High oil prices to boost GDP but widen deficits. Will lead to inflation

High oil prices to boost
GDP but widen deficits
Will lead to inflation
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Rising oil prices will indirectly boost economic growth said the Institute of International Finance (IIF) in a report released recently. It will also lead to a widening of the fiscal and current account deficits, and will increase inflationary pressures.

The ‘MENA Oil Importers-Impact of Higher Oil Prices’ report said that the rise in oil prices would lead to an increase in remittances and foreign direct investment from GCC countries. Lebanon would also benefit from an improvement in bilateral trade and more tourist arrivals from the Gulf region. These positive factors would improve economic growth and more than offset the dampening effect of higher oil prices on local private consumption.

According to Riad Salameh, Governor of the Central Bank, economic growth is forecasted at two percent this year, taking into consideration the stagnation in the real estate sector and the stability in the consumption component of the economy.

Growth in Lebanon, however, could be significantly decoupled from that in the GCC due to political developments, according to the report. Ongoing official travel warnings, which have resulted in a noticeable decline in tourism from the GCC, show that the historically high capital flows from that region must not be taken for granted, the IIF said.

Rising oil prices will raise the import bill and thus will widen the current account deficit, but the country will be unable to ease the impact through currency depreciation due to its fixed exchange rate, according to the report. IIF estimates show that if average oil prices rise this year by $18/barrel as expected, the country’s current account deficit will widen by 2.9 percentage points of GDP.

Higher oil prices are expected to worsen fiscal deficit especially because the State heavily subsidizes electricity rates. “Electricity tariff rates were last adjusted in 1996, based on an oil price of $21 per barrel. As a result, we expect government transfers to the loss-making electricity company EDL to increase from the equivalent of 2.5 percent of GDP in 2017 to 3.1 percent in 2018, leading to a wider fiscal deficit of about nine percent of GDP,” the IIF said in the report.
Subsidy cuts would shield budgets from oil price increases, but they are politically challenging, according to the report.

The rise in oil prices will have a significant impact on the inflation rate because the weight of items that directly reflect fuel prices in the Consumer Price Index’ basket is about 20 percent which is considered high.

According to Salameh, the inflation rate is expected to range between four and five percent in 2018. He said earlier this month that higher inflation along with political risks and global interest rate hikes, is contributing to the rise in interest rates.
Reported by Shikrallah Nakhoul
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Date Posted: Jul 27, 2018