Palestine Monetary authority
(PMA)
Inflation Report
First Quarter 2016
Volume 18
Copyright © June, 2016
All Rights Reserved.
Suggested Citation:
Palestine Monetary Authority (PMA), 2016. Inflation Report: First Quarter 2016.
Ramallah – Palestine
All Correspondence should be directed to:
Palestine Monetary Authority (PMA)
P. O. Box 452, Ramallah, Palestine.
Tel.: 02-2409920
Fax: 02-2409922
E-mail: [email protected]
www.pma.ps
ii
Executive Summary
The inflation rate in Palestine decelerated during 2016Q1 to 0.6 percent, compared to
around 1.5 percent in the preceding quarter, and the same rate in the corresponding
quarter of 2015. This slowdown came as a result of decelerated inflation in the West
Bank, in addition to a price drop in Gaza Strip. Dislike previous quarters, the consumer
price index showed minimal benefit from the reduction in global commodity prices
during this quarter, which indicates the domination of domestic factors over foreign
ones. However, inflation in Palestine was much lower than that registered in the MENA
region in 2016Q1, but exceeded that in Jordan and Israel. In general, analysis revealed
that inflation in Palestine is largely imported and shows highly sensitive to world prices,
particularly for food and fuel.
The approach followed in this report for inflation analysis and forecasting purposes
depends on two key variables: (i) cost of imports, which reflects the inflation and
exchange rates of Palestine’s main trading partners, among which Israel accounts for the
highest portion (80 percent of exports and 70 percent of imports on average), and (ii)
world food prices, as food has the highest weight (35 percent) in the consumer price
index in Palestine.
Inflation forecasts show that consumer prices in Palestine are expected to increase by
around 1.0 percent during 2016Q2 on an annual basis, and decrease to 0.8 percent in 2016.
Forecasts depend on assumptions concerning the most likely future paths for (i) prices
and exchange rates in Palestine’s most important trading partners, (ii) prices in the
international food markets, as predicted by international organizations such as the IMF
and foreign central banks, and (iii) domestic and seasonal factors.
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 shock in Palestine’s cost of imports and in
world food prices. The expected effects on Palestine’s alternative inflation outcomes
show that a positive one-standard deviation shock in external conditions would increase
Palestine’s prices from 1 percent under the baseline scenario to nearly 1.6 percent on
iii
average during 2016. On the other hand, a negative one-standard deviation shock may
bring consumer prices in Palestine down, to -0.1 (deflation), compared to 1 percent
inflation under the baseline scenario.
As for financial developments in Palestine, 2015Q4 data indicate that average lending
rates on the JD and the NIS have declined compared to the previous quarter, while the
rate on the USD has increased. On the other hand, average deposit rates on the JD and
the NIS remained relatively stable, while the rate increased on the USD. The margin
between lending and deposit rates in Palestine remained noticeably higher than its
counterpart in the issuing countries. Still, this margin increased on the USD to 6.1
percentage points, and reached 6.5 and 8.6 percentage points on the JD and the NIS,
respectively, during 2015Q4.
Dampened by a routine performance, the Palestinian stock index (Al-Quds Index) fell by
5.0 percent compared with 2015Q4, reaching 506.3 points. This drop was driven by the
decline in the price indices of services, banking, and investment sectors, but at varying
degrees.
iv
Contents
I. RECENT ECONOMIC DEVELOPMENTS ..............................................................................................1
REAL GDP ...................................................................................................................................................1
AGGREGATE DEMAND...................................................................................................................................4
INFLATION ...................................................................................................................................................5
GLOBAL AND LOCAL PRICES ..........................................................................................................................6
LABOR FORCE AND WAGES ...........................................................................................................................7
EXCHANGE RATES ......................................................................................................................................12
II. RECENT FINANCIAL DEVELOPMENTS ...........................................................................................12
INTEREST RATES ........................................................................................................................................12
STOCK MARKET ..........................................................................................................................................15
III. MODEL BASED INFLATION FORECAST .........................................................................................17
INFLATION MODEL AND ESTIMATION TECHNIQUE ........................................................................................17
BASELINE INFLATION FORECAST..................................................................................................................18
IV. THE BALANCE OF INFLATION RISK ...............................................................................................19
v
I. Recent Economic Developments
Real GDP
A more pessimistic outlook prevailed in 2016Q4 regarding global growth, amid signs of
slowing activity in both advanced economies and emerging and developing ones, and
specifically in the United States. Stimulus packages to spur economic growth pursued by
policymakers in major economies have apparently failed to stimulate domestic demand,
while concerns lingered in financial markets regarding possible future crises. Investors
closely followed monetary policy developments and its repercussions on stock markets,
the latter facing significant fluctuations during the quarter, in addition to growing
stability risks stemming from asset markets, specifically in Asian economies. In light of
the above, the International Monetary Fund (IMF) downgraded its growth expectations
for the global economy1 by 20 basis points to 3.2 percent in 2016, while expecting growth
to reach 3.5 percent in 2017.
A closer look at the world's major
economies
reveals
a
Figure 1: Real growth rates in some main economies
continued
10
8
slowdown in activity within the U.S.
6
market during the fourth quarter,
4
disappointing investors and analysts
2
0
across world markets despite positive
initial
estimates
that
-2
ultimately
USA
contributed to raising interest rates in
EA
Japan
China
Source: Different Sources2
the U.S. A stall in consumer spending,
weaker exports and slowing state and local government spending, have all weighed
down on growth during 2015Q4, which reached 2.0 percent y-o-y, compared to 2.1
percent in the preceding quarter, and driving IMF growth forecasts down by 20 basis
points to 2.4 percent in 2016. The fund forecasts a 2.5 percent real growth in 2017, in
light of absent signs of significant improvements in the medium term.
1
2
International Monetary Fund, World Economic Outlook, April, 2016. Previous estimates were published in January, 2016.
