Saudi dilemma over spending and inflation

Saudi Arabia is caught in a quagmire where it faces two difficult options: either to restrain public spending to curb inflation and risk fresh erosion in growth and living standards or to keep it high and let loose the inflation monster.

On more than one occasion, the world's oil superpower has acknowledged that its spiraling public expenditure triggered by a surge in its petrodollar income is one of the principal factors that are driving inflation.

But it has stopped short of taking any measures to curb spending, which shot up to its highest level in 2007 and is projected to hit a record high in 2008.

In one of its strongest hints, Saudi Arabia's central bank said this month it was time for the country to make that sacrifice and become less extravagant on the grounds Saudis are accustomed to slow growth but not high prices.

Presenting the annual economic report to King Fahd bin Abdul Aziz, Saudi Arabia's monetary chief underscored that plight.

"The kingdom is facing a difficult challenge because the measures needed to combat inflation are based on tightening liquidity and public spending," said Hamad Al Sayyari, Governor of the Saudi Arabian Monetary Agency (Sama).

"These measures contravene with our country's ambitious objectives aimed at stimulating growth through adopting an expansionary fiscal policy to complete development projects and improve the living standards of the citizens."

Like its Gulf neighbours, which are experiencing a sustained economic boom due to strong oil prices, Saudi Arabia has reeled under high inflation rates over the past two years because of surging rents and food prices, a sharp rise in public spending, high international prices of some commodities and other factors.

Riyadh has ignored calls by the International Monetary Fund (IMF) to put brakes on spiraling public spending as part of measures to tackle inflation, which stood at 4.1 per cent in 2007 and soared to double digits in the first half of this year.

The IMF expects the rate to exceed 10 per cent through 2008.

Sayyari said the kingdom, the world's dominant oil power, has taken a series of measures to reverse an upward trend in inflation but added such steps did not include any cuts in public spending. These steps involved instructions by Sama to banks to increase their reserves with the Agency and a 17-point alleviation plan announced by the government early this year.

"But because the economy is dominated by the fiscal policy, I think there is a need to programme and revise spending priorities

so they conform to the capacity of the national economy and its developmental goals," Sayyari said.

"It is hoped the measures taken by the government and Sama will combine with a revision of public expenditure growth to achieve the aspired results in bringing inflation rates back to their previous low levels in the near future," he said.

Tempted by strong crude prices, Saudi Arabia has overshot annual budgeted spending by at least 15 per cent over the past few years but the budgets remained in large surplus as revenue growth surpassed overspending.

Actual Saudi spending hit a record SR466 billion (Dh455.82bn) in 2007, nearly SR73bn higher than expenditure in 2006 and almost double the 2002 spending. It was nearly SR86bn higher than the budgeted spending of SR380bn.

Actual spending is expected to leap to SR532bn in 2008 against budgeted expenditure of SR410bn. It is projected to swell to SR611bn in 2009 and a record SR685bn in 2010, according to the Riyadh-based Jadwa Investments, a leading financial consultancy firm in the kingdom.

Public spending in Saudi Arabia and other Gulf oil producers has remained the wheel of economic activity despite a steady expansion in the private sector over the past decade. It was the surge in government expenditure that has triggered high growth rates in the kingdom and reversed an erosion in per capita income during the 1990s because of low oil prices and high population growth. During that period, Saudi Arabia reeled under massive fiscal deficits and negative economic growth in some years, but inflation was negligible, not exceeding one per cent most of the time.

In a report last month, Sama said inflation surged to as high as 10.5 per cent in the first quarter and is projected to continue through the third quarter.

"Indications point to continued inflationary pressure on the Saudi economy through the third quarter probably at a lower rate as inflation rates were high in the previous period and government measures, including subsidising some essential food items and cutting fees, have started to make an impact," the report said.

"Domestic supply also appears to be responding to strong demand. But there are some factors that are expected to keep up inflationary pressure in general during the coming period. They include both local and foreign factors – the local factors comprise higher government expenditure."

In a recent study, a prominent United States economist based in Saudi Arabia projected inflation in the kingdom to nearly double this year.

"By adding to money supply growth and tightening various supply bottlenecks within the economy, higher government spending will feed into inflation, which is continuing to rise at an alarming pace," said Brad Bourland, Chief Economist at Jadwa Investments.

"Rents and food prices remain the main sources of inflation, but the price rises are now spreading. In year-on-year terms inflation picked up in each of the eight subcomponents of the cost of living index in February. This spread of inflation will complicate policy to contain it and further fuel the public's inflation expectations.

"We have again revised up our forecast for inflation for this year; we now expect it to average 8.2 per cent."

Saudi Arabia, which pumps just above nine million barrels per day of crude, has been tempted to exceed forecast expenditure because of a surge in its oil income, which is expected to smash through the SR1 trillion mark for the first time this year. It was as low as SR130bn in 1998.

"The government will most probably exceed budgeted expenditures by an average of 13-15 per cent this year, to reach around SR507bn, as has been historically the case. The alleviation package will probably be one factor for the government's overspending this year," said National Commercial Bank (NCB), Saudi Arabia's largest bank.

"Also, consistent with its indirect fiscal stimulus strategy, the budget surplus will be large enough to stimulate the economy further by injecting additional funds into specialised credit institutions and the retirement of public debt."

Follow Emirates 24|7 on Google News.