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Feeding fears of inflation

September 2012

Soaring food prices come at a delicate time for Arab countries still dealing with the aftermath of 18 months of political upheaval and economic turbulence


by Rosamund de Sybel
rosamund@tradearabia.net

Back in March 2008, Bahrain’s central bank governor, Rasheed al Maraj, expressed concern over bread riots in Egypt. According to a US diplomatic cable released by the website Wikileaks, Al Maraj “hoped these conditions would not spread to Bahrain,” where political authorities were feeling the heat of public pressure to de-peg from the dollar citing rising prices of basic staples. Protests over food prices did reach Bahrain, after spreading to Jordan, Morocco and Yemen. It is no coincidence that three years later, the same countries endured political upheaval.

Food prices are again rising across the region. The surge in global commodity prices over the summer has raised fears of food inflation across the Arab world. This summers’ drought in the US, which dried out nearly half of America’s corn and soybean crops, prompted fears of another global food crisis. Forecasts for Russia’s grain harvest have also been cut as a result of drought in two of its major growing regions.

Supply shocks have serious repercussions for much of the Arab world; price spikes caused by the Russian export ban contributed to high food inflation in 2010, and to demonstrations in 2011.

As the world’s biggest importer of agricultural commodities, the Middle East and North Africa (MENA) is particularly vulnerable to droughts and price swings (see chart). Egypt is the world’s single biggest importer of wheat. Morocco and Algeria – also major importers – are particularly vulnerable too. Research from analysts Roubini Global Economics points out that “new governments, with already wide fiscal deficits, may be ill-equipped to deal with these shocks.” According to the consultancy’s Agricultural Sensitivity Index (which measures how painful high agricultural prices are for economies, including effects on consumer spending, terms of trade and inflation), Egypt is ranked second. Morocco is fourth.

MENA oil importers, who have already been hit by rising crude prices, may now be forced to spend more than they can afford on subsidies.

“Governments in these countries may well feel obliged to increase spending on subsidies in order to keep price rises in check, but of course they can ill-afford this at the moment, given generally poor fiscal positions, made worse by high and rising oil prices,” says James Reeve, an economist at Samba Financial Group, a Saudi bank.

The biggest worry is Egypt, he says, where food subsidies represent a large chunk of government spending.

“Egypt’s finances are in terrible shape, so a further rise in subsidy spending is the last thing they can afford. It would be extremely bold if Mr Mursi’s government were to allow food prices to rise significantly, but he might consider that now is the time, since he has lots of political capital. It’s a tough call, but in the end, I think they will raise subsidy spending and seek additional funds from abroad.”

Jordan is also vulnerable, says Reeve, pointing to the kingdom’s large fiscal and current account deficits – and its restive population.

Even the rich Gulf countries have increased food subsidies. In May, the United Arab Emirates ordered that Ramadan food subsidies be applied throughout the year. Last year, Kuwait announced it would provide free staple food for everyone for 14 months.

The GCC, which imports most of its food, is expected to see the value of its food imports double over the next decade. The Economist Intelligence Unit predicts that total GCC food imports will reach $53.1 billion by 2020, an increase of 105 per cent from 2010.

Gulf states have, however, been cushioned by high oil prices. “For the oil rich economies, the increase in agricultural prices is offset by higher hydrocarbon prices,” says a research note from Capital Economics. It points out that the bloc’s net hydrocarbon exports are 20 times bigger than their food imports. Nevertheless the report cautions that “both the resource-rich and resource-poor Arab states should be concerned by rising agricultural prices.”

Indeed, Gulf governments have little space to react to food price spikes. The region’s dollar pegs limit the space for monetary policy, and as Jarmo Kotilaine, chief economist at NCB Capital explains, “monetary tightening in the face of what is genuinely a supply shock would probably prove counterproductive anyway.”

Most GCC states have enough money to afford increased subsidy spending for a sustained period of time, which will keep a lid on inflation.

“Saudi Arabia will almost certainly step up subsidy spending: it can afford to and in the current circumstances it is unlikely to countenance a pronounced rise in inflation,” says Reeve.

Should prices continue to rise, analysts point to Bahrain and Oman as vulnerable Gulf countries. Bahrain, however, would likely be able to secure discreet financing from Saudi Arabia. Oman, meanwhile, would likely have to finance subsidy spending through a drawdown in foreign assets, if necessary.

Efforts by Gulf states to embark on food security programmes by buying up foreign farmland in Asia and Africa have so far proven largely ineffectual, say analysts.

Another challenge to the Gulf’s food security effort is the threat of an Israeli strike on Iran’s nuclear facilities. The potential for conflict with Iran has raised fears over how food imports would reach Gulf states, should the Islamic Republic realise its threat of closing the Straits of Hormuz, the strategic waterway through which many imports pass. Even if Iran is unable to completely close the Straits, it could potentially reduce traffic to a trickle.

“On that basis, food imports would have to go to Oman and Jeddah, and more through the Suez Canal,” says Reeve. “Rerouting food in this way would take time and in the meantime there would almost certainly be a spike in food prices, which would presumably most pronounced in Kuwait, Qatar, Bahrain and UAE. But I think this would be temporary,” he concludes.

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