IFS database, BoEA, and
http://www.tradingeconomics.com.
1
Similarly, performance in the Euro Area slowed during 2015Q4, as real GDP growth
slightly declined to 1.9 percent, compared to 2.0 percent in 2015Q3, on the backdrop of
subdued exports and sluggish domestic demand. The quarter, however, brought out
different growth patterns among member countries, as signs of slowdown appeared in
Germany in light of weak exports, while the French and Italian economies accelerated to
mirror improvements in investments and several aspects of consumption in both
countries. Contraction in Greece has also eased due to a relative increase in government
spending and investment. Yet such developments could not prevent a drop in IMF
forecasts for EA's 2016 growth by 20 basis points to 1.5 percent. Growth in 2017 is not
expected to exceed 1.6 percent.
In Japan, government efforts to spur growth failed to stop a return to slowdown, as
private demand and exports remained below desired levels, with growth reaching 0.7
percent in 2015Q4, compared to 1.7 percent in the previous quarter. The Japanese
economy is set to face additional internal and external challenges, if the slowdown
continues in China and the euro area, or if the government remains adamant on raising
consumption tax. As such, the IMF downgraded growth forecasts by 50 basis points in
2016, down to 0.5 percent, while it forecasts a 0.1 percent contraction in 2017.
In the meantime, activity continued to slow in China in light of stalling industrial
production, private investments, and services. Growth in real GDP slowed to 6.8 percent
during 2015Q4, compared to 6.9 percent in 2015Q3, amid persistent concerns of
emerging financial crises in Asian markets and receding global trade. The IMF expects
current growth trends to persist in the next two years; the Chinese economy is
forecasted to grow by 6.5 percent in 2016, and 6.2 percent in 2017.
In a similar context, political and economic turmoil lingered within the MENA region,
limiting its capacity to achieve adequate growth levels, particularly in countries like Iraq,
Syria, Egypt, Libya and Yemen. As a result, the IMF lowered the region's expected
growth from 3.4 percent to 2.9 percent in 2016 in light of absent political stability and
the inevitably negative spillovers of sliding oil prices on exporting countries in the
medium term. The region is expected to grow by 3.3 percent in 2017.
2
Regionally, growth in Israel picked up for the second quarter this year, as growth
reached 2.7 percent, as opposed to 2.2 percent in the previous quarter. Government
spending increased markedly following
Figure 2: Real growth rates in Palestine, Jordan, and
Israel
a late budget approval, in addition to a
smaller drop in exports suffering from
modest
European
demand.
12
8
Private
4
spending and investment, on the other
0
hand, witnessed nothing but slowdown
-4
until the end of the year, driving IMF
-8
2016 forecasts down to 2.8 percent. The
Palestine
Israeli economy is expected to grow by
Jordan
Israel
Source: PCBS, CBS, and the Central Bank of Jordan.
3.0 percent in 2017.
Similarly, activity in Jordan stabilized, as growth hit 2.6 percent for the second
consecutive quarter. Decelerating activity in several sectors, including manufacturing,
trade, services and transportation, were met with a pick-up in construction and
agricultural activities. IMF forecasts for Jordanian growth stabilized at 3.2 percent in
2016 and 3.7 percent in 2017, according to latest estimates.
Domestically, the real GDP growth in 2015Q4 relapsed to 6.1 percent y-o-y, as opposed to
9.6 percent in the preceding quarter, as a result of similar trends in the West Bank and
Gaza Strip. However, such relatively high figures mostly reflect a marked improvement
in GS economic conditions compared to the corresponding quarter (the months
following the recent Israeli war in 2014).
Real growth in the WB stalled to 1.0 percent in 2015Q4 compared to 4.0 in 2015Q3,
despite stable fiscal conditions and consistent flows of Palestinian workers into the
Israeli labor market. Such developments come amid heightened political and security
tension, and growing Israeli violations during the comparison period. This modest
growth mainly reflected sluggish activity in most economic sectors, with a 23.9 percent
contraction in agriculture and fishing y-o-y, a 5.0 percent decline in industry; a 2.8
percent fall in public administration and defense and a slight contraction of 0.1 percent
in communications. A modest growth occurred in trade, construction, and services by
0.9, 1.0 and 2.5 percent, respectively. In contrast, financial services and insurance, in
3
addition to transportation, constituted the only exception during this quarter, growing
by 10.0 and 8.7 percent, respectively, although still lower than what was achieved in the
preceding quarter.
Meanwhile, annual comparison points to a similar deceleration in activity in GS, as
growth reached 24.7 percent, compared to 33.3 percent in the previous quarter.
Nonetheless, such rates remain an indication of leaps in production levels, compared to
poor economic conditions following the war in the corresponding quarter. Value added
tripled in the construction sector during the fourth quarter owing to a surge in flows of
construction materials to the Strip, while growth in trade and manufacturing amounted
to 25.6 percent and 18.1 percent, respectively.
Other activities, on the other hand witnessed more stable growth patterns during
2015Q4, as general services and financial and insurance services grew by 12.8 and 11.2
percent, respectively. Transportation and communications grew by 7.2 percent and 4.3
percent, while public administration and defense grew by a mere 0.7 percent. It is worth
noting that although such developments indicate some improvement, resumed activity in
the Strip, remains below levels necessary to achieve pre-war levels, not to mention those
needed to create jobs and maintain economic stability in the long-run.
Aggregate demand
Gross Domestic Product (GDP) in
Table 1: Aggregate demand at constant prices (2004=100)
Palestine has grown during 2015Q4,
(USD million)
2014
reaching USD 1,988.5 million in 2004
prices, scoring a growth on annual
basis as most of GDP components
have expanded during the quarter,
particularly in the WB.
