How Saudi Arabia Fixed Its Cash Crunch
In an interview in Davos last month, Saudi Arabia’s central bank governor, Ahmed Alkholifey, announced that the cash crunch that squeezed commercial lenders last year is over.
He’s correct. Total deposits in the banking system showed an improvement from mid-2016, rising to 0.8 percent year-on-year in December compared with a year earlier. The Saudi Arabian Monetary Authority has done its job by intervening twice in 2016. And in February 2016 it increased the loan-to-deposit ratio from 85 percent to 90 percent to increase liquidity. By that time, its three-month interbank rate had reached a seven-year high. Equally critically, bets for a devaluation of the riyal reached their highest in about two decades in January 2016, even after the authorities had pledged to keep its currency peg. Almost every trader outside of Saudi Arabia was convinced that the kingdom was close to devaluing its currency or even depegging.
The fuel to the devaluation debate had two elements. First, the 2015 fiscal deficit had reached an all-time high of 15 percent of gross domestic product and a runaway deficit was anticipated for 2016. Second, markets were worried that high spending would diminish the country’s foreign reserve cushion within less than five years. In 2015, foreign reserves managed by the central bank fell by $116 billion and at this rate the decline would encroach into the reserve apportioned to support the currency.
All looked perilously difficult as oil revenue fell, government spending halted, government arrears to the private sector (especially contractors) were unpaid, liquidity was scant and confidence declined. The currency debate was dire for businesses that couldn’t price risk and capital outflows continued. By the first half of 2016, Vision 2030, an ambitious roadmap for restructuring the economy from state-driven to private-sector led, was announced. It was followed by the 2020 National Transformation Plan, tasked with fulfilling the Vision and identifying the challenges faced by government bodies in the economic and development sectors.
By early summer of 2016, Saudi banks’ combined loans-to-deposit ratio, a key measure of liquidity, climbed to 90.2 percent in June, the highest since November 2008, according to central bank data. Demand for private sector credit was strong and rising borrowing costs could prove debilitating for non-oil growth.
As a result, in June 2016, the central bank had to intervene more concretely to prop up liquidity in the banking system. It offered domestic lenders about 15 billion riyals ($4 billion) in short-term loans at a discounted rate. Along with providing liquidity and easing rules on lending, the Saudi Arabian Monetary Authority (SAMA) became particularly vigilant regarding banks that were low-balling interest-rate submissions.
By October 2016, the authorities had made good on a promise to sell the kingdom's first international bond, a $17.5 billion offering that was the largest from an emerging-market nation. Also, repaying debts and disbursing about $27 billion in November and December, to contractors and businesses, helped abate the liquidity squeeze. The central bank had won, bringing down borrowing rates by more than 40 basis points. The loan-to-deposit ratio fell to below 88 percent and gradually falling; excess bank reserves are at a very healthy 10 percent of GDP. Government expenditures fell in 2016 which should help keep intact fiscal consolidation targets. The pace of foreign-reserves drawdown decelerated and ended 2016 at $80 billion.
What to expect going forward? Because 2016 was the year of fiscal consolidation and transformative announcements, markets will be looking for opportunities. Green shoots are appearing. The non-oil economy is expected to pick up from nearly zero growth last year. The latest Purchasing Managers’ Index indicated the return of some growth: It rose to 56.7 last month from 55.5 in December. A level above 50 means business is expanding.
Growth-boosting measures as well as investments in renewable energy and a stimulus package, totaling $53 billion, in support of the private sector will begin to make their imprint in this year’s economy. Saudi Arabia will start soliciting bids in the next few weeks for the first phase of a “massive” renewable-energy program costing $30 billion to $50 billion. On the fiscal side, consolidating is prudent but capital spending is important and will focus more on health and education and sufficient infrastructure projects to spur private sector activity. Debt capital markets will do well this year. There will be less local debt issued, in order not to suck out much-needed liquidity, and more sovereign debt issued internationally to fill the fiscal gap. This should help generate a natural yield-curve and will spur corporates to issue more and better priced paper, Saudi Aramco being the latest participant. Saudi Aramco’s bond is a harbinger to its 2018 IPO and in line with its open-book policy.
The country could also sell sukuk with different maturities. Long-duration sukuk debt would be in demand from Shariah-compliant investors.
The inclusion of Saudi securities in the MSCI emerging market index over the next year or a bit more will help equities perform better than some of their peers and delink them more from oil. As the Saudi reform story deepens, healthcare, petrochemicals, transport, food, and general services should perform well this year.
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