Download Inflation Report - Palestine Monetary Authority

‫ الربــــــــع األول‬- ‫تقــــريـــر التــضخم‬
2014
Inflation Report - First Quarter
‫تقري�ر التضخم‬
2014 ‫الربع األول‬
‫العدد العاشر‬
www.pma.ps
Inflation Report
First Quarter 2014
Volume 10
www.pma.ps
Inflation Report
First Quarter 2014
Volume 10
Research & Monetary Policy Department
May 2014
Copyright © PMA, May, 2014
All Rights Reserved.
Suggested Citation:
Palestine Monetary Authority (PMA),
2014. Inflation Report: First Quarter
2014.
Ramallah – Palestine
All Correspondence should be
directed to:
Palestine Monetary Authority (PMA)
P. O. Box 452, Ramallah, Palestine.
Tel.: (+ 970) 2-2409920
Fax: (+ 970) 2-2409922
E-mail: [email protected]
www.pma.ps
Executive Summary
‫ا‬Inflation rate in Palestine reached 2.2 percent in the first quarter of 2014 compared with
the first quarter of 2013, and 0.6 percent compared with the fourth quarter of 2013. Inflation rate came higher than the rate registered in the previous quarter (2.0 percent) and in
the corresponding quarter of 2013 (1.7 percent). This rate is much lower than the rate registered in the MENA region (around 13.0 percent), but higher than in Israel (1.3 percent). The
analysis revealed that inflation in Palestine is largely imported and shows high sensitivity
to world prices, particularly for food and fuel.
The approach followed in this report for inflation analysis and forecasting purposes depends on two variables:(i) cost of imports, taking into account the inflation and exchange
rates of Palestine’s main trading partners, among which Israel accounts for the highest
portion (90 percent of exports and 70 percent of imports) of Palestine’s trade, and (ii)
world food prices, as food has the highest weight in the Palestinian consumer basket.
Inflation forecasts show that consumer prices in Palestine are expected to increase on average by around 2.5 percent during the second quarter of 2014, and by 2.2 percent for the
whole year. Forecasts depend on assumptions concerning the most likely future paths for
(i) prices and exchange rates in Palestine’s most important trading partners, and (ii) prices
in the international food markets, as predicted by key international organizations such as
the IMF and foreign central banks.
Given that Palestine’s inflation may deviate from the baseline scenario due to deviations
in foreign prices and exchange rates, the forecast is supplemented with a risk analysis. Beside the baseline, the forecast takes into account four alternative scenarios based on positive and negative one-standard deviation shocks in Palestine’s cost of imports and world
food prices. The expected effects on Palestine’s alternative inflation outcomes show that
a positive one-standard deviation shock in external conditions may increase Palestine’s
inflation to nearly 3.3 percent, on average, during 2014. While a negative one-standard deviation shock may bring Palestine’s inflation down to 1.2 percent during the same period.
As for the financial developments in Palestine, 2013Q4 data indicate that the lending interest rate on JD and USD has decreased compared to the previous quarter, while it increased
for NIS during the same period. Looking at the deposit rate, while it increased on USD and
NIS, it decreased slightly on JD. In addition, the margin between lending and deposit rates
in Palestine is relatively higher than in the issuing countries of the respective currencies.
Palestinian stock market performance witnessed an eye-catching performance during the
2014Q1; Al-Quds index gained about 15.9 percent in 2014Q1 compared with corresponding
quarter of 2013, reaching 548.4 points. Also, the performance of stock markets of some
selected Arab countries have improved during 2014Q1 compared with 2013Q4.
iii
Contents
Executive Summary
iii
I. Recent Economic Developments
1
Real GDP
1
Inflation and Prices
3
Aggregate demand
9
Labor force and wages
10
Exchange rates
11
II. Recent Financial Developments
11
Interest Rates
12
Stock market
15
III. Model Based Inflation Forecast
17
Inflation model and estimation technique
17
Baseline inflation forecast
19
IV. The Balance of Inflation Risk
21
I. Recent Economic Developments
Real GDP
The global economy is in the process of recovery since mid-last year, supported, mainly, by the recovery of advanced countries (AC). Fiscal consolidation is slowing and investors are less worried about debt sustainability. On the other hand, the financial
system worldwide is getting stronger.
The global economy grew by around 3.3 percent during 2013Q4 compared with 3.5
percent in the previous quarter and 2.2 percent in the corresponding quarter of 2012.
IMF expects the global economy to grow by around 3.6 percent and 3.9 percent in 2014
and 2015 respectively.
AC grew by 2.0 percent in 2013Q4 compared with 1.3 percent in the previous quarter
and 0.6 percent in the corresponding quarter of 2012. AC are expected to grow by 2.2
percent and 2.3 percent in 2014 and 2015 respectively according to the latest IMF World
Economic Outlook (WEO)[1].
The United States (US) economy is continuing its good performance since the beginning of 2013. In 2013Q4, US real GDP grew by 2.6 percent compared with around 2.0
percent in 2013Q3 and 2012Q4. The main reasons behind this performance are the increase in domestic demand, inventory accumulation, and strong export growth. IMF
expects US economy to grow by 2.8 percent in 2014 and 3.0 percent in 2015.
