Case Study 2: Inflation

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Case Study 2: Inflation

There is a wide spread global concern that the economic world is about to enter an era of high inflation given the imbalanced fiscal and monetary systems monitored over the last three decades. It is the perception that Saudi Arabia despite its natural resource pools will not be able to move away from the global implications given that it has depicted the same economic patterns as other big markets over the last five years. The government’s open trade system and substantial fiscal expansion are insufficient to shield the country from subsequent high inflation rates. Economists fear that despite inflation rates being moderate since the 2008 high (11%), government fiscal expansion raised by 10% and global inflation in feeds will proportionally influence Saudi Arabia through its import channel.

CPI in Saudi Arabia

Consumer price Indexes in the kingdom measure changes in pricing that consumers experience per basket of goods and services. The consumer price index in the country puts emphasis on foodstuffs and beverages (26%), water, fuel, rent and renovation (18%), telecommunication and transport (16%). Other minor CPI categories include home furniture (11%), footwear, clothing and fabrics (8%), education and entertainment (6%), Health Care (2%) and other service expenses at 13% of the total weight.

According to the Central Department of Statistics and Information in the kingdom, there are no frequent surveys made in the labor market on its productivity and inflationary expectations (Office of the Chief Economist 4). In addition, the source identifies inflation in the country to be a measure of also the Cost of Living Index (CLI) and Wholesale Price Index (WPI). When compared to the American basket of goods and services, the two nations highlight integration of the same consumer price index categories. Both countries focus on foods and beverages, transportation, housing, recreation, medical services, education and communication and other expenses. Divergence exists in the percentages of relative importance to CPI. For instance, Saudi Arabia joins education and entertainment while the USA combines education with communication. In terms of relative importance, housing and other goods and services represent the biggest and least significant baskets in the USA CPI. In Saudi Arabia, food and beverages represent the biggest CPI factor while health care represents the smallest. The divergence highlights the varying rates of consumerism in the two economic markets.

Unlike the United Sates or other major economies, Saudi Arabia does not depend on household consumptions given its supremacy in terms of natural resources. Household consumptions only represent a third of the GDP at 29.4% having its relationship with inflation as weak (Office of the Chief Economist 6). Economic principle dictates that higher consumption rates result in elevated demand that in turn structures inflation. Despite the pack of dependence on household consumptions, the Saudi market depicts higher dependence on food and beverages given its climatic conditions structuring the high inflation rates in the kingdom. Similar to the United States is the influence that urbanization has in determining consumer price indexes as it fashions patterns of consumption.

Historical Trends of Inflation Rates and Reasons Behind

The Kingdom of Saudi Arabia has a low and stable history of inflation. The CPI inclusive of a large variety of products is based on a 1999 index where 10% of the goods and services are subsidized by the national authorities. The prices set on these goods and services are fixed for lengthy time margins therefore rarely make an impact on the CPI. The Saudi Central Bank employs an overreaching policy that ascertains exchange rate and price stability. Consumer prices rose in the region by 1.3% in 1990-1999 and by 0.6% in 2000-2006 (Alhamad 2). Despite the good pricing, there were several changes on the exchange rate. According to the Central Department of Statistics and Information, the kingdom owes it period of moderate inflation to number of factors that include the ease in cheap imports, an open capital account and flexible labor market. The fixed exchange rate facilitated mitigation of the inflation expectations as experienced by other countries.

Major inflation in the country began in the year 2007 where the consumer price inflation rose to 4% from 2.1% in 2006. At the end of the financial year, the inflation rate had risen to 6.5% (Office of the Chief Economist 8). Prices continued to rise until 2008 where it reached its peak at 11.1%. Saudi economics argued that the countries exchange rate peg was behind the sharp price increments. Forceful monetary tightening employed by the central bank was ineffective. Under the approach, there were two highlighted factors. One, the peg system was generating import inflation because the price increments coincided with the weak American dollar at the time. Two, the Saudi trade weighted basket had an upward pressure from the import prices necessitating proportional adjustments in retail pricing. Another reason behind the inflation was the rigid monetary system employed by the central bank. The monetary policy constrained leeway by dictating interest rates therefore domesticating credit growth. When the Saudi rates fell away from major currencies because of the system, it risked unwanted capital flows that in turn caused upward stress on the exchange rates (Office of the Chief Economist 9).

Subsequent investigations on the inflation rate supported the International Monetary Fund (IMF) in its association of the predicament with trading partner’s inflation. The organization in its findings highlighted that the country’s lack of exchange rate adjustments had a direct and heavy impact on domestic prices. Given that Saudi Arabia’s top most consumables are foods and beverages, it was imperative that the republic fall prey to the global food crisis in the ending years of the past decade. In the year 2007, there were significant increments in the inflation rates of Germany and China, which represent Saudi Arabia’s third and second importation bazaars respectively. After the 2008 inflation peak, consumer prices cooled down. Prices fell to 4.5% from 6.5% by the end of the year 2009 (Office of the Chief Economist 9). The causes of price reduction also exemplified the argument of the IMF. Given the global financial crisis in 2008, adjustments made by the USA to address its Subprime Mortgage Crisis resulted in a strengthening dollar. The global competence matched the reduction in food prices in Saudi Arabia as investors found safety in the American market. The dollar made it easy for Saudi importers to carry out price exchanges. The inflation pattern was the same in the four major economies that are China, Germany, the United Kingdom and Japan.

Current Cost of Living versus 20 Years Ago

Despite the Kingdom of Saudi Arabia having identified modern inflation dynamics, the republic still depicts elevated conditions of living. Inflation remains relatively high even after the kingdom joined the World trade Organization increasing its volumes of imports and exports. Having an average of 4.17% in terms of inflation in 2007 to 2013, consumable prices are the worst in the determination of cost of living (Alhamad 3). Based on billions of dollars, the consumer price index in the country in 1995 was 4.67 as according to the American Department of State. By the end of the year 2014, beverages had the same inflation rate at 6% while the Housing industry, Gas, Electricity and other fuels had an average of 7.9%. In comparison with the year 1995, fuel inflation was at 4.06%. A concern to the Saudi population is that the rate of inflation increase supersedes that of wage increments resulting in further constraints in the cost of living for the average citizen. According to the Ministry of Economy and Planning, the average consumable pricing in the year 1995 was at 96.6 dollars, but has risen to 130.337 in 2014 (Alhamad 3). The values represent a 35-40% increment in consumable pricing within a twenty-year period. Implications of this on the average cost of living are yet to be substantiated fully.

Despite the spike in inflation in the kingdom over the last two decades, the outlook is promising. Beginning with food, 2014 depicted stability with supply lagging behind demand in the strong agricultural sector. High cereal prices during the 2008 spike resulted in elevated plantation of the crops creating higher yields for subsequent financial years (Alhamad 3). Therefore, wheat stocks that represent the largest food consumable in the country are adequate since the spike. The stability equally lowers importation of cereal foodstuffs reducing government expenditure. The global market under the standardization of economic practices after the 2008-2009 crises depicts greater production levels. In this, supply supersedes demand in most of the influential CPI baskets such as transportation and housing.

Works Cited

Alhamad, H. S. The High Cost of Living in Saudi Arabia: Growth and Inflation in a Macroeconomic Perspective. The Student Pulse. 5 May 2015. Web. 27 June 1015. < http://www.studentpulse.com/articles/918/the-high-cost-of-living-in-saudi-arabia-growth-and-inflation-in-a-macroeconomic-perspective>

Office of the Chief Economist. Inflation in Saudi Arabia: Drivers, Trends, and Outlook. Samba Financial Group Report Series. (2013). 1-16. Print.