change in

20%

Oct-00

since the early 2000s. However, in

25%

4%

Aug-01

Total foreign deposits held by the

Dec-99



Chart 20, Foreign Currency Deposits / Total Deposits

5%

Foreign Currency Deposits/ Total Deposits (RHS)



Change 6-month moving Avergae

Since that spike, markets calmed down and depositors started to switch

40%

back to local currency. As a result, foreign deposits as a percent of total deposits witnessed a slight drop (Chart 20).

30% 20%

Chart 21, Banks' Foreign Assets / Total Asets Bank's Foreign Assets/ Total Assets % Change in Bank's Foreign Assets/ Total Assets

40% 35% 30% 25%

10% 20% 0% 15%

On the asset side of the balance sheet

-10%

we see the same trend. There was a

-20%

5%

-30%

0%

spike in foreign assets held at a level that had not been reached since 2009

10%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015



(Chart 21). Charts 20, 21 Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

In late 2014 banks and depositors began changing their perception about the Saudi Riyal. Increased foreign assets and foreign deposits means there is a fear of a devaluation in the system. Since foreign assets and currency deposits are starting from a low base (foreign deposits are at around 10% of total deposits and foreign assets are less than 15% of foreign assets), there is minimal pressure on foreign reserves. However, if this trend persists, the pressure on foreign reserves will gradually increase.

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13 | P a g e

Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

A deeper look into commercial banks’ assets – liabilities: Is it any different? Chart 22, Banks' Foreign Liabilities vs Assets $40.0

increased

as

on

a

and Saudi Arabia in particular, increased

$15.0

lending

and

$10.0

deposits to Saudi banks (Chart 22)

$5.0

$10

$0.0

$0

Jan-13

Jan-15 Jan-14 Mar-15

Jan-09

Jan-07

Jan-11

dropped

Nov-12

banks

Jul-10 Sep-11

Arabian

Jan-05

In the same period local Saudi

$30 $20

Jan-03

direct

Billions

Riyal

Jan-01

through

$40

Saudi

Jan-99

the

$60 $50

Jan-97

to

$70

$20.0

Jan-95

exposure

their

$25.0

$80

Banks' Foreign Assets

$30.0

Jan-93



banks

Banks' Foreign Liabilities

$35.0

currency

revaluation in the GCC in general foreign

$90

speculation

their

foreign assets exposure (Chart 22). This led to zero net foreign assets

Chart 23, Banks' net Foreign Assets $70

from March to June 2008 (Chart 23), the lowest level since 1992.

Banks' net Foreign Assets

$60



In 2015 the opposite happened

$40

Billions

$50

and speculation about currency devaluation increased, which led to an increase in local banks’ foreign

$30

$20

assets and a big drop of foreign

highest level ever reached in Saudi Arabia. This level has since dropped to ~ US

Charts 22, 23 Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

$ 42 billion, which is still high compared to past levels (Chart 23).

Overall, the combination of increased foreign assets of commercial banks and the drop of claims on local banks from foreign institutions is a sign of pressure in FX markets. The highlight from this analysis shows that both local and foreign financial institutions are prepared for a potential devaluation.

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May-16

May-09

Jan-07 Mar-08

Nov-05

Jul-03 Sep-04

May-02

Jan-00 Mar-01

Nov-98

60 billion at the peak. This is the

Jul-96 Sep-97

$0

May-95

Net foreign assets reached ~ US $

$10

Jan-93 Mar-94

banks’ exposure to Saudi banks.

Banks' Foreign Assets

2007–08

Billions

In

Banks' Foreign Liab.



14 | P a g e

Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Section 7: Credit, Inflation, and Asset Prices Chart 24, Capital Formation

The government ran a public budget surplus throughout the period between

30%

2003

total

25%

accumulated surplus of ~ US $ 54

20%

20%

billion.

In this period, government

15%

15%

expenditure was the main driver of

10%

10%

5%

5%

0%

0%

In the same period, Gross Capital

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

Chart 25, Credit / GDP vs CPI

7%

20%

-3%

25). The effect is more obvious in equity markets as presented in Chart 26.