Private consumption4 has grown in
the WB by 5.1 percent on y-o-y basis,
Private
consumption
Government
expenditure
Investment
2015
Q4
Q1
Q2
Q3
Q4
1,734.0
1,703.0
1,746.3
1,665.7
2,776.1
498.3
473.7
535.6
524.6
556.5
355.1
339.5
457.6
386.2
491.5
Exports
427.4
398.6
456.7
387.5
418.1
Imports
1,117.4
1,096.3
1,206.8
1,262.1
1,236.7
GDP3
1,874.8
1,852.0
1,959.3
1,921.9
1,58889
Source: PCBS.
while public consumption also grew, by 11.0 percent. Moreover, investment has expanded during
3
4
The difference between the sum of former items and the GDP is the net errors and omissions.
The private consumption includes; household consumption and the consumption of non-profit institutions serving households
"NPISH".
4
the same period by 6.4 percent. On the other side, trade indicators show a negative developments
as exports declined by 2.1 percent, while imports notably grew by 11.4 percent. This resulted in a
wider trade deficit to USD 662.1 million (in 2004 prices), which forms around 44.5 percent of
GDP.
However, private consumption in GS is still weak and below the pre-war level; it declined by 8.4
percent in 2015Q4, compared to corresponding levels in 2015Q4. Tarde indicators have also
weakened as exports declined by 4.3 percent, while imports increased by 6.4 percent, resulting in
a widening trade deficit. Conversely, extensive growth in public consumption eased the impact
on GDP growth, as it increased by 12.8 percent, accompanied with another increase in
investment to USD 44.3 million, due to improvement in building investment.
Inflation
Global commodity prices witnessed a further drop during 2016Q1, which affected the inflation
rates of various countries in different ways. On one side, the decline in global prices stimulated
higher consumption in some economies, which in turn led to higher inflation rates. However,
that was not sufficient in some countries that suffered from the economic consequences of the
financial crisis, and weakened demand in those countries led to a fall in inflation.
Apart from these divergences, inflation rates
Figure 3: Inflation rates in World regions
in main economies persisted at low levels,
16
and didn't exceed in most of them the (2
12
percent) threshold during 2016Q1. In the
8
U.S. for example, inflation slightly increased
4
from 0.5 percent in 2015Q4 to 1.1 percent
0
this quarter due to an increase in prices of
services like shelter and medical care.
World
AC
EDC
MENA
Moreover, inflation in both the Euro Area
Sources: IFS and PCBS.
and Japan stabilized at a very low level
(close to zero) in light of weak local demand. In general, and due to the increased inflation in the
U.S in particular, inflation in Advanced Countries (AC), in 2016Q2 increased slightly by 16 basis
points, reaching 7.67 percent.
However, inflation in Emerging and Developing Countries (EDC) exceeded that in the AC.
Although data for EDC's group are not available for 2016Q1, preliminary indicators revealed a
slight increase in inflation of main economies, particularly in China where inflation increased
5
slightly, to 2.1 percent. It is worth mentioning that the EDC have experienced persistent price
hikes during the past few years, as inflation reached its peak in 2011, before it started to decline
afterwards. The MENA region experienced a notable downward trend during previous quarters,
reaching its lowest levels in more than a decade, affected by both declines in commodity prices
(as MENA countries depend heavily on imports), and the appreciation of the USD. As a result,
inflation declined to 4.9 percent by end 2015Q4, as the most recent data indicate.
In sum, due to the slight increase in both the AD and the EDC during the first quarter of 2016,
global inflation grew marginally, by 4 basis points to around 3.0 percent (see figure 3).
Likewise, inflation rates in Palestine and
Figure 4: Inflation rates in Palestine, Jordan, Egypt, and
Israel
neighboring countries experienced different
14
trends during 2016Q1. As figure (4)
12
10
indicates, the movement of the inflation rate
8
in Palestine during the quarter was
6
4
conversely related to those in Israel and
2
Jordan, while it consisted with Egypt.
0
-2
Inflation resumed its decline in Palestine
from 1.5 percent in 2015Q4 to 0.6 percent
this quarter due to a lower inflation in the
Palestine
Jordan
Egypt
Israel
Sources: IFS and PCBS.
WB, along with a deflation in GS. Likewise,
inflation in Egypt decreased from 10.6 percent to around 9.4 percent during the comparison
period. Despite price fluctuations, Egypt had the highest inflation rates among neighboring
countries, which reflects its continuous political turmoil since 2011.
Meanwhile, Jordan and Israel continued to experience a deflation due to a continuous drop in
imported commodity prices. But deflation in both countries declined marginally during this
quarter, to -1.2 and -0.5 percent compared to a deflation of -1.4 and -0.9 percent in the previous
quarter, respectively.
Global and local prices
This section deals mainly with developments in local and global markets commodity prices, the
most important determinant of inflation trends. Figure (5) shows a downward trend of global
prices since the second half of 2014, particularly world oil price (WOP), which dropped by about
36.6 percent in 2016Q1 compared to the corresponding level in 2015, and by 68.4 percent
compared to the corresponding level in 2014 (before the sharp declines). Moreover, the crude oil
6
price declined by 22.4 percent compared to the previous quarter, reaching USD 32.8 during
2016Q1. The continuous decline in the crude oil price reflected weak demand for oil worldwide
due to a global economic slowdown, along with a hike in oil production to compensate for the
fall of prices.
Likewise, the fall in world metal prices (WMP) reflected the global slowdown, particularly the
sluggish growth in China which consumes roughly half of the global metals production. As a
result, global metal prices declined on both
Figure 5: Indices of primary commodity prices,
2010=100
annual and quarterly bases by 20.3 percent
140
and 1.1 percent, respectively. Also, world
120
food prices (WFP) declined by 8.3 percent
100
compared to the corresponding quarter of
80
2015 due to abundant food supplies;
60
40
however, the case is the opposite when
comparing with the previous quarter. Crop
WFP
damage at end 2015, caused by the drought
WMP
WOP
Source: IFS.
in vast agricultural areas of the world,
pushed up some prices during 2016Q1, particularly those of edible oil, with expectations of
further increases in coming months. As a result, WFP increased by 3.0 percent this quarter on qo-q basis.
