Inflation in the GCC has retreated rapidly after the unprecedented period of accelerating prices in 2007-2008.
But while the consumer prices indices are looking more comfortable than they once did, the situation is far from being ‘back to normal.’ Awareness of inflation, whether as a reality or a risk, is far greater than it used to be. Nonetheless, the near-term outlook is unusually sharply differentiated among countries.
This reflects above all the importance of housing costs in the Consumer Price Index (CPI) and the sharp differences in the outlook for the regional real estate markets.
As much as the inflationary boom of 2007-2008 seems like a thing of the past, it revealed a number of uncomfortable truths about the monetary policy challenges facing the region. In particular:
• The exceptional, and growing, dependency of the regional economies of imported food makes them vulnerable to external weather-related and political risks. Given the small relative size of the exportable surplus in many producer countries, price pressures can emerge very quickly and are sometimes amplified by quantitative risk by way of efforts to restrict trade.
• The GCC housing markets are young and not yet supported by comprehensive regulations and established mortgage finance facilities. This means that they remain vulnerable to sharp fluctuations and speculation.
• The monetary policy autonomy of the GCC central banks is very limited in the near term. The Dollar pegs still make eminent sense for a whole host of reasons but they present short-term policy management challenges at a time when the business cycles in the Gulf and in the US have diverged sharply.
In the near term, the Gulf countries will increasingly find themselves squeezed between these conflicting pressures. The food price index in the region has been pushed sharply up by a historically poor monsoon and harvest in India.
While the effects of this will abate over time, the greater reliance on imports in a tightening global supply situation presents the risk of continues pressures and recurrent peaks. For instance Saudi Arabia is steadily reducing its support for wheat cultivation with a view to phasing it out altogether by 2016. The robust economic recoveries in many populous emerging markets will add further pressure.
The near-term outlook in the real estate space has become markedly different between Saudi Arabia and some of the coastal Gulf countries. Robust real estate booms led by Dubai and Kuwait have imploded and sharply reversed. This has brought housing costs sharply down in the affected economies and the prospect of excess capacity, especially in Dubai, will continue to contain them for some time.
Indeed, a solution to the Dubai World crisis may result in the resumption of a number of stalled construction projects, thereby increasing the probability of further price corrections. Nonetheless, it looks likely that even the coastal markets have now experienced most of the decline and some of them are likely close to a recovery of sorts, however tentative and gradual. This will put an end to the downward effect of housing costs on the regional CPIs.
In Saudi Arabia, the situation is far less benign. Although the Saudi market was by no means spared from the correction, the price declines were both smaller and much more segment-specific. In general, the Saudi housing market remains robust and price pressures are underpinned by significant housing shortages.
Recent estimates suggest that there is a need for some 160,000 housing units a year during the coming decade. Pressures will be further increased by raw material costs which, after a period of correction, are once again rising.
Although inflationary pressures have come down markedly in a region, the pace has been far slower in Saudi Arabia than in the economies hardest hit by the real estate correction. While inflation temporarily dipped below 4 per cent, it has since once again exceeded it. This seems to reflect at least to a degree elevated inflationary expectations.
The policy challenge is made all the greater by the fact that inflation remains far above its historical levels at a time when the economy is yet to fully resume broad-based growth in a fragile international economic environment.
The challenges facing GCC policy-makers are made all the greater because of the seemingly widening divergence in the economic performance of the region as compared to the advanced economies of the West. Recent developments in the oil market are further accentuating the impact of this divergence.
New demand for oil is above all driven by the emerging economies of Asia which have largely de-coupled from the West and whose growth is supported by strong domestic drivers. Hence, the continuing weakness of the West is not necessarily going to do much to stall the oil price recovery, provided their situation does not begin to actually deteriorate.
At the same time, the weak recovery, a lack of inflationary pressures and a cluster of endemic structural problems are likely to military for a protracted period of exceptionally loose monetary policy in the US.
Even though the Federal Reserve has started to scale back some of the emergency measures adopted at the height of the crisis, its official stance suggests a very low probability of a near-term retreat from its current stance on rates. Some observers expect actual rate increases to be delayed into 2012. Even though GCC policy makers will have some leeway in tightening money even in the presence of the Dollar peg, previous experience suggests that this is not easy.
Moreover, the strong commitment to the Gulf Monetary Union creates few incentives for uncoordinated changes in monetary policy before the Union and a new monetary policy regime are finalised.
This leaves the GCC between the rock and the hard place but also with an opportunity to pay greater attention to the structural causes of inflation. Well-controlled mortgage markets and real estate are part of this but so are efforts to foster competition and transparency, not to mention greater regional economic integration with efficiency gains it promises.
Ultimately, a broad-based approach to dealing with inflation will help increase the flexibility and competitiveness of the regional economy. Higher inflation looks likely to persist for some time, especially in Saudi Arabia, but a fair bit can be done to prevent its further acceleration on a sustained basis. Managing expectations is key in this regard.
Email the writer:
j.kotilaine@alrroya.com
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