The EA’s real GDP growth, finally, achieved positive rates, after a long-standing decline
(the EA economy was declining since the beginning of 2012), due to exports improvement. During 2013Q4, the EA economy grew by 0.5 percent, compared with a decline
of 0.3 percent in 2013Q3 and 1.0 percent in 2012Q4. The EA economy is expected to
grow by 1.2 percent and 1.5 percent in 2014 and 2015 respectively, according to the IMF.
[1] IMF, World Economic Outlook, April 2014.
Inflation Report - First Quarter, 2014
1
The Japanese economy grew by 2.5 percent in 2013Q4 compared with 2.4 percent in
the previous quarter and -0.3 percent in the corresponding quarter of 2012. IMF expects the Japanese economy to grow by 1.4 percent and 1.0 percent in 2014 and 2015
respectively.
Although exports to AC increased, the EDC economies slowed down slightly during
the 2013Q4. EDC grew by 4.8 percent in 2013Q4 compared with around 4.9 percent and
5.0 percent in the previous and corresponding quarters, respectively. EDC are expected to grow by 4.9 percent and 5.3 percent in 2014 and 2015 respectively.
The Chinese economy grew by 7.7 percent in 2013Q4 compared with 7.8 percent in
2013Q3 and 7.9 percent in 2012Q4. IMF states that the Chinese economy is expected
to continue slowing down to 7.5 percent and 7.3 percent in 2014 and 2015 respectively.
Middle East and North Africa (MENA) region still suffers
from several political and
economic problems. Many
countries like Iraq, Syria,
Egypt, Libya, and Tunisia suffer from political instability
that affects their economic
performance. MENA economies grew by 2.2 percent in
2013 and expected to grow by
higher rates during 2014 and
2015 (3.2 percent in 2014 and
4.5 percent in 2015) according
to the IMF.
Figure 1: y-o-y real GDP growth rates in the World
and Palestine
Source: IFS, WEO, and PCBS.
Looking at the region, the Israeli economy grew in 2013Q4 by 2.8 percent compared
with 2.4 percent in 2013Q3 and 3.1 percent in the corresponding quarter of 2012. The
Israeli economy is expected to grow by 3.2 percent and 3.4 percent in 2014 and 2015
respectively according to the IMF.
In Jordan, despite the regional conditions of the Syrian crisis and its aftermath, the
Jordanian economy has continued to recover as real GDP growth rate reached 4.5
percent in 2013Q4 compared with 2.8 percent in 2013Q3 and 2.2 percent in the corresponding quarter of 2012. The Jordanian economy is expected to grow by 3.5 percent
and 4.0 percent in 2014 and 2015 respectively according to the IMF.
2
Palestine Monetary Authority (PMA)
The Palestinian economy
Figure 2: y-o-y real GDP growth rates in Palestine,
slowed down in 2013Q4; on
Jordan, and Israel
y-o-y basis, real GDP grew by
2.1 percent compared with
a growth rate of 2.6 percent
in in 2013Q3. This slowdown
came as a result of two different growth paths in the WB
and GS. WB’s real GDP grew
by 0.4 percent in 2013Q4 compared with a growth of 2.5
percent in 2013Q3, as a result
of a slowing of most of its eco- Source: IFS, WEO, PCBS, and the Central Bank of Jordan.
nomic activities. On the other hand, GS’s real GDP grew by 7.4 percent in 2013Q4 compared with 2.8 percent in
2013Q3, due to an increase in construction, internal trade, and public administration
and defense activities.
Inflation and Prices
Global inflation rate continued to decline in the first
quarter of 2014, mainly because of the continued weak
global demand especially in
the EA. Figure (3) shows that
the global inflation rate in
2014Q1 declined to 2.8 percent, compared with the
previous and corresponding
quarter of 2013.
Figure 3: Average y-o-y inflation rates in Palestine
and other World regions
Inflation rate in AC stabilized Sources: IFS and PCBS.
at 1.2 percent compared with
2013Q4, but declined compared with 2013Q1 (1.4 percent). Although inflation increased
in the US, it declined in the EA compared with the previous quarter. Inflation in the US
increased to 1.4 percent in 2014Q1 compared with 1.2 in 2013Q4. While in the EA, it continued to fall below the target (2 percent) since the end of 2010, reaching 0.6 percent.
Inflation Report - First Quarter, 2014
3
In EDC, inflation declined from around 6.0 percent in 2013Q4 to 5.1 percent in 2014Q1,
which also declined compared with 2013Q1. MENA region suffers from high inflation
rates, which are considered among the highest in the world. Inflation is expected to
reach around 13.0 percent during 2014Q1 compared with 14.0 percent in 2013Q4 and
16.0 percent in 2013Q1.
Figure (4) compares the average annual inflation rate in
Palestine with the neighboring countries (Jordan, Egypt,
and Israel). As shown in the
figure, the movement of inflation in Palestine is highly
consistent with the rates in
Israel and to a lower degree
with Jordan and Egypt. In
2014Q1, Palestine’s y-o-y inflation increased to 2.2 percent
compared with 2.0 percent in
the previous quarter and 1.7
percent in the corresponding
quarter of 2013.
Figure 4: Average y-o-y inflation rates in Palestine,
Jordan, Egypt, and Israel
Sources: IFS and PCBS.
In Jordan, inflation continued declining since the beginning of 2013. In 2014Q1, it
reached 3.2 percent compared with 3.6 percent in 2013Q4 and 7.4 percent in 2013Q1.