Total Credit / GDP LHS

25%

Correlation between credit growth and

20%

equity market valuations is high (Chart

15%

26). Market PE peaked in 2006 at 60 x

2015

-2%

credit creation played a role (Chart

2014

-1%

25%

2013

30%

2012

0%

2011

35%

Inflation as measure by CPI peaked in

2010

1%

2009

2%

40%

2008

45%

2007

3%

2006

4%

50%

2005

55%

2004

stable at an average of 13% of GDP

2003

5%

2002

60%

2001

Formation by the private sector was

2000

6%

Saudi Arabia in 2008 at 6% while



25%

65%

(Chart 24). 

70%

2001

2003 to 27% of GDP in 2014 (Chart 24).

2000

which increased from 20% of GDP in

1999

a

1998

with

1997

2014

30%

Private Sector Gross Capital Formation % of GDP Gross Capital Formation % of GDP

1996

and

increased Gross Capital Formation



35%

Government Gross Capital Formation % of GDP

1999



35%

CPI

Chart 26, Market PE vs Credit Growth

70 X 60 X 50 X 40 X

10%

earnings (after touching the 100 x mark 0%

10 X

Market Valuation PE x

Credit Growth LHS

Charts 24, 25, 26 Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

Samer Ghaddar, CFA. All Rights Reserved, as per the last page of this document

2016 E

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

X

2002

-5%

2001

20%.

20 X

2000

was at the highest yearly growth at

5%

1999

in February 2006) while credit creation

30 X

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA



August 31, 2016

Credit for finance listed equity purchases has a high correlation with equity markets. The stock market index peaked in 2016 after a peak in equity financing. In the last 5 quarters,

equity

financing

Chart 27, Share Financing vs Stock Index 20,000

18,000

18,000

16,000

16,000

14,000

14,000

12,000

12,000

has

10,000

dropped as did the index with a slight

8,000

10,000 8,000 6,000

6,000

delay (Chart 27).

4,000

4,000

2,000

2,000 -

Credit

Share financing ($ mn) LHS

Money supply and credit creation,

Chart 28, Money Supply (M3) vs Equity Valuations 120 x

Money Supply (M3)

Billions

mainly private sector credit, have a direct impact on equity valuation.

Saudi Stock Index

$600

$500

100 x

PE (x) (RHS)

$400

80 x

average of 15.0x earnings while

$300

60 x

current PE stands at 12.75x (Chart 28).

$200

40 x

$100

20 x

$0

Oct-15

Feb-14

Dec-14

Jun-12

Apr-13

Oct-10

Aug-11

Feb-09

Dec-09

Jun-07

Apr-08

Oct-05

Aug-06

Feb-04

Dec-04

valuations still trade between 1 standard deviation with a lower

x

Jun-02

any market re-rating. Current market

Apr-03

creation and money supply will hinder

Aug-01

The recent drop in private credit

Dec-99

Market PE is trading below the 10-year

Oct-00



-

Q1 2000 Q4 2000 Q3 2001 Q2 2002 Q1 2003 Q4 2003 Q3 2004 Q2 2005 Q1 2006 Q4 2006 Q3 2007 Q2 2008 Q1 2009 Q4 2009 Q3 2010 Q2 2011 Q1 2012 Q4 2012 Q3 2013 Q2 2014 Q1 2015 Q4 2015

Equity valuations and money supply &

Chart 29, PE Range 25 x

bound at 8.45x earnings and the upper bound at 22x earnings (Chart

20 x

29). 15 x



If the drop in credit growth and

10 x

- 1 Stdv.

money supply to the private sector continues as presented in Charts 26 &

PE (x)

+ 1 Stdv. 5x

28, it would negatively impact

negative credit growth would negatively impact

corporate

profitability.

Samer Ghaddar, CFA. All Rights Reserved, as per the last page of this document

Charts 27, 28, 29 Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

Jan-16

Jul-15

Jan-15

Jul-14

Jul-13

Jan-14

Jan-13

Jul-12

Jan-12

Jul-11

Jul-10

Jan-11

Jul-09

Jan-10

Jan-09

Jul-08

Jan-08

Jul-07

This is mainly due to the fact that

x

Jan-07

current and future equity valuation.