Meanwhile, local prices witnessed several developments but conflicting trends between the WB
and GS during 2016Q1. Such trends are less sensitive to domestic prices than to external factors,
and the differing country-specific political and economic conditions.
In the WB, commodity categories' prices either increased or remained stable. However, the
general trend for main price categories was upward during 2016Q1. Thus food prices increased by
4.4 percent for the second consecutive quarter given the weak agricultural season; also the
education price index increased by the same percent due to a gradual raise of tuition fees.
Moreover, despite the sudden reduction of about 20 percent in local and imported medical drugs
supplies in February, thus medical care price index increased by around 2.7 percent on a y-o-y
basis. Additionally, the price indices of textile, restaurants and cafes, and furniture have all
increased, by 2.3 percent, 1.9 percent, and 1.1 percent, respectively. Also, the transportation price
index increased for the first time in three years by 1.2 percent, despite the decline in fuel prices
during the same period.
7
In contrast, prices of housing services continued their downward trend that began two years ago,
partially affected by the decline in oil prices, in addition to the oversupply of housing units, as
some observers noted. The result, the housing service price index declined by 7.3 percent on
annual basis. Likewise, the communication price index declined marginally, by 1.0 percent; and
the alcohol and tobacco price index declined by only 0.2 percent.
In sum, the WB consumer price index increased by 1.4 percent on annual basis due to the
increase in most price categories. However, consumer prices declined by 1.2 percent compared
with the previous quarter due to the decline in the food price index by 2.9 percent.
Meanwhile, the conflicting price trends in GS were clearer. On one side, the transportation index
continued to increase, rising by 10.8 percent on annual basis. This rise reflected mainly the effect
of the aggravated fuel crisis, which has relatively stabilized since the previous quarter.
Furthermore, tobacco prices also notably increased in light of weak control over tobacco traders,
in addition the continued adverse effect of both the blockade, and the destruction of smuggling
tunnels. As a result, the tobacco and alcohol price index increased on y-o-y by 6.2 percent. Also,
the price indices of cafes and restaurants services and textile have both continued to increase
during this quarter, rising by 8.8 percent, and 4.1 percent, respectively.
In contrast, housing services, prices continued to decline for a year, and dropping lately by 3.9
percent this quarter in light of an increasing flow of building raw materials entering the Strip. In
sum, the supply of homes increased pushing house rents down. Besides, the food price index fell
by 1.9 percent due to over supply during the quarter (particularly the chicken, eggs, and
vegetables), coupled with a limited ability to export. Also, prices of medical care declined
notably, by around 5.0 percent. There are no
Figure 6: Web chart of the CPI components
contribution to the inflation rate in Palestine
good reasons to explain this decline.
However, tracking its movements revealed a
Others
temporarily hike during corresponding
Restaurants
quarter, but it returned to its normal levels
afterwards. Likewise, price indices of
Education
communication and furniture declined by
1.5
1.0
0.5
0.0
-0.5
-1.0
Food
Recreation
1.9 percent and 1.3 percent, respectively. In
Tobacco
Textiles
Housing
Furnature
Communications
Medical
Transport
sum, CPI in GS during 2016Q1 declined on
annual and quarterly bases, scoring a
WB
deflation by 0.2 percent and 0.8 percent,
respectively.
8
GS
Overall, while food prices contributed 1.5 percentage points to inflation in the WB during
2016Q1 (see figure 6), they accounted for most of the deflation rate (-0.8 percent) in GS during
the same period.
Regardless of different price determinants in the WB and GS, commodity prices in Palestine hit
much higher levels than in the world market, because changes to global prices are not reflected
completely in local prices, which contributed in widening the price gap in recent quarters as it
indicated in figure (7).
Tracking price movements during 2016Q1 reveals that global gasoline price dropped by more
than 33.0 percent. Meanwhile, gasoline retail price in Palestine declined by only 7.7 percent
during the same period. Likewise, global
gasoline prices dropped on a quarterly basis
Figure 7: Gasoline prices in USD per liter
by 22.4 percent, but local prices declined by
2.7
only 6.6 percent. Consequently, gasoline
Palestine
World
local to global price ratio (right)
6
5
2.2
price in Palestine in 2016Q1 has become 4.6
1.7
times its level in the global market,
1.2
compared to around 3.8 times the price in
0.7
1
the previous quarter, particularly in light of
0.2
0
4
3
2
the appreciation of the USD against the NIS
during the quarter. It is noteworthy that the
Source: PCBS and IFS.
continuous decline in gasoline prices that started a year and half ago was accompanied by a high
USD exchange rate against the NIS, and thus,
Figure 8: Local prices to global prices
the possible benefits for local consumers
4.2
were limited. As a result, one liter of gasoline
Wheat
Rice
Sugar
3.7
was about USD 1.4 (around NIS 5.6) in the
3.2
local market, compared with USD 0.3 in the
2.2
2.7
1.7
global market during 2016Q1.
1.2
As is the case in fuel prices, other commodity
0.7
prices like wheat, rice, and sugar are much
higher locally than in world markets. During
Source: PCBS and IFS.
2016Q2, global prices of the three abovementioned commodities decreased both globally and
domestically. However, the price gap remained considerably wide. Both rice and wheat prices in
the local market are 3.8 times their price in global markets, while the local prices of sugar became
around 1.2 times the global prices during 2016Q2 (see figure 8). Several factors stand behind these
9
discrepancies, including: taxes imposed on imported products, the high cost of transportation
and storage, and the oligopolistic prices.
