Saudi deflation won’t continue for long, says Capital Economics

Saudi Arabia is unlikely to face a long period of deflation, but slow economic growth and a stronger US dollar mean that underlying price pressures will remain subdued over the coming years, London-based Capital Economics said in a report.

According to figures released recently, consumer prices in Saudi Arabia fell by 0.4 percent year-on-year (YoY) in January, putting inflation in the negative zone for the first time since early 2000 and igniting fears that the kingdom’s economy could be entering a cycle of weaker demand and declining prices.

The consultancy, however, noted that such a scenario appeared unlikely as deflation in Saudi Arabia appeared to be the result of supply-side factors, along with weak demand.

“Headline inflation has been dragged down by a sharp decline in food prices,” CE said, adding that the weak food inflation could be explained by the delayed impact of previous declines in global food prices.

Upcoming policy changes, meanwhile, are expected to boost headline inflation over the coming years.

Another round of subsidy cuts is expected in mid-2017 and a value-added tax is set to come into force in early 2018.

If a 5 percent VAT is introduced covering 50 percent of goods, it would directly raise inflation by 2.5 percentage points, the report said.

“At the same time, concerns about the balance sheet effects of deflation are limited,” CE said.

While private sector debt in Saudi Arabia has risen in recent years, it is not at an alarming level. On the other hand, the budget deficit has narrowed and the government still has a large positive net asset position.

“As a result, the authorities could loosen fiscal policy if deflation becomes a real threat,” it added.