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Inflation in Saudi Arabia

The Saudi Arabia Economy
The Economy of Saudi Arabia has been one of the best in the world over the years. These rates are due to its economic activities such as extraction and selling of petroleum and a firm government control. The government has been encouraging and supporting private sectors in the investment of downstream products like petrochemicals, with the aim of allowing continuous diversification in the economy. The country is the largest petroleum exporter in the world and is ranked second in crude oil extraction. Due to the rapid generation of revenue from this business, the government has been increasing its infrastructures over the years. The main once are schools, development of new cities for businesses, airports, new and better roads. (Mohammed 279).
However, things are never the same anymore. The gross domestic product per capita is dropping, and the rate of unemployment is increasing over time. The main reasons are the rapid increase in the population growth, and the continuous rise in the number of foreignersin the hope finding greener pastures (Mohammed 351). Due to all these changes in the economy and other factors as described below, there has been a progressive increase in the general prices of commodities. This inflation has raised a lot of concern among people, as a fixed amount of cash continues to cover fewer and fewer commodities and services over time.

Inflation

Economists state that a moderate inflation is not bad as it encourages the growth of the economy. During deflation (a decline in prices) the economy can suffer from a recession or depression, experience lower production and consumption vicious cycle and rise in unemployment rates (Ball 376). That is why most countries would prefer inflation to deflation since inflation if controlled can much boost the economy.
Inflation can lead to more productivity since it motivates companies to increase their production to attract more revenues. Moreover, workers would be forced to work more due to inflation and increase their earnings since the inflation has made their wages and money value to decrease a bit (Ball 377). Deflation will make companies delay their investments, leading toa decline in general output and increase in unemployment rate. However, if inflation is not controlled (hyper-inflation), it can stimulate capital flight and reduce the future value of profits, which in turn discourage investments and hold economic planning.
Inflation in Saudi Arabia
In the 80s and 90s, inflation in Saudi Arabia was very low, around one percent. The main reason was due to a decline in oil revenues due to the presence of weak oil markets. Since the year 2003, the inflation rate has increased, and by the year 2008, it was over 11%. These rates are increasing to date. This alarming risein inflation has negatively affected many people especially those close and below the poverty line (SAMA n. p). The primary areas affected include costs of electricity, housing, gas, and water. This is very unfortunate considering that these commodities fall under the category of basic needs. What has contributed this inflation in Saudi Arabia?

Nominal GPD and Real GDP

The gross domestic product (GDP) of Saudi Arabia was about $745 billion in the year 2013 and was ranked number 19 in the world (Alhamad para 5). Of these GDP findings, half came from oils production, and the other half from both private and public sectors. Putting in mind that the oil sector is owned by the government, this means that the results of GDP mainly depend on the government operations. The growth in real GDP from 2004 to 2013 was 6.3%, and that of nominal GDP was 13.4%. Nominal GDP represents the value of products an economy produces expressed in current prices, and real GDP represents the value expressed in the prices of some base year. The difference of the two is the definition of inflation. This big difference between the two GDPs implies high inflation in Saudi Arabia (Alhamad para 6).

The figure above shows both nominal and real GDP in Saudi Arabia (HammadAlhamad).

Money Supply
The Government of Saudi Arabia has been increasing the total stock of money in the economy by 20% annually over time. This action has caused import rate to rise, increasing the money supply of the foreign exchange market, causing a downward pressure on the rate of exchange. According to economics, change in either foreign prices or exchange rate will cause changes in price levels in the local country. Increasing money supply more than output usually results in inflation (Altowaijri 109). Inflation rates are controlled by the Quality Theory of Money, which is represented by MV=PT.
T= Output or Transaction
P= Price Level
V= Velocity of circulation
M= Money Supply
P and V are controlled by the economic productivity, and (in the long run)the increase in money supply causes an increase in inflation (a direct relationship).

Increase in Oil Revenue

Oil revenue in Saudi has been increasing over time due to the increase in the oil prices (Altowaijri 109). This increase has both boosted the economic growth, and Saudi Arabia flooded by the cash. Due to this increase in the government revenue, there was an increase in the government expenditure, which in turn generated demand in the economy. This action led to the creation of a gap in supply and demand. The result was inflation.

Investment

In focusing on investment, residential and non-residential building construction investment comprise 16% and 38% respectively of the total investment in Saudi (SAMA, n. p). This investment creates high demands in the real estate sector, resulting in an increase in inflation in the real estate market (SAMA, n. p).In addition, SAMA shows that between 2009 and 2013 the real estate loans hiked by an average of 25% annually, increasing the real estate demand further. There are a number of factors that explains this increase in demand for Saudi Arabia real estate. After the 2007 market stock crash in Saudi, most investors shifted to real estate, creating demand, and making the prices in that sector to increase. Another factor is the increase in the number of marrying people, who are searching houses to start their marriage life (Alhamad para 11). All these factors much caused an increase in inflation rate.

Current Exchange Rate

A change in the Saudi Riyal exchange rate against other currencies will cause a direct effect on all goods except for those imported from the U.S markets. The rate of SRI$ is constant. Between the 2006 and 2008, the value of the dollar lowered as compared to other major currencies, making the Saudi riyal value also to weaken. This is because the Saudi riyal is pegged with the dollar. This means that foreign importers had to pay extra Riyal for the same quantity of commodities. What happened is that they passed on these excess costs to the customers through increasing their domestic prices. Since Saudi Arabia relies very much on the importation of goods from non-US nations, the consumer price index is expected to rise whenever the dollar weakens. Due to insufficient domestic production, Saudi depends on imports to a large extent, but less than 15% comes from the U.S.

Government Expenditure

In order to control inflation in Saudi Arabia, the government needs to come up with ways that can diversify its economy and increase the domestic production to reduce its imports independency. In addition, it should also make some changes in the policy of exchange rate, with the aim of stopping the current pegging of the dollar the Saudi Riyal. If this is implemented, and considering that the economy of Saudi Arabia is booming, the country can be one of the best places to live in and life can be very enjoying.

Works Cited

Alhamad, Hammad. The High Cost of Living in Saudi Arabia: Growth and Inflation in a Macroeconomic Perspective. Web 27 April 2015.
Altowaijri, Hamad. “Determinants of Inflation in Saudi Arabia”.World Review of Business Research. (2011): 109-114: Print
Ball, Laurence. “Why Does High Inflation Raise Inflation Uncertainty?” Journal of Monetary Economics 29 (1992): 371–388. Print
Mohammed, Ramady. The Saudi Arabian Economy: Political Achievements and Challenges. New York: Springer, 2005.Print
SAMA. Forty Third Annual Report, Research and Statistics Department, Riyadh. Web 27 April 2015.

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