IMPACT OF RISING FOOD/COMMODITY PRICES - SAUDI

C O N F I D E N T I A L RIYADH 000707

SIPDIS

SIPDIS

EEB/TPP/ABT/ATP FOR JANET SPECK

E.O. 12958: DECL: 09/17/2017
TAGS: EAGR EAID ETRD ECON PGOV PREL SA
SUBJECT: IMPACT OF RISING FOOD/COMMODITY PRICES - SAUDI
ARABIA

REF: A. 07 RIYADH 2529

B. RIYADH 373

C. SECSTATE 39410

Classified By: Economic Counselor Robert B. Murphy
for reasons 1.4 (b) and (d).


1. (U) Summary. Driven primarily by rising rents and food
prices, inflation in Saudi Arabia hit a 27-year high of 8.7%
in February. Rents are up 18%, food prices have risen 13%,
and Saudi food imports increased 44% for the 12 month period
ending in January. The Saudi government has announced
various measures to battle inflation and implemented numerous
food subsidies in an attempt to control prices. The efficacy
of these measures is questionable given the difficulty of the
SAG controlling monetary policy because of the riyal's peg to
the dollar, and its unwillingness to limit government
spending on long overdue and needed infrastructure,
educational and health projects during an oil boom. End
Summary.

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Inflation Hits 27-year High
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2. (U) Driven primarily by rising rents and food prices,
inflation in Saudi Arabia hit a 27-year high of 8.7% in
February. Rents are up 18%, food prices have risen 13%, and
Saudi food imports increased 44% for the 12 month period
ending in January. While heightened food prices in the
Kingdom are chiefly attributable to the global rise in food
prices, they are further boosted by retailers passing on
rising rents to consumers and by the Saudi riyal's fixed peg
to the declining U.S. dollar. Also, domestic agriculture has
been impacted by skyrocketing fertilizer costs (up 300% since
January) and recent bad weather. Poor weather in December
negatively impacted domestic vegetable harvests which
comprise 75% of vegetables consumed in Saudi Arabia. The
recent rise in the cost of living has been an economic shock
to Saudis who enjoyed inflation averaging less than 1% for
the 15 years preceding the recent upsurge.

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The SAG Responds
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3. (U) On January 28, the Saudi Council of Ministers
approved 17 measures to control rising prices and inflation
in the Kingdom. The SAG will:

--add a compounding 5% cost of living allowance to the
salaries of its employees for each of the next three years;

--increase social insurance benefits by 10%;

--decrease the level of indirect taxation (it does not
collect an income tax) by bearing 50% of the fees relating to
passports, vehicle licenses and ownership transfers, and
renewal of residence permits for domestic workers for the
next three years;

--bear 50% of all port fees for the next three years;

--expedite construction of public housing;

--establish a national housing authority;

--enact a new mortgage law;

--continue to review prices of medicines;

--approve a supply policy that aims to diversify sources of
supply of goods to ensure that local demand can be satisfied
at reasonable prices;

--activate a law to promote fair competition and prevent
monopolies;

--activate the role of the Association of Consumer Protection
to monitor the market and enhance public awareness on market
developments;

--combat trade fraud;

--require shops to place lists of products prices in a
prominent place within stores;

--better coordinate consumer information campaigns; and

--continue to control the prices of basic commodities.



4. (U) On March 3, King Abdullah bin Abdulaziz al-Saud
replaced Hashim Abdullah Yamani with Abdullah ibn Ahmed
Zainal Alireza as Minister of Commerce and Industry (reftel).
Yamani created an uproar in 2007 when he observed that the
price of rice is governed by global prices (not the Saudi
government) and consumers have a choice to buy cheaper rice.
He was viewed by much of the Saudi public as inefficient and
ineffective, and was blamed for high housing and food costs
in Saudi Arabia. In contrast, Alireza, a highly successful
businessman, has a solid reputation for achieving economic
results. The Saudis are looking to him to rein in inflation.

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Focus on Strategic Commodities
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5. (U) Saudi Arabia suffered a shortage of wheat flour, one
of its basic staples, for a six month period ending in March.
The Kingdom achieved self-sufficiency in wheat production in
1985, and since has only imported small retail packs of flour
and specialized baking flour. The SAG allocates wheat
production quotas to farmers, purchases locally grown wheat
at $266.67 per metric ton, and sets retail prices at $148.21
and $207.31 per metric ton for white and whole wheat flour,
respectively. These low prices have not changed since 1985
and contributed to the three causes of the wheat shortage.
First, large quantities of Saudi flour were smuggled to Yemen
where the price of wheat flour has increased sharply.
Second, local livestock owners began to use wheat flour as
animal feed when the price of barley, the main camel and
sheep feed in Saudi Arabia, reached $13.33/50 kilograms
compared to $6.75/45 kilograms for white wheat flour. Third,
local snack food producers increased the use of wheat flour
to expand production and exports to nearby countries.