In Israel, inflation declined to 1.3 percent in 2014Q1 compared with 1.9 percent in
2013Q4 and 1.4 percent in 2013Q1. The rate is within the target level set by Bank of
Israel, which is between 1 percent and 3 percent.
The change in global, regional, and local inflation rates is mainly due to the change
in commodity prices worldwide. Figure (5) shows that WOP declined in 2014Q1 by 0.8
percent compared with the previous quarter and declined by 1.5 percent compared
with the respective quarter of 2013. This decline came as a result of the decline in the
demand for oil worldwide.
4
Palestine Monetary Authority (PMA)
WFP increased in 2014Q1 by
3.7 percent compared with the
previous quarter, but declined
by 2.5 percent compared the
respective quarter of 2013.
This increase came as a result
of the bad weather in main
food exporting countries like
USA, which negatively affected the world supply of food.
Figure 5: Indices of primary commodity prices,
2005=100
WMP declined in 2014Q1 by
4.2 percent compared with
Source: IFS.
the previous quarter, and by
14.2 percent compared with 2013Q1.
As for q-o-q inflation rate, Palestine experienced a decline in inflation to 0.6 percent in
2014Q1 compared with 1.0 percent in 2013Q4, as a result of the increase in prices in GS
and Jerusalem by 3.2 percent and 2.7 percent respectively, while prices in WB declined
by 0.4 percent.
In general, the volatility of
q-o-q inflation rate in Palestine tended to decline after
2008. As shown in figure (6),
the inflation in 2014Q1 is lower than its mean, which is
slightly less than 0.9 percent
since 2008Q1.
Figure 6: q-o-q inflation rate in Palestine
Comparing CPI in Palestine
with the CPI in Israel and
Jordan, table (1) shows that
m-o-m average and standard Source: PCBS.
deviation of inflation in Palestine is less than Jordan, but higher than in Israel.
Among CPI categories, alcoholic beverages and tobacco prices continue to have the
highest inflation since 2012Q3. During 2014Q1, this category’s prices increased by 13.0
Inflation Report - First Quarter, 2014
5
percent compared with 2013Q1. Table 1: m-o-m average inflation rate and standard
Medical care prices come in the
deviation in Palestine, Israel, and Jordan
(January 2005 – March 2014)
second place with an increase
Standard
of 9.0 percent, then restaurants
)%( Average
Deviation
and cafes prices with 5.4 perPalestine
0.61
0.29
cent. Education, housing, and
Israel
0.44
0.19
food and soft drinks prices inJordan
0.98
0.44
creased by 5.1 percent, 4.6 percent, and 1.3 percent respectively during the same period. On the other hand, prices of
transportation, cultural goods and services, furniture, communications, and textiles
declined by 3.7 percent, 2.6 percent, 2.2 percent, 1.9 percent, and 1.5 percent in 2014Q1
compared with the respective quarter of 2013.
Figure 7: Web chart of the CPI components
Figure (7) shows the contricontribution to the y-o-y inflation rate in Palestine
bution of the different broad
CPI components to the y-o-y
inflation in the first quarter of
2014 compared with 2013Q1.
The web chart indicates that
alcoholic beverages and tobacco prices made the highest
contribution to inflation rate,
while transportation prices
recorded the lowest contribution. The contribution of alcoholic beverages and tobacco
prices to the y-o-y inflation
reached 0.7 percent during
2014Q1 compared with 0.5 Source: PCBS.
percent during 2013Q1. Whereas the contribution of transportation prices reached
-0.5 percent during 2014Q1 compared with 0.1 percent during 2013Q1.
Also the contribution of food and soft drinks, housing, medical care, education,
restaurants, and miscellaneous goods and services prices to inflation increased between 2013Q1 and 2014Q1. The contribution of the remaining categories declined
during the comparison period.
6
Palestine Monetary Authority (PMA)
In general, commodity prices in Palestine are much higher than the world levels. If we
look closer at prices, we find that the retail price of gasoline in Palestine is among the
highest in the world. One liter costs 7.4 NIS (≈USD 2.1), which is more than double the
world average price, USD 1.0 during 2014Q1.
It is worthwhile to mention
Figure 8: Gasoline prices in USD per liter
that there is a high correlations between fuels prices in
Palestine and worldwide. But
in spite of that, it seems that
gasoline prices in Palestine in
2014Q1 increased by 0.6 percent compared with the previous quarter, and by 4.2 percent compared with 2013Q1,
whereas the average world
price of gasoline declined by Source: PCBS, IFS, and http://www.nationmaster.com .
0.8 percent, and 1.3 percent
during the previous and corresponding quarters. This countercyclical behavior is
mainly due to the exchange rate effect (gasoline prices in NIS declined in 2014Q1 compared with 2013Q1).
The case is the same with
some other commodity prices, such as wheat, rice, and
sugar. The prices of these
commodities in Palestine are
higher than the world prices.
During 2014Q1, wheat prices
in Palestine were around 2.4
times the world prices, rice
prices were around 2.8 times
the world prices, while sugar
prices were around 1.3 times
the world prices.
Figure 9: Wheat prices in USD per Kg
Source: PCBS and IFS.
Inflation Report - First Quarter, 2014
7
Also the prices of some
non-imported commodities
(such as fresh, chicken and
beef meat) which are not sensitive to the world prices are
still much higher than world
prices, due to the high costs
of production. Fresh chicken
meat prices in Palestine were
around 2.1 times the world
price and beef meat prices
were more than 3.2 times the
world prices during 2014Q1.
