Inflation in Saudi Arabia - Essay Example

The first will talk about the economy of Saudi Arabia. It is known that various macroeconomic factors can contribute in the progress of an economy. Inflation is one such factor. The assignment will discuss the effect of inflation on the economy of Saudi Arabia. It will also talk about the solutions and how the common people are affected because of inflation. Graphs will represent the changes in the rate of inflation for a period of 10 years. Introduction The development of the economy of Saudi Arabia occurred with the establishment and the expansion of the Saudi state in the past five decades. The economy of the country of Saudi Arabia is oil based with active government intervention in major economic activities. The country ranks on the top in exports of petroleum products and plays an active role in OPEC. The petroleum sector of the economy accounts for 45% of the total revenues. Currently the government is engaged in encouraging the growth of the private sector within the economy as they believe such strategies will reduce the dependence on oil. The growth the private sector will also create employment opportunities. It has permitted investments in the telecommunication and the power sectors. In an effort to diversify the economy, the country acceded to the WTO in 2005. Focus was given to form a regulated market and the Saudi Arabia Monetary Agency (SAMA) emerged in 1984 after the government passed an instruction. The Capital market authority took over the responsibilities of the agency after its formation in 2003. November 26 marked the day when the first corporate governance code was implemented. The sections provide provisions like preliminary level, board of directors, lucidity and disclosure, shareholders authority and the provisions for the general assembly and the closing provisions. Some of the experts opine to measure corporate governance using the Gompers and Metric. Some contradict by saying that ownership of stocks of the board members and the separation from the position of CEO seems to impact positively on the anticipated performance. Some negative correlation also exists among some variables. Both the suggestions can be ignored as corporate governance lacks to shed any impact on the future performance of the stock market. Considering the resource endowment of the country it was a logical decision to increase the development of oil and gas resource through downstream investments in refineries. Three factors influenced the decision. The investments were mostly capital intensive which was just appropriate for the small population of the country with enormous reserves of oil. It would have been possible to generate value added income which would maximise the revenues of the country through the export of refined petroleum as well as crude oil. The natural gas which would have been wasted can also be utilised and processed. Inflation The budget impacts on the growth of the economy and allocation or redistribution of resources. The difference between budgetary spending and revenues is defined as the budget deficit. Budget deficit contribute in the level of national debt. A variety of problems can result because of budget deficit. Lower national savings rate, higher rates of interest and inflation are some of them. It is possible to treat inflation as the continuous or sustained rise in the level of prices. A situation marked by inflation is witnessed by continuous reduction in the value of money. The transformation of the general level of prices is a common situation of inflation. In a situation characterised by inflation, the period of the rise in prices continues for a year, week or month. Some of the factors that lead to inflation are rise in the costs of imported materials, the costs of labour to rise and the high rate of indirect tax from the part of the government. In cases where the rise in the general price level is caused by increase in the level of wages as well as raw materials are regarded as cost push inflation. With rises in the costs of production the firms tend to raise the prices of the products so that they can gain the same amount of profits. This is a situation of cost push inflation. The cost push inflation is frequent when the level of employment is on the downward sloping curve. When there is shortage of skilled labour the organizations are left with the only option to increase the wage rate with the aim to retain the existing employees. The idea of the organizations is to expand output. A situation of excess supply paves the way for demand pull inflation. An excessive growth in the level of demand can lead to demand pull inflation. The factors that can leave the economy under such scenario are depreciation of the exchange rates, the reduction of taxes, money supply takes the upward sloping curve, the confidence of the consumers rises and the other countries are on the verge to experience rapid growth. Historically much time has been lent to justify the causes behind the occurrence of inflation. Different schools of thought different definitions on the causes of inflation. Mostly there have been two broad theories namely the quantity theory of inflation and the quality theory of inflation. The quality theory of inflation is based on the assumption that a seller will accept a currency with the objective he can exchange it while acting as a buyer. The quantity theory of inflation is dependent on the quantity theory of money which relates the supply of money, the velocity and the nominal value of exchanges. In the current scenario the quantity theory of money is regarded as the acceptable model of inflation