Being a securities exchange, the opportunities and threats it faces are very much dependent on the local, regional, and global economies. The ebb and flow of economies determine the need of corporates for finance and propensity of investors to invest. Tadawul’s business model, strategies, and operations need to be aligned to the realities of the operating environment on which we have to keep a close watch.
The global scenario
The COVID-19 pandemic has been the worst economic calamity the world has experienced for decades. Economic activity came to a near standstill for months as movement was sharply curtailed by lockdowns and curfews. Some industries such as travel, tourism, hotels, and entertainment were completely devastated. Apart from the economic consequences, the pandemic took an enormous toll on human lives and health.
Despite efforts by Governments around the world to combat the impact of the pandemic by fiscal and monetary policy, a contraction of the global economy by 3.5% in 2020 is estimated according to the IMF World Economic Outlook (WEO) Report. Advanced economies as a whole are expected to have shrunk by 4.9%. In emerging market and developing economies, the GDP decline is expected to have been 2.4%, while in the Middle East and Central Asian Region it is expected to have been 3.2%. China, an exception among major economies is expected to have grown by 2.3%, which is however far below its growth rates of around 6% in the previous five years. Giving assistance to individuals and enterprises which have been badly affected has been a daunting task for most Governments when they are faced with declining tax revenues. On average, Government deficits are expected to have increased by 9% of GDP in 2020, while global public debt is expected to have reached unprecedented levels. As reported by CNBC, job losses in the second quarter of 2020 compared to the last quarter of 2019, was the equivalent of 400 million full time jobs. Employment in informal sectors, women and youth was particularly affected. An additional 90-100 million people are expected to fall into extreme poverty in 2021 as per the WEO Report. Due to the exigencies of the situation many firms have had to resort to heavy borrowing which raises the possibility of many of them becoming insolvent.
WEO forecasts a recovery to a 5.5% global growth in 2021 and 4.2% in 2022 is forecast based on expectations of the impact of the vaccines and policy support in certain advanced economies. There is also the likelihood that increased public investment in advanced economies will spur increased private investment. However, there is no cause for optimism about an early end to the pandemic. The degree of the recovery is expected to vary widely across different countries. Strong multilateral cooperation and financial support is required to bring the benefits of the vaccine to third world countries.
In tandem with most other sectors, stock exchanges were drastically affected as a result of the COVID-19 pandemic. At the onset of the pandemic, exchanges saw a decline in share prices and market capitalization unprecedented in recent times. Yet most stocks showed a surprising recovery by the end of the year. To give a broad picture, the MSCI global index showed a 14% rise for stocks and a 5% rise for bonds over the year. Stock markets are forward looking and expectations of improvements in 2021, especially with vaccines becoming available, may have played a major role in the recovery.
However, results varied across and within asset classes. For example oil stocks plunged 24%, reflecting the impact of recessions on energy demand. Technology stocks on the other hand performed well. Not all indices have fared well, either. The UKs FTSE100, weighed down by struggling airlines, oil companies and banks slid by 14% over the year, notwithstanding a steady rise over the last few months.
The GCC economies have all suffered a downturn due to the COVID-19 pandemic and the reduced global energy demand, which has constrained oil prices. The estimated GDP contraction for the region is 5.4% according to the ICAEW Middle East Economic Update. The GCC countries generally refrained from imposing severe constraints of the type seen in some European countries and eased out of lockdowns. However, the slump in certain sectors such as travel and tourism and the need for social distancing have slowed the recovery. While compliance with OPEC+ production limits has given some boost to oil prices, they are still down 26% from January. While there will be a slight increase in production from January 2021, there is little hope for large price increases up to 2023.
The dampened oil prices will constrain GCC Governments’ ability to provide fiscal support. The forecast growth in 2021 for the region is only 2.4%. Growth may not return to 2019 levels before late 2022. However, there is the prospect of sectors such as hospitality and airlines recovering with the availability of vaccines. This should benefit countries such as Bahrain and the UAE with a high share of tourism.
In common with the rest of the GCC, the Saudi economy has been seriously affected by lower oil prices and production; GDP is estimated to have contract by 4% in 2020. Oil production has been kept low to keep in line with commitments to OPEC. ICAEW reports that this will result in an estimated 4.6% year-on-year drop in the oil sector GDP, followed by an expected growth of 1.4% in 2021. Growth in the non-oil sector was also dampened due to social restrictions, cutbacks on capital spending, and VAT increase. The sector is expected to have contract by 3.6% in 2020. The Kingdom’s strong fiscal and foreign currency reserves have given it the resilience to withstand the impacts of the pandemic and lower oil prices. The Government intends to maintain fiscal discipline, with estimated expenditure for 2021 being 7.3% less than that of 2020. Medium-term fiscal deficits are expected to continue leading to a rise in public debt. However, the Kingdom’s relatively low debt/GDP ratio will permit further borrowing. Total public debt in 2021 is estimated at 32.7% of GDP. Real GDP growth is forecasted to reach 2.8% in 2021, driven by less stringent restrictions and an improvement in the trade balance.
Capital expenditure was slashed in 2020, due to the difficulties of the private sector and reallocation in Government spending away from capital spending to COVID-19 related support and stimulus. A drop of around 12% in private sector capital spending is expected. While Government revenues have been hit, this has been limited somewhat by the tripling of VAT rate to 15% and increases in import duties.
The Saudi banking sector has also had to face major headwinds in the wake of the COVID-19 pandemic which have been described in the KPMG Banking Pulse Quarterly. Credit losses in the third quarter have shown a period-on-period increase over the previous year of 41%. Over the corresponding period overall profitability dropped by 6%. The situation was alleviated by support from SAMA; interest-free deposits of SAR 110 Bn were received up to September 2020. Activity in the lending space has picked up, especially auto and mortgage financing. This reflects the strong demand in the Kingdom for housing and the efforts of the Government to promote home ownership. The home ownership levels have now exceeded 50%, which was an intermediate milestone in the Vision 2030 plans. The loan growth has contributed a year-on-year asset growth of 10% over 3Q 2019 and the customer base has grown by 3%. However, profitability in the banking sector is expected to decline with weakened credit demand and non-performing loans increasing in certain sectors. With declining oil prices impacting Government coffers, funding for banks will also suffer.
Nevertheless, the banking sector has shown itself to be agile and innovative in the face of the crisis. Saudi banks have robust capital ratios which will provide resilience, despite reduced ability of borrowers to meet commitments. Looking ahead, driven by customer and investor expectations, banks and the entire corporate sector are likely to become more conscious of ESG considerations. With issues such as climate change coming to the forefront, ESG is likely to play an increasingly important role in the agendas of managers and regulators in the entire commercial sector.