Also interesting are prices for some non-
Table 2: Prices of selected commodities in Palestine
NIS per unit5
imported commodities, like fresh chicken and
2015
beef meat. Local prices of these commodities
Q1
Q2
2016
Q3
Q4
Q1
are not sensitive to global trends but are still
Rice
2.7.7
137.3
136.7
135.9
134.6
much higher than world prices due to their
Wheat
2...7
150.3
148.8
147.9
146.2
Bread
..8
3.9
3.8
3.8
3.7
Beef meat
Chicken
meat
Powder Milk
(Nido)
Yogurt
(local)
Chicken Eggs
19.2
53.3
58.7
57.3
54.3
21.6
26.9
17.2
14.9
15.2
96.2
96..
96.4
95.7
95.9
..7
..2
5.1
5.0
5.1
29.7
2..8
13.9
14.2
13.0
Tomatoes
1.1
1.9
3.1
6.2
3.3
Sugar
212.6
2...6
132.8
128.1
126.7
Gas
6..7
6..7
57.1
56.6
57.4
Diesel
..6
..8
5.5
5.3
4.9
Gasoline 95
6.2
6.1
6.2
5.9
5.6
high cost of production. Besides, global prices
of these commodities witnessed further
decline in 2016Q1, while local prices increased,
which resulted in widening the price gap. For
instance, fresh chicken meat prices in
Palestine are now around 1.6 times the world
price, and beef meat prices became more than
3.7 times the world prices during 2016Q1.
Table (2) shows price developments for some
Source: PCBS
selected commodities (imported and non-imported) in the local market during the current and
previous quarters.
Labor force and wages
Labor force participation rate6 in Palestine
slightly increased during 2016Q1, by 0.1
Figure 9: Labor force main indicators in Palestine
50
115
however, it remained relatively stable for the
45
110
40
105
last two years. Meanwhile, unemployment
rates continued to increase by rising 8 basis
points to 26.6 percent during this quarter.
This fluctuating trend is clearer in GS due to
NIS / Day
percentage point reaching 45.8 percent;
35
100
30
95
25
90
20
85
15
80
the political and economic developments in
the Strip. During 2016Q1, the number of
LFPR
UNEMPR
ADW (right)
Source: PCBS.
5
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.
6
The total number of persons aged 15 years and over in Palestine reached 2,894,600 in 2016Q1.
10
Gazan workers declined, raising the unemployment rate to 41.2 percent from the previous level
(38.4 percent). Meanwhile, the number of workers in the WB relatively stabilized, and the
participants in labor market declined, resulting in a slight decline in unemployment rate by 0.7
percentage point to 18.0 percent. It is noteworthy that a large number of the WB labor force
work in Israel and settlement accounting for 20 percent of the total during 2016Q1. However. the
Israeli labor market remains completely shut to GS workers for years7 until the beginning of
2016, when a limited number less than 100 workers during 2016Q1 were in.
Palestinian participation in the Israeli labor market is of a significant impact on both average
wages and price levels in Palestine. The relatively higher daily wages of workers in Israel and
settlements push local wages to rise, while the increased disposable income creates more demand
for goods and services, of which the big share is imported. These pressures ultimately lead to
undesirable price inflation.
During 2016Q1, nominal wages in the three regions have risen compared to the previous quarter,
but with varying amounts. Data revealed a huge increase in the WB nominal wages to their
highest level ever, growing by 6.8 percent and reaching NIS 99.8 a day. Likewise, nominal wages
of Palestinian workers in Israel and settlements increased by 5.9 percent. It is noteworthy that
the increments to wages of Palestinian workers in Israel and settlements exceed that for WB,
which has further widened the wage gap between the two areas. In 2016Q1, wages of Palestinian
workers in Israel and settlements were about 2.1 times those of WB workers, reaching around
NIS 212.5 a day. However, the growth in Gaza’s nominal average daily wage remained slight
(below 1.0 percent) to a total of NIS 61.8 a day.
The reciprocal relation between prices and wages implies that when inflation exceeds the rise in
the average nominal wage, the purchasing power of real wages decline, and vice versa. During
2016Q1, the drop in prices has strengthened the purchasing power of wages. The q-o-q deflation
of 1.2 percent in the WB resulted in a growth in the real wages of workers in both the WB, and in
Israel and settlements by 8.0 percent and 7.1 percent, respectively. Also, in light of a deflation by
0.8 percent in GS, Gazan real wages grew by 1.6 percent. On a different note, the appreciation of
the USD and the JD against the NIS during 2016Q1 raised the purchasing power of to the
worker's real wages paid in these currencies by 0.8 percent.
7
The Israeli labor market closed to GS workers since the Israel's withdrawal from Gaza in 2005.
11
Exchange rates
Figure (10) shows the nominal and real
effective exchange rates (NEER and REER)
Figure 10: Effective exchange rates and CPI in
Palestine, 2010=100
in Palestine8. The discrepancy between the
112
NEER and REER indicates that changes in
110
inflation in Palestine relative to its trading
108
partners contributed to the appreciation of
106
the real exchange rate during this period. The
104
102
appreciation of the NEER indicates that the
100
NIS appreciated against Palestine's trading
partners’ currencies, while the appreciation
of the REER indicates that Palestine lost
REER
NEER
CPI
Source: PMA and PCBS.
competitiveness against its trading partners9.
Data show that the NEER has appreciated by 1.7 percent during 2016Q1, compared with 2015Q1,
which indicates that the NIS appreciated against Palestine trading partners’ currencies.
Likewise, the REER appreciated further by 2.1 percent during the comparison period, which
indicates that Palestine lost some competitiveness against its trading partners. It is worth
mentioning that the Palestinian foreign trade is substantially affected by the Israeli-imposed
restrictions and other obstacles, and these effects were much stronger than the effects of changes
in NEER and REER.
