Food price fears gnaw at GCC

The spectre of inflation is beginning to haunt Gulf states as demand for commodities grows and the rising cost of staples fuel concern over supplies.

ABU DHABI, UNITED ARAB EMIRATES -- August 10, 2010 -- People shop for groceries and food at a store in Abu Dhabi. Lee Hoagland / The National
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One of the few silver linings of the global credit crunch for businesses and consumers in the Gulf has been the taming of inflation.

While companies grappled with weak demand and falling sales, they also enjoyed reduced rents and other costs, boosting the region's business competitiveness.

Now, as demand for commodities begins to pick up after the global downturn, the spectre of inflation may begin to loom once again.

Driving the latest upward move has been concerns about supplies of vital food staples.

The US department of agriculture this month warned of "dramatically" lower supplies of important agricultural products. Supply pressures have been building up due to worse than expected harvests after hot summers in the US, droughts and fires in Russia and heavy rain in Canada and Europe.

"The latest trends leave the GCC economies in a potentially uncomfortable situation," says Dr Jarmo Kotilaine, the chief economist of Saudi Arabia's NCB Capital.

The region imports between 70 and 100 per cent of its food, leaving it particularly vulnerable to supply problems.

Inflation pressures have already been steadily building. Saudi Arabia's food price inflation rate is 8 per cent, with Kuwait's rate nearing 11 per cent.

Although consumer prices in the UAE are considerably lower, inflation rose at the fastest monthly pace in 11 months in August as food price inflation reached 4.2 per cent.

With five of the six GCC economies pegged to the US dollar, the cost of imports is determined by the strength of the greenback. A stronger dollar helped to counter rising food prices earlier in the year, moderating import costs to the region.

But since the dollar began weakening in May, the cost of food imports have been edging higher. With the US Federal Reserve expected to begin a second round of quantitative easing next month, pumping more money into the economy to try to bring the dollar lower still, import prices could rise further.

In theory, central banks around the world can respond to the risk of inflation by flexing monetary policy muscles. However, the dollar peg means Gulf economies are duty bound to closely mirror the low interest rates employed by the Fed. In addition, economists say monetary tightening can be ineffective in the face of supply shocks.

"With rising agricultural prices likely to continue to push upward, the Middle East has little ability to tighten monetary policy," says Tim Fox, the chief economist at Emirates NBD.

"It will be fiscal and competition policy again that will have to be used if onshore food prices continue to gain."

Signs of prices of food and other soft commodities rising further are evident. The department of agriculture's warning this month included a forecast that the country's stocks of corn would halve to their lowest levels in 14 years.

Such a prediction is significant, given that the US is the biggest corn producer globally with exports accounting for almost all of the international trade in the grain.

The department lowered its previous forecast of a record year for corn after high temperatures and strong rainfall affected agricultural output.

Bad weather is threatening the outlook for other soft commodities too. Coffee prices have come under pressure to rise due to poor weather in Latin America and a drop to 10-year lows of US stockpiles of the commodity. Cotton prices have been pushed up by weak harvests in China and India, the main global cotton producers.

Economists fear a return to 2007 and 2008 when a similar lack of availability led to a rapid rise in soft commodity prices.

Supply restrictions have already led some buyers to engage in stockpiling and speculative purchases of stock, worsening market conditions. Concern is now turning to whether producers will start to limit exports to protect domestic supplies of goods.

"As in 2007-2008, the GCC faces an acute quantity risk in the event that exporters decide to limit sales," wrote Dr Kotilaine in a recent research note produced by the bank.

"As during the previous commodity boom, this presents a credible prospect of additional inflationary pressures at a time when consumer prices are climbing virtually across the region."

For the Gulf, the risk is that this may present a painful taste of two years ago. Then, higher imported food prices contributed to rampant inflation, exacerbated by a fall in the US dollar against the euro and other major currencies, pushing up the cost of food for consumers.

Last year saw a sharp decline in inflation as consumer demand ebbed and foreign investors cut back expenditure during the financial crisis, causing consumer prices to drop.