Saudi Arabia is set to take the lead in regional infrastructure investment and construction spending. Over the next 15 years, the MENA construction sector will be a key beneficiary of the implementation of structural reforms to raise productivity of the nonoil sector and the economy's potential output, according to a new medium term outlook BofA Merrill Lynch Global Research Report "GCC 2020: Time to Shift Gears."

“Due to many years of underinvestment, we expect Saudi Arabia to take the lead in terms of construction spending in the MENA region as the Kingdom responds positively to pressing social needs such as labor, housing and education,” said Philip Southwell, Bank of America Merrill Lynch president and country executive, Middle East and North Africa.

The MENA infrastructure and construction market is among the world's most attractive given its sheer size, according to the report. Forecasting figures predict a total of $ 4.3 trillion will be invested in construction projects across the MENA region by 2020, representing an increase of almost 80 percent from today's spend in the sector. To put these projections in a broader context, the region is expected to account for 12 percent of the global emerging markets and 4.4 percent of the world construction markets within the next decade. Saudi Arabia is expected to continue leading the way.

Although MENA contract awards have been somewhat disappointing for the period
January to May 2012, declining by 41 percent from a year earlier, the main reasons for this decline can be primarily attributed to delays in awarding petrochemicals projects in Egypt and delays in awarding construction and infrastructure contracts in the UAE, Kuwait and Iraq.

“The construction and infrastructure sub-sectors in Saudi Arabia, however, remain strong, growing by 177 percent over the same period, and currently accounting for 46 percent of the 2012-2013 MENA project pipeline totaling $ 448 billion,” said Merrill Lynch Kingdom of Saudi Arabia CEO Mutashar Murshed.

“It is a trend we expect to continue,” Southwell said. “With its young and expanding population, Saudi Arabia should remain the most buoyant market, in line with its overall economic development plan. Furthermore, the recent approval of the mortgage law should help to drive growth in residential construction in response to the current housing shortage.”

BofA Merrill Lynch report said Saudi banks seem best placed among GCC peers to produce loan growth and improved ROEs. Saudi Arabia should be able to maintain a similar pace of growth compared to the previous seven years at around 14 percent CAGR playing on both the consumer as well as infrastructure themes noted earlier in the report. A long-term normalization of interest rates from historical lows will support their ROEs given their franchise deposit base.

The remaining GCC banking systems will be more of a play on the infrastructure theme given their greater skew toward corporate lending while ROEs are unlikely to materially change.

With credit to GDP averaging 58 percent within EM countries credit penetration is not enticingly low within most of the GCC even after accounting for the higher per capita income. However, looking more closely Saudi Arabia and Oman stand out as having more room for growth. “We expect the two countries along with Qatar (which is preparing for the World Cup 2022) to produce 14 percent CAGR growth in lending between now and 2020. Beyond 2020, Saudi Arabia is likely to have further room to grow especially on the mortgage lending side,” BofA Merrill Lynch said in its report.

One example of structural improvements in credit penetration is mortgage lending in Saudi Arabia. Home finance loans currently stand at 1.4 percent of GDP, 12 percent of retail loans and 4 percent of total loans. They averaged CAGR of 25 percent 2003 to 2011and current pace is 7 percent QoQ and 31 percent YoY in March 2012. The government has recently passed the countries first mortgage law which will allow banks to provide longer duration loans backed by the underlying asset.

“We expect growth to accelerate to 38 percent CAGR in 2011-14 with penetration around 4.5 percent of GDP by 2016E. The legal reform is driven by the government's need to alleviate housing shortage and strong population growth,” BofA Merrill Lynch said.