Figure 10: Fresh beef meat prices in USD per Kg
Source: PCBS and IFS.
The following table shows average prices of selected commodities in Palestine.
Table 2: Prices of selected commodities in Palestine NIS per unit[2]
2013
2014
Q1
Q2
Q3
Q4
Q1
Wheat
157.2
156.7
155.5
153.6
149.6
Bread
3.9
3.8
3.8
3.8
3.8
Rice
106.3
104.5
103.8
103.5
109.6
Beef meat
50.8
50.7
50.5
50.1
47.7
Chicken meat
16.5
17.9
18.3
16.0
16.7
Powder Milk (Nido)
94.5
94.7
94.8
95.5
95.3
Yogurt (local)
5.0
4.8
4.8
4.8
4.8
Chicken Eggs
17.8
16.6
16.6
17.4
17.8
Tomatoes
2.9
2.3
2.2
3.8
3.1
Sugar
181.4
176.1
174.2
172.8
141.2
Gas
70.9
66.5
64.1
68.7
73.0
Diesel
6.7
6.1
6.3
6.4
6.7
Gasoline 95
7.5
6.9
7.1
7.0
7.4
Source: PCBS.
[2] Unit for Wheat: 60 Kg sack; Bread: 1 Kg; Rice: 25 Kg sack; Chicken and Beef meet: 1 Kg, Powder Milk: 2.5 Kg can;
Yogurt: 500 g can; 2 Kg box; Tomatoes: 1 Kg; Sugar: 50 Kg sack; Gas: 12 Kg cylinder, Diesel and Gasoline: 1 Liter.
8
Palestine Monetary Authority (PMA)
Aggregate demand
Data related to the aggregate demand in Palestine (table 3) shows that real GDP
reached USD 1770.2 million in 2013Q4, increasing by 2.1 percent compared with 2012Q4
and by 1.0 percent compared with 2013Q3. The y-o-y increase in real GDP is mainly
attributed to the increase in private consumption and exports.
Analyzing aggregate domestic demand shows that private consumption increased
by 4.1 percent in 2013Q4 compared with the respective quarter of 2012, and increased
by around 1.0 percent compared with the previous quarter. While on the other hand,
public consumption declined by 9.8 percent in 2013Q4 compared with 2012Q4 and by
10.4 percent compared with 2013Q3.
Table 3: Aggregate demand at constant prices (2004=100)
(USD million)
2012
2013
Q4
Q1
1,627.0
1,574.7
1,700.0
1,678.1
1694.4
Government expenditures
535.0
485.7
525.0
538.7
482.5
Investment
279.7
231.2
262.2
239.1
260.3
Exports
284.2
316.2
339.2
314.4
357.3
Imports
992.7
963.0
1,051.0
1,018.0
1024.3
1,733.2
1,644.8
1,775.4
1,752.3
1770.2
Private consumption
GDP
Q2
Q3
Q4
Source: PCBS.
Also, investment declined by 6.9 percent compared with 2012Q4, but increased by 8.9
percent compared with the previous quarter.
As for the external demand, exports jumped by 25.7 percent in 2013Q4 compared with
2012Q4 and by 13.6 percent compared with 2013Q3. While imports increased by 3.2
percent in 2013Q4 compared with 2012Q4 and by 0.6 percent compared with 2013Q3.
Inflation Report - First Quarter, 2014
9
Labor force and wages
In 2014Q1 the participation rate in labor force in Palestine increased to 46.3 percent of
total number of persons aged 15 years and over[3] compared with 43.4 percent in the
respective quarter of 2013 and 44.5 percent in the previous quarter.
Unemployment rate increased to 26.2 percent in 2014Q1 compared with 25.2 percent in the previous quarter,
Figure 11: Labor force main indicators in Palestine
and 23.9 percent in in 2013Q1.
Looking at the geographical
pattern of unemployment,
the WB shows much lower
rates than GS, i.e., 18.2 percent in the WB, compared to
40.8 percent in GS in 2014Q1.
It is worth mentioning that
unemployment in the WB did
not change compared with
the previous quarter, while in
GS it increased (38.5 percent Source: PCBS.
in 2013Q4).
Average daily wages in Palestine declined in 2014Q1 compared with previous quarter,
to reach NIS 99.3[4] compared with NIS 100.3 in 2013Q4. Comparing the ADW based on
work location, a big gap shows between those who work in Palestine and those who
work in Israel and settlements. ADW for those who work in Palestine reached NIS 81.1
(NIS 90.2 in WB and NIS 61.7 in GS) versus NIS 182.6 for those who work in Israel and
settlements[5].
[3] The total number of persons aged 15 years and over in Palestine reached to 2,707,500 in 2014Q1, compared with
2,684,300 persons in 2013Q4.
[4] It also includes the ADW of the Palestinian workers in Israel and settlements.
[5] An analytical study was conducted to explore the relation between aggregate demand, unemployment, and
wages on the one hand and inflation on the other hand. The results showed no statistically significant relationship
between these variables and inflation in Palestine. These results prove that the inflation in Palestine is imported and
influenced by external factors more than by internal conditions.
