Why food prices have risen in Saudi Arabia 
Brad Bourland
Chief Economist and Head of Research, Jadwa Investment
October 2007

Why food prices have risen in Saudi Arabia 

Food prices have risen rapidly in recent years. Every household has been affected by higher food prices, which are the most visible, and for most people, the main source of inflation in Saudi Arabia. Higher global commodity prices are the main reason for the rise in food prices. Structural shifts in patterns of consumption and use of agricultural products have been aggravated by temporary factors such as poor weather conditions to push up food prices throughout the world. Over time, supply will catch up with demand and agricultural commodity prices will fall, but over the next few years annual food price inflation is expected to average around 5 percent. 

With agricultural commodity prices rising and food price inflation in Saudi Arabia in line with other countries in the GCC and not much above that in the US and UK, we see little evidence that local retailers have been a major cause of the price rises. However, there appears more justification in claims that prices are raised unnecessarily during Ramadan. Other local factors, including a cut in agricultural subsidies, higher fertilizer prices and cold winters, have contributed to increased food prices, but it is the following international factors that are the main reason for higher food prices:

• Shifting consumption patterns: Rising income levels in China and India have caused a major shift in global food consumption patterns. As people get wealthier their eating habits change. With a combined population of nearly 2.5 billion, the shifts occurring in China and India are having a big impact on global food prices. For example, higher Indian consumption is largely responsible for the sharp increase in rice prices in Saudi Arabia. 

• Use of crops for energy production: Production of crops for use as a feedstock for ethanol production (mainly corn, wheat and sugarcane) has reduced the area planted with food crops (particularly in the US) and sharply pushed up prices. 

• Poor growing conditions: The last few years have seen some unusually bad weather in key agricultural producers. Most significantly, Australia suffered its worst drought in at least a century in 2006; Europe and parts of North America have also experienced poor growing conditions in recent years. 

• Higher costs for imported goods: The jump in oil prices has added to transportation costs and the weakening of the riyal has also lifted prices for some imported food products. 

Although the impact of some of the above will fade (for example, through a normalization of weather conditions) conditions are in place for a period of above average food price inflation. As higher food prices are the result of international trends in commodity prices, there is little the government can do in response. 

Food prices have increased rapidly

The persistent rise in food prices has been the main, and generally the most visible, source of inflation in Saudi Arabia in recent years. Although rents are now rising faster than food prices, strong rental growth is largely confined to Riyadh and the costal cities of the Eastern Province. In contrast, food prices have risen markedly throughout the Kingdom. From 1983 to 2003, food prices increased by just 8.4 percent; since the start of 2004 they have surged by 16.8 percent. Rising food prices affect all households. As consumers tend to buy similar baskets of food on a regular basis, these price changes are very noticeable. Despite government controls on the prices of certain basic foodstuffs, such as bread, milk, flour, wheat and barley, it is likely that poor households are suffering the most from the price rises, because food accounts for a larger proportion of their total spending. 

Not all food prices have risen rapidly. The table above shows the main breakdown of food prices captured by the Central Department of Statistics in the Cost of Living Index. It shows that food price rises have been concentrated in certain areas; particularly, legumes and tubers (such as potatoes and carrots), eggs, fresh fruits and to a lesser extent, fish and crustaceans and meat and poultry.

Why have food prices risen?

Higher food prices in Saudi Arabia are mainly the result of rises in global commodity prices. These have pushed up food prices throughout the world. Food price inflation in the US hit a 26-year high of 5.9 percent in February and peaked at 6 percent in the UK in April and 18.2 percent in China in August. Some local factors have added to inflationary pressure, but their impact has not been great, as recent trends in food prices in Saudi Arabia are in line with those in other countries in the GCC. Latest data put food price inflation at 5.6 percent in Kuwait and the UAE; in Qatar it was 7.5 percent. 

