infrastructure investment and assets price bubble in saudi arabia, a study of inflation

81 Pages·2017·0.97 MB·English

by  Ibrahim M. Balilah

INFRASTRUCTURE INVESTMENT AND ASSETS PRICE BUBBLE IN SAUDI
ARABIA, A STUDY OF INFLATION

A Thesis
Presented to the
Faculty of
California State Polytechnic University, Pomona

In Partial Fulfillment
Of the Requirements for the Degree
Master of Science
In
Economics

By
Ibrahim Balilah
2017
SIGNATURE PAGE

THESIS: INFRASTRUCTURE INVESTMENT
AND ASSETS PRICE BUBBLE IN
SAUDI ARABIA, A STUDY OF
INFLATION

AUTHOR: Ibrahim M. Balilah

DATE SUBMITTED: Winter 2017

Economic Department

Dr. Carsten Lange
Thesis Committee Chair
Economic Department

Dr. Mohammad Safarzadeh
Economic Department

Dr. Bruce Brown
Economic Department

i i
ABSTRACT

The paper analyzed two different economic topics for Saudi Arabia: the effect of
infrastructure investment on inflation and the assets price inflation. Despite the vast
amount of studies on inflation determinates in the Kingdom, very few studies analyzed
the effect of infrastructure investment on inflation. I am replicating a study by Robert
Looney in 1990, using ordinary least square regression model and data for the period
1980 to 2015, this research studies the effect of infrastructure investment on inflation.
The results of the regression indicate that infrastructure investment has no significant
impact on inflation for the period. Moreover, this is the first paper to analyze the Saudi
real estate data provided by Saudi Ministry of Justice to examine current market trends.
Additionally, this study connects data to market bubbles theory to conclude that Saudi
lands market is experiencing a market bubble, reaching a peak in 2015. Furthermore, the
paper provides a complete overview of the current Saudi housing crisis, its causes, and
the current government policies. Lastly, I am presenting some key solutions to policy
makers in the kingdom to ease the housing shortage.

ii i
TABLE OF CONTENTS
SIGNATURE PAGE ......................................................................................................... ii
ABSTRACT ...................................................................................................................... iii
LIST OF TABLES ........................................................................................................... vi
LIST OF FIGURES ........................................................................................................ vii
1. INTRODUCTION ........................................................................................................ 1
2. INFRASTRUCTURE INVESTMENT AND INFLATION ...................................... 4
2.1 Theory Overview .................................................................................................... 4
2.2 Determinates of Inflation in Saudi Arabia ........................................................... 6
2.3 Empirical Studies .................................................................................................... 8
2.4 The Empirical Framework .................................................................................. 13
2.4.1 Data .................................................................................................................. 13
2.4.2 Methodology .................................................................................................... 15
2.4.3 Empirical Results ............................................................................................. 15
2.4.4 Diagnostic Testing ........................................................................................... 20
2.5 Results Interpretation .......................................................................................... 23
3. ASSETS PRICE INFLATION .................................................................................. 25
3.1 Introduction ........................................................................................................... 25
3.2 The Bubble Theories in the Literature ............................................................... 25
3.3 Highlight of Saudi Real Estate Market and Housing Shortage ........................ 27
3.4 Housing Rent Inflation ......................................................................................... 29
3.5 MOJ Data .............................................................................................................. 30
iv
3.5.1 Trend in Average Prices ................................................................................... 32
3.5.2 Analysis ............................................................................................................ 38
3.5.3 Transaction Volume and Average Size of Transaction ................................... 41
3.6 Current Government Policies .............................................................................. 43
3.6.1 Macro Prudential Policy .................................................................................. 43
3.6.2 White Land Tax ............................................................................................... 43
3.7 Bubble Burst, Future Market Trends, and Opportunity Cost ......................... 46
3.8 Trends in Residential Buildings, Villas, and Apartments for all cities ............ 47
3.9 Reasons for the Decline of Asset Prices in Saudi Arabia .................................. 51
3.10 The Importance of Housing ............................................................................... 52
3.11 Government Initiative for Housing Solutions .................................................. 53
3.12 Suggested Solutions ............................................................................................ 56
4. SUMMARY ................................................................................................................. 63
REFRENCES .................................................................................................................. 67
DATA SOURCES ........................................................................................................... 73
v
LIST OF TABLES
Table 1. Augmented Dickey-Fuller Unit Root Test.......................................................... 16
Table 2. First Regression Results...................................................................................... 17
Table 3. Regression Results After Removing Serial Correlation Ar(1) ........................... 18
Table 4. Augmented Dickey-Fuller Unit Root Test for Residual of the Regression ........ 18
Table 5. Final Regression Results ..................................................................................... 19
Table 6. Correlation Table ................................................................................................ 20
Table 7. VIF Test .............................................................................................................. 21
Table 8. BPG Test for Heteroscedasticity ......................................................................... 22
Table 9. Ramsey Rest Test................................................................................................ 23
Table 10. Percentage Change in Average Price and Square Meter for Riyadh. 2011 –
2016................................................................................................................................... 38
Table 11. Percentage Change in Average Price and Square Meter for Jeddah. 2011 – 2016
........................................................................................................................................... 39
Table 12. Percentage Change in Average Price and Square Meter for Dammam. 2011 –
2016................................................................................................................................... 40
Table 13. Percentage Change in Weighted Average Price and Square Meter for Riyadh,
Jeddah, and Dammam. 2011 – 2016 ................................................................................. 41
Table 14. Number and Distribution of applications received by MOH to comply with
WLT Regulations – Stage one (MOH, 2016) ................................................................... 45
Table 15. Percentage Change in Weighted Average Prices of Square Meter for Buildings,
Villas, and Apartments in Riyadh, Jeddah, and Dammam ............................................... 50

