KUWAIT: Despite higher interest rates, non-oil economic growth remained solid, standing at 5.3 percent in 1H2023 following a 4.8 percent expansion in 2022. The private sector (+5.7 percent in H1) remained the main growth driver, although the government sector’s expansion strengthened to 3.7 percent. Sector-wise, trade, restaurants, and hotels contributed the most to GDP growth, expanding by 8.7 percent in H1 supported by the strong focus on boosting tourism. In terms of expenditure on GDP, private investment continued to contribute the most to GDP growth, expanding by 8.5 percent in H1 while government investment was the fastest growing at 21 percent, both indicating a solid expansion in production capacity, which bodes well for future growth.

The favorable growth dynamics are expected to be sustained in the remainder of 2023 and 2024, despite elevated interest rates. Consumer spending remains strong with the value of POS transactions up around 10 percent y/y through October, though softening from +18 percent in 2022. Despite tighter liquidity in the banking sector, credit growth, although moderating, remains in double digits at around 10 percent y/y through September driven by corporate credit (+12 percent) and, although softening, mortgage lending (+13 percent). PMI levels continue to indicate strong growth, averaging 57.2 in Q3, but lower than the multi-year high of 59.2 in Q2. Given all that, we forecast the non-oil sector’s growth to finish 2023 at 4.7 percent, moderating to a still strong 4.5 percent in 2024 driven by north of 5 percent expansion in the private sector.

This constructive growth outlook is driven by the government’s ongoing reforms as well as by an expansionary fiscal policy. The 2024 pre-budget statement has government spending in 2024 and 2025 13 percent higher than previously budgeted as the government switched to an expansionary fiscal policy, projecting fiscal deficits in these two years after previously forecasting surpluses. The role of the Public Investment Fund and the National Development Fund in terms of enabling that growth is crucial with the former, for example, creating more than 560k direct and indirect jobs since 2016.

Meanwhile, given a 5.25 percent increase in the US federal funds rate since March 2022, SAMA has hiked its policy rates by a similar 5 percent, and together with ongoing tight liquidity in the banking sector (given a faster growth in credit than in deposits) drove interbank rates to multi-decade highs of north of 6 percent. Nevertheless, the tightening cycle is close to being done with current market-implied expectations pointing to US rate cuts commencing in the second half of 2024, which will alleviate some pressure on Saudi interbank rates, and hence drop the cost of borrowing, which will be positive for credit expansion and non-oil growth.

As for the oil sector, growth was negative in H1 (-1.5 percent) given the production cuts, which have deepened since July, resulting in a projected 8.7 percent plunge in 2023.Given our house view on oil market dynamics, Saudi oil production is expected to increase from current levels, but growth to remain slightly negative (-1 percent) for 2024. However, KSA will likely continue to take a very proactive and nimble role in affecting the global oil supply, which could result in a steep deviation with our oil production assumption for 2024. All in all, total GDP is forecast to drop by a limited 0.7 percent in 2023 pressured by the oil sector, then grow by 2.4 percent in 2024 driven by the non-oil sector.

Inflation eases

Inflation continued to soften, standing at1.7 percent y/y through September with housing rentals (+9.8 percent y/y) nearly the sole driver of price pressures over the past year. Nevertheless, housing rentals are likely beyond their peak y/y increase, relieving pressure on the overall inflation rate going forward, which we project at an average of 2.3 percent this year and 2 percent in 2024. Solid non-oil growth and ongoing Saudization initiatives dropped the unemployment rate among Saudis to 8.3 percent in Q2, down from 9.7 percent one year before and nearly half the post-COVID high of 15.4 percent recorded in mid-2020.

Limited fiscal deficits

A 12 percent increase in spending in 9M2023 and a 24 percent drop in oil revenues resulted in an estimated1.5 percent of GDP fiscal deficit as non-oil revenues expanded by a solid 22 percent. We project limited deficits of 2.1 percent and 1.7 percent of GDP in 2023-2024, despite the higher levels of government spending, mainly due to ongoing solid increases in non-oil revenues and higher dividends from Aramco, given the newly-adopted performance-linked dividends. Hence, debt levels should remain contained, below 27 percent of GDP by 2024.A main upside risk is higher-than-forecast oil production in 2024, leading to stronger GDP growth, while the major downside risk is a steeper-than-expected softening in non-oil growth driven by elevated interest rates and geopolitical tensions.