10
Palestine Monetary Authority (PMA)
Exchange rates
Figure (12) shows the nominal and real effective exchange rates (NEER and REER) in
Palestine[6]. The discrepancy between NEER and REER indicates that changes in inflation in Palestine relative to its trading partners contributed to the appreciation of the
real exchange rate during this
Figure 12: Effective exchange rates and CPI in
period. While the appreciaPalestine, 2005=100
tion of the NEER indicates that
the NIS appreciated against
Palestine trading partners’
currencies, and the appreciation of the REER indicates that
Palestine lost competitiveness
against its trading partners[7].
It is worth mentioning that
Palestinian foreign trade is
substantially affected by the
Israeli measures and obstaSource: PMA and PCBS.
cles.
Data show that the NEER increased by 2.2 percent in 2014Q1, compared with 2013Q1
which indicates that the NIS depreciated against Palestine trading partners’ currencies. The REER, also, increased by 2.7 percent in 2014Q1, compared with the 2013Q1,
which indicates that Palestine lost some competitiveness against its trading partners.
On the other hand, cost of imports declined by 0.5 percent during the same period,
which will contribute to slowing down the inflation rate in Palestine.
II. Recent Financial Developments
This section focuses on interest rate developments in Palestine during the fourth
quarter of 2013, and the main developments in the Palestinian financial market, compared with those in the regional markets during the first quarter of 2013.
[6] The NEER provides a weighted average of a country’s nominal bilateral exchange rates, indexed on a chosen base
year; The REER corrects the NEER for relative price developments.
[7] NIS is the currency used in the calculation of the CPI and thus NEER and REER.
Inflation Report - First Quarter, 2014
11
During 2013Q4, lending rates on JD and USD have decreased, while the rate on NIS
has increased during the same period. Looking at the deposit rate, while it increased
on USD and NIS, it decreased slightly on JD. And during 2014Q1, the Palestinian stock
market has witnessed an eye-catching performance.
Interest Rates
The historical trend of relaFigure 13: Nominal lending and deposit rate of USD
tively high lending rates compared with low deposit rates
continued for this quarter as
well. Data indicates that lending rates in Palestine are relatively higher, while deposit
rates, except for USD, are relatively lower, than the rates in
countries of origin of respective currencies. Lending rates
on the NIS and USD currencies
Source: Database IFS, PMA.
circulating in Palestine are
more than double their counterparts in the countries of origin. Whereas lending rate
of the JD was almost equal in both Palestine and Jordan.
Lending rate on USD has declined during 2013Q4 by around 70 basis point, reaching
7.06 percent. IMF data indiFigure 14: Nominal lending and deposit rate of JD
cate that lending rate on USD
in USA was relatively stable at
about 3.25 percent during the
same period.
Also, lending rate on JD in Palestine has decreased by about
55 basis points, to 8.98 percent in 2013Q4, unlike its rate
in Jordan, which increased
relatively to 4.97 percent (see
figure 14).
12
Source: Database IFS, PMA.
Palestine Monetary Authority (PMA)
Figure 15: Nominal lending and deposit rate of NIS
In contrast, lending rate on
NIS, which is the highest in
Palestine, has increased again
after a gradual decline during
the last four consecutive
quarters, reaching 11.97 percent during 2013Q4. The high
NIS lending rate is mainly due
to the intensive use of NIS in
daily transactions, which creates high demand for it. In addition to that is the high cost Source: Database IFS, PMA.
of shipments due to the Israeli
measures and restrictions imposed on shipping this currency.
As for deposit rates, deposit rate on NIS in Palestine (1.4 percent) was higher than the
rate in Israel (1.12 percent) for the second consecutive quarter. This might be attributed to lowering the deposit rate in Israel since the beginning of the year, in order to
preserve competitiveness of Israeli goods and services in the global markets.
Moreover, banks in Palestine
are paying higher deposit rate
on USD, 0.75 percent, than
that in USA (0.087 percent)[8].
On the contrary, deposit rate
on JD in Palestine remains
less than its level in Jordan;
while banks in Palestine paid
around 2.09 percent on JD deposits in 2013Q4, banks in Jordan paid around 4.97 percent
during the same period.
Figure 16: Margins between lending and deposit
rates in Palestine compared with issuing countries
Source: Database IFS, PMA.
[8] “Money market rate” used as a proxy for the deposit rate in USA.
Inflation Report - First Quarter, 2014
13
The overall result reveals that
the margin between the lending and deposit rates is remarkably higher in Palestine
than in the issuing countries;
around double on JD and USD,
and around 3.5 times on NIS.
Figure 17: Real lending and deposit rates in Palestine
by currency.
As for the real interest rate[9],
it’s shown that real lending
rates are always positive and
higher than 5 percent. On the
contrary, real deposit rates are
negative, except for JD during
the last three quarters. Figure Source: PMA.
(17) shows the recent developments in real lending and deposit rates in Palestine by
currency.
In general, we can summarize the main developments in interest rates as:
‫ ٭٭‬For the third consecutive quarter, real deposit rate on JD is positive, but decreased
to near zero (0.09 percent), implying that depositors of JD have gained less profit
during 2013Q4. On the other hand, the depositors in NIS and USD are losing more,
as the real deposit rates have deteriorated to -1.25 percent and -0.6 percent, respectively.
‫ ٭٭‬Real lending rates are always positive, implying that banks are making profits overtime.