International prices of many key foodstuffs have shot up in recent years. Since the start of 2004 the IMF.s food price index (which includes cereals, vegetable oils, meat, seafood, sugar, bananas and oranges) has jumped by 29 percent. Over the same period the beverage index (which includes coffee, tea and cocoa) was up by just over 40 percent. The following factors are behind the global rise in prices of agricultural commodities: 

Shifting consumption patterns: Rising income levels in China and India have caused a major shift in global food consumption patterns. As people get wealthier their eating habits change, with staple foods increasingly supplemented and replaced by those that provide a greater source of protein. Income per capita is rising at an annual rate of around 7 percent in India and nearly 10 percent in China, generating a surge in demand for meat, eggs and milk; beef and chicken consumption is currently increasing by 20 percent per year in China. With a combined population of nearly 2.5 billion (just over one-third of the world.s total) the shifts occurring in China and India are having as big an impact on global food prices as they are on other commodities (economic growth in these countries is one of the main factors behind the jump in the oil price over the last four years). 

A change in Indian consumption patterns is largely responsible for the sharp increase in rice prices in Saudi Arabia. Indian consumers have substituted basmati rice for cheaper and lower quality varieties as their incomes have risen, which combined with a slight decline in production and a broader international shortage (global rice stocks are at a 30-year low) has caused prices to jump. The chart to the right shows that the cost of basmati rice in India has climbed by over 30 percent since December. A 9 percent fall in the riyal against the Indian rupee over the same period has added to the price that Saudi consumers are paying (the bulk of basmati rice on sale in Saudi Arabia is imported from India). Concern over the availability of future supplies has pushed the price for deliveries of Indian basmati rice to the EU up by 90 percent this year. It is likely that Saudi importers are also paying a premium to secure supplies. 

Use of crops for energy production: High oil prices, environmental concerns and the US government�s quest for energy independence have encouraged the development of alternative sources of energy, one of which is ethanol. Ethanol is produced by the fermentation of crops including sugarcane, corn and wheat. Corn (maize) is the most efficient crop for making ethanol in the US and with government subsidies encouraging its production, the amount of corn planted for use as ethanol feedstock has tripled in the US since 2000. 

However, this is reducing the supply of corn available for other uses, causing the corn price in the US to nearly double over the past year and international corn prices to surge by over 50 percent in the two years to August 2007. This has had a clear effect on prices of goods as varied as tortillas in Mexico, pasta in Italy and beer in German, all of which have corn as an important input. Corn is also a major source of feed for livestock. Higher animal feedstock costs are raising costs for farmers and ultimately pushing up the price of meat and poultry and related products (such as eggs). In addition, in the drive to produce ethanol, farmers are cutting back their output of other crops, also causing shortages and raising prices. 

Poor growing conditions: Food production is vulnerable to weather conditions; when these are poor, output of crops declines and prices rise. The last few years have seen some unusually bad weather in key agricultural producers. Most significantly, Australia experienced its worst drought in at least a century in 2006, which more than halved its production of wheat and barley, contributing to a continuing global shortage. Europe and parts of North America have also experienced poor growing conditions in recent years affecting other foodstuffs such as carrots and potatoes. Even if production in Saudi Arabia�s main import markets is not directly affected by poor weather, strong demand from countries elsewhere in the world seeking to make up for weather-affected supplies will force up the price Saudi importers pay. Changes in global commodity prices are not the full story. Raw commodities (such as grains, fruit and meat) are the main input into most of the food products available in Saudi shops, but in many cases they account for little of the final price. Processing, packaging, marketing and distribution costs need to be added before the final products reach the consumers. There appears to have been little change in the first three of these areas, but two factors have pushed up the distribution costs of imported (though not locally produced) products: 

Rising transportation costs: Poor local growing conditions means that Saudi Arabia needs to import many food products, often from far away. Australia and New Zealand are the main sources of barley and cheese; most frozen beef and chicken comes from Brazil and apples from Chile. The jump in international oil prices (up 140 percent since the start of 2004) has significantly added to transportation costs and therefore the price charged for imported products. 

