Low dollar brings back inflation woes to GCC

A weakening in the US dollar is bringing back the specter of painful inflation in the Gulf oil producers just two years after the global fiscal distress pushed them out of the throes of their worst inflation problem.

The fall in the dollar against major currencies because of the so-called global currency war and other factors has already allied with higher food prices and persistent increases in local rents to push inflation rates in Saudi Arabia back to pre-crisis levels although they are still relatively low in other Gulf nations.

“The Gulf countries are fairly rapidly growing and hence, in spite of the limited openness of some of their markets, vulnerable to growing capital inflows and consequent asset bubbles,” said NCB Capital, which is owned by Saudi Arabia’s largest bank, National Commercial Bank.

“An artificially inflated boom in emerging markets would inevitably result in inflationary pressures, a trend which would be amplified by the liquidity effect of a higher oil price and increased costs of imports. The prospect of a period of dollar weakness, through the dollar pegs, would further contribute to such a scenario.”

While inflation rates have remained relatively low in the UAE and most other Gulf countries, the level has started to worry analysts after surged above six per cent in August because of high rents and food prices.

Saudi Arabia, the world’s top oil exporter and largest Arab economy, suffered from its highest annual inflation rate of around 9.9 per cent in 2008 before it dipped to nearly five per cent in 2009 due to lower food and oil prices.

The rate has steadily climbed over the past few months as the improvement in oil prices is tempting the government to maintain high spending levels and the weak US dollar is making the country’s import bill costlier.

“One worrying trend for the Saudi economy is the acceleration in inflation to above six per cent in August – the highest rate in the Gulf,” said John Sfakianakis, chief economist at Banque Saudi Fransi.

“While annual rental inflation continues to decelerate, food price inflation has been accelerating quickly this year due to a number of factors globally and domestically…. Saudi Arabia relies heavily on food imports to feed its population of about 27 million, particularly as it moves toward phasing out certain water-intensive agricultural industries as wheat cultivation. Imports of food accounted for 15 per cent of total imports in 2009.”

He said this has made Saudi Arabia vulnerable to shifts in global commodity prices, adding that high rents are another driver of inflation in the Kingdom.

“Rental inflation, while declining year on year, has nonetheless continued to accelerate month on month and will remain a key factor behind historically high inflation rates,” he said. “One effort to ease rental inflation will be the government's planned construction of one million housing units to meet 80 per cent of demand from 2010-2014, as outlined in the Ninth Development Plan.”

In Kuwait, official data showed inflation climbed to a 15-month high of 4.4 per cent year-on-year in August, driven mainly by a rise in food prices.Inflation in the OPEC oil exporter has been accelerating this year as the oil-reliant economy recovers from last year's sharp contraction.

Consumer price growth stood at around four per cent on an annual basis in July, still well below a record high of 11.6 per cent in August 2008.

The central bank governors of Kuwait and Saudi Arabia voiced their concerns last month about rising inflationary pressures stemming from external factors they cannot directly influence such as food costs.
NCBC said that although property price corrections in some GCC countries have given their authorities a temporary respite, inflation is increasingly obviously establishing itself as an overriding policy concern in the region, it said in a study.

“The ability of the regional economies to respond the external shocks is clearly limited, even if the recurrent pressures in the area of food are likely to fuel growing pressures for national or regional reserves in key agricultural commodities in an attempt to smoothen short-term price variations,” it said.

“The GCC remains vulnerable to unpredictable shocks, both in the form of food prices and in terms of liquidity waves created by short-term oil bubbles, especially once bank lending normalizes. Temporary policy interventions may once again become necessary to contain inflationary expectations.”

Sitting atop 45 per cent of the world’s recoverable oil deposits, Gulf Cooperation Council (GCC) countries were the main victim of soaring inflation in the Middle East in 2007 and 2008 given their currencies’ peg to the dollar.

The problem was aggravated by high public spending and a surge in oil prices to an all time high in 2008, sharply stimulating domestic demand. Many of them reacted by raising interest rates to dissuade banks from lending.

In 2008, inflation rates jumped to 15.2 per cent in Qatar, 12.3 per cent in the UAE, 9.9 per cent in Saudi Arabia, 12.4 per cent in Oman, around 10.6 per cent in Kuwait and 3.5 per cent in Bahrain.
Waning domestic demand coupled with lower oil and food prices, and credit squeeze by banks depressed the rates in 2009 to only 1.1 per cent in the UAE and plunged Qatar into a deflation. The rate also plunged in other members.

“The dollar peg is a major cause of inflation in the GCC…I believe the GCC countries should unpeg their currencies from the US dollar and adopt a basket of currencies, of which the dollar should not account for more than 60 per cent,” said Ibrahim Al Karasneh, head of training at the Abu Dhabi-based Arab Monetary Fund, a key Arab League financial institution.

“Besides inflation, a weak US dollar caused by higher public debt and trade deficit will adversely affect the GCC’s foreign assets as most of them are based in US dollar,” he said at a training seminar in Abu Dhabi this week.

Follow Emirates 24|7 on Google News.