Deflation persists for Gulf economies

VAT masked the trend

The sudden decline caught some forecasters by surprise. For example, as recently as October 2018, the IMF was expecting 2.0% inflation for Saudi Arabia in 2019 and 2.4% for the GCC overall. Its updates published in the April World Economic Outlook adjusted this down to -0.7% deflation for Saudi Arabia and 0.5% inflation for the GCC. However, even these may prove to be an underestimation of the trend, which could result in overall GCC deflation for the year.

Part of the reason that the deflationary trend seemed surprising is that the introduction of VAT in UAE and Saudi Arabia in 2018, together with cuts in fuel subsidies and excise taxes in some countries, masked underlying trends. The 5% VAT rate probably added about 3 percentage points to inflation in Saudi Arabia and 2 points in UAE (owing to a narrower scope than Saudi Arabia and household expenditure that is skewed more heavily towards VAT-free items such as rent). If the VAT impact were excluded, Saudi Arabia would have likely suffered deflation in 2018 (as it did for most of 2017) and the GCC as a whole would have seen flat prices.

Within the UAE, a significant gap has opened up between Dubai and Abu Dhabi. Dubai is undergoing the sharpest deflation in the region, (peaking at -3.9% y/y in February) whereas the price decline is much milder in Abu Dhabi. This is a notable shift, because as recently as late 2017 Dubai was experiencing higher inflation than Abu Dhabi.

Rent drives deflation

The predominant driver of deflation is rents, which saw both the largest decline (5.6% overall in April) and is the largest component of the regional Consumer Price Index (CPI) basket (28%). A confluence of factors is causing this, including oversupply of property and a decline in expatriates in places (particularly as a result of Saudi nationalisation efforts). Saudi rents are down the most, by -7.8% y/y in April. Although Dubai’s decline is not quite so steep (-6.3%), rent and utilities comprise 44% of its CPI basket, compared with just 25% for Saudi Arabia, meaning the impact is greater. Rents were also down in Abu Dhabi (-3.6%), Qatar (-2.7%) and Kuwait (-0.6%) and Oman (-0.2%).

During the first quarter, transportation saw the second largest decline (-1.8% y/y in Q1) and made the next largest contribution to overall deflation. However, this was a temporary factor owing to the dip in oil prices in December and January, as the UAE and some others now set domestic fuel prices on a monthly basis, and fuel rebounded to inflation in April (though just 0.1% y/y). There were also declines in communications, clothing and miscellaneous goods and services. Food prices, the second largest component of the CPI, are in deflation in UAE and Qatar but rising elsewhere.

Policy offsets

The regional deflation has happened despite the introduction of VAT in Bahrain and excise taxes in Qatar and would have been even steeper without these measures. There will be further policy boosts to prices later this year, including excise taxes in Oman from June 15th. However, the region may see flat or falling prices for the year as a whole. Dubai stands out because its deflation is broad-based, spanning 83% of its CPI basket. This may be due to its more competitive economy and could provide advanced notice of trends that will hit other countries later in the year. Overall, deflation is a boon for consumers but will squeeze corporate profit margins and could stifle investment and growth.