IMF Comment: Will Inflation In Saudi Return to 2008 Levels?

With the ongoing rebound in economic activity, a question that emerges is whether inflation will increase again as it did in 2007–08 when the annual increase in consumer prices peaked at 11.1 percent in July 2008. Many of the drivers of inflation then are also present now, including higher food prices, depreciation of the nominal effective exchange rate, expansion of credit, and rising government spending.

However, the increases in these various drivers of inflation are at present generally smaller than they were in 2008. The one area where the pressure is greater now is fiscal spending, which is projected to increase by 24 percent in 2011 compared to 12 percent in 2008.

Still, a large part of this increase is capital injections to the Real Estate Development Fund and to the Saudi Credit and Saving Bank that are unlikely to be fully utilized this year.

Overall, these figures suggest that inflation will remain well below the levels of 2008. This conclusion is also supported by a more formal econometric analysis, which using a range of models suggests average inflation during 2011 in the range of 5.8–6.6 percent.

One potential concern, however, is the buildup of liquidity in the banking system and the risk that it will translate into much higher credit growth in the months to come. One indication that this is not likely to be the case is that credit growth in 2008 was accompanied by an even larger increase in the monetary base. Compared to that experience, the current increase in the monetary base is more modest. In particular, the authorities have been largely successful in sterilizing fiscal spending, despite the ongoing repayment of government debt, through increased issuance of central bank t-bills. Credit growth is also likely to be more constrained than in 2008 due to more subdued corporate demand and strengthened prudential measures on consumer borrowing.