The specter of inflation that seemed to be once haunting the GCC region in the summer is showing some signs of retreating. The Saudi economy in particular has served as something of a bellwether on regional trends due to its relative economic stability throughout the crisis.
The disinflationary effect of a major housing market correction did not take place in the Kingdom whereas it served as the main force tempering price pressures in some of the Gulf coast economies. Inflation in Saudi Arabia accelerated relatively quickly during from a temporary trough of 3.5 per cent in October 2009 to a peak of 6.1 per cent in August. Since then, the headline reading has edges down to 5.8 per cent in October. Also Kuwait has seen a slight downward dip as of October, from 5.3 per cent to 5.1 per cent. However, even this figure is sharply ahead of the 2.8 per cent reading at the beginning of the year.
Elsewhere in the region, inflation has continued to trend up. In Oman, it reached 4.2 per cent in September, up from only 1.7 per cent in January. In Bahrain and the UAE it remains at the much more moderate levels of 2.1 per cent and 1.9 per cent. Qatar in fact still faces a deflationary scenario with the latest monthly reading at -0.9 per cent, a significant improvement, nonetheless, on the -5.6 per cent figure for January.
The inflationary outlook for the region is above all driven by food and housing-related costs, which jointly tend to make up roughly one-half of the consumer price basket. Problematically, the outlook in both areas is ambiguous. In the case of housing costs, the recent increase in inflationary pressures seems to have represented a combination of persistent, indeed structural, shortages in markets such as Saudi Arabia, and the end or reversal of the regional housing corrections.
While the structural shortages are a serious issue, their impact is unlikely to increase in the near-term. With relatively stable price pressures, the additional inflationary impulse should begin to wane. More generally, although confidence is improving against the backdrop of better economic prospects, the housing market is unlikely to develop significant additional momentum except in very select markets or market segments. In some cases, most notably Dubai, the reactivation of suspended projects will likely ensure a period of excess supply, which should contain the upward pressure on housing costs. Consequently, the baseline scenario for housing costs is increasingly one of price stability or moderating price increase. And even as the economic picture is becoming brighter, there are still market segments where prices may fall further before they find a more sustainable equilibrium. All of this should make housing costs slightly less of a concern for headline inflation going forward.
The situation with food is different but not fundamentally so. The unexpected series of harvest failures globally has created substantial pressures in the soft commodity space. The relevant question here is the extent to which these more challenging market realities have now been factored into the prices. So far, even though some countries have imposed export restrictions, it looks like the worst-care scenario of an all-out trade war has been avoided. This increases the likelihood relative price stability in the coming months, even if the price levels themselves are much higher than had been expected. Futures prices currently support such a scenario. With additional upward price pressures waning, the incremental inflationary impact should prove fairly limited in duration. The year-on-year rate of increase will remain at close to the current levels for much of the coming year but is unlikely to deteriorate further unless additional disruptions materialise.
Beyond this, the various factors determining the regional inflationary outlook look to be broadly in balance. Imported inflation is likely to gain at least some respite from the recent recovery of the US Dollar vis-à-vis the Euro as a result of the European sovereign debt woes. The outlook for the Euro remains unusually uncertain because of the risk of significant discontinuities as more countries may run into difficulties. Nonetheless, it seems fairly likely a combination of bail-out measures and European Central Bank intervention would contain the problem for now in a way that avoids significant contagion. While this would contain the downside on the Euro, the likelihood of the Euro appreciating significantly vis-à-vis the Dollar is looking increasingly remote in the near term, even allowing for the downward effect of quantitative easing. Emerging market currencies are likely to continue their gradual appreciation vis-à-vis the Dollar but almost certainly at a very measured pace.
Oil has historically been an important driver of prices, partly due to its impact on liquidity, partly given its role in supporting broader economic confidence. The oil price, in spite of volatility, has proven remarkably stable within a fairly narrow range since its speedy recovery from the post-Lehman Brothers trough in the spring of 2009. And even though the price seems to be looking for a slightly higher support level – as suggested by the recent OPEC assertions in favor of a slightly higher USD70-90/barrel price range – the uncertain global environment will likely check the positive momentum. The European debt woes are one factor, the prospect of fiscal consolidation another. But also China, one of the key drivers of the recent commodity boom, is increasingly concerned about inflation and once again seeking new ways to combat it. This reduces the probability of a sustained major rally in the near term.
Also the money supply situation in the GCC suggests little momentum, even with interest rates at historically low levels. For instance in Saudi Arabia, the growth of bank deposits has almost stalled, largely as a result of declining risk aversion. At the same time, banks in the region are still to resume lending. They remain cautious and for instance the Saudi banks were still in Q3 working their way through non-performing loans. Even though the regional banks are healthy, their willingness to return normal financial intermediation seems to be resuming only very slowly.
Overall then, inflation, having been the main macroeconomic challenge for especially Saudi Arabia this year, is showing tentative but fairly clear signs of becoming less of a problem. Instead of continuing to edge up, it looks likely to stabilise and even begin to slow down gradually. But none of this means that inflation has gone away. Especially Saudi inflation is historically high and the outlook facing the economy can quickly change once the recovery begins to gather momentum and commodity prices resume their rise. Moreover, the vulnerability to external price shocks remains acute.
Email the writer:
j.kotilaine@alrroya.com
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