‫ ٭٭‬Real deposit rates are convergent; in contrast, real lending rates are divergent.
[9] Fisher’s equation; (1+nominal interest rate) = (1+real interest rate)*(1+expected inflation rate).
14
Palestine Monetary Authority (PMA)
Stock market
Palestinian stock market witnessed an eye-catching performance during 2014Q1;
where Al-Quds index improved continuously reaching around 600 points by February.
This significant improvement reflected investors’ optimism due to several succeeding
events in February. These included mainly the financial disclosure of listed companies
for 2013 with their financial statements showing a distinguished performance and
remarkably high profits.
Also, the prime minister has signed the draft resolution to modify the investment
promotion law, which includes restructuring the tax rates that will positively affect
profits of the listed companies. In the same context, the Palestine Capital Market Authority (PCMA) has attained membership in the International Organization of Securities Committees (IOSCO) in late February.
As a result, 2014Q1 has ended up with an improvement in Al-Quds index by 1.3 percent
compared with 2013Q4; and by 15.9 percent compared with the corresponding quarter
of 2013. It reached 548.4 points in 2014Q1, compared with 541.5 points in 2013Q4.
All sectors, especially investment, witnessed good performance during 2014Q1 compared with 2013Q4, as well as with the corresponding quarter of 2013. Investment
sector grew by around 27.2 percent during 2014Q1, reaching 30.5 points. Banking sector grew by about 2.8 percent to reach 122.8 point during the same period (table 4).
Table 4: Al-Quds index and the share price indices
2013
2014
Q1
Q2
Q3
Q4
Q1
Banking
106.8
108.4
109.4
119.4
122.8
Industry
62.7
63.1
65.4
66.8
69.3
Insurance
46.2
44.9
44.6
44.5
46.2
Investment
18.4
18.5
20.7
23.9
30.5
Service
49.1
45.6
46.9
50.4
50.6
AL-Quds
472.2
455.4
470.7
541.5
548.4
Source: www.pex.ps
Inflation Report - First Quarter, 2014
15
As for the performance of stock markets of some selected Arab countries, all markets
have improved during 2014Q1 compared with 2013Q4. Dubai stock exchange was the
biggest gainer of about 32.1 percent increment, followed by a notable improvement in
Egypt stock market with a growth by 15.1 percent, during the same period. In addition,
all of the stock markets of the selected countries have made profit on the basis of
annual comparison. The general index in 2014Q1 compared with 2013Q1 has increased
by 14.3 percent, 61.8 percent, and 41.2 percent, in Dubai, Abu Dhabi, and Egypt, respectively.
Figure (18) summarizes the
percentage change of stock
market indices in some selected Arab countries during
2014Q1.
Data revealed that Palestinian
stock market is significantly
affected by both Amman and
Egypt stock markets. The effects of other Arab stock markets were tested and showed
insignificant influence on the
Palestinian market. Figure
(19) shows q-o-q growth rate
of the general index.
Figure 18: Percentage change in selected Arab stock
markets
Source: http://www.bloomberg.com
Figure 19: Stock markets performance in Palestine,
Amman, and Egypt during 2012Q2 – 2014Q1
Source: http://www.bloomberg.com
16
Palestine Monetary Authority (PMA)
III. Model Based Inflation Forecast
Inflation model and estimation technique
The consumer price index (CPI) calculated by the PCBS is expressed in NIS, which is
the main instrument used for retail transaction purposes. This implies, in fact, that
the past and current monetary arrangement in Palestine resembles the case of a perfectly fixed exchange rate. It also implies that, in the long run, and in a reduced form
sense, the main determinant of inflation is related to the cost of imported goods and
services.
Analysis shows that the CPI
in Palestine is co-integrated
with (i) the CIM, which is a
weighted average cost of imports, expressed in NIS, and
calculated regularly by the
PMA, and (ii) the world food
price index. The importance
of WFP is related to the high
weight food occupies in the
CPI basket in Palestine[10].
Figure 20: CPI, CIM, and WFP
Given the existence of a co-integrating vector between these variables and the CPI,
the question arises as to how this long-run relationship is best estimated, and how
to model the short-term dynamics that explain how fast shocks to this long-run relationship are corrected over time to bring the CPI back to its long-run equilibrium
value.
In this respect, long-run and short-run relationships are estimated using three different approaches, which are: the Johansen’s (1991, 1995) system-based reduced rank
approach, which is frequently used as the preferred co-integration and modeling
technique. The estimated VECM in which the world food price index is treated as an
[10] For more details about inflation determinants in Palestine, see Palestine Monetary Authority (PMA), 2011. Inflation Report 2010: April.
Inflation Report - First Quarter, 2014
17
exogenous variable gave the following results on the inflation equation:
ΔLCPIt = - 0.141 VVECM, t + 0.191 ΔLCPIt-1 - 0.358 ΔLCPIt-2 + 0.182 ΔLCPIt-3 + 0.169 ΔLCIMt-1 +
0.003 ΔLCIMt-2 - 0.137 ΔLCIMt-3 - 0.130 + 0.029 LWFPt
Where VVECM, t is the long run co-integration vector and is estimated as:
VVECM, t = LCPIt – 0.945 LCIMt + 0.275
The second approach is the ARDL test which is based on Pesaran, Shin (1999) and
Pesaran, Shin, Smith (2001). This technique is especially suited for our reduced form
equation approach and has several other advantages. The test is based on a single
ARDL equation, rather than on a VAR as in Johansen, thus reducing the number of
parameters to be estimated. Also unlike the Johansen approach, the restrictions on
the number of lags can be applied to each variable separately. Furthermore, the ARDL
approach also does not require pre-testing for the order of integration (0 or 1) of the
variables used in the model. The following is the estimated ARDL model.
