Following a big jump in inflation in 2018 after the implementation of a 5 per cent value-added tax, some economists believe that the UAE economy will slip into deflation this year following a persistent decline in housing and fuel prices and an oversupply in the retail and hospitality sectors.
Monica Malik, chief economist at Abu Dhabi Commercial Bank, said the UAE consumer price index contracted by 2.4 per cent on a year-on-year basis in January from a 0.4 per cent rise in December.
"We had expected to see deflation from January as the impact of the introduction of VAT in 2018 dropped out of the annual data and with the fall in housing and fuel prices," she said.
The UAE levied 5 per cent VAT on a host of goods and services from January 1, 2018 as part of a GCC framework agreed among the Gulf nations, resulting in a spike in inflation in the first few months of the implementation.
"The January 2019 drop in prices was concentrated in certain major components of the inflation basket, driving the deflation. Notably, housing and utility prices contracted by 5.8 per cent on a year-on-year basis in January, reflecting the ongoing moderation in rental costs. Transportation prices fell 6.4 per cent year-on-year on the back of the plunge in the oil price at end-2018. Food prices also dropped by 1.1 per cent year-on-year in January, likely reflecting VAT falling out of the data," Malik said in the latest note.
Deflation occurs when the inflation rate falls below 0 per cent - a negative inflation rate. Inflation reduces the value of a currency over time, but deflation increases it.
Garbis Iradian, chief economist for Middle East and North Africa at the Institute of International Finance, expects average CPI inflation for the UAE to be around 0.5 per cent in 2019 compared with 3.1 per cent in 2018.
"However, it is likely that some of the months this year will show a small negative year-on-year inflation due to base effect following the introduction of the VAT in early 2018 and the rise in domestic fuel prices in 2018," he said.
Iradian attributed the continued decline in rents or housing, a fall in transportation or utilities cost due to the decline in domestic fuel prices, a relatively weak domestic demand and the depreciation of the euro and the Chinese yuan with respect to the US dollar, which made UAE imports from the eurozone and China cheaper as main reasons for relatively low inflation or the possibility of small deflation this year.
"Note that the average inflation for this year could be small negative if economic activity remains weak, say if non-oil growth fails to exceed 2 per cent. My forecast, however, is that real non-oil GDP growth will accelerate from 2.9 per cent in 2018 to 3.5 per cent in 2019," he added.
The International Monetary Fund has forecasted a massive drop in the CPI inflation to 1.9 per cent this year from 3.5 per cent in 2018.
Malik noted that both Abu Dhabi and Dubai saw deflation on at 0.9 per cent and 3.6 per cent, respectively, on a year-on-year basis.
"The deeper contraction in Dubai reflects the greater fall in housing prices and the larger weighting of this component in the inflation basket. We expect to see rental prices continuing to fall throughout 2019 in Abu Dhabi and Dubai as supply growth continues to outstrip demand growth, particularly in Dubai," she said in the note. "Regarding transportation costs, we forecast a lower annual average crude oil price for 2019 than in 2018, which should be reflected in domestic fuel prices. However, some months could see positive year-on-year growth in 2019, potentially March."
Malik doesn't see any meaningful strengthening in household spending as the deflation partly reflects structural challenges to the economy - namely, the oversupply in housing - despite the rise in purchasing power. This, along with other macro headwinds - such as oversupply in other key sectors such as hospitality and retail, the strong dirham, lackluster external demand, etc - is continuing to result in a weak labour market, including job uncertainty and soft wage growth.
"Moreover, the expected deflation backdrop will also likely contribute to the outlook for limited wage growth."
Anita Yadav, senior director and head of fixed income research at Emirates NBD, says inflation in the UAE is expected to fall below 2 per cent in the current year as job growth remains muted. Also strength of the dirham against its major trading partners will keep imported inflation low.
"We do not expect deflation in the UAE over the forecast period. That said, the decline in inflation going forward is likely to come mainly from falling housing costs and low energy and food prices. Also, last year's inflation was impacted by introduction of VAT which will drop off in the current year-on-year calculations," said Yadav.
By Waheed Abbas
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