The planned slowdown in public spending in Saudi Arabia will prove credit negative for banks in the kingdom, ratings agency Moody’s Investors Service has said in a new report.
Following years of high expenditure, the Saudi government is planning to moderate the pace of spending due to the persistent drop in oil revenues. Oil prices are down by over 50 per cent compared to June 2014, slashing revenues for oil producers such as Saudi.
The International Monetary Fund estimates that Saudi will face a budget deficit of over $100bn this year, amounting to 21.6 per cent of gross domestic product.
Moody’s anticipates that government spending growth will slow to 2 per cent in 2014 and 4 per cent in 2017, from 14 per cent on average between 2010 and 2014.
“We expect that this slowdown in government spending will be credit negative for Saudi banks as it will dampen credit growth and moderate deposit flows to the banks” said vice president and senior credit officer at Moody’s Olivier Panis.
The rating agency expects credit growth to slow to around 8 per cent in 2015 and around 5 per cent in 2016, from 12 per cent in 2014.
Deposit flows are also likely to weaken as the government reduces balances placed with the banks, the report found.
While this would lead to tighter funding conditions, the agency said that the overall impact will be partly offset by Saudi banks’ “stable funding structure and robust liquidity buffers”.
Lenders primarily depend on non-interest bearing deposits with a limited dependence on more costly capital market funds, it said.
“We also expect that lower public expenditure will trigger some weakening of banks’ loan performance, although this will be mitigated by lenders’ strong loss-absorption buffers and resilient profitability,” added Panis.
Moody’s forecasts that problem loan levels will increase to around 2 per cent of gross loans, from 1.1 per cent as of June 2015. However, lenders in the kingdom banks have built up strong loss-absorption capacity in recent years, it stated.
The rating agency also expects that banks will sustain solid profitability, owing mainly to the increased holdings of higher yielding long-term government debt issuances versus short-term instruments.
“In Moody’s opinion, Saudi banks will remain resilient to a moderation in government spending growth in the next 18 months, but a further, or more prolonged slowdown in spending, would increase downside risks for the banking sector,” the report added.
A similar report by Standard & Poor’s in August predicted that lower oil prices will soon start to weigh on Saudi Arabia’s banks.
“Over the past few years, we have seen a stabilisation in asset quality and it has been a story of declining credit losses. But we now believe that through the end of this year we will begin to see credit losses picking up,” banking analyst at S&P Timucin Engin said.