v i
LIST OF FIGURES
Figure 1. Government capital spending 1970 – 2015 ......................................................... 9
Figure 2. Residual graph ................................................................................................... 22
Figure 3. Housing, water, electricity, and gas plotted with CPI general index. 2007 - 2015
........................................................................................................................................... 29
Figure 4. Riyadh average transaction value in US dollars. 2010 M1 - 2016 M12 ........... 34
Figure 5. Riyadh average square meter prices in US dollars. 2010 M1 - 2016 M12 ....... 34
Figure 6. Jeddah average transaction value in US dollars. 2010 M1 - 2016 M12 ............ 35
Figure 7. Jeddah average square meter prices in US dollars. 2010 M1 - 2016 M12 ........ 35
Figure 8. Dammam average transaction value in US dollars. 2010 M1 - 2016 M12 ....... 36
Figure 9. Dammam average square meter in US dollars. 2010 M1 - 2016 M12 .............. 36
Figure 10. Weighted average transaction prices for all three cities in US dollars. ........... 37
Figure 11. Weighted average square meter prices for the three cities in US dollars. ....... 37
Figure 12. Aggregate sum of residential lands transactions volume for Riyadh, Jeddah,
and Dammam. 2011 – 2016. ............................................................................................. 42
Figure 13. Average size of residential transactions for Riyadh, Jeddah, and Dammam.
2010 – 2016....................................................................................................................... 42
Figure 14. Percentage of eligible lands size, arranged by city, as reported by WLT ....... 45
Figure 15. Average price per square meter for Jeddah, buildings, villas, and apartments in
US dollars.......................................................................................................................... 48
Figure 16. Average price per square meter for Riyadh, buildings, villas, and apartments in
US dollars.......................................................................................................................... 48
Figure 17. Average price of square meter in Dammam, buildings, villas, and apartments
in US dollars. .................................................................................................................... 49
vi i
Figure 18. Weighted average price of square meter in Riyadh, Jeddah, and Dammam for
buildings, villas, and apartments in US dollars................................................................. 50

vi ii
1. INTRODUCTION

Before 2003, Saudi Arabia was successful at keeping inflation very low and in a
sustainable rate. However, after 2003, inflation kept rising and remained relatively high
up to 2016. For example, in 2008, Saudi Arabia’s inflation rate reached 11%, the highest
in the decade. Therefore, inflation today is an important subject especially in times of low
oil prices and growing government budget deficit. Inflation, as defined in the literature, is
the continuous increase of the price level of goods and services, and inflation rate will be
represented in my paper by the annual change in the Consumer Price Index (CPI)
published by Saudi Arabia Monetary Agency (SAMA) (Mishkin, 2004, p. 635). In other
words, inflation is the annual change of CPI from its own value in the past year.
Despite the vast amount of studies on inflation determinates in the Kingdom, very
few studies have analyzed the effect of infrastructure investment on inflation. Therefore,
this paper will replicate a study by Robert Looney in 1990, using the ordinary least
square regression model and data for the period 1980 to 2015, this research studies the
effect of infrastructure investment on inflation.
Moreover, recently, Saudi Arabia has witnessed a great increase of assets price
inflation, particularly in land prices, that is also an increasingly important issue as it is
causing a housing shortage. This housing shortage is driving the Saudi CPI upward,
through the great increase of housing rents, which is a major component of the Saudi
CPI. Therefore, we will analyze the Saudi real estate data provided by the Saudi Ministry
of Justice (MOJ) to examine the price trends in lands, buildings, villas, and apartments.

1
Moreover, an assets bubble is defined in the literature as an increase in land
values in a rate higher than the rate of market fundamentals (Schurle et al., 2012, p. 136).
The trends in MOJ data, suggests that the Saudi lands market has witnessed a market
bubble that deflated in 2015. Therefore, this paper connects the data to economics bubble
theory. Finally, a large part of this paper will be dedicated to highlight the housing
shortage, examine the causes of the shortage, government policies, and suggests
solutions.
Therefore, the structure of this paper will be as the following: The first chapter is
an introduction that will provide a background on Saudi Arabia’s economy and policy
structure. The second chapter is a literature overview of inflation theory and it will
provide studies about inflation determinates for Saudi Arabia. Additionally, chapter two
will provide empirical evidence of infrastructure investment and its effect on inflation.
The third chapter will study the asset price inflation and housing shortage of Saudi
Arabia, through analyzing real estate data and examining the trend in lands market.
Finally, the fourth chapter is just a summary of the main points of the paper.
Highlights of the Saudi Economy
According to the International Monetary Fund (IMF) report (2016), the two main
key features of the Saudi Arabian economy are its dependence on oil and the pegged
exchange rate to the US dollar. Oil revenue accounts for 90% of the government fiscal
revenues and 85% of its exports revenue. Further, the oil sector accounts for over 40% of
the overall GDP of the country. Nevertheless, even the activity of the non-oil sector is
greatly correlated with oil prices through government spending channels (IMF, 2015, p.
2