Inflation settles in!
Delinking the currencies could not fully control inflation as declining value of the US dollar is merely part of the problem. Another challenge concerns expansionary fiscal policy through higher allocations for capital and current expenditures

By Dr Jasim Husain Ali

Doing away with inflation in the Gulf Cooperation Council (GCC) nations is undoubtedly a daunting task. Increasingly, double-digit inflation rates are becoming a norm in the GCC economies. Last year, Qatar and the UAE suffered from inflation rates of 14 per cent and 11 per cent, respectively.

Inflation rate in Saudi Arabia stood at 10.5 per cent in April. Kuwaiti inflation rate was 10.4 per cent in February. It reached a record 12.4 per cent in Oman in April. Notwithstanding official figures, inflation rate in Bahrain is believed to have passed 10 per cent in the last few months.

Just a few years ago, inflation was not a problem to be reckoned with in the GCC economies. According to Merrill Lynch, inflation rate averaged 0.3 per cent in 2001, only to increase to 6.3 per cent in 2007. The IMF put inflation rate of 7 per cent in the six-nation GCC last year, only to raise it to 8 per cent by 2008 end.

Chief culprits
Studies and reports suggest that housing and food costs are chiefly responsible for the growing inflationary pressures. In Saudi Arabia, rents, fuel and water costs increased by 18.5 per cent in May. Food and beverages grew by 15.1 per cent in the same period. With regards to inflation in Kuwait in February, rental rates increased by some 16 per cent, followed by rise of 15 per cent in drinks and tobacco products and 9 per cent in food stuffs.

By one account, imported inflation is responsible for as much as 30 per cent of overall inflationary pressures encircling regional economies. This is a consequence of having GCC currencies linked to the US dollar, which in turn suffers from declining value. Currencies not linked to the dollar have appreciated in value over the past few years. For example, the value of Chinese currency (yuan) increased by almost 7 per cent in 2007. The yuan appreciated by almost the same value in the first half of 2008 alone. Also, the Euro has risen by 40 per cent in five years. At the moment, merely 0.73 euro cents can buy a US dollar. In 2003, 1.20 Euro was required to purchase a dollar. All said, GCC economies are dependent on imports from euro-zone countries and China for a considerable amount of their needs for vehicles, machineries and toys, to name a few.

The rise in property prices reflects failure of supply meeting demand. Rising demand reflects availability of liquidity on the back of firm oil prices and other limited investment alternatives. Many investors like to invest in property market as they expect to make attractive returns−as much as 40 per cent per annum. Yet, corrections of the stock markets in 2006 are serving as a reminder of the dangers associated of placing funds in bourses.

Enemy within
A significant portion of inflationary pressure stems from domestic economic conditions, namely the fiscal policy. Reference is made to the sharp growth of public sector spending in the GCC economies, which averaged around 17 per cent in 2007. In contrast, budgetary expenditures grew by merely 3 per cent in 2002. (the two years don’t compare) The extraordinary growth of public expenditures is the direct result of stronger oil revenues. Yet, the governments have no choice but to invest rising oil proceeds on infrastructure projects such as road network, airport expansion and utilities to offset demand. The increasing demand is not met by similar growth of supply, thereby causing shortage and subsequent rise in prices.

Additionally, the authorities are using part of extra oil proceeds to help locals adjust to inflationary pressures. All GCC governments have increased public sector salaries in the last 12 months. Only in June, Kuwaiti authorities agreed to a demand made by the newly elected parliament to increase salary of Kuwaiti nationals working in both public and private sectors by KD50 (US$182) for those earning less than KD1,000 monthly.

Not surprisingly, M2 or broad money supply is growing at exceptionally high rates. The growth averaged around 30 per cent in 2007, up from 10 per cent in 2003. M2 consists of currency outside the banking system plus private demand and savings (short and long-term). The growth of M2 reflects the mood amongst the consumers and investors in the region.

Undermining monetary union
Growing inflationary pressures could derail the planned monetary union by 2010. Recently, the UAE Central Bank Governor Sultan bin Nasser Al Suweidi pointed out that inflation was causing differences of opinion within the regional grouping. He went on to suggest that the inflation factor could defer issuance of a single currency by the target date.

In reality, inflation is a serious concern when it comes to meeting one such condition attached to the monetary union project, namely limiting that to the average rate in member states plus two per cent. According to the IMF, inflation rates amounted to 14 per cent and 4.1 per cent in 2007 in Qatar and Saudi Arabia, respectively. In 2006, Oman advised of its desire not to join the monetary union in a foresighted move.

Kuwait’s experience
Kuwait remains an exception by having its currency linked to a basket of currencies since May 2007. Still, it is believed that the US dollar constitutes some 60 per cent of all currencies included in the basket. So is the case due to the significance of the dollar in Kuwait’s weighted international trade, notably the hydrocarbons industry.

At any rate, according to a report issued by Central Bank of Kuwait, inflation rate stood at a whopping 10.4 per cent in February. In contrast, inflation rates amounted to 9.5 per cent in January and still a lower 7.5 per cent in December 2007.

The Kuwaiti experience shows that a single measure, namely ending the peg to the dollar, could not contain inflationary pressures. Thus, de-linking the currencies with the dollar could not fully overcome inflationary pressures. Declining value of the US dollar is merely part of the problem. Another challenge concerns expansionary fiscal policy through higher allocations for capital and current expenditures. In turn, this is constrained by limited monetary policy options to affect economic conditions by virtue of importing interest rates prevailing in the US and absence of taxation.

The author is an eminent economist and Member of Parliament, Bahrain.
 

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