ΔLCPIt = 0.001 - 0.140 VARDL, t + 0.299 ΔLCPIt-1 - 0.254 ΔLCPIt-2 + 0.372 ΔLCIMt + 0.049
ΔLWFPt - 0.005 SD1 - 0.009 SD2 - 0.005 SD3
Where VARDL, t is the long-run levels relation and is estimated as:
VARDL, t = LCPIt-1 - 0.716 LCIMt-1 - 0.296 LWFPt-1
As can be seen, the sum of both cost components in the above equation is close to
unity, which is in accordance with theoretical expectation.
As mentioned by Pesaran, Shin, and Smith, the ARDL estimation procedure is directly
comparable with the semi-parametric Fully Modified OLS approach (FMOLS) of Phillips and Hansen (1990). The following estimated levels CPI inflation equation with
FMOLS is obtained:
ΔLCPIt = 0.011 - 0.139 VFMOLS, t + 0.300 ΔLCPIt-1 - 0.255 ΔLCPIt-2 + 0.369 ΔLCIMt + 0.049
ΔLWFPt - 0.005 SD1 - 0.009 SD2 - 0.005 SD3
Where VFMOLS, t is the long run equation reads as:
VFMOLS, t = LCPIt-1 - 0.702 LCIMt-1 - 0.296 LWFPt-1
As can be seen, the FMOLS results are much closer to those obtained with the ARDL
approach.
18
Palestine Monetary Authority (PMA)
Baseline inflation forecast
The objective is to use the basic inflation model to generate a quantitative CPI outlook
for the current and next years on a quarterly basis that is over the period 2014Q2 till
2015Q4. To that end, a baseline scenario for the exogenous variables CIM and WFP is
needed.
The CIM is basically the denominator of the REER index calculated by the PMA. The
baseline scenario for the CIM was derived from the VECM. Thus CIM is assumed to
increase by 0.8 percent in 2014 and by around 2.9 percent in 2015.
The most recent forecasts coming from the IMF state that food prices will decline in
2014 compared with 2013 and will continue declining in 2015. According to this, world
food prices will decline by around 1.8 percent in 2014 and decline by around 3.1 percent
in 2015.
The estimation of the basic inflation model, according to the three mentioned estimation techniques[11], combined with the common baseline growth rates for the CIM,
and the WFP as explained in table 5, result in an inflation forecast of 2.5 percent on
average, for 2014Q2 as compared to 2013Q2.
As is well known, the use of econometrically estimated models to forecast future inflation is subject to model and coefficient uncertainty. To reduce this specific uncertainty, the baseline CPI outlook for 2014 and 2015 is forecast as the simple average of
the three models which results in a forecast of 2.2 percent and 1.8 percent increase of
CPI on average during 2014 and 2015 respectively. It is worth mentioning that these
forecasts show no change compared with our previous forecasts which was published
in the previous issue.
[11] VECM, ARDL, and the FMOLS.
Inflation Report - First Quarter, 2014
19
Table 5: y-o-y inflation outlook of the three models
Assumptions
Inflation Forecasts
CIM
WFP
VECM
ARDL
FMOLS
Aveg.
2013*
0.27
1.11
1.72
1.72
1.72
1.72
*
14Q1
-0.47
-2.49
2.18
2.18
2.18
2.18
14Q2
0.04
-4.04
2.71
2.47
2.44
2.54
14Q3
0.82
-0.92
2.22
1.90
1.84
1.99
14Q4
2.63
0.59
2.14
2.37
2.27
2.26
2014
0.76
-1.76
2.31
2.23
2.18
2.24
15Q1
3.86
-3.45
2.32
2.30
2.18
2.27
15Q2
3.64
-3.63
2.47
1.99
1.88
2.11
15Q3
2.82
-3.29
2.17
1.56
1.47
1.73
15Q4
1.46
-2.05
1.80
0.99
0.92
1.24
2015
2.93
-3.11
2.19
1.71
1.61
1.84
* Actual data.
On the other hand, the actual inflation rate for the first quarter of 2014 came very
close to our forecast which published in the previous issue (actual = 2.18 percent, forecast = 2.12 percent).
Table (6) shows Palestine baseline CPI inflation rate outlook along with the assumptions on the exogenous variables for the current and next quarters on q-o-q bases.
Table 6: q-o-q inflation outlook of the three models
Assumptions
CIM
WFP
Inflation Forecasts
VECM
ARDL
FMOLS
Aveg.
2013*
0.27
1.11
1.72
1.72
1.72
1.72
14Q1*
-0.85
3.75
0.64
0.64
0.64
0.64
14Q2
0.49
-0.30
0.11
-0.12
-0.15
-0.05
14Q3
1.19
-1.14
0.45
0.37
0.34
0.39
14Q4
1.79
-1.63
0.92
1.46
1.43
1.27
2014
0.76
-1.76
2.31
2.23
2.18
2.24
15Q1
0.34
-0.42
0.81
0.57
0.55
0.64
15Q2
0.28
-0.48
0.26
-0.42
-0.44
-0.20
15Q3
0.38
-0.79
0.16
-0.05
-0.07
0.01
15Q4
0.45
-0.37
0.55
0.90
0.88
0.78
2015
2.93
-3.11
2.19
1.71
1.61
1.84
* Actual data.
