Saudi Arabia recently announced that its annualized inflation rate had hit 6.1 percent, causing some to worry that it might be slipping into another phase of double-digit inflation. While those fears are unlikely to be borne out in the near term, watin-p Saudi Arabia’s undesirably high inflation rate is a symptom of deeper structural problems in its economy, specifically with regard to food and housing.
Recent reports of an escalation in Saudi Arabia’s rate of inflation have raised concerns that the kingdom may be on the verge of careening into another bout of high inflation as it did in the summer of 2008. Saudi inflation reached an all time high that July of 11.1 percent, driven largely by a dizzying rise in global food prices. During the recession the following year, rates moderated to more benign levels, but a recent government report that inflation has reached an annualized rate of 6.1 percent has raised the specter of a return to double-digit inflation.
The prospect of a return to higher inflation in Saudi Arabia is indeed troubling. Yet what is worrying about the recent inflation report is not that it portends a probable return to double-digit inflation-in fact this is unlikely. Rather, this website it is another data point along a long-term trend line that demonstrates that Saudi Arabia may have reached a structurally higher level of inflation.
High inflation in Saudi Arabia is less an illness in and of itself than it is a symptom of deeper underlying economic tensions that result from poor public policy. Specifically, the inflationary trend is being driven by escalating food prices and housing rents, both of which are caused by supply bottlenecks and economic inefficiencies. To cure inflation in the long run, Saudi Arabia’s leaders must address these maladies first.
There are some who would counter that inflation must be tackled head on. In 2008, a number of economists argued that monetary factors were largely responsible for the kingdom’s inflation, nadiya specifically the Saudi riyal’s peg to the US dollar. To maintain the currency peg of 3.75 riyals to the dollar the Saudi Arabian Monetary Authority (SAMA) must keep domestic interest rates closely tied to US rates. As the US Fed cut interest rates beginning in 2007, SAMA was forced to follow in lockstep so as to prevent creating upward pressure on the riyal. However, at the time the Saudi economy was already overheating and economists argued that the untimely loosening of monetary policy exacerbated already rising inflation.
A second factor cited as linking the currency peg to inflation is the relative weakness of the US dollar to other major currencies, which drags down the value of the riyal as well. In 2009, Saudi Arabia received 22 percent of its imports from the Eurozone and these goods (as well as others from Great Britain, Japan and elsewhere) become more expensive when the riyal’s value weakens.
The conclusion economists drew from these arguments was that the Saudi riyal ought to be pegged at a higher exchange rate or, in more extreme proposals, allowed to float freely. With inflation rising again today, similar calls for a revaluation are beginning to emerge.
Yet allowing the riyal to appreciate would not only be wrongheaded, sho but it would have a serious detrimental effect on the kingdom’s long-term economic health. The riyal’s peg to the dollar is not the primary or even a major driver of inflation, so changing it would serve little purpose. Low interest rates were reduced almost to zero during 2009, yet rather than drive further price rises, inflation actually dropped to a three-year low of 3.5 percent in October. And the currency effect is likely negligible, since 65 percent of Saudi imports are denominated in US dollars (this is because so many imports are commodities, which are often paid for in dollars regardless of their origin). Moreover, as Brad Bourland of Jadwa Investments has pointed out, close scrutiny of the Saudi cost of living index reveals that those goods imported from places like Europe and Japan (autos, mobile phones, manufactured goods) have seen little to no elevation in price.
Most important though, a revaluation of the riyal would elevate the price of Saudi exports in overseas markets. As the kingdom seeks to diversify its largely oil-dependent economy into new manufacturing sectors, making its goods more expensive could have a devastating effect on these emerging industries.
So if tackling inflation head-on with monetary policy is not the solution, what can be done?
First, it is important to understand that Saudi Arabia’s high inflation has two principal drivers-rents and food. In 2009, when Saudi Arabia posted a relatively modest inflation rate of 5.1 percent due to the global recession, rents still increased by 14 percent. Food inflation moderated that year (due to lower global food prices), but in the most recent inflation report food prices rose by 8 percent. Rents likewise grew by 8.9 percent. Indeed, forbixindia the most recent bump in inflation to 6.1 percent was likely caused by the seasonal ramp in food prices that occurs every year during the month of Ramadan. It is for this reason that alarmist expectations of a return to double-digit inflation are unlikely to be borne out-with Ramadan over, food prices will moderate and the inflation rate will likely return to a more normalized level.
Yet this does not detract from the kingdom’s medium-term problem of an inflation rate that remains hovering at a worrying 5 percent. Not only is this a higher rate than economists normally consider to be healthy, but with the economy recovering from its low during the economic crisis and the government about to embark on a major spending and investment program, additional inflationary pressures could push the rate even higher. Middle class Saudis are already grumbling as they see their quality of life gradually erode. Additional economic pressure on working Saudis could, in an extreme scenario, generate political or social unrest.
The good news is that though the kingdom’s inflation problems cannot be resolved overnight, they can be addressed over the medium term with well-crafted public policy.
The issue of rents has been on the Saudi government’s radar for the better part of a decade. According to the Saudi Home Loans Company, Saudi Arabia’s home ownership rate is only 30 percent, leaving the majority of the population to rent their lodgings. Saudi Arabia has an extremely underdeveloped mortgage market and it is next to impossible for lower or middle class Saudis to obtain the financing to build or buy their own houses. The population is growing quickly and the housing stock has not been able to keep up-some estimates have the deficit at 2 million housing units. The result has been rapidly escalating rent prices, which have flown through into the inflation rate. The government has tried to ameliorate the problem by providing cheap, Shari’a-compliant mortgages directly to citizens, through a state-run Real Estate Development Fund. But these loans have not been enough to move the needle. A new mortgage law apparently under review would make it easier for lenders to foreclose on properties in default and would establish a central authority through which debtors’ records could be reported. However, the bill has been under discussion for 10 years and there is still no clear timetable for when it will be adopted.
Rising foods prices present a somewhat thornier problem. Saudi Arabia relies on imports for 70 percent of its food supply, leaving it exposed to sometimes volatile swings in global food prices. Moreover, the kingdom’s reliance on imports is likely to increase further as the government wisely puts an end to a series of extremely wasteful, water-intensive domestic agricultural projects.
In its quest for food security, the Saudi government has turned to other countries that are better suited for agricultural production. In January 2009, it launched the King Abdullah Agricultural Initiative, which provides funding for Saudi businesses to invest in agricultural production in countries like Ethiopia, Vietnam, Egypt, Sudan and Turkey. The crops from these projects would be shipped directly back to Saudi Arabia and would help to insulate the kingdom from global fluctuations in food prices. Yet, this plan has been criticized for being largely exploitative, leaving little of value for the citizens of the recipient countries, some of which are net food importers themselves. Moreover, there are questions as to the wherewithal of Saudi food companies to make optimal use of land in often unstable foreign markets.