in the long run. In the long run the rate of inflation is correlated with the supply of money. But in the middle or in the short run the rate of inflation can be affected by the demand pressures or get influenced by the elasticity of interest rates, prices as well as wages. The modern macroeconomic approaches describe inflation using a tradeoff between inflation and the rate of unemployment. It can be regarded as the Philips curve. Apart from cost push and demand pull inflation there are two other types of inflation namely the pricing power inflation and the sectoral inflation. The pricing power inflation is more frequently called the administered price inflation. Such kind of inflation occurs when the businesses take the decision to increase their profit margins by increasing the prices. The pricing power inflation occurs when the sales are strong and the economy is not under recession. The term sectoral inflation occurs when any of the discussed factors affects an industry causing inflation. The industry under the grasp of inflation can be a supplier of another industry and therefore inflation becomes more wide spread although it originated in a basic sector. If left uncontrolled inflation will move from the initial stage towards the stage that can be harmful. Therefore it is necessary to control inflation before it gains strength. An inflation of stronger intensity is much difficult to control than the mild one. It should be kept in mind that that it is not possible to control hyperinflation. Effect of inflation on Saudi Arabia Economic Factors Despite adverse external environment driven by problems in Euro zone and also due to weaker growth rate in Asian countries, the economic activity of Kingdom has hold up as real GDP growth in 2011 recorded at 7.1%. The Saudi project market strived with valued project which currently values at US$745 billion about 13% higher than a year before. Inflation remained subdue at 5.0% in spite high cost of housing, low interest rate and expansionary government. The kingdom is comfortable with the current price of oil and is largely dominated by the oil sector and overall activity depends on the oil sector although a huge contribution comes from the non oil segment for over the past two decades. The drastic increase in the sector of oil provided the Saudi economy with a unique opportunity to develop and expand in short time and during past few years, major economic as well as monetary indicator have experienced rapid increase. An important factor which has affected the money market in Saudi Arabia is the international reserves which get generated from oil revenue. Saudi Arabia has also enlarged its external and fiscal surpluses. KSA export has exceeded nearly about three times as compared to imports and current account surplus rose to 14.8% of its GDP in 2010 to about 27.4%. Monetary expansion has accelerated for the past year and so and has reported a growth of 13.3% in 2011 and about 3.4% on May 2012 which is highly driven by growth in bank credits towards the private sector and through large surplus in BOP. Net foreign assets (NFA) grew by US$104.1 billion in the year 2011 and in the first five months of 2012 it grew to US$49.4billion. At the banking sector, the activity of banks grew by 9.1% in the previous financial year and to about 3.5% during the first five month of 2012. The expansion was mainly due to strong economic growth rate, highly flexibility and high liquidity of the banks and also reduction in the real lending rates. The following figures shows the nominal GDP along with real growth rates and figure 2 discloses the GDP as per economic activity of various sectors, Figure 1 Figure 2 (Source: Bank Audi, 2012, p. 2) Analysing the past trend of inflation, the annual average inflation rate, when calculated on moving average and measured by annual change in “cost of living” indices at the end of the financial year June 2012 it rose to about 5.2% a compared to the average inflation rate which stood at 5.6% during past five years. During the past five years, four important sectors highly contributed to about 43% of cost of living basket also registered an inflation rate much higher than the average rates. Inflation rate on goods and services rose to 8.3%, transport and telecommunication by 2.1%, entertainment and education by 2.8%, clothing, fabrics and footwear grew by 1.8% as compared to the average of past five years. On the other hand, sectors which comprised the general “cost of living index” registered a lower inflation growth rate as compared to the average during the past years. Food sector and beverage rose by 4.6%, housing and appurtenances by 8.4%, medical care by 0.1% and furnishing by 2.3% (Saudi Arabian Monetary Agency, 2012). Saudi Arabia Inflation Rate According to National Commercial Bank, Saudi Arabia’s average inflation annually is forecasted to be at 4.8% in the current financial year. The monetary situation of Saudi Arabia continued to expand and inflationary pressure tend to remain subdue. Monetary base of Saudi Arabia recorded an annual growth of 14.3% in the month of September as it had reached SR287.8billion and the main contributor towards the growth rate was deposit with the “Saudi Arabian Monetary Agency (SAMA)” which stood at 20% (Saudi Gazette, 2012). The liquid state of the Saudi economy however suggests that the price should remain stable without any concern for the policy makers. Average inflation rate in the last financial year was 5%. Inflationary pressure in Saudi Arabia the largest economy globally are expected to become constant in third quarter of the year as global increase in the food sector slowed