20
Palestine Monetary Authority (PMA)
IV. The Balance of Inflation Risk
Apart from the abovementioned risks of
model uncertainty, the CPI outlook also
crucially depends on the assumptions
concerning the course of the exogenous
variables used in the model forecast,
which exclusively refer to external conditions as implied by foreign inflation
trends, bilateral exchange rates of the NIS
and the world food market prices.
To evaluate the risks for the CPI outlook
stemming from potential shocks in these
external conditions, 4 alternative scenarios were set up to capture all possible
combinations of positive and negative 1
standard deviation shocks in the baseline
growth rates of CIM and WFP.
These results demonstrate that
taking a one Standard Deviation (1SD) shock may not fully
reflect the implied risk. Because
of the existence of excess kurtosis[12], the probability distributions are leptokurtic, implying
that the occurrence of extreme
shocks has a probability that is
higher than one would expect
on the basis of a normal distribution. Together with the baseline, the scenarios can be identified as follows:
Table 7: Descriptive statistics for ΔLCIM
and ΔLWFP
ΔLCIM
ΔLWFP
Mean
0.006
0.006
Median
0.006
0.012
Maximum
0.064
0.150
Minimum
-0.040
-0.291
Std. Dev.
0.015
0.063
Skewness
0.957
-1.210
Kurtosis
7.146
8.258
Sum
0.436
0.460
Sum Sq. Dev.
0.015
0.284
Observations
68
72
Figure 21: Scenario assumptions for CIM and WFP
[12] Kurtosis measures the peakedness or flatness of the distribution of the series.
Inflation Report - First Quarter, 2014
21
The results of this scenario analysis are mentioned in table (8). They indicate that,
given the assumptions, the average inflation forecasts during 2014 range between 1.2
percent and 3.3 percent with 2.2 percent as the central baseline outlook. In 2015, the
average inflation forecasts are expected to range between -2.4 percent and 6.1 percent
with 1.8 percent as the central baseline outlook.
Table 8: Baseline and risk analysis of the CPI in Palestine for 2014 and 2015
(Percentage point)
Scenario
Shock
Implied annual growth rate
CIM
Implied annual growth rate
WFP
Implied inflation forecast
2014
2015
2014
2015
2014
2015
1
Baseline
0.8
2.9
-1.8
-3.1
2.2
1.8
2
+1SD CIM +1SD WFP
2.4
7.3
5.0
15.4
3.3
6.1
3
+1SD CIM -1SD WFP
2.4
7.3
-8.1
-19.3
2.3
1.5
4
+1SD WFP-1SD CIM
-0.8
-1.3
5.0
15.4
2.1
2.1
5
-1SD WFP -1SD CIM
-0.8
-1.3
-8.1
-19.3
1.2
-2.4
Figure (22) shows the risk analysis of the inflation in Palestine during 2014 compared
with the risk analysis predicted in the previous issue for 2014. As can be seen from
the figure, scenarios 3 and 4 give close results to the baseline forecast, while scenarios 2 and 5 entail upside and
Figure 22: Web chart of the balance of Palestine’s
downside outliers respectivey-o-y inflation risk
ly. The figure shows that the
risk declined compared with
our risk analysis presented in
the previous issue.
The upside risk to the inflation forecast is clearly related
to a higher expected risk in
world food prices, combined
with a higher inflation in Palestine’s main trading part-
22
Palestine Monetary Authority (PMA)
ners compared to what is assumed in the baseline. Conversely, inflation in Palestine
may turn out to be considerably lower than predicted in the baseline in case world
food prices, together with inflation in the main trading partners, turn out to be lower
than expected.
Apart from model uncertainty and uncertainty related to external conditions, the inflation outlook for Palestine also hinges on potential specific shocks that may perturb
the economic and political conditions in Palestine itself, which are independent of
shocks occurring in the rest of the world.
Examples of such shocks include inflation spikes in 2002, and in 2007 - 2008, related
to restrictions on Palestine’s international trade, as illustrated by the relatively high
number of closure days for trade. As past experience shows, these country-specific
risks are mainly on the upside.
Figure (23) shows the fan chart
Figure 23: Fan chart of the balance of Palestine
of the balance of Palestine’s
inflation risk during 2014Q2 – 2015Q4
inflation risk during 2014Q2
– 2015Q4. This fan chart contains the quarterly profile of
the baseline inflation forecast mentioned above. The
risk parameters start from a
standard deviation equal to
0.2 for the second quarter of
2014, which is based on the
inflation volatility observed
during the most recent years.
It then rises up to 2.7 for the
fourth quarter of 2015, reflecting the fact that uncertainty rises with the forecasting
horizon. It should be mentioned that the range of the potential outcomes is fairly
broad, reflecting the uncertainty of the forecast which is the consequence of all risk
factors mentioned above, including the country specific ones. It should also be mentioned that the most likely outcomes for the predicted inflation are situated in the
darkest shaded regions of the chart. The lighter the shade is, the smaller the perceived
probabilities of these potential outcomes.
Inflation Report - First Quarter, 2014
23