JEDDAH: Inflation rate in Saudi Arabia will continue the downward momentum into 2011 even as economic activity picks up pace, Banque Saudi Fransi said in its latest report on Saudi economy entitled "Inflation strain subsides: Outlook highlights lower inflation amid steady economic upturn" released Thursday. The report, prepared by the bank's economic research team headed by chief economist Dr. John Sfakianakis, said inflation is likely to average 4.7 percent in 2011 against a prior estimate of 5.1 percent., down from 5.3 percent this year, as rental inflation subsidies due to higher base effects. The report said although rents are poised to continue climbing month on month, the rate of annual increase is set to decline, thus removing a great deal of the burden on the annual inflation rate. High soft commodity prices, continued real estate supply constraints and imperfect domestic competition came together to nudge Saudi inflation to 6.1 percent in August for the first time in 18 months. however, inflation rates dipped back below 6 percent since then. "We anticipate the deceleration in inflation rates will continue in 2011 as a consequence mainly of high base effect adjustments for rents and stabilizing food prices," it noted. The primary downward pressure should stem from falling rental inflation. The rent and utilities index, which comprises about a fifth of the index, is likely to record average inflation of 9.5 percent this year, although next year we see the rate falling to 6.7 percent. "While we still expect moderate month-on-month gains in rental inflation, the annual rate of rental inflation is likely to decline during 2011 due to the higher base effects," the report said. In 2009, rental index inflation averaged 14.3 percent, down from about 18 percent in 2008. A slowdown in home furniture inflation and in other expenses and services, which together comprise more than 20 percent of the index, is also expected. The largest weighting in the Saudi cost of living basket is food and beverages, accounting for almost a third of the total. Food price trends are somewhat more difficult to predict because they depend on movements in global commodity prices, and may also be influenced by fluctuations in the US dollar. When the dollar is weaker, this raises the cost of importing food into Saudi Arabia, heightening imported inflation. A stronger US dollar in 2011 and some softening in food commodity prices should be anticipated, although food inflation rates will likely hover in a similar range as this year. Any decline in food price inflation will be slight given price stickiness. In recent months, data of the Food and Agriculture Organzation show some food prices, particularly sugars and cereals, are on the rise again, although there is evidence that food prices are near peaks and are unlikely to face significant upward pressure in 2011. Saudi Arabia's food price index broadly tracks trends in the FAO food price index, albeit much more moderately, the report further indicated. Sustained higher food prices globally are likely to be offset by the stronger dollar, and food inflation would rise in the first part of 2011, and then should ease during the second half of next year. Food and beverage inflation in 2011 is likely to be slightly lower than the projected 6.2 percent average we foresee for this year, although the index has varied widely in recent years based on global circumstances. In 2008, food and beverage inflation averaged around 15 percent and fell to 2 percent in 2009, the bank report said. Moreover, Saudi money supply growth, traditionally a contributor to inflation, is beginning to pick up due to greater lending and economic activity in general, although remains far from levels that we expect would lead to a build up in inflationary pressures. In September, M3 money supply growth was 5.1 percent, compared with between 10 percent and 27 percent in every month between 2005 and the end of 2009. The bank forecast that M3 money supply growth will average 5 percent this year and 9.6 percent next year, adding that it would have a much less-pronounced impact on inflation rates. Moreover, bank credit growth is poised to continue in the coming months which would lead to a reduction in growth in bank claims on the private sector to 8.5 percent from 12.2 percent. Momentum behind credit growth is likely to continue to lag until a substantial pipeline of project financing is integrated into bank balance sheets and the private sector moves toward expansion financed through a combination of equity and debt. The trends should start to unfold in the second half of 2011 and encourage a return to double-digit rates of credit growth in 2012 and 2013. "While state-led growth is likely to continue in 2011, we do see the starting signs of greater involvement by the private sector, although its reintegration into economic activity is likely to take place slowly over the next two to three years," the report said. Nominal GDP of the government sector expanded 13.5 percent in the first six months, more than double the private sector's rate of growth at current prices. Against a backdrop of a relatively inactive, deleveraging private sector, the government's fiscal expenditures will continue to expand, although we have reason to believe the pace of expansion may slow in the coming years. Authorities are becoming more cognizant of the fact that higher spending raises the risk for fiscal deficits in the medium term, especially as the oil price needed to balance the budget has leapt to $72 a barrel this year. The state revenue is forecast to SR658.9 billion this year as a result of sustained higher oil prices and will swing into surplus in 2010 amounting to 2.5 percent of GDP, the report said. With state investments leading the way, the burden on public fiscal balances is clear, the report said. The government announced in November it would not phase out an inflation allowance that had raised salaries of state employees by 15 percent over the last three years. The allowance was meant to be removed after this year - but due to continued high inflation the finance ministry has decided to keep it intact, costing the government an estimated SR33 billion a year (inclusive of public sector employees and pensioners). However, the report said the allowance will not to create any significant inflationary pressures. Overall for this year, “we have revised down our state expenditures target to SR618 billion as we expect additional expenditures will be billed forward.” The report also projected that the government will slow the pace of budget expansion in 2011 and unveil a budget later in December including announced expenditures of not more than SR590 billion, up from SR540 billion this year, a 9.3 percent increase. Budgeted expenditures in 2010 budget were 13.6 percent bigger than 2009, which itself was 15.9 percent bigger than the year-earlier budget. This slowdown in budget expansion is necessary and prudent following years of overspending budget targets by more than 20 percent. But it is not only the growth of projected spending that we expect will slow - growth in actual spending is also likely to outpace forecasts by a smaller degree as the government moves to better rationalize spending and implements efforts to rein in excessive spending by government departments. In 2009, the Saudi government overspent its budget targets by 26 percent. Such exorbitant overspending is not sustainable over the long term, the report noted. In the meantime, however, budgets are easily financed with rich foreign asset reserves, which, due to higher oil prices, the Kingdom has been in a position to enlarge this year. In the first nine months of the year, Saudi Arabia's central bank added SR61 billion to its net foreign asset holdings, taking them to SR1.58 trillion, the highest since February 2009. According to data of JODI, Saudi oil production in the first nine months of 2010 averaged 8.13 million barrels per day (mbpd), which is actually lower than the same period last year, when the Kingdom produced 8.19 mpbd of crude, on average. This leaves little scope for growth in oil GDP in 2010. Our forecast for oil GDP growth of 2.7 percent this year stems from a view that the government integrates investments in oil infrastructure into its calculation of oil GDP at constant prices. OPEC has cited a pick up in oil demand in the third and fourth quarters, particularly due to better-than-expected oil demand in OECD countries which prompted the organization to revise its world oil demand growth forecasts upward by 0.19 mbpd, or 1.6 percent, to 1.32 mbpd. Developing countries account for 83 percent of that total, including a 6.4 percent climb in demand from China, according to OPEC estimates in its monthly Oil Market Report. OPEC also upwardly revised 2011 projections for oil demand growth to 1.36 percent in 2011. The Kingdom is a key beneficiary of strong oil demand growth from Asian clients since about 54 percent of exports in 2009 were destined for Asia, up from 45 percent just nine years earlier. Against this backdrop, Saudi oil sector GDP growth will accelerate to 3.7 percent in 2011, BSF said.