II. Recent Financial Developments
Interest Rates
Lending and deposit rates in Palestine frequently move over time according to changes in the
monetary policy in the issuing countries of the currencies circulated in Palestine and also to the
level of cash in the banks operating in Palestine. However, tracking these movements during
previous quarters reveals that lending rates on the three currencies circulating in Palestine are
higher than their counterparts in the countries of origin. On the other hand, deposits are higher
than their counterparts in the countries of origin for the NIS and USD, but are consistently lower
for the JD in Palestine.
8
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.
9
NIS is the currency used in the calculation of the CPI and thus NEER and REER.
12
Average lending and deposit rates have witnessed various developments during the fourth
quarter of 2015. The average lending rate on the JD and on the NIS moved in the same direction,
but conflicting with USD, due to economic developments in the U.S, as will be clarified later in
this section. In sum, the average lending rate on the JD and on the NIS has declined during
2015Q4, but increased on the USD. On the other hand, the average deposit rate on the JD and the
NIS remained relatively stable, while it increased on the USD during the quarter,
The average lending rate on the JD in
notably
declined
after
Figure 11: Lending and deposit rates of JD
three
10
consecutive quarters of increase, reaching
6
8
Lending Rate
8.75 percent in 2015Q4, compared to 9.49
percent in the previous quarter. Likewise, the
average lending rate on the JD in Jordan
4
6
4
2
2
0
continued to decline for a year and half, and
Deposit Rate
Palestine
0
14Q1 14Q2 14Q3 14Q4 15Q1 15Q2 15Q3 15Q4
decreased by 13 basis points during this
LR in Palestine
DR in Palestine
Source: PMA and IFS.
quarter, to around 8.27 percent. It is worth
LR in Jordan
DR in Jordan
noting that the JD is the least circulated
currency in the Palestinian market and is rarely used in daily transactions. Credit share in this
currency is also the lowest, reaching 14.9 percent of total credit in 2015Q4.
Similarly, the average lending rate on the NIS
in Palestine has decreased below the 10
Lending Rate
percent threshold for the first time, reaching
9.92 percent. Conversely, it marginally
increased in Israel by 2 basis points to 3.43
percent, but remained at its lowest level, as
the
Bank
of
unprecedented
Israel
low
percent).
maintained
interest
rate
2.5
2.0
8
1.5
6
1.0
4
0.5
2
0
0.0
14Q1 14Q2 14Q3 14Q4 15Q1 15Q2 15Q3 15Q4
the
(0.1
12
10
Deposit Rate
Figure 12: Lending and deposit rates of the NIS
LR in Palestine
DR in Palestine
Source: PMA and IFS.
LR in Israel
DR in Israel
It is worth mentioning that the high lending rate on the NIS in Palestine is mainly due to the
intensive use of the NIS in daily transactions, which increases demand for the NIS. This is
evident given the fact that the NIS lending rate in Palestine is consistently the highest among
circulating currencies.
13
Conversely, the average USD lending rate
continued to increase by 48 basis points,
Figure 13: Lending and deposit rates of the USD
percent. At the same time, the lending rate on
6
the USD in the U.S. increased during 2015Q4
for the first time since the beginning of 2009.
In October and November the lending rate in
the US stabilized at the previous level (3.25
percent), but then increased 3.37 percent In
December. This change concurred with the
1.3
1.0
0.8
4
0.5
2
0
0.3
14Q1 14Q2 14Q3 14Q4 15Q1 15Q2 15Q3 15Q4
LR in Palestine
DR in Palestine
Source: PMA and IFS.
Deposit Rate
8
Lending Rate
reaching its highest in two years at 7.13
0.0
LR in USA
DR in USA
changes of the official interest rate, which has been raised by the Fed in December for the first
time in years, in light of indications of rising economic recovery.
Movements in average deposit rates on currencies circulating in Palestine were limited during
2015Q4, especially for the JD and the NIS. The average deposit rate on the JD stabilized at 2.21
percent, but declined in Jordan from 3.32 percent to 3.12 percent. Additionally, the average
deposit rate on the NIS remained relatively stable at 1.36 percent (declining by only 1 basis
point), concurrent with the stable rate in Israel at 0.45 percent. It is worth noting that NIS
deposit rates are historically lower in Palestine than in Israel, yet the repetitive lowering of key
interest rates by the Bank of Israel (BoI) during the past two years has reversed this trend since
then.
Conversely, the average USD deposit rate in Palestine and in the U.S. increased by the same
amount (13 basis points), reaching 1.02
percent and 1.14 percent, respectively10.
Figure 14: Margins between lending and deposit rates
in Palestine compared with issuing countries
Generally speaking, deposit rates within the
10
three issuing countries are low due to the
8
vulnerable
and
6
accommodative monetary policy, especially
4
in the U.S. and Israel.
2
economic
conditions
0
Consequently, the margins between the
Palestine USA
USD
average lending and deposit rates remain
remarkably higher in Palestine than in the
10
Palestine Jordan Palestine Israel
JD
NIS
15Q1
15Q2
15Q3
15Q4
Source: PMA and IFS.
Interest rates on government securities and government bonds in the short-term were used as a proxy for the deposit rate in the
U.S.
14
issuing countries, rising for the USD, and slightly falling for the JD and the NIS during 2015Q4
(see figure 14). The margin on the USD in Palestine amounted to 2.8 times that in the U.S., while
the margin on JD amounted to 1.3 times that in Jordan. In comparison, the margin on the NIS
remained the highest; almost three times the margin in Israel during 2015Q4.
As for real interest rates11, data indicate that
real deposit rates in Palestine began to
Figure 15: Real lending and deposit rates in Palestine by
currency.
12
10
8
6
4
2
0
-2
-4
14Q1 14Q2 14Q3 14Q4 15Q1 15Q2 15Q3 15Q4
decline during 2015Q4, in light of the
increase in inflation from 0.9 percent during
2015Q3 to 1.5 percent during 2015Q4.
