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05-Feb-2018

Saudi Arabia Economics - January PMI at seven-year low as economy adjusts to fiscal measures; expect normalisation to start in 2Q18

VAT likely key disruption to consumption patterns; employment only bright spot in January

Saudi Arabia’s non-oil business activity plunged to its lowest since at least Aug 2009 when the Index was first launched, according to the Emirates NBD PMI Index. The overall Index reading in Jan plunged to 53.0 from 57.3 in Dec and an average of 56.1 in FY17. The slowdown was driven mostly by deteriorating domestic demand, with new orders falling to 54.7 in Jan vs. 63.2 in Dec and an average of 60.3 in FY17. Meanwhile, export orders slowed only marginally to 51.2 from 52.0 in Dec. The notable slowdown comes in line with our expectations, as we foresaw the economy adjusting to fiscal measures adopted earlier in the year. Key amongst those, in our view, is the introduction of VAT, which has likely driven some pre-buying activities from both consumers and traders, leading to a sharp slowdown after the tax was introduced. Uncertainty about the extent of protection of real incomes by the gov’t’s handouts (though the Citizen Account) may have also, in our view, weighed on consumer confidence (Fig. 4 shows consumer confidence denting lower in Jan). Employment trends were positive, showing a year-high expansion. 
 
Businesses facing rising cost pressures

The Index shows that businesses have faced rising pricing pressures for the second month in a row, with input costs index rising to 56.2 in Jan (Dec: 54.3; Nov: 52.8). This is likely driven by rising fuel, electricity and labour costs in addition to VAT, in our view. To our surprise, though, the output price index shows businesses have largely not chosen to pass these increased costs to consumers (the index was nearly unchanged at 50.4 in Jan vs. 50.2 in Dec). This goes against anecdotal evidence that point to most businesses, especially in F&B, passing the 5% VAT on to consumers. We would await the release of Jan’s Consumer Price Index to have better visibility on inflation.
 
Maintain outlook of gradual pick-up starting 2Q18

We expect the economy to remain in an adjustment mode for most of 1H18, especially in 1Q18, as consumers adjust to pressures on their personal incomes. While we expect the Royal handouts announced in Jan to be a net booster to Saudi Arabian nationals, it is still expected to be accompanied by a rising inflation environment, which might still leave consumers conservative in their spending patterns. In addition, expats are likely to face increasing pressures on incomes this year as they bear the full brunt of the fiscal measures. We expect the economy to gain more ground in 2H18 as consumption patterns normalise and the investment cycle – to be initiated by the gov’t as per the expansionary budget for this year – is deployed at an accelerated base.
 
Mohamed Abu Basha