down and inflation tend to ease in other countries leading to inflation rate of 3.8% from 4% in July (Carey, 2012). It has been analysed that Saudi Arabia has been experiencing low inflation growth rate which currently stood a 3.8% and this means that the price tends to rise but at a slower rate. The low rate in Saudi Arabia’s inflation rate can be attributed towards lower ret prices in the Kingdom and according to experts the falling inflation rate in Saudi Arabia will help to ease the notion of overheating economy encouraging an increase in consumer spending and lending rates. Growth in consumer price has slowed down gradually peaking at about 5.45 in March, 4.0% in July. According to an economist Jarmo Kotilaine, the factor which tends to drive inflation up at present has slowed down. The rate of inflation however will also depend on how fast the rate of international food price increases. Further low rate of inflation will help the country to attract more competitive export, more certainty in investment in Saudi Arabia, help in increased productivity along with better technology (Reuters, 2012). With low inflation rate the country seems to conduct bilateral agreement with other countries in order to prevent double taxation. In addition to it Saudi Arabia with its low inflation rate tends to attract countries that are looking to invest with high GDP and stable economic growth rate. Saudi Arabia is largest free economic market comprising of 25% of “Gross National Product” (GNP) (Modon, 2012). The solution for Inflation Before taking any such actions that would be beneficial for the economy, it is the responsibility of every government to draw down the plans that would keep the level of inflation in check. There are presences of various agencies in every nation that are responsible to forecast inflation and suggest the appropriate macroeconomic plans. The Central Bank of the country is involved in the task with the Ministry of Finance. It is not a hidden secret that a responsible or quasi government makes the forecast of inflation in such manner that in itself can cause the level of inflation to rise in the coming months. The reason being in the short run the rate of inflation depends on the anticipation of the people. The level of inflation can get worsened by the expectations of higher inflationary rate and so the prices can be stabilized with the view to present people the fact that prices will follow the stable path in the long run. Most analysts are of the opinion that the demand for goods as well as services can be raised by implementing effective monetary policies. However some are of the opinion that the periods after excessive demand the non competitive elements in the labour market has the potential to push up the prices in spite the monetary policies being less expansionary. The price lag compared to the falling demand can be treated as imperfect information in forming the expectations of prices rather than monopolistic power. The settlements on wages are meant based on the current situation and not over the period of agreements. When the supply of money is reduced the consumers or the purchases find less money on their hands. With the objective to maintain the cash balances they take the path of reducing the expenditures. They try to reduce the costs by reducing the working hours. Again if the price incentive is not enough the producers will follow the step of lying off workers until the excess demand is cleared in the market at profitable price. The workers who lost their jobs because of wage settlements will eventually hook upon with jobs. Therefore restriction on output and increase in the price level will partially be offset by increase in productivity and falling prices. Classical economists are of the view that inflation can be checked by controlling the supply of money. If there is excess money than anticipated within the economy, the consumers will increase the level o spending ad therefore the prices will tend to rise with increase in demand conditions. The government needs to keep a close eye on the issue of money by the central bank. The credit control policies should be pursued by the central bank. If the central bank needs to control credit it can increase the bank rate as well as raise the minimum cash reserve ratio. It can also serve notices to the other banks to control credit. In a situation of inflation the government can reduce the public expenditures. One of the reasons for inflation to occur is excess public expenditure in order to build roads, bridges. The payment of old debts can be delayed so that people do not have the extra purchasing power. The government can take the path of imposing some new tax burden on the purchasers. Over valuation of money can be thought of as yet another step but to control the overvaluation it is necessary to encourage imports while discourage exports. The production of goods whose prices are likely to rise in the recent future can be increased. In order to increase the productivity the public sector can be expanded while the private sector can gain more incentives. The scarce goods shall be imported as much as possible. Attractive savings scheme can also help to reduce the inflation rate. Investments in industries shall be increased where the production of goods is possible within short time span. The flow of investments to the industries taking longer time to produce goods shall be reduced. The effect on the single person in Saudi Arabia With the rise in the level of inflation across the Gulf region, the perennial problem for Saudi Arabia has been unequal distribution of wealth. The poor Saudis queue up in search of