Tricky times ahead for Saudi Arabia
The Saudi authorities remain committed to the dollar peg, mainly due to constraints related to political economy, and are unlikely to opt for a major currency move any time soon. Instead, they will try and control inflation through a mix of unorthodox policy measures, which, in our view, will prove completely ineffective.
"We therefore expect Saudi inflation rates to catch up with the 15 per cent inflation rates prevailing in the UAE and Qatar fairly quickly, possibly within the coming 12 months. That said, we continue to believe that the GCC exchange rate regimes will become more flexible, but that the more conservative and still highly dollarised Saudi Arabia is unlikely to be the first to move."
Is that fair? I am tempted to say "You tell me". But regardless of how uncomfortable this might be, it is worth making the point that Goldman is a big, bulge-bracket investment firm with a strong-reputation for insightful analysis.
So let's run through Ahmet Akarli's thinking. Against an official figure of 9.6 per cent year on year inflation during March, the Goldman analyst instead looks at "inflation momentum," measuring a three-month moving average. This, says Akarli, puts underlying price rises at a worrying 15.5 per cent – and while he expects this to ease somewhat later in the year as food price inflation abates, he insists fundamental inflationary pressures will remain rather strong. Indeed, he believes Saudi inflation will eventually catch up with the 15 per cent to 20 per cent rates assumed in the UAE and Qatar.
Quite simply, the four-fold increase in oil prices, and the associated jump in the flow of capital in Saudi has produced a major acceleration of credit and money growth. With the Saudi riyal pegged firmly to the weakening US dollar, the required real exchange rate adjustment is magnified – and can only occur through higher domestic prices.
Akarli adds: "With its $400bn (Dh1.4 trillion) economy, sizeable overseas investments and substantial natural resource endowment, Saudi Arabia is the heavyweight economic and political power of the Gulf and the Middle East.
"However, the Saudi economy has lagged badly behind its peers in the Gulf region in terms of both per capita income and overall living standards – in particular, it lags the rapidly diversifying and prosperous economies of the UAE, Kuwait and Qatar. However, encouraged by the impressive transformation taking place in Dubai and Doha, and historically high oil prices, the Saudi authorities have also started to entertain the idea of economic diversification and are currently investing heavily in large real estate and infrastructure projects."
Yet Saudi investment levels remain low compared with the country's substantial savings and relative to other rapidly diversifying members of the GCC.
The Goldman analysts is worried that what he calls "political economy" considerations – unemployment – will push the Saudi authorities into unorthodox policy measures and higher public spending, both of which risk putting further upward pressure on inflation. Akarli sees the GCC economies as a whole moving progressively towards a more flexible exchange rate and monetary policy, but he does not see Saudi leading the pack.
Three reasons are cited: Risk aversion. The peg has served Saudi well in the past. Anticipation of a dollar rebound. The Saudi authorities lean towards the view that the dollar's weakness has been overdone. International political considerations. The Saudis do not want to be seen to be undermining the reserve currency status of the US dollar.
There is the possibility that the Saudi's could respond to the inflation problem with a large one-off currency revaluation. But Goldman sees this as unlikely in the short term. Instead, the bank's analysts think the Saudi authorities could either simply try and sit through the situation, waiting for an improvement, or they could introduce a series of unorthodox measures to try and sterilise capital flows and ease inflation. These measures might include credit controls. But such action would lead, eventually, to inefficiency.
More importantly, perhaps, such controls would not sit well with the avowed policy goals of diversifying the Saudi economy and catching up with some of the more dynamic thinking employed by its neighbours.
Tricky times, clearly.
Paul Murphy is associate editor of the Financial Times.