Qatar grapples with rising inflation in construction

As already seen in Qatar’s real estate segment, inflation is becoming a challenge to future growth. Although it has yet to reach the same highs as in 2008, inflation has been rising in recent years, with contractors facing escalating labour, land and materials costs as the state rolls out wave after wave of infrastructure builds. Although the ongoing problem of supply bottlenecks will be alleviated to some degree when Hamad Port comes on-line in 2016, growing materials and labour needs are still set to see prices rise, leading the government to push forward new investments in local industry, aimed at increasing domestic supply and further enhancing economic diversification targets, as outlined by Qatar National Vision 2030. Contractors’ market prices comprise input costs for materials, labour and land, as well as allowances for preliminaries, overheads, profit and risk, including cost escalation. Tender prices are driven by the balance of construction supply and demand, as well as growth and inflation rates, contracting capacity, availability of specialist contractors and labour, and commodity prices. As Qatar saw dozens of multimillion-dollar construction contracts awarded in 2014, nearly all of these costs are set to rise in the mid-term. EC Harris reports that contractors and their supply chain typically respond to increased activity by raising profit margins in competitive tenders, with construction tender price inflation tending to fluctuate more than consumer price index (CPI) inflation, due to the cyclical nature of demand for projects. In relatively small markets like Qatar, the supply chain’s ability to absorb workload fluctuations remains limited. “As a result, the risk of fluctuations in prices in response to workload is even greater, setting the foundation for a heightened price inflation risk,” stated a March 2013 report from EC Harris. The report said that the country’s construction industry is at risk of overheating, with some of its inflation scenarios warning that the market could fail as a result of inflation. Although Qatar’s inflation has not yet returned to the high of 15% seen in 2008 prior to the slowdown, EC Harris warned that similar inflation growth is likely to be witnessed in the lead-up to the 2022 FIFA World Cup, projecting construction inflation could peak at 18% annually between 2016 and 2019, adding billions of dollars to the cost of development.

INFLATION: Inflation gained momentum in 2014, with Qatar National Bank (QNB) reporting in September 2014 that domestic inflation has been on an upwards trajectory since its 2009 low of -6.2%, rising to reach 3.3% in 2014. Overall inflation is driven by rental inflation, which comprises 32% of the CPI basket, although this remains tied to the rising cost of land, which has also posed a problem for the construction industry.

Although inflation projections vary, the general consensus among banks is that it will continue to rise in 2015; QNB projects it will reach 4.2% in 2014, 5.2% in 2015 and 5.3% in 2016, while the National Bank of Kuwait reported in December 2014 that Qatar will reach 3.4% and 4.1% inflation in 2015 and 2016, respectively. Standard Chartered Bank predicted in October 2014 that Qatar’s inflation would reach between 6% and 6.5% in 2015, the highest level in the GCC.

LAND PRICES: Rental inflation expanded by 7.9%, 8.1% and 8.2% in August, September and October 2014, respectively. Land prices have a dramatic effect on rental inflation, according to QNB, which reported in September that land prices increased by 52.7% during the first six months of 2014.

The bank noted that land is the main cost in increasing housing stock, with land prices correlated to future movements in rental prices. According to QNB, six months after land prices in a certain area rise, rental rates on the land also increase, making land prices an important contributing factor to overall inflation, and negatively impacting the construction supply chain.

All of this puts Qatar at risk of repeating the same mistakes as were made in 2008. In an unpublished brief on Qatar’s real estate market, consultancy DTZ reported that land prices reached unsustainable levels by late September 2008, and fell by 30% to the end of 2009, following the onset of the global financial crisis. In 2014 land prices appeared to be on a similar trajectory, with DTZ reporting that population growth and rapidly expanding demand in the wake of a long-awaited construction boom have led to speculation that has seen land traded at 20-40% above its actual economic worth, noting that similar conditions were witnessed in 2008 prior to the market correction.

“In 2013, based on statistics released by the Ministry of Justice (MoJ), 63% of the total value of real estate transacted in Qatar related to land. This is significantly higher than would be expected in a more developed real estate market. The MoJ data shows that between 2011 and 2014, land values on average increased by 65%. Furthermore, in the past six months there has been some evidence of a 30% year-on-year increase in land value, suggesting that the price of land in Qatar is accelerating,” said DTZ’s brief.

GROWING PAINS: Labour costs are also set to rise, with Qatari media already reporting ongoing labour shortages in 2012 and 2013. The authorities estimate that the state will require a further 1.2m workers between 2012 and 2022. At the same time, material costs, exacerbated by supply bottlenecks at the existing Doha Port, are expected to rise significantly in the medium term due to requirements for projects including the Doha Metro, Lusail City, the Expressway Programme and the expansion at Hamad International Airport.

SOLUTIONS: EC Harris reported that Qatar’s construction market still had 30% spare capacity in 2014, similar to the wider GCC market. Yet output is expected to grow by more than 12% annually until 2019, necessitating rapid supply chain expansion. A number of options are available to help curb inflation; EC Harris recommends Qatari authorities monitor barriers to entry for new companies, ensuring that they do not become a limiting factor on future capacity, while the supply chain will also need to be closely watched. As highlighted in a May 2014 Deloitte report, the government is already moving to improve the commodity supply chain, and is considering establishing a single import authority which would sell to contractors in the state, as well as building up material stockpiles through investment in domestic industry (see materials analysis).

EC Harris also recommends that contractors build solid relationships with reliable sub-contractors, both domestically and internationally, to avoid contract disputes, cost overruns and project delays, while reforms to the current tendering system could also help. “The cycle of projects is the biggest hindrance to contractors in the country. After submitting pricing for tenders, you often wait months before you hear any response,”

Chakib Nayfe, general manager of Medgulf Construction, told OBG. “A normal cycle for awarding a package should take three to four months, but in Qatar it can often take six to 12 months. This creates issues around planning, mobilising labour and pricing in the market.”