Saudi Arabia's economic outlook remains “broadly positive” and the banking system is “fundamentally sound”, although vulnerabilities remain especially from the volatility of oil prices, the International Monetary Fund (IMF) said in a statement on Friday following its annual Article IV Consultation Mission to the Gulf region's largest economy. “Saudi Arabia was well prepared in confronting the global crisis, reflecting lessons learnt from the mid-1980s, when oil prices collapsed and the country experienced a severe banking crisis,” the IMF said. The Kingdom has good supervisory and regulatory frameworks, prudent macroeconomic and financial politics, and its fiscal stimulus was well targeted, it added. Providing jobs for a fast growing population through high and sustainable growth in non-oil industries is the main medium- term challenge, the IMF said. Following the consultation, concluded July 12, the IMF also said Saudi authorities should continue using monetary policy to carefully balance supporting economic activity and controlling inflation. The IMF statement said the outlook for the Saudi economy remains broadly positive, but warned that the key risk is a sharp decline in oil prices. Non-oil GDP is projected to increase to 4.25 percent in 2010, with continued support from an expansionary fiscal stance and a pick-up in credit. “Both the fiscal and external accounts are projected to improve,” the IMF said, “reflecting an improvement in oil revenues.” According to the statement, IMF directors considered that Saudi monetary policy should continue to carefully balance supporting economic activity and controlling inflation. “While the current monetary stance is appropriate, excess liquidity will need to be mopped up in case inflationary pressures emerge,” it said. Recent data shows the inflation pressure is already building in the Saudi economy, and Saudi CPI inflation has been on an upward trend since the beginning of the year. The Central Department of Statistics and Information released its latest inflation data which showed headline inflation accelerating to a 17-month high of 6 percent in July. This, according to research by Barclays Capital, puts Saudi inflation at the highest among the six member Gulf Cooperation Council nations and three times the 2 percent weighted average for GCC countries so far in 2010. The IMF said Saudi inflation should remain around 5 percent in 2010, “reflecting persistence in rent and food inflation, and an expansionary fiscal and accommodative monetary stance.” Beyond 2010, the IMF sees inflation gradually declining in line with the expected rise in global interest rates and the gradual exit from the fiscal stimulus. It also said the impact of the sovereign debt problem in Europe “has been limited so far.” In the statement, IMF executive directors applauded Saudi Arabia's preparedness ahead of the recent global crisis, citing the country's adoption of good supervisory and regulatory frameworks and the pursuit of prudent macroeconomic and financial policies in previous years. “Directors commended the authorities for the strong and timely policy measures, particularly the large and well-targeted fiscal stimulus and the skillful conduct of monetary policy that limited the impact of the crisis, supported solid growth of the non oil sector, and contributed to reviving global demand,” it said. The IMF also supports the Saudi authorities' plans to unwind the fiscal stimulus and return spending growth to sustainable levels once economic growth becomes self-sustaining. In addition, “Directors supported efforts to slow the growth in domestic consumption of oil products,” the statement said, as a comprehensive reform of the subsidy system would contribute to lower fiscal costs. IMF directors commended the Saudi authorities for their “leadership role” in stabilizing oil markets, the statement said, and for persevering with capacity expansion plans “despite record low prices and production of oil.” And even though the riyal-dollar peg constrains the Saudi monetary authority from conducting an independent monetary policy to influence inflation, the IMF maintained its support for Saudi Arabia's decision to maintain the peg, saying it has provided a credible and stable nominal anchor and contributed to macroeconomic stability. The IMF exhorted the Saudi authorities to continue developing its technical and operational capacity to conduct a more effective monetary policy, which could be valuable in the context of the planned GCC monetary union. IMF directors also noted the staff assessment that the level of the exchange rate is broadly aligned with its fundamentals, “while recognizing the methodological limitations of such assessment in the case of oil exporters.” While concerns remain concerning the banking systems of other GCC countries, such as Bahrain and the UAE, the IMF said the Saudi banking system is fundamentally sound. Going forward, it stressed continued improvements in credit appraisal by banks and more transparency and disclosures, especially by large conglomerates. In addition, the IMF counseled that addressing gaps in the framework governing insolvency and creditor rights would help ease small and medium-sized enterprises' financing constraints. The IMF welcomed the recent improvement in Saudi Arabia's credit outlook - its domestic debt rating was raised by Moody's to Baa1 from Ba1 in June - which is critical for future economic growth. The statement also said the development of a local bond market will be important for diversifying the economy's sources of funding and enhancing its resilience. However, providing jobs, for what it described as a “fast growing population,” through high and sustainable growth in the non-oil sector is the main medium-term challenge for Saudi Arabia, the IMF said. It said achieving this goal will involve a multifaceted approach with structural reforms in various sectors of the economy, including the labor market, continued progress with education reform, training, and improving the business climate.