water while the rich Saudis use imported American cars for the mode of transportation. The couples were to cut costs by forgoing weddings in favour of the mass weddings organized by the Saudi princes. The surging oil prices have led to the turnaround in the economic feature of the country. The rise in the prices of oil has led to increase in the Gross Domestic Product of the country. According to the estimates of the International Monetary Fund the per capita income will increase by 27.6% in the year 2011. Economist Fahad Jumaa estimated the population of Saudi Arabia will reach at 19.8 million based on the population growth of 2.21%. The per capita income is expected to reach 31,170 dollars on current prices and 12,012 dollars on fixed prices. He expressed that the rising inflation will be a major threat to the income of the population in the current year. Other economist analysts opined that the gains in income for the population has enormously affected by the inflation over the last few years. He disclosed that the real income of the citizens has remained unchanged since 1980s according to the economic indicators. In case of Saudi Arabia, the rate of inflation has moderated considerably since 2008. But some local analysts argue that quick swelling in the level of prices and the rise in the level of inflation on the global arena will move into the country through the import channels. The year 2007 marked the emergence of serious inflation. In 2007, the consumer price inflation took the rising curve to an annual average of 4%. The IMF specifies that the changes in the prices of the trading partners are usually stable but the changes on the rates of exchange are not. Therefore the exporters need to protect the share of the market and they might be willing to absorb a part or whole of the impact of the changes in exchange rate by adjusting the mark ups on profits. On the other hand the importers of Saudi Arabia may also like to adjust in the same fashion in order to preserve the market share. The development bank of Saudi Arabia provides offer n interest free loans in order to subsidize the farmers as the products are sold at relatively lower price than the cost of production. Few economists argue investment in housing as well as in agriculture as investments in the stock of infrastructure. Why there is inflation in Saudi Arabia The country recently introduced that the annualized inflation charge had touched 6.1%. The situation led to the fear that the country can again be slipping into another stage of ambigu-digit inflation. The fears of the individuals are not likely to borne out in the around expression. The undesirable high rate of inflation in the country of Saudi Arabia is the result of deeper structural issues in the economy especially on the grounds of foods as well as housing. The escalation of the rate inducted trauma within the economy and it was anticipated that the economy will be forced move around the inflation spiral as it witnessed in the summer months of the year 2008. The world wide rise in food prices led to the rise in inflation to an all time substantial level. In the phase of economic downturn the costs moderated to more benign rates. But the authorities announced the latest rate of inflation to be at 6.1% which elevated the return to ambigu-digit inflation. The prospect of the return of high rate of inflation can be troublesome for the country. What is more stressing about the report on inflation is not that the country may be exposed to higher degree of inflation but it posits an expression pattern which shows that the country may have attain a higher degree of inflation rate than the predicted level. The bad manifeste coverage lead to high rates of inflation and it is a symptom of deeper financial tensions within the economy. The inflationary pattern is witnessing the pushes from the rising prices of foods and housing rents. The prices of food and housing are triggered by the financial inefficiencies and bottlenecks. To deal with the rising level of inflation the leaders of the country need to come up with extended strategies that will not hurt the consumers and will also provide stability to the economy. Economists argue that the Saudi’s riyal peg to the U.S. dollar contributed in raising the inflation bar for the kingdom. The Saudi Arabian Financial Authority needs to maintain the curiosity prices matched with the costs in United States. When the Fed reduced the fascination costs staring in the year 2007, the authority was pressured to adhere to the lock in step which led to upward pressure on the currency. The conclusion that economists drew from the researches made was riyal must be pegged at a substantial trade price or can be authorised to float freely. As currently inflation is on the high calls are being made for revaluation of the riyal. Revaluation of riyal will make the exports of the country to cost higher. The kingdom is currently willing to diversify the oil dependent economy and explore the new production sectors. In this case if the newly created products are highly priced then devastating effects can be the outcome for the economy. Changes in the inflation rate The following charts will provide the idea on how the level of inflation changed over the 10 year period. The first shows the changes in the rate of inflation for the year 2003. It can be seen from the above graph that the rate of inflation was highest in the month of August, 2003 while the rate was lowest in October and November of the same year. The rate remained relatively stable during the months of April and May, 2003. A sudden rise in inflation in the last month of the year