Saudi admits public spending faults

Saudi Arabia has admitted that failure to rein in public spending is stoking inflation, which could double this year despite a rescue plan.

The Kingdom said its inflation problem was compounded by the country's vulnerability to foreign markets and a surge in rents spawned by a shortage.

The Saudi Arabian Monetary Agency (Sama) said inflation surged as high as 10.5 per cent in the first quarter and is projected to continue through the third quarter albeit at a slower pace.

"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 impact… domestic supply also appears to be responding to strong demand," Sama said.

"But there are some factors that are expected to keep inflationary pressure in general during the coming period… they include both local and foreign factors… the local factors include higher government expenditure," the Central Bank said.

It said the problem would be compounded with a surge in domestic demand because of higher family spending during the new school year, Ramadan and Eid Al Fitr.

Local factors also include a slow growth in domestic housing supply and a steady increase in construction costs because of higher prices of fuel and building materials and a surge in local labour costs.

As for foreign factors, the openness of Saudi economy to international markets and the peg between the riyal and the US dollar have sharply boosted the import bill and the problem is expected to persist in the coming period. Despite calls by the International Monetary Fund to cut public expenditure to tackle inflation, Saudi has continued to largely overshoot budgeted spending, tempted by a growth in its petrodollar income.

The surge in spending has allied with higher private investments, soaring rents and food prices and the weak US dollar to push up inflation rates in Saudi Arabia, rising to one of their highest annual levels of 4.1 per cent last year. It sharply accelerated in the first and second quarter despite a 17-point government plan announced in January to reverse the upward price trend.

In a recent study, a prominent US economist based in Saudi projected inflation in the world's oil superpower to nearly double this year because of higher public expenditure, soaring rents and other factors.

"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 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 the 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 the alleviation plan was not making any downward impact on inflation.

Jadwa forecast inflation would ease to 6.2 per cent in 2009 and five per cent in 2010 although public spending is projected to increase steadily. From SAR443 billion (Dh443bn) in 2007, spending is expected to surge to SAR532bn in 2008 and SAR611bn in 2009.

Saudi Arabia, which pumps just above nine million bpd of crude, has been tempted to exceed forecast expenditure because of a surge in its oil income, which is expected to smash through the SAR1 trillion mark for the first time this year. It was as low as $35 billion (Dh128.4bn) in 1998.

"The government will most likely exceed budgeted expenditures by an average of 13 per cent to 15 per cent this year, to reach around SAR507bn, as has been historically the case," said the National Commercial Bank.