6. (U) In response, the SAG assigned more law enforcement
officials to track down and arrest wheat smugglers, and is
paying better attention to wheat flour distribution in the
region where most of the wheat smuggling is carried out.
Further, the SAG increased the import subsidy on feed barley,
added seven additional animal feed ingredients to its
imported animal feed subsidy program, revoked the licenses of
wheat flour distributors that sold wheat flour to animal
farms and banned the sale of flour as cattle feed. The
government is also considering ordering local snack producers
to import wheat flour from the international market. The SAG
has not indicated any consideration of addressing the root
cause of the shortage (artificially low prices) by limiting
its wheat subsidies. Wheat flour is now available at
supermarkets at regular prices. A two kilogram bag of wheat
flour costs $0.53.


7. (U) Rice, the Kingdom's second basic staple, is not
grown domestically. Retail prices of imported rice increased
from between 11% (for U.S. long grain parboiled rice) and
113% (for Pakistani white rice) from February 2007 to
February 2008. In March 2008, the SAG began to subsidize
rice imports at the rate of $266.67 per metric ton and
increased the government subsidy of imported baby formula.
All government subsidies paid on imported animal feed, rice
and baby formula are paid directly to the local importer with
the hope (but not requirement) that the savings will be
passed on to consumers.


8. (U) On April 1, the SAG exempted wheat, wheat flour and
other grains from import duties and reduced duties on 75
other foodstuffs to 5%. These foodstuffs include chilled and
frozen poultry and their products, eggs, cheese, cheese
cream, vegetable oils, pasta, canned meat, fruit and
vegetable juices, mineral and ordinary water, long life milk,
corn flakes, peas, beans, peanut butter, yeast and baking
powder.

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No Change in Monetary or Fiscal Policy
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9. (U) The Saudi Arabian Monetary Authority (SAMA),the
Saudi central bank, has made it clear that it is committed to
the Saudi riyal's exchange rate peg to the U.S. dollar
despite public calls for depegging. SAMA points to inflation
in Kuwait as evidence that depegging the riyal will not serve
as a quick fix for inflation. However, SAMA's adherence to
the peg does require Saudi monetary policy to mirror that of
the U.S. Federal Reserve despite divergent economic cycles in
the Kingdom and in the U.S. SAMA has followed the U.S.
Federal Reserve in reducing interest rates even though these
cuts are expected to have negative consequences for inflation
given that money supply growth in the Kingdom hit a 30-year
high in January. The efficacy of SAMA's recent move to raise
reserve requirements was blunted by this excess liquidity.

Despite the disadvantages of maintaining the peg as it
currently impacts inflation, abandoning it would lead to a
harmful contraction in Saudi wealth rather than easing
inflation.


10. (C) In a recent meeting with EconOffs, Abdulrahman
al-Hamidy, Deputy Governor for Technical Affairs at SAMA,
stated that the SAG will principally address the consequences
rather than the causes of inflation. He explained that
government spending (most of the spending in the Kingdom) is
focused on long-delayed investments in health, education, and
basic infrastructure, as well as economic investments. These
economic investments include new petrochemical plants,
greenfield economic cities and Saudi Aramco projects. Such
investments did not keep pace with demand in the
fiscally-strapped 1980s and 1990s when oil prices were low.
Al-Hamidy expressed concern that if the SAG curtailed these
projects it might limit Saudi Arabia's future growth. He
further explained that the SAG is not making cash transfers
to poor Saudis because it would take government bureaucracy
"a year" to accomplish this while the poor are facing higher
rents and food prices now.


11. (C) On April 30, Ministry of Finance officials told
Ambassador Fraker that inflation in the Kingdom had reached
10%, but that it was largely beyond government control since
it was caused by global food prices and local construction
bottlenecks. SAG officials confirmed that they are not
sterilizing oil revenues and that they fully understand that
subsidies are not a long term solution for rising food
prices. For a long-term solution, they added, SAG is looking
to invest in agricultural production both at home and abroad.

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Under Pressure
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12. (C) Comment. The SAG is under public pressure to
control inflation, particularly food and rent prices. The
SAG's means to accomplish this are limited given that rising
food prices are a global phenomena and the Kingdom is
experiencing an oil boom. Further, the SAG's monetary policy
is effectively set by the U.S. Federal Reserve, and there is
little public support for cutting government spending.
Inflation was a serious problem for Saudi Arabia during the
last two oil booms and we expect it will continue to be a
problem during the this one. However, we also expect the SAG
will preserve the affordability of basic food items such as
bread, rice and chicken. End Comment.
FRAKER