Exchange rate weakness: The rise in food prices has coincided with a period of US dollar weakness which, because of the exchange rate peg, has raised the riyal price of imported goods that are not priced in US dollars. The bulk of agricultural commodity trade is done in US dollars, but many of the final products available in the shops are priced in other currencies. The currencies of regional suppliers have stayed fairly constant against the riyal, but the euro has declined by 36 percent since the end of 2002 and the Australian dollar by 53 percent. Although we believe that retailers have so far absorbed much of the higher costs through reducing their profit margins, exchange rate weakness has contributed to rising food prices. The data is not available to isolate the impact of exchange rate weakness on food price inflation, but given the changes in international commodity prices, we do not think that it is a major factor. 

The following regional and local factors have combined to add to inflationary pressure on food prices in Saudi Arabia: 

Reduction of subsidies: Government support to farmers has been reduced as part of Saudi Arabia's deal to accede to the World Trade Organization. In 2005 subsidies on farm machinery and equipment and irrigation engines and pumps were cut, in some cases by a half. This raises costs for all Saudi producers and is therefore likely to have contributed to higher prices. Further subsidy cuts are planned. 

Higher input costs: In the first quarter of this year the fertilizer price was 14 percent higher than during the same period of 2006. According to local press reports, higher production costs caused Sabic to raise the price of fertilizer for local customers. 

Poor weather: Cold winters have reduced the supply of some locally produced fruit and vegetables. For example, onion production was down by almost 20 percent in 2006 and melon production fell by 10 percent. However, output of many other crops has increased. Monthly food price inflation Increase in food prices 

Shortage of agricultural workers: The demand for expatriate workers throughout the economy (particularly in construction) has drawn them away from the agricultural sector, raising local production costs. 

Bird flu: Concerns about bird flu have pushed up the price of fish and imported poultry. In response to a major outbreak of bird flu in Asia in 2004, the government banned the import of poultry from 42 countries, forcing suppliers to turn to more expensive sources. These bans were lifted in February of this year. In addition, worries about the health effects of eating chicken have hit demand for poultry throughout the region and led to greater consumption of seafood, an alternative source of white meat, which has pushed up the prices of fish and prawns despite rising local production. 

The role of retailers in the increase in food prices has received a lot of negative comment amid accusations that they have increased prices beyond the level justified by changes to their costs ( price gouging.). A look at the financial statements of companies with food retail operations that are listed on the stock exchange (Al Hokair, Al Marai, Assir, Savola and Thimar) does not show the consistent rise in net income that would be consistent with this. Indeed, competition from recently opened hypermarkets (such as Geant and Carrefour) has been one factor keeping prices under control in the main cities. 

Another indication of whether retailers are artificially inflating prices is whether the price consumers pay for final products (the retail price) is rising much faster than the price wholesalers pay. The chart to the right shows that the prices consumers pay rose faster than those paid by wholesalers until mid-2004, when the relation started to breakdown. Over the last three quarters, retail prices have risen by less than wholesale prices. We therefore do not believe that retailers are a major reason for the recent rises in food prices. 

Outlook for food prices

The period of above average growth in food prices is set to continue. Structural changes in the global economy and the way agricultural products are used will be the main forces pushing up global commodity prices. Local factors are expected to put further pressure on the prices paid by Saudi consumers. 

Around one-third of the world�s population are directly benefiting from what appears to be a sustainable economic boom in China and India. This will continue to lift standards of living and alter food consumption habits, raising demand and therefore prices for higher quality and more sophisticated foodstuffs. The requirement for feedstock for the many new ethanol plants currently under construction will further add to global food prices. 

A recent report from the Organization for Economic Cooperation and Development (OECD) and the United Nation�s Food and Agriculture Organization projects that agricultural prices will rise by between 20 and 50 percent over the next 10 year. Projections by the US Department of Agriculture also point to continued rises in prices of major crops until the end of the decade. Higher agricultural commodity prices will be passed on to the consumer in the form of higher prices for food products in the shops. 

