Inflation may bring fresh woes to GCC

After they were rattled by the global financial crisis and the ensuing crash in crude prices, Gulf oil producers appear to be facing a new challenge – inflation, a key Saudi investment company said yesterday.

The six Gulf Co-operation Council (GCC) countries, which control over 40 per cent of the world's proven crude deposits, are again facing the spectre of resurging inflation rates because of strengthening global commodity prices due to growing demand and investors' appetite, said NCB Capital, which is owned by National Commercial Bank, Saudi Arabia's largest bank.

With oil prices soaring recently above $80 a barrel to their highest level in more than a year and the price of other commodities gaining ground, the GCC nations could again feel the pinch of soaring domestic prices although the rate is unlikely to rise to such high levels recorded in 2008.

According to NCB Capital, the GCC countries could find it difficult to deal with high inflation levels for the time being as they have to keep interest rates low as part of their counter-crisis expansionary fiscal policies.

But financial analysts said they supported projections by the International Monetary Fund (IMF) that consumer prices in the GCC would remain within acceptable levels in the next two years on grounds that banks are still cautious in lending and the real estate sector has undergone a sharp downturn in some member states in the wake of the 2008 crisis.

NCB Capital noted that commodity price pressures have been among the main challenges facing the global economy before and during the crisis. It said the current tentative recovery looks unlikely to be any different.

Role of emerging markets

The report believed the situation has been driven above all by the highly differentiated economic performance of the advanced and the emerging economies.

The latter, thanks to their macro-economic stability and relative lack of structural problems, have remained a strong source of demand for commodities almost throughout the crisis.

It added that the impact of the cyclical downturn was further muted because of the importance of strategic purchases by countries such as China for their reserves.

Commodity markets have also experienced important changes on the supply side while the demand side has also changed as a result of the "discovery" of commodities by new classes of investors. "The prospect of commodity strength, along with the risk of increased volatility, presents the GCC economies with particular challenges due to their heavy reliance on hydrocarbons exports and on imports of most other commodities. The past couple of years have underscored the continued profound impact of oil price variations on the broader macro picture in the region, primarily because of the close link between the oil price and the external and fiscal balances," NCB Capital said.

"A strong oil boom can create waves of liquidity that the regional economies struggle to absorb, as happened in 2007 and early 2008. At the same time, price pressures in other commodities can create supply-side shocks that further amplify the inflationary impact. Under the current monetary policy paradigm, such challenges can prove difficult to deal with."

Rates and reserves

The GCC states – the UAE, Saudi Arabia, Kuwait, Qatar, Bahrain and Oman – reeled under record inflation rates in 2008 as a result of soaring global commodity prices, weakening of the US dollar to which most of their currencies are pegged, and a surge in local rents and food prices.

The six members responded by hiking rates several times and forcing banks to increase reserves with the Central Bank before they were forced by the global crisis to reverse such measures. Rates are now at their lowest levels while monetary authorities have largely eased reserve requirements.

But such moves have failed to spur banks to resume normal lending after most of them tightened their credit lines in response to debt default problems by regional institutions, to which many of them were exposed.

"The GCC states have limited fiscal tools at present to deal with high inflation rates, as they have been locked in a cyclical fiscal policy following the crisis and the ensuing collapse in crude prices," a UAE banker said. "But I don't think inflation rates will return to their 2008 levels… domestic demand is unlikely to rise to the 2008 level, while rents in some member states have largely gone down and are not expected to rebound sharply. The dollar is relatively strong and oil prices are still within acceptable limits, so the only major factor that could stoke inflation in the region is a sharp rise in commodity prices, given the GCC's heavy reliance on imports mainly from major industrial nations. Yet inflation rates will remain relatively low."

IMF estimates showed that inflation in the UAE could rise to 2.2 per cent in 2010 and around three per cent in 2011 from 1.5 per cent in 2009. But the rate is much lower than the record level of 12.3 per cent in 2008.

Kuwait could see inflation slip to 4.5 per cent this year and four per cent in 2011 from 4.7 per cent in 2009 but the level remains high compared to the early years of the latest oil boom.

Qatar, which recorded the highest inflation rate in the GCC in 2008, could see a resurgence of inflation to one per cent this year and three per cent in 2011 after recording deflation in 2009.

Bahrain is also projected to record higher inflation rates in 2010-2011 while the rate in Oman could remain unchanged at about 3.9 per cent in 2010 before easing to 2.9 per cent in 2011, according to the IMF.

Inflation in Saudi Arabia, the largest Arab economy, could edge up to 5.2 per cent in 2010 from 5.1 per cent in 2009 before easing to around five per cent in 2011. But the rate is considered high by the kingdom's fiscal standards.

"We think the rate of inflation in the kingdom will remain broadly stable in 2010, averaging around 4.5 per cent, before edging up to five per cent in 2010 as trading partners' inflation picks up, albeit slightly, wheat prices rise, and domestic economic activity firms," the Saudi American Bank said. "This rate of inflation is high for Saudi Arabia, but is well within bounds for an emerging economy at this stage of development."

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