can raise eyebrows for the analysts and research can be done to realize the underlying causes. The next graph will plot the inflation rate data for January, 2004 to December, 2004. One of the striking feature in the graph is the rate of inflation was nil in the month of October in that year. The year witnessed relatively stable rate of inflation while the rate was low for the months of July and August. The rate was highest in the months of May and December in that year. The next graph will provide the inflation data for the months of January, 2005 to December, 2005. The year started at the rate of inflation at much higher levels. The rate took the falling curve in the course of the year which again rose in the month of July. This month witnessed sharp rise n the rate but the rate decreased substantially in the months following July. The later part of the year the rate of inflation were on the high and loopholes in the economic strategies can be accounted to the reason. In the discussion so far, the rate of inflation for the first time stayed at more than 1% in the month of December, 2005. Serious financial tensions and the lack of the policy makers to tackle the ill effects of inflation allowed the exponential growth of inflation rate. The following graph will provide the data on the rate of inflation for the period of January, 2006 to December, 2006. The year 2006 brought serious macroeconomic problems for the economy of Saudi Arabia. This is evident from the rates of inflation prevailing in that period. It is astonishing to see the level of inflation to cross the 2% mar in April, 2006. What is surprising is that the rate of inflation stayed at the level for the period of 5 months on the trot. The rate decreased slightly in September, 2006 but aging took the steep curve in October, 2006. The last months of the year presents the highest rate of inflation which is anticipated to continue in the following year. The following graph will provide the data on inflation rate for January, 2007 to December, 2007. As discussed above the rate of inflation was the highest in 2007. The graph shows no difference. The rate remained at relatively stable rates in the early part of the year but after August the rate took the exponential curve. For the first time in the discussion the rate reached at 6% in December, 2007. The sustained rise in the rate is evident from the above graph. The following graph will provide the data on inflation rate for January, 2008 to December, 2008. A much more terrible situation was waiting for the economy in 2008. In the middle moths of the year the rate was the highest while it started at almost half the rate. Although the initiatives of the government or some injections into the economy brought the rate down in the late months but the situation acted to be the warning for the policy makers. The following graph will provide the data on inflation rate for January, 2009 to December, 2009. It is of no surprise that the year started with high rate of inflation. But the rate declined in course of time. The arte was highest in February, 2009 and lowest in November, 2009. The following graph will provide the data on inflation rate for January, 2010 to December, 2010. The year started with relatively low rate of inflation and the arte remained stable throughout the period. The arte was highest in August, 2010 and lowest in February, 2010. The following graph will provide the data on inflation rate for January, 2011 to December, 2011. In this year the highest rate of inflation was in the month of February as well as in October while the rate was lowest in June. Conclusion Conclusively it can be stated that inflation is a major macroeconomic indicator. Every country needs to have a close look at the inflation level as the indicator can affect the consumers directly. The first section of the assignment discusses more on the economy if Saudi Arabia while the following discussion sheds more light on the contributions of inflation in the progress of the economy. The assignment also provides importance on the solutions that can keep the level of inflation at the stable level. Few contradictory solutions have been presented in the discussion which provides the opportunity to the policy makers to select the right policy for the economy. The effects that the rate of inflation can have on the citizens of Saudi Arabia have not been ignored. In fact the level of inflation will affect the citizens of any country almost equally if the authorities lack the capability to take the right decisions at the right time. The causes of inflation will be helpful for the policy makers to detect the right causes that are leading to an inflationary effect for the economy. References Bank Audi. (2012). Saudi Arabia Economic Report. Retrieved from Carey, G. (2012). Saudi Arabia’s 2012 Annual Inflation Forecast at 4.8%, NCB Says. Retrieved from < http://www.bloomberg.com/news/2012-09-17/saudi-arabia-s-2012-annual-inflation-forecast-at-4-8-ncb-says.html> Modon. (2012). Investment in Saudi Arabia. Retrieved from < http://www.modon.gov.sa/English/AboutKingdom/Pages/InvestmentIncentivesinSaudiArabia.aspx> Reuters. (2012). Saudi economic growth slows, inflation hits 3-year low. Retrieved from < http://www.kippreport.com/2012/09/saudi-economic-growth-slows-inflation-hits-3-year-low/> Saudi Arabian Monetary Agency. (2012). Inflation Report Second Quarter 2012. Retrieved from Saudi Gazette. (2012). Saudi inflation to stay below 4% in 2012 as money supply grows. Retrieved from Trading Economics. (2012). Saudi Arabia Inflation Rate. Retrieved from < http://www.tradingeconomics.com/saudi-arabia/inflation-cpi> Read More