The silver lining of the credit crunch was its taming of inflation. The GCC economies were starting to overheat before the global financial crisis hit at the end of 2008 and this was most evident in consumer prices across the region. Inflation in the GCC rose rapidly from just 2.9 per cent in 2005 to peak at 11 per cent in 2008.

The reasons for the price increases are well documented. Sustained high oil prices prompted unprecedented state expenditure, creating excess liquidity. This was compounded by the rise in global commodity values, forced up by strong demand as the global economy gathered pace, as well as the weakness in the dollar.

Imported inflation

The import-dependent GCC states, unable to manipulate their interest rates to calibrate their domestic economies, imported much of this inflation.

Qatar was the worst hit as its economy grew at an extraordinary rate. Real gross domestic product (GDP) growth reached more than 15 per cent in each of the three years up to the end of 2008. Consequently, inflation in Qatar shot up to 15.2 per cent that year.

The severity of the downturn was such that consumer prices fell even faster than they had climbed

In the wake of the credit crunch prices in Qatar have shown the fastest drop. The severity of the downturn was such that consumer prices across the region fell faster than they had climbed, with aggregate inflation dropping to 3 per cent in 2009.

If it were not for Saudi Arabia (the most heavily-weighted country), where consumer price inflation fell significantly, but remained high on housing and rental costs, aggregate inflation in the GCC in 2009 would have struggled to exceed 1 per cent.

The quarterly data show consumer price growth slowed in every consecutive quarter in 2009 in each of the Gulf states with the exception of Qatar. Inflation in Qatar started to contract as early as the second quarter.

Real GDP growth (percentage change)
  2009 2010f
Bahrain 2.9 3.5
Kuwait -2.7 3.1
Oman 3.4 4.7
Qatar 9 18.5
Saudi Arabia 0.1 3.7
UAE -0.7 1.3
f=forecast; Source: IMF

In the final quarter of 2009, deflation in Qatar hit 10 per cent year-on-year, reflecting the sharp fall of some 12 per cent in rents and utility charges over the year. This decline is set against a large rise in the same category the previous year of almost 20 per cent, highlighting the volatility of the real estate sector.

Along with the decline in import prices, which came about primarily due to the fall in global commodity prices, a large stock of housing units was released into the market in 2009, easing supply considerably.

Housing and rentals costs constitute almost one-third of the consumer price index basket, and such volatility is a concern for banks with large mortgage exposure.

In order to stabilise the sector, Qatar’s authorities have taken a number of measures, such as lifting the freeze on rent rises for residential properties. The freeze remains in place for commercial properties.

The government originally imposed the rent increase ban in 2008, when the over-heating housing sector started to push prices upwards.

Faisal Hasan, head of research at Kuwait’s Global Investment House, says the decision to lift the ban “will not have a great impact on lifting rentals considerably”.

“The market is directly governed by demand and supply fundamentals rather than speculation”, thereby limiting the efficacy of such a move, he says.

Lifting the freeze on rents is not the only measure the Qatari government has adopted. In 2009, the government extended support to local banks, buying up a real-estate equity portfolio in banking stock worth some $4bn, helping those banks heavily exposed to the property market with their cash flow.

The government is looking to extend this support by buying directly into the real estate sector, though its investment vehicle Qatari Diar.

With some 10,000 new homes due to come into the market this year, property prices are forecast to fall some 15 per cent, following on from a decline of up to 40 per cent in 2009.

With the real estate sector in Qatar contributing as much as 15 per cent of non-hydrocarbon GDP, its collapse will certainly impact the wider economy. The impact will be alleviated to some degree by “the ongoing expansionary fiscal policy adopted by the government”, says Hasan.

Housing shortage

In Saudi Arabia, inflation is currently much higher than in the other GCC states, not least since “the kingdom never really had a recession”, says Khan Zahid, chief economist of local Riyad Capital. He suggests the effect of real estate deflation in the other GCC countries is depressing their overall inflation rates.

Housing shortages are keeping prices in the kingdom buoyed. Earlier this year, the Saudi Arabian Monetary Agency, the kingdom’s central bank, said price pressures would remain due to a continued shortage of housing units.

The kingdom has been experiencing a steady rise in inflation since October 2009. This is partly due to the increase in government spending and its commitment to development projects which feed demand for expatriate workers, ensuring continued pressure on rents.

The peg will protect Saudi Arabia … from runaway inflation … prices may end up closer to 5 per cent

Khan Zahid, Riyad Capital

The large-scale state spending programme is likely to continue. Earlier this year, Saudi Arabia’s Finance Minister, Ibrahim Abdel-Aziz al-Assaf said the government’s expansionary fiscal stance would continue as long as the economy needed the support.

The budget for this year shows a 14 per cent increase compared to 2009’s spending plan. The Saudi economy is picking up on the back of the sustained strength of public consumption and Zahid says “inflation is already on the rise”. But the external factor is also important when considering Saudi prices. “As much as 60 per cent of Saudi inflation is imported,” he says.

Imported food and raw materials in the kingdom are driven by international commodity prices, a significant component in domestic prices.

The Saudi riyal’s peg to the dollar did it no favours prior to the credit crunch, pushing up prices, but the reverse trend is in now evidence.

“The peg will protect Saudi Arabia to some extent from runaway inflation,” says Zahid. “I suspect inflation may end up closer to 5 per cent by the end of the year.”

Saudi Arabia has a history of low and stable inflation and 5 per cent is relatively high, but it manageable, say analysts.

UAE subdued

The recovery of the dollar and the fall in global commodity prices also explains the fall in prices in the UAE over the course of 2009. But according to Simon Williams, chief economist, HSBC Middle East, that is only part of the tale. “The real story is the shift in domestic demand trends,” he says.

“[In 2009] the trends that over-heated the economy in the previous three years came to an abrupt halt. Price pressures, not just those on consumer prices, but also on asset prices, then went into reverse.”

Given the acute U-turn in the economy’s fortunes, prices in the UAE actually rose in 2009 when they reached 1.6 per cent.

But in the first quarter of this year, prices contracted and Williams expects this to be the trend for the rest of the year. “Asset and real estate prices will remain weak and consumer prices flat,” he says.

Kuwait has taken steps already to encourage lending by cutting rates, a measure designed to stimulate the non-oil sector. The move supports one of Kuwait’s most expansionary budgets to date. Expenditure will increase by 34.5 per cent in 2010-11.

Hasan does not expect the rise in spending to have a huge effect on prices over the course of the year.

Gulf Investment House forecasts inflation of 4.5 per cent in Kuwait this year, compared with 4 per cent in 2009.

“Higher price levels will be directly linked to both the higher cost of imports and higher energy prices,” he says.

Hasan does not expect these to rise significantly until the domestic and global economies regain full momentum, which is not expected before the end of 2011 at the earliest.

The IMF agrees. It projects Gulf inflation for 2010 at 3.8 per cent, not significantly higher than the 3 per cent recorded in 2009. But with oil and soft commodity prices forecast to pick up from 2011, a sharper rise may be in the offing.