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GCC Economics: Inflation - When a Fall is Good

Global Arab Network - - George Haddad

Thursday, 27 August 2009 11:44

Inflation No Longer A Policy Challenge: After being a key policy challenge and economic concern in 2008, inflation levels have fallen sharply in the GCC in 2009. We are likely to see two different trends in the region, with some countries expected to see sharp disinflation and others seeing deflation. The main reason for the variance in inflation outlook will be domestic factors, namely the housing component.

· External Trends More Similar: External developments will add to the downward pressure on prices in 2009e. We are likely to see a similar trend for the external drivers of inflation with food prices falling in the region in line with global developments. Wider imported inflation is moderating with the overall strengthening of the USD from 2008 levels and weaker inflation rates in exporting countries to the GCC.

· Deflation Not A Concern in the GCC: While deflation is generally seen as negative and undesirable in economic terms, we believe that given the nature of GCC economies the overall impact is not detrimental. We do not forecast to see a sustained deflationary environment developing or a deflation spiral. There are three main characteristics specific to the GCC economies that result in inflation or deflation not becoming entrenched in the economy: 1) the role of government spending; 2) the flexible labour force; and 3) the importance of external factors determining tradable prices. Going forward, external factors are likely to become more important in driving inflation.

· Deflation in the UAE and Qatar : The UAE and Qatar will see the greatest reversal in inflation trends, from the highest regional inflation rates in 2007 and 2008 to deflation in 2009e due to a fall in housing prices. While we are expecting to see deflation in both Qatar and the UAE, the economic realities on the ground are diametrically opposite. Qatar will continue to see solid non-oil economic activity, while the UAE is seeing a structural correction. In Qatar , the fall in the rental prices are mostly due to a marked increase in housing supply entering the market in 2009. In the UAE, it will be a result of both the correction in the property sector along with the increased supply in housing.

· Positive Inflation in Saudi Arabia and Kuwait : Both Saudi Arabia and Kuwait are likely to see positive inflation rates, although slowing sharply, with rental price growth decelerating and not contracting. Again, Saudi Arabia and Kuwait have different economic outlooks with Kuwait forecast to see a contraction in non-oil GDP growth, while Saudi Arabia continues to have a solid outlook supported by government spending.

· Support to Consumption and Competitiveness: We expect the downward pressure on prices to provide a key support to private consumption in 2009e in the region. One notable exception to this is Dubai , due to its large level of exposure to the property sector. The fall in rental prices is also positive for the international competitiveness of the GCC countries, especially for the UAE and Qatar who have seen double digit inflation for a number of years.

· Expansionary Monetary and Fiscal Policy: The sharp fall in the inflation rate has allowed the GCC governments to loosen monetary policy to support growth. It has also enabled regional governments to prioritise much needed capital spending, focusing on infrastructure and investment needs of the economy. This shift to capital spending in order to meet the medium-to-long terms infrastructural needs of the economy is more positive than current spending.

· Little impetus for Currency Reform: With the fall in the inflation level, the economic reasons for currency reform have dissipated in the near term. GCC monetary policy is now inline with that of the US , which regional countries have to track due to the USD pegs. We reiterate our view that currency policy will remain focused on stability as investment programmes remain central to their policy initiatives and in light of the global crisis. Going forward, the currency reform debate could once again reemerge with a sustained weakness in the USD and a desire for greater monetary policy flexibility.

Global Arab Network

This article is an extract from report (GCC Economics Note - Inflation) by EFG-Hermes Holding SAE

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