Accordingly, the average real deposit rate
declined to -0.5 percent for the USD; 0.69
percent for the JD; and -0.16 percent for the
LR on USD
LR on NIS
DR on JD
NIS.
At the same time, the increase in inflation
LR on JD
DR on USD
DR on NIS
Source: PMA and PCBS.
rates in Palestine led to a drop in the average real lending rates to 5.61 percent, 7.23 percent and
8.4 percent on the USD, JD and the NIS, respectively.
Figure (15) illustrates recent developments in average real interest rates during 2015Q4,
including:

Average real deposit rates on the three currencies circulating in Palestine have declined, and
registered negative value for the USD and the NIS compared to 2015Q3. This decline implies
that the real value or the purchasing power of deposits in these currencies has declined.

The average real lending rates remained positive but declined for all currencies circulating in
Palestine, implying that the real value of banks’ credit has decreased during the quarter.
Stock market
With the advent of 2016, and before the deadline of the annual disclosure due in February, the
Palestinian stock market “Palestine Exchange” fell routinely. However, it showed better
performance in mid-quarter due to distributing dividends in several companies, particularly the
National Bank (TNB), which distributed cash dividends for its shareholders for the first time
since its establishment in 2005. Nevertheless, dividends' distribution is usually followed by a
11
Fisher's equation: (1+nominal interest rate) = (1+real interest rate) * (1+ expected inflation rate).
15
decline in shares' prices as investors tend to change their investment positions to maximize
profit.
As a result, this quarter ended with a decline
Table 3: Palestine stock exchange index (Al-Quds
index)
in Al-Quds index by 5.0 percent from its
2015
previous level, down to 506.3 point (see table
Q1
Q2
Q3
Q4
2016
Q1
3). This decline resulted from a notable drop
Banking
119. 8
229.6
124.6
143.6
in indices of services and banking sectors by
Industry
68.1
66.1
64.2
69.9
70.6
Insurance
46.3
11.6
45.3
49.1
54.8
6.1 percent and 5.2 percent, respectively, in
136.1
Investment
24.1
11.8
22.2
24.0
23.8
addition to a decline in the investment index
Service
43.3
11.9
45.7
48.4
45.4
by 0.9 percent. However, indices of the
Al-Quds
474.9
4.884
484.7
532.7
506.3
industry and insurance sectors grew by 1.1
Source: www.pex.ps
percent and 11.6 percent, respectively.
Regionally, the performance of some selected
-20
led to huge losses in Arab stock markets,
-25
-30
particularly of the Gulf States, whose public
budgets were adversely affected by the
y-o-y
KSA
-15
decelerating global economy. Those concerns
Qatar
-10
Muscat
-5
continued to decline, in addition to the
Kuwait
prices
Egypt
oil
Dubai
confidence as
Bahrain
investors'
5
0
Abu Dhabi
in
Amman
10
experience significant losses due to a decline
Palestine
Figure 16: Stock markets performance, some selected
Arab markets
Arab countries’ stock markets continued to
q-o-q
Source: http://www.gulfbase.com, http://www.ase.com.jo and
http://www.egx.com.eg.
dropping oil prices.
The Saudi Arabia, (KSA) stock market index, for example, continued to decline for the third
consecutive quarter, declining by end of 2016Q1 by 4.5 percent from the previous quarter.
Moreover, indices of Bahrain and Kuwait stock markets declined by 7.0 percent and 6.9 percent,
respectively, during the comparison period. Furthermore, the losses became clearer on annual
comparison, particularly in the Saudi Arabian and Bahraini stock markets, in addition to the
Egyptian stock market which was influenced by Egypt's weakening economic conditions.
However, except for a sudden progress in the Egyptian stock market at the end of the quarter,
and the stability in the Dubai stock markets indicators, the growth in the rest of selected
financial markets were very limited during the quarter, as indicated by figure (16).
16
As to the relation between the Palestinian stock market and the stock markets in the region, data
revealed that the Palestinian stock market
Figure 17: Stock markets performance in Palestine,
Amman, and Egypt (q-o-q)
was significantly affected mainly by the
25
20
15
10
5
0
-5
-10
-15
Jordanian stock market, and to a lesser
extent, by the Egyptian stock market (see
figure 17). However, the movements in the
Palestinian stock market during 2016Q1 were
more affected by internal factors, conflicting
with the trends in both the Jordanian and the
Palestine
Amman
2014
2015
Egypt
2016
Source: http://www.ase.com.jo, http://www.egx.com.eg.
Egyptian stock markets.
It is worth mentioning that the effects of other Arab stock markets were tested and shown to be
virtually insignificant. This implies that the local stock market continues to be relatively shielded
from the influence of factors affecting the region's stock markets.
III. Model Based Inflation Forecast
Inflation model and estimation technique
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,
Figure 18: CPI, CIM, and WFP
and calculated regularly by the PMA, and (ii)
122
118
114
110
106
102
98
94
90
86
the world food price index. The importance
of WFP reflects the large weight food
occupies in the CPI basket in Palestine12.
Considering this relationship 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
CPI
CIM
WFP
Source: PCBS, PMA, and IFS.
how fast shocks to the relationship are corrected over time in order 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. The first is the Johansen’s (2992, 299.) system-based reduced rank approach. The
12
For more details about inflation determinants in Palestine, see Palestine Monetary Authority (PMA), 2011. Inflation Report, April
2010.
17
second is the ARDL test which is based on Pesaran, Shin (1999) and Pesaran, Shin, Smith (2001).
The third is the semi-parametric Fully Modified OLS (FMOLS) approach of Phillips and Hansen
(1990).
Baseline inflation forecast
The objective of this section is to use the basic inflation model to generate a quantitative CPI
outlook for the following years on a quarterly basis, i.e. for the period 2016Q2-2017Q4. 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 calculated to decline by 0.85 percent in 2016,
and to increase by around 1.3 percent in 2017.
