'High expenditure behind inflation spiral in Saudi'
As spending is projected to be even higher this year and government measures to tackle the problem have been ineffective, inflation could nearly double to more than eight per cent this year, the highest annual average in the Gulf Kingdom.
While the worsening problem could force Riyadh to consider radical solutions such as a revaluation, economists believe such a move would not resolve the underlying causes of inflation, mainly soaring rents.
"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. Inflation hit 9.6 per cent in March, up from just 3.1 per cent in June of last year," said Brad Bourland, chief economist at the Riyadh-based Jadwa company, a leading Saudi investment consultant.
"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."
Jadwa and other key investment and financial institutions in the world's oil superpower had earlier forecast inflation rate in 2008 at around five per cent, slightly higher than the 4.1 per cent recorded in 2007.
But many of them have started to revise up their estimates for 2008 following official Saudi reports about a sharp increase in monthly inflation rates in the first quarter. Some of them based their new forecasts on the fact that a 17-point alleviation plan announced by Saudi Arabia in January was not making any impact on inflation, which was as low as 0-2 per cent in previous years.
Jadwa forecast inflation would ease to 6.2 per cent in 2009 and five per cent in 2010 although actual public spending is projected to steadily rise. From SAR443 billion (Dh438 billion) in 2007, spending is expected to surge to SAR532 billion in 2008 and SAR611 billion in 2009. It could climb to a record SR685 billion in 2010.
Soaring inflation rates have allied with a sharp decline in the dollar and a series of interest rate cuts by the Saudi Arabian Monetary Authority (Central Bank) to put pressure on the riyal and fuel speculation that the Kingdom and other Gulf oil producers could revalue their currencies, most of which are pegged to the dollar.
"Domestic pressure for a revaluation of the riyal against the US dollar is likely to increase over the summer. Inflation may well hit double digits in the next few months and the effect of the decline in the riyal will be clearly visible to the many Saudis that take their vacations in Europe," Bourland said.
"Adjusting the exchange rate peg would not address the underlying causes of inflation and would have significant adverse impacts elsewhere in the economy, but it is probably the most effective way of reducing inflation in the short term."
According to the Saudi National Commercial Bank, the steep fall in the dollar against other major currencies has sharply depressed the riyal and this has complicated Riyadh's efforts to curb inflation. Its figures showed that since the start of 2008, the riyal has nominally depreciated by 5.8 per cent against the euro and 10.6 per cent against the Japanese yen. The decline has combined with a series of interest rate cuts to stimulate money supply and push up inflation rates, the bank said.
"The decline in the US dollar has adversely affected our currency but I don't think this is a permanent problem… it is not more than a mere market volatility and I believe the riyal's peg to the dollar has some advantages such as financial stability," said Rashid Abdul Aziz, Chairman of the Riyadh Bank.
"As for inflation, I don't believe unpegging from the dollar will contribute to lowering inflation in the medium and long term because as you know there are other factors which are having stronger effects on inflation."
In another report, Jadwa expected stronger pressure on Saudi Arabia to revalue its currency despite recent statements by the Kingdom and its partners in the Gulf Cooperation Council (GCC) that there are such plans at present.
"With all sectors of the population suffering from inflation and the weak exchange rate there will be pressure on the government to respond… to date, the policies aimed at controlling inflation have had little impact," it said.