Saudi inflation to soar to 6.5% this year



Inflation in Saudi Arabia is projected to climb to a record annual average of 6.5 per cent in 2008 because of an expected new spate of interest rate cuts and a surge in rents and food prices, a prominent Saudi finance centre said yesterday.

The rate could moderate to five per cent in 2009 and four per cent in 2010 but it remains high compared to inflation history in the Kingdom, which had recorded one to two per cent inflation rates in most years over the past two decades. Between 2002 and 2005, the rate remained below one per cent.

Forecasts by Saudi economists and bankers early this year showed inflation in the world’s oil powerhouse could average around 4.5 per cent this year compared to 4.1 per cent in 2007 as the Kingdom finds itself forced to follow US Fed interest rate cuts despite a sharp expansion in its economy.

As more Fed interest rate cuts are predicted this year to counter a US economic slowdown, the Saudi Arabian Monetary Agency (central bank) could again follow suit to bring its currency, the riyal, under further pressure, and give rise to speculation about a revaluation, according to the experts.

“Inflation has continued to rise. Year-on-year inflation jumped to 8.7 per cent in February from seven per cent in January. Rents and food prices continue to be the main sources of inflation, climbing 18 per cent and 13 per cent respectively,” the Riyadh-based Jadwa Financial Consulting Centre said in a study.

“While rents are rising due to local factors, global pressures are pushing up food prices… Saudi food prices have moved in line with global food prices [based on the IMF’s food price index]. With food prices rising faster than we had anticipated and rent rises showing little sign of slowing, we have revised up our forecast for average inflation for 2008 to 6.5 per cent,” the study said.

Saudi experts are now forecasting higher inflation rates despite measures taken by the government to alleviate the problem.

“Based on the pace of increase in food prices and rents, strong domestic demand, high public spending and inflation figures for the past two months, I think inflation this year will be much higher than in 2007,” said Khalid Al Dakhil, assistant professor of political sociology at King Saud University.

“What supports this view is that Sama has no choice but to follow the US Fed in cutting interest rates or it has to depeg the riyal from the US dollar, which is unlikely at present,” he said.

Sama has cut the repo rate on six separate occasions by a total 275 basis points since September to match the Fed rate reductions. This has contributed to money supply growth and is not what a central bank would normally do in an economy facing rising inflation.

It has also brought into question the viability of the exchange rate peg and encouraged speculation about a revaluation.

With the Fed Funds rate at 2.25 per cent, there is still scope for further interest cuts [the bottom of the last US rate cycle was just one per cent]. However, concerns about inflation are likely to limit the Federal Reserve’s room for manoeuvre, according to Jadwa.

“We expect that Sama will continue to lower its repo rate in line with the Fed Reserve. The commercial bank reserve requirement may also be raised further from its current level of 10 per cent in order to curb bank lending and absorb some of the inflationary pressures,” the Jadwa study said.

“However, these measures alone will not be sufficient to contain inflation, and we expect pressure on the riyal to continue,” it said.

Saudi economists said lower rates boosted domestic liquidity, with the broad money supply (M3) hitting a 30-year high of 23.9 per cent in January. Both demand deposits and time and savings deposits were up by more than 30 per cent despite a Sama decision early this year to raise the banks’ reserve requirement from seven to nine per cent.

In late March, Sama cut interest rates again, trimming the reverse repo rate by 75 basis points to 2.25 per cent following an equal cut in the US Fed funds rate.

The repo rate (the rate Sama charges for lending) remains unchanged at 5.5 per cent, signaling that Sama does not want commercial banks to reduce lending rates and therefore stimulate credit growth.

“The effectiveness of this policy has been mixed. Commercial bank lending rates have not been that responsive to lower interest rates, but interbank rates have continued to track the reverse repo rate,” Jadwa said.

“The cut in interest rates has raised further questions about the sustainability of the exchange rate peg among some investors.

“The one-year forward rate, which measures what the market expects the exchange rate to be in one-year’s time, touched SAR3.66  against the dollar in mid- March, its highest rate since late-November. However, Sama has reiterated its commitment to maintaining the exchange rate peg at SAR3.75 against the dollar and we are confident that the peg will be in place at the current level in one year’s time.”


Money supply surges


The Saudi Arabian Monetary Agency’s (Sama) figures showed Saudi M3 soared to a record SAR815 billion (Dh799bn) at the end of January, nearly 3.2 per cent above its level at the end of last year and more than 23 per cent higher than a year ago.

Credits to the private sector grew by around three per cent to SAR594 billion at the end of January compared to the previous month and by nearly 24 per cent a year ago. The figures showed a sharp rise in deposits allowed Saudi banks to expand their lending activity as they swelled to a record SAR743bn at the end of January compared to SAR717bn at the end of December and around SAR591bn at the end of 2006.