In addition, the reduction of agricultural subsidies in Saudi Arabia in line with the Kingdom�s WTO commitments is likely to increase the cost of locally produced foodstuffs. Higher prices for locally produced goods will give a truer reflection of the cost of growing crops that are unsuited to the climate in Saudi Arabia. 

Local retailers have been criticized for their role in the increase in prices, but it appears that in recent months they have actually been holding prices down. It seems inevitable that the jump in wholesale price of food since the final quarter of last year will soon be passed on to consumers through higher consumer prices. Over the medium term we expect competition stemming from the spread of hypermarkets to be one of the factors restraining the growth in food prices, and inflation more broadly, across the Kingdom. 

Some factors behind the recent rise in food prices will fade. A normalization of weather conditions will boost output from areas suffering from drought. The impact of bird flu will be contained to the extent that it has little impact on broader food prices. Fuel prices are not expected to rise as rapidly as they have done in recent years, and the riyal is not expected to fall as fast. Over time, supply will catch up with demand and agricultural commodity prices will fall, but for the next few years food price inflation is expected to be above average. We forecast that food price inflation will average around 5 percent per year until 2010.

Policy options for the government

Higher food prices have hit consumers and generated pressure for government action. The main policy options are: 

• Tighter monitoring of wholesaler and retailer behavior: In the near term this may bring some success as is does appear that some prices are raised unnecessarily during Ramadan and that there is collusion between some wholesalers. Over the longer term, greater competition in both sectors would do a more effective job of keeping prices in check. 

• Extending price controls: This would prevent prices from rising. However, it would also deepen distortions within the economy, to the long-term detriment of economic performance. 

• Greater subsidies for local producers: This contravenes WTO rules and is therefore not an option. 

• Exchange rate adjustment: The weakening of the riyal is not a major part of the food price inflation story, so a revaluation would have little success in lowering food prices. A revaluation would also have many other negative effects on the economy. 

• Monetary policy adjustment: As rising food prices are the result of international factors, policies that could be used to combat broader inflation, such as raising interest rates, will not be effective. 

We believe that there is little that the government can do to counter rising food prices that would not have a detrimental impact elsewhere in the economy. 

Disclaimer of Liability 
Unless otherwise stated, all information contained in this document (the Publication.) shall not be reproduced, in whole or in part, without the specific written permission of Jadwa Investment. Jadwa Investment makes its best effort to ensure that the content in the Publication is accurate and up to date at all times. Jadwa Investment makes no warranty, representation or undertaking whether expressed or implied, nor does it assume any legal liability, whether direct or indirect, or responsibility for the accuracy, completeness, or usefulness of any information that contain in the Publication. It is not the intention of the Publication to be used or deemed as recommendation, option or advice for any action (s) that may take place in future. October 2007 

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October 2007 
For comments and queries please contact: 
Brad Bourland 
Chief Economist and Head of Research 
[email protected]  
Head office: 
Phone +966 1 279-1111 
Fax +966 1 279-1571 
P.O. Box 60677, Riyadh 11555 
Kingdom of Saudi Arabia 
http://www.jadwa.com   

Reprinted with permission of Jadwa Investment

Brad Bourland is head of research at Jadwa Investment, Riyadh.  From 1999 through 2007 Brad was the Chief Economist at Samba Financial Group, formerly Saudi American Bank, in Riyadh, where he published regularly on issues related to the Saudi and global economies and the world oil market. He appears frequently in the domestic and international media and is a regular public speaker. Before joining Samba, Brad spent an 18-year career as diplomat, economist, and manager with the U.S. Department of State. During the last three years of his diplomatic career he was in Riyadh as the American Embassy's First Secretary responsible for financial affairs, where he analyzed the Saudi economy for the U.S. Government and conducted financial aspects of US-Saudi relations. Brad has his BA and MA magna cum laude from the University of Utah, and is a CFA (Chartered Financial Analyst) charterholder.

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