The most recent IMF forecasts indicate that food prices will decline in 2016 compared with 2015
but will resume increasing in 2017, albeit at a slower pace. Accordingly, we calculate that the
world food prices will decline by around 3.3 percent in 2016, and will slightly increase by around
0.4 percent in 2017.
Inflation will be forecasted according to
Table 4: Inflation outlook of the three models
the above-mentioned three estimation
techniques13,
combined
with
Assumptions
the
CIM
common baseline growth rates for the
Inflation Forecasts
WFP
VEC
M
ARDL
FMOLS
Aveg.
-17.12
1.43
1.43
1.43
1.43
2015*
-0.41
16Q1*
-1.46
-8.20
0.64
0.64
0.64
0.64
16Q2
-1.28
-4.64
0.85
1.07
1.07
1.00
16Q3
-0.59
-2.91
1.12
1.05
1.05
1.07
16Q4
-0.06
3.26
0.54
0.34
0.33
0.40
econometrically estimated models to
2016
5889-
-3.29
58.5
58.8
58..
58.8
forecast future inflation is subject to
17Q1
1.00
0.40
1.38
1.31
1.28
1.32
17Q2
1.27
0.46
1.40
1.22
1.20
1.27
17Q3
1.48
0.47
1.13
1.07
1.04
1.08
reduce this uncertainty, we will take the
17Q4
1.57
0.36
1.16
1.19
1.32
1.22
simple average of the three models.
2017
1.33
*
Actual data.
0.42
18..
18.5
18.1
18.1
CIM, and the WFP, as explained in
table (4).
As
is
well
known,
the
use
of
model and coefficient uncertainty. To
Accordingly
the
average
inflation
forecast for 2016Q2 will be 1.0 percent, as compared to 2015Q2. Also, we expect the average
inflation rate for 2016 to drop to 0.78 percent, but to resume increasing to 1.23 percent in
2017 (see table 4).
13
VECM, ARDL, and the FMOLS.
18
IV. The Balance of Inflation Risk
Apart from the abovementioned risks of model uncertainty, the CPI outlook also crucially
depends on the assumptions regarding the
course of the model's exogenous variable's
Figure 19: Scenario assumptions for CIM and WFP
forecasts; these exclusively refer to external
130
120
110
100
90
80
70
60
conditions reflecting foreign inflation trends,
NIS bilateral exchange rates, and world
market food prices.
We evaluate the risks for the CPI outlook
stemming from potential shocks to these
CIM Baseline
CIM+1SD
CIM-1SD
external conditions by setting up four
alternative scenarios, resulting from all
WFP Baseline
WFP+1SD
WFP-1SD
possible combinations of positive and negative one-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 kurtosis14, 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 (see figure 19).
The results of these scenarios are
displayed in table (5). They
indicate
that,
assumptions,
given
the
the
range
(Percentage point)
average
inflation forecasts during 2016
would
Table 5: Baseline and risk analysis of the CPI in Palestine for 2016 and
2017
between
Scenario
-0.1
percent and 1.6 percent, with 0.8
1
percent as the central baseline
2
outlook. In 2017, the average
inflation forecasts are expected
3
to range between -2.1 percent and
4
4.6 percent, with 1.8 percent as
the central baseline outlook.
14
Shock
5
*
Baseline
+1SD CIM
+1SD WFP
+1SD CIM
-1SD WFP
-1SD CIM
+1SD WFP
-1SD CIM
-1SD WFP
Actual data.
Kurtosis measures the peakedness or flatness of the distribution of the series.
19
Implied
annual
growth rate
CIM
Implied annual
growth rate
WFP
Implied
inflation
forecast
2016
2017
2016
2017
2016
2017
-0.85
1.33
-3.29
0.42
0.78
1.23
0.58
5.25
3.29
19.31
1.62
4.56
0.58
5.25
-9.50
-16.13
0.90
0.80
-2.26
-2.48
3.29
19.31
0.63
1.56
-2.26
-2.48
-9.50
-16.13
-0.07
-2.08
Figure (20) shows the current risk analysis of inflation in Palestine during 2016 compared with
the risk analysis in 2016 predicted in the previous report (volume 17). The figure indicates that
scenarios 3 and 4 give results close to the baseline forecast; but scenarios 2 and 5 involve upside
and downside outliers, respectively. The figure reveals that the risk declined compared with the
risk predicted 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 partners, compared to what
is assumed in the baseline. Conversely,
Figure 20: Web chart of the balance of Palestine’s
inflation in Palestine may turn out to be
inflation risk
considerably lower than predicted in the
2.8
2.3
1.8
1.3
0.8
0.3
-0.2
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,
2016 this issue
the inflation outlook for Palestine also
2016 previous issue
CIM: Cost of imports
WFP: World food price index
↑: Increase by one-standard deviation
↓: Decrease by one-standard deviation
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.
An example of such shocks was the Israeli withholding of clearance revenues during 2015Q1,
resulting in delays and/or disruptions in payment of government employees’ salaries, which
depresses demand and causes a fall in
prices.
Figure 21: Fan chart of the balance of Palestine inflation
risk during 2016Q2 – 2017Q4
6.0
Figure (21) shows the fan chart of the
balance of Palestine’s inflation risk during
2016Q1–2017Q4. The chart contains the
5.0
4.0
3.0
2.0
1.0
quarterly profile of the baseline inflation
0.0
forecast
-1.0
mentioned
above.
The
risk
parameters start from a standard deviation
equal to 1.5 for the 2016Q2, which is based
-2.0
-3.0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
2015
2016
2017
on the inflation volatility observed during the most recent years. It then rises up to 2.5 for the
2017Q4, reflecting the fact that uncertainty rises with the forecasting horizon.
20
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 weaker the
shading in the chart, the smaller the perceived probabilities of these potential outcomes.
21