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Furthermore, the higher cost of funding would drag down profitability of listed banks through lower interest margins. Section 8: Can Saudi Arabia keep the peg intact?

Chart 30, Reserve Assets to Monetary Base 14 x

Saudi Arabia has enough reserve assets to

12 x

12 x

back the currency in circulation, monetary

10 x

base, M1 and M2.

Multiple

14 x

8x

8x

6x

6x

Reserve assets stand at around 7 times monetary base, defined as the sum of

10 x

Reserve Assets/ Monetary Base

4x

2x

(deposits held by banks and other depository

x

Avg.

institutions in their accounts at the central bank)11. This means the country can easily process known as dollarization of the

4x

economy12, since the reserve assets to

4x 3x

Multiple

5x

monetary base ratio far exceeds the

3x

one to one ratio required. However,

2x

this ratio has been dropping since

2x

2013 and currently the ratio is below

1x

the 15-year average of 7 times (Chart

1x

Reserve Assets/ M1 Avg. Reserve Assets/ M1 Reserve Assets/ M2 Avg. Reserve Assets/ M2

x

30) 

Chart 31, Reserve Assets / Money Supply

move from the Saudi Riyal to USD, a

The second ratio to consider is total reserves to M1 and M21. o

Jan-01 Oct-01 Jul-02 Apr-03 Jan-04 Oct-04 Jul-05 Apr-06 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12 Jan-13 Oct-13 Jul-14 Apr-15 Jan-16



Charts 30, 31 Proprietary Research, SAMA Monthly & Yearly Statistics July 2016

(M1 is defined as the sum of currency held by the public and transaction deposits at depository institutions. M2 is defined as M1 plus savings deposits, and retail money market mutual fund shares).

11 12

Federal Reserve of the United States https://www.federalreserve.gov/faqs/money_12845.htm Baltic states need not devalue; monetary policy consistent with pegs: Steve Hanke

Samer Ghaddar, CFA. All Rights Reserved, as per the last page of this document

2x

x

Jan-01 Oct-01 Jul-02 Apr-03 Jan-04 Oct-04 Jul-05 Apr-06 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12 Jan-13 Oct-13 Jul-14 Apr-15 Jan-16

currency in circulation and reserve balances

4x

17 | P a g e

Saudi Arabia Macro Analysis Samer Ghaddar, CFA



August 31, 2016

SAMA is an orthodox central bank and not a currency board system and can therefore print money. As such, it is necessary to also consider a ratio that covers the wider money supply such as total Reserves to M1 or M2. This ratio measures the ability of the central bank to move the money in circulation and deposits into USD.



Reserves to M1 and M2 stand at 1.85 times and 1.35 times, respectively, which is higher than the one to one ratio needed. However, both ratios have been steeply dropping and are lower than their 15-year average (Chart 31).

In summary, the combination of these ratios (all with a coverage ratio above 1), means SAMA has the ability to convert all money in circulation and deposits at financial institution to US Dollar. However, this ratio is dropping fast and currently below historical averages. The highlight from this analysis shows that a potential devaluation is not imminent. However, given the rapid decline of the ratios, in particular reserves to M1 and M2, a potential devaluation is likely in the medium term.

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18 | P a g e

Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Section 9: Conclusion o

SAMA has stressed lately that there will be no change to the peg system which indicates that devaluation is not on the table; however, sustained lower oil prices, widening budget and current accounts deficits, trade deficit, the fast drop in currency reserves, and a number of other factors are likely to force authorities to devalue the Riyal in the medium term.

o

In the short term, policymakers are likely to deal with the FX reserves drain by increasing public debt. Since Debt / GDP is low at 8%, Saudi Arabia has capacity to increase Debt / GDP to around 50% (mainly through foreign debt), which is around US $ 270 billion. In parallel, policymakers will seek to transform the economy to increase non-oil exports and allow foreign direct investment to fill the gap in the balance of payments in anticipation of the medium term when all monetary policy tools are exhausted.

o

Banks and depositors have started changing their perception about the Saudi Riyal. Increased foreign assets and foreign deposits means there is a fear of a devaluation in the system.

o

Overall, the combination of increased foreign assets within local commercial banks and the drop of claims on local banks from foreign institutions are both a sign of pressure in the FX markets. Both local and foreign financial institutions are more prepared for a potential devaluation.

o

Reserves Assets to M1 and M2 stand at 1.85 times and 1.35 times, respectively. The combination of these ratios (all with a coverage ratio above 1), means SAMA has the ability to convert all money in circulation and deposits at financial institution to US Dollar. This analysis shows that a potential devaluation is not imminent. However, given the rapid decline of the ratios, a potential devaluation is likely in the medium term.

