(P)GCC Inflation on the Rise

The (Persian) Gulf Cooperation Council states' citizens should brace themselves for an increase in inflation this year. But a rise in MENA inflation bodes well for currencies and import costs, according to experts.

Influenced by internal and external factors, the inflation rate in (P)GCC countries (Saudi Arabia, Kuwait, the UAE, Qatar, Bahrain, and Oman) may reach 9.8% and 9.6% in 2017 and 2018 respectively, the Arab Monetary Fund predicted in its latest Arab Economic Outlook report, AMEinfo reported.

The report said 2016 saw a rise in inflation rates in the Arab countries as a group to roughly 8.4%, compared with the approximately 6.6% recorded during 2015.

The report said: "This increase reflected the effect of reforms adopted to rationalize subsidy systems, especially for fuel and energy products in most of the Arab countries, as well as the impact of measures that have been taken by some countries to rationalize imports of luxury goods due to pressures on the exchange rates. The inflation rate in 2016 was also affected by the internal conditions in some countries and their impact on the supply of goods and services.”

Explaining internal and external factors that affect inflation in Arab countries, the AMF said: “Internally, the general price level will be impacted in some Arab countries by the continuation of reforms aiming at rationalizing subsidy systems, the adoption of value-added taxes, as well as the tendency towards imposing taxes on harmful goods. On the other hand, the expected improvement in agricultural production will mitigate part of the inflationary pressures in some Arab countries.”

About external factors, it stated the inflation rates will be influenced by the expected increase in international oil prices, in line with the agreement between the main oil-exporting countries to adjust production, as well as the expected increase in the dollar value against the other major currencies, which will reduce the value of imports in Arab countries adopting fixed exchange rate regimes against the dollar.

Stronger Currencies

Economists at Citi Research forecast a 10% appreciation of the dollar against the euro, partly due to the expected fiscal stimulus and rising rates under a (US President Donald) Trump administration.

Citi said in its Middle East Economic Outlook: “With the (partial) exception of the Kuwaiti dinar, (P)GCC currencies are pegged to the dollar, meaning that these too will strengthen in 2017.”

The report argued that a strengthening currency reduces the cost of imports, thereby strengthening the terms of trade. “This reinforces the impact of rising oil prices, which has helped the terms of trade improve by 61% since the start of the year.”

By the end of 2017, the strengthening dollar should see (P)GCC terms of trade improve by almost 90% relative to their nadir in January of this year (still more than 50% down from its peak in June 2014), said the report.

“Strengthening terms of trade are generally a good thing for an economy as they imply a higher standard of living and stronger economic growth, particularly where economic inputs are largely imported. They also imply lower inflationary pressures as the imported basket of consumption will see price deflation,” economists explained.

In the (P)GCC states, where a large percentage of domestic consumption is import-dependent, this effect is momentous.

The report said: “On the other hand, a strengthening in the terms of trade may not be such a good thing in the context of efforts to diversify (P)GCC economies. A stronger currency erodes competitiveness, for example, which will have a negative impact on non-oil exports such as tourism, a major pillar of the economy in Dubai and Oman.”

Stronger currencies hinder inward foreign direct investment flows as operating costs for foreign companies rise. “Finally, it dampens incentives for import substitution, reducing the viability of nascent domestic industries which have to compete with cheap foreign imports,” economists at Citi argued in the report.

All of these are potentially negative for (P)GCC economies as they seek to grow the private non-oil sector.