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Saudi high public spending stokes inflation

Saudi Arabia is stoking its own inflation by keeping publishing spending high while rising rents and food prices are adding fuel to the inflation blaze in the world's dominant oil power, according to a key Saudi investment firm.

Inflation hit a one-year high of 5.5 per cent in June and is out of step with inflation trends elsewhere in the world, the Riyadh-based Jadwa Investments said.

The rate is over four times higher than the average for the other five members of the Gulf Cooperation Council (GCC) and is contrary to what is happening in most of the rest of the global economy, Jadwa said in a study.

"With rental inflation likely to go up, Ramadan and unfavorable weather conditions in central and Eastern Europe set to lift food prices and higher electricity tariffs, we have raised our forecast for average inflation to around 5.2 per cent in 2010 and 4.2 per cent in 2011," the study said.

"The divergence in the direction of inflation is because rising domestic demand is causing some supply bottlenecks in the kingdom, while most other countries still have large spare production capacity. High government spending has pushed up the prices of raw materials and rises in government pay, pensions and other benefits are stoking domestic demand."

While strong domestic demand for housing is continuing to push up rents and keeping overall inflation high, rental inflation has fallen, Jadwa said.

But it added that rents remain much higher than elsewhere in the GCC, which explains the difference in inflation rates.

"In other GCC countries, particularly the UAE and Qatar, rental inflation was driven by an influx of expatriates. As the economic downturn hit, many expatriates lost their jobs and left these countries at the same time as more accommodation came on stream, causing rents to plunge," it said.

"In contrast, the demand for property in the kingdom is being driven by domestic population dynamics and a reduction in the average household size."

Turning to external factors, Jadwa said the effect of higher international food prices earlier in the year continues to work through the Saudi economy, with food prices the component of inflation that has increased the most recently.

Nonetheless, some external factors are dampening inflation in Saudi Arabia, the report noted, referring to the strengthening in the Saudi currency, the riyal, against most of the currencies of the Kingdom's main trading partners. Shipping costs are also well below where they were one year ago.

"Inflation is probably close to its peak, but we do not expect it to fall too much in the coming months. Ramadan will lift food prices. Since 2002 food prices have risen more than five times faster in the Gregorian month in which Ramadan starts than the average for the other 11 months of the year," Jadwa said.

"A further factor that is set to push up inflation is an increase in electricity tariffs introduced at the start of July. Government, commercial and industrial users are now paying on average around 9.6 per cent more for electricity. The price was hiked to encourage greater efficiency in energy consumption."

According to the report, prices of other commodities will likely rise owing to the ongoing global economic recovery, but those of precious metals, which have a more direct impact on inflation in the kKingdom, should fall as risks to the recovery diminish. Little movement in the dollar is anticipated.

"Even if inflation falls to our forecast level, it will remain high on a global basis. Last month the International Monetary Fund lowered its prediction for inflation in advanced economies in 2011 to just 1.3 per cent. While inflation in fast growing emerging economies such as Saudi Arabia would generally be higher than in advanced economies, price controls and an abundant supply of low wage expatriate workers in the kingdom should hold down prices to a greater extent than elsewhere in the emerging world," it said.

"For the moment, we think that the government will accept the relatively high level of inflation. Its main concern remains supporting the recovery of the private sector and we do not foresee it holding back the implementation of projects, particularly as the costs of the necessary skills and technology are generally well below where they were a few years ago. While bank lending growth remains sluggish, there is little likelihood of an adjustment to interest rates, which in inflation-adjusted terms, are heavily negative."

By Nadim Kawach

© Emirates Business 24/7 2010