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

References 



 

  



  





  

George T. Abed, S. Nuri Erbas, Behrouz Guerami (2003). The GCC Monetary Union: Some Considerations for the Exchange Rate Regime. IMF Working Paper No. 03/66 Abdulrahman Al-Hamidy (2012). Aspects of fiscal/debt management and monetary policy interaction: the recent experience of Saudi Arabia. Bank of International Settlements Papers No. 67, pp 301-307 Muhammad Al-Jasser and Ahmed Banafe (2005). Foreign exchange intervention in Saudi Arabia. Bank of International Settlements Papers No. 24, pp 265-72 Laura Davidson (2011). The Causes of Price Inflation & Deflation, FUNDAMENTAL ECONOMIC PRINCIPLES THE DEFLATIONISTS HAVE IGNORED. LIBERTARIAN PAPERS VOL. 3, ART. NO. 13 (2011) Richard Duncan (2005). The Dollar Crisis: Causes, Consequences. 1st ed. Wiley Richard Duncan (2012). The New Depression: The Breakdown of the Paper Money Economy. 1st ed. Wiley Andrew Filardo, Madhusudan Mohanty and Ramon Moreno (2012). Central bank and government debt management: issues for monetary policy. Bank of International Settlements Papers No 67. pp 51-71 Steve Hanke (2009). Baltic states need not devalue; monetary policy consistent with pegs. http://ftp.lankabusinessonline.com/news/baltic-states-need-notdevalue;-monetary-policy-consistent-with-pegs:-steve-hanke/955909581 Steve H. Hanke Lars Jonung, and Kurt Schuler (1993). Russian Currency and Finance: A Currency Board Approach to Reform. 1st ed. Routledge Greenwood, John (2007). Hong Kong's Link to the US Dollar: Origins and Evolution. 1st ed. Hong Kong University Press Jonathan D. Ostry, Atish R. Ghosh, Karl Habermeier, Marcos Chamon, Mahvash S. Qureshi, and Dennis B.S. Reinhardt (2010). Capital Inflows: The Role of Controls. IMF Staff Position Note SPN/10/04. Mario Pessoa and Mike Williams (2012). Government Cash Management: Relationship between the Treasury and the Central Bank. International Monetary Fund Federal Reserve of the United States https://www.federalreserve.gov/faqs/money_12845.htm . SAMA Yearly Statistics. http://www.sama.gov.sa/enUS/EconomicReports/Pages/YearlyStatistics.aspx SAMA Monthly Statistics. http://www.sama.gov.sa/enus/EconomicReports/Pages/MonthlyStatistics.aspx SAMA Inflation Reposts. http://www.sama.gov.sa/enUS/EconomicReports/Pages/InflationReport.aspx SAMA Financial Stability report http://www.sama.gov.sa/enUS/EconomicReports/Pages/FinancialStability.aspx SAMA Development Report http://www.sama.gov.sa/enUS/EconomicReports/Pages/DevelopmentReports. aspx

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Saudi Arabia Macro Analysis Samer Ghaddar, CFA

August 31, 2016

Disclaimer For Informational purposes only and not an offer or solicitation. All data is confidential and proprietary and not for distribution. The text, graphs and other materials contained in this report are proprietary to Samer Ghaddar (The Author). and constitute valuable intellectual property. No material from any part of this report can be transmitted, broadcast, transferred, assigned, reproduced or in any other way used or otherwise disseminated in any form to any person or entity, without the explicit written consent of the Author. The Author reserves the right, without further notice, to pursue to the fullest extent allowed by the law any and all criminal and civil remedies for the violation of his rights.

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