04/12/2010
Inflation strain in Kingdom subsides
The Saudi economy is finishing off 2010 in better form than it started due to healthy oil prices, recuperating business and financial activity, improved trade and tourism, and inflationary pressures that are beginning to taper off from summer peaks. Oil prices have averaged a secure $78.76 a barrel in the first 11 months of 2010, almost 30 percent above prices during the same period last year. Along with growing global energy demand, robust oil prices are strengthening the Kingdom's fiscal position and outlook and enabling the state to continue engaging thoroughly in the economic recovery process.
Government sector GDP growth rates in the first half of the year exemplify the fundamental role played by state and quasi-state investors in the economy. 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. 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.
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. We have raised our state revenue forecast to SR658.9 billion this year as a result of sustained higher oil prices. Following this revision, and a reduction in our expenditures forecast, it looks likely that Saudi Arabia will swing a surplus in 2010 amounting to 2.5 percent of GDP.
Accelerating price pressures due to a combination of global and local factors have characterized 2010. 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. Inflation rates dipped back below 6 percent since then, and 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. 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. Our forecast of 5.3 percent inflation in 2010 remains intact, and we foresee inflation subsiding in 2011 to 4.7 percent, against a prior estimate of 5.1 percent.
Reduced inflationary pressures and expectations for a stronger US dollar in 2011 will relieve speculation that Saudi authorities will rethink a long-standing policy of pegging the riyal to the dollar. Credit Agricole CIB, our joint-venture foreign partner, expects the euro-dollar to end 2011 at 1.18, signaling a serious trend reversal. Euro weakness is likely to result from the spillover effect from debt-troubled nations elsewhere in the euro zone as well as a robust US economic outlook.
A weaker dollar tends to raise the cost of imports into Saudi Arabia, particularly for food items, but it also increases the appeal of non-oil exports to global customers and makes tourism into the Kingdom, primarily for religious purposes, more affordable for those whose currencies strengthen against the greenback. November's Haj pilgrimage illustrated this strong demand, with preliminary estimates indicating a record number of pilgrim visits. This is bound to have a positive ripple effect on the wider services and hospitality sectors for this year and 2011.
