GCC remains 'vulnerable' to inflation pressure

Soaring inflation rates have started to again loom over Gulf oil producers and this illustrates their vulnerability to price pressures given their heavy reliance on food imports, a key Saudi investment firm said on Monday.

Gulf Cooperation Council (GCC) countries, which control nearly 45 per cent of the world’s recoverable oil deposits, get more than 90 per cent of their food needs from foreign markets and the recent dramatic developments in the global farming sector make them more exposed to a fresh bout of high inflation, said NCB Capital (NCBC), an affiliate of the Saudi National Commercial Bank.

Although property price corrections in some GCC countries have given their authorities a temporary respite, inflation is increasingly establishing itself as an overriding policy concern in the region, it said in a study.

“The ability of the regional economies to respond the external shocks is clearly limited, even if the recurrent pressures in the area of food are likely to fuel growing pressures for national or regional reserves in key agricultural commodities in an attempt to smoothen short-term price variations,” it said.

The report stressed that in the area of housing, regulation is an important instrument for containing short-term price bubbles and ensuring what it described as an acceptable longer-term demand-supply balance.

“While the disinflationary impact of house price corrections is likely to pass in economies such as the UAE, the prospect of excess supply in markets such as Dubai should help contain the resumption of high inflation,” it said.

“Yet the GCC remains vulnerable to unpredictable shocks, both in the form of food prices and in terms of liquidity waves created by short-term oil bubbles, especially once bank lending normalises. Temporary policy interventions may once again become necessary to contain inflationary expectations.”

But NCBC stressed that in spite of the recent pick-up in price pressures, mainly in Saudi Arabia, and the threat of increasing expectations, the current outlook for inflation in the GCC is relatively benign.

It added that the most intense price pressures should over time begin to pave way to a more stable situation, with this year likely to be a medium-term peak for inflation in Saudi Arabia, while the rest of the region will likely see some acceleration towards three to four per cent in the medium-term.

“The resurgent inflation pressures in the GCC are driven by both cyclical and structural factors. The region’s heavy reliance on imported food leaves it acutely vulnerable to external price variations,” NCBC said.

It cited figures by the World Trade Organisation showing the GCC countries are the leading importers of food in the world and external sources account for more than 90 per cent of their total farm needs.

The figures showed the GCC’s combined agricultural commodity imports climbed to about $10 billion (Dh36.7bn) in 2007, equivalent to nearly 1.3 per cent of the region’s GDP and about 70 per cent higher than the average net imports in 2000-2004.

Moreover, rising oil prices have caused freight costs to increase sharply in recent months, although a pronounced reversal in the Baltic Dry Index has materialised this summer due in part to increased capacity, the report said.

It showed Saudi Arabia’s food import bill, the largest in the Arab World, rose to $17.3bn in 2009, accounting for nearly 15 per cent of its total imports.

“Food imports are further expected to surge as the Kingdom is phasing out subsidies to domestic wheat production in order to conserve its water resources. Food inflation is likely to continue to increase as rising per capita consumption of a rapidly growing population swells GCC import bills,” the study said.

“The policy predicament facing the GCC has been made increasingly acute by the mounting evidence of structural constraints in the global market for agricultural commodities, which likely left the supply shocks of 2007-2008 a herald of things to come. The exportable surplus is being increasingly eroded by structural drivers such as rapidly rising demand in most emerging markets (due to a combination of rapid population growth and higher living standards) and the growing diversion of agricultural commodities towards bio-fuels in the West and some emerging economies.”

According to the study, expectations of a longer period of relative global price stability in the agricultural commodities area have during recent weeks abruptly give way to renewed price pressures.

It noted that drought-like conditions in Russia have already resulted in a spike in global wheat prices despite bumper production in the US.

“In practice, however, the GCC authorities have their hands largely tied in the face of structural pressures, as highlighted by their relative inability to contain inflation in 2007-2008,” NCBC said. 

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