RIYADH, 18 June 2007 — In a series of recent reports we presented some interesting, some path-breaking analysis and observations on inflation in Saudi Arabia. In this report, we summarize the lessons learned and discuss what it means for the Saudi economy.
• Overall inflation in Saudi Arabia remains in the low single-digits but has picked up in recent months.
Nevertheless, it remains in line with major global economies and significantly below the double-digit rates in neighboring countries (the “Gold Rush” economies).
• Food and housing, the two biggest components for a typical family in Saudi Arabia (accounting for as much as 60 percent-70 percent of family budget), show different inflation trends and differential impact on the economy.
• Food prices in the Kingdom have an observable seasonal pattern related to Ramadhan and Haj.
They rise more than usual during Ramadhan and Haj, but, they also fall more than usual in subsequent months, thus leaving a smaller lasting footprint.
• We have seen that, aside from the seasonal pattern, food prices are correlated with liquidity (money supply) in the Kingdom in recent years.
• Housing cost (rental, maintenance, fuel) inflation in the Kingdom has doubled in recent months, but still remains at single-digit levels.
• Our research does not show any seasonal pattern in housing cost inflation, unlike food prices.
• Lack of a seasonal pattern in housing costs (rent, maintenance, fuel, energy, etc) suggest that lease renewals (when rents are raised) in the Kingdom are spread more-or-less evenly around the year.
• This may also explain why the rental inflation figures are low compared to anecdotal information. With lease renewals distributed around the year, the impact of large raises in individual cases (15- 20 percent) gets diluted in the overall numbers.
What does inflation mean for the Saudi economy? Inflation, in general, is bad because it hurts consumers and business. Consumers are hurt directly because inflation reduces their purchasing power by reducing the real value of their income and wealth (shares, property, other assets). When consumers buy less food and take fewer trips to restaurants, say, businesses see a drop in revenue.
This, in turn, leads to drops in employment, or in company profits and fuels a spiraling round of reductions.
However, there are situations where some are not hurt by inflation.
For example, inflation benefits borrowers at the expense of lenders, especially, if lenders are unable to raise interest rates as is true in Saudi Arabia (riyal interest rates are tied to US dollar rates).
Inflation also may not hurt some segments of businesses or consumers, depending on its source, e.g., (1) cost push, or (2) demand pull (The former is a shift in the supply curve, and the latter is a shift in the demand curve).
Cost-push inflation in Saudi Arabia is due to the rising cost of euro-denominated imports in line with euro depreciation, and rising commodity prices (steel, energy, raw materials). Wage inflation is minimal in Saudi Arabia because most private sector workers are low-cost expats, and employers can switch to cheaper source countries. Cost-push inflation does not hurt businesses that have “pricing power” (they can raise their prices to compensate for higher costs). The ones hurt will be those sectors in which competition is too high for them to pass on the rising costs to consumers (e.g., retail).
Demand-pull inflation occurs when demand increases, say due to rising income or wealth. In the Kingdom, this has happened from the huge liquidity injection from oil revenues in recent years. Our analysis showed that food prices are correlated with liquidity, thus suggesting a case of demand-pull inflation. In general, demand-pull inflation can benefit those businesses that can keep costs below inflation. However, consumers whose purchasing power doesn’t keep up with inflation may be hurt.
(Khan H. Zahid is chief economist and vice president at Riyad Bank based in Riyadh.)