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02 October 2023

Coping with price shock in the UAE

By Matt Smith



Keeping inflation under control is perhaps the biggest challenge facing the UAE right now, economists warn. With the booming economy expected to grow 16 per cent this year, high inflation is inevitable, but the soaring cost of living is leaving residents with less money in their pockets, while sky-high rents show no sign of abating.


We are noticing higher prices in the shops and our declining purchasing power is much debated. Imported inflation is frequently blamed, but changing or abandoning the dirham’s dollar peg will not be the solution hard-pressed residents hope for, experts say.


This is because imported inflation accounts for only a quarter of overall inflation, with the real problems lying close to home.


So what is driving high inflation? What can the UAE do to fight inflation and what are the consequences of rising prices? Are there any benefits to high inflation and could the UAE’s economic bubble be about to burst?


Business 24|7 put these questions to some of the country’s top economists, plus leading players in the retail and tourism sectors, industries that are at the sharp end of the inflation debate.


Most agree the UAE should strive to rethink its currency regime to enable the country to forge a more independent monetary policy, particularly over interest rates, while the declining dirham is threatening to scare away expatriate workers as the relative value of remittances continues to fall.


The panel


Jannie Holtzhausen, Spinneys Chief Executive:

“[Inflation] also creates a feeling of insecurity and despondency, especially among those in the middle and junior management, who do not have the means to pay the higher rent and have to move and/or downscale their accommodation regularly.”


Nasser Saidi, chief economist, DIFC:

“High inflation is a major macroeconomic policy challenge faced by the UAE… inflation implies an erosion of purchasing power with the dirham in your pocket commanding fewer goods and services; the real value of money declines.”


Richard Fox, Fitch Ratings head of Middle East and Africa Sovereign Ratings:

“Rising inflation is fuelling wage demands and labour unrest.”


Guy Epsom, Hilton International regional director for sales and marketing:

“For those paid in dirhams, their income is being quickly eroded. Goods in the shops are more expensive, rents are increasing and remittances home are fast losing value.”


Monica Malik, EFG Hermes senior economist:

“If people find they are saving less money and are remitting less money home, then the UAE could become a less attractive place for expatriates to live.”


What are the most significant contributors to inflation in the UAE?


SAIDI: Greater economic diversification has resulted in the non-oil sector [including trade and services] growing at a faster rate than the oil sector. Given the peg of the dirham to the dollar, high oil prices have resulted in large balance of payments surpluses and capital inflows that have fed high money growth rates, in excess of 23 per cent per year.


The result has been average inflation of 6.2 per cent between 2003 and 2007, in sharp contrast to the low rates achieved in the past (2.2 per cent from 1998 to 2002).


FOX: In general, rapid demand growth, notably government spending of oil revenues and consumption fuelled by rapid bank lending growth, which in turn puts pressure on resources. The sheer pace of economic development is also bringing in more workers and raising demand for housing and rents, which is the biggest single contributor to inflation. The weak dollar is another factor, given the importance of imports from non-dollar areas. But the more pertinent aspect of the dollar link is the fact that interest rates are being forced down when anywhere else they would be rising.


EPSOM: Items purchased from non-dollar linked economies, such as cars and food, become more expensive. Rents still seem to be increasing despite the control measures that have been put in place. Increase in fuel prices and Salik charges have also had an impact.


MALIK: Rent is the main driver, accounting for more than half of the UAE inflation. There is also imported inflation due to the dollar’s weakness, which has led to higher food costs, while strong liquidity is adding to the money supply growth and inflationary pressure.


HOLTZHAUSEN: In our company, we find that we have two main cost drivers:


- Imported inflation due to the weakening of the dollar against the euro and the pound sterling. It is not possible for us to absorb these changes and we have to pass it on to the consumers.


- We are faced with the cost of rent for new supermarkets where the rates for similar stores have more than doubled in the past 24 months. This will manifest itself in an increase in rental as a percentage of sales, which will force us into a structural cost change. A more immediate impact on the cost of operating the business is the effect of the drastic increase in the cost of housing of staff. This is not only a financial burden on the company but individuals as well.  It also creates a feeling of insecurity and despondency, especially among middle and junior management, who don’t have the means to pay the higher rent and have to move and/or downscale their accommodation regularly.


What are the most serious consequences of inflation?


SAIDI: Inflation implies an erosion of purchasing power with the dirham in your pocket commanding fewer goods and services; the real value of money declines. Inflation also implies a reduction in real income to the extent that wages and salaries are not adjusted for inflation, with people earning fixed incomes [salaries and pensions] the main losers. In turn, a higher cost of living can affect the ability to attract foreign human capital resources and affect the location decisions of companies.


FOX: Rising inflation is fuelling wage demands and labour unrest. It also tends to worsen income distribution, especially as imported food prices rise, with potential political consequences. It also costs the government more in subsidies.


EPSOM: For those paid in dirhams their income is being quickly eroded. Goods in the shops are more expensive, rents are being increased and remittances home are fast losing value. Dubai and the UAE are becoming far less attractive places to work as a result. This could result in difficulties staffing all the new projects that are planned for the city.


MALIK: The increase in the cost of projects. It’s getting harder to recruit people to the UAE, especially construction workers. Inflation has also reduced competitiveness, and also distorts prices and investment decisions.


HOLTZHAUSEN: In our case [it is] an increase in food prices on the shelves. It is important to note that with food and related products, unlike housing, we source similar products from countries with weaker currencies like South Africa and fixed exchanges like the US. It is therefore possible for customers to change brands and minimise the effect.


What can the UAE do to combat continued high inflation? How can the government limit money supply and what impact could this have?


SAIDI: High inflation is the major macroeconomic policy challenge faced by the UAE. It has to be addressed by a combination of policy measures, including structural policy measures that will reduce housing and real estate shortages, while focusing on the growth of government expenditure on infrastructure services that can raise overall productivity growth.


On the other hand, the use of monetary policy measures is constrained because of the peg to the dollar. However, the authorities can limit the growth of the monetary base and therefore money growth from external capital inflows resulting from higher oil revenues, by investing the large current surpluses outside the UAE.


FOX: It has long been argued that rents will fall as more property comes on stream. That is more likely in Dubai than Abu Dhabi, where the property pipeline is less advanced.


The dollar peg means the authorities have little independent control on interest rates. So they can tell banks to curb lending or introduce formal restrictions, for example on lending to property, for equity purchases and so on. They could also raise banks’ reserve requirements, which would freeze part of banks’ deposit base.


EPSOM: I think there are a number of measures that could be adopted to reduce the impact. Control the rents better, move the dollar peg to a basket of currencies. Raise interest rates.


MALIK: There’s very little the government can do on the housing front, it is already increasing supply. On the monetary side, interest rates need to be higher – real interest rates are negative.


However, given the dirham’s peg to the dollar, interest rates have to follow the US. The reserve requirements of lending banks could be increased to tighten credit and the Central Bank can issue more paper.


One major step would be to switch to a basket of currencies instead of the dollar peg. This is better than simply revaluing because it will increase the monetary tools available and will give the government greater freedom in shaping policy.


Negative interest rates in real terms have prompted very strong credit growth. The sharp fall in the dollar and US interest rate cuts have led us to believe there will be currency reform in the first half of next year.


HOLTZHAUSEN: It does not make a lot of sense to lower interest rates when both growth and inflation are running away.


Does high inflation reduce the incentive for UAE residents to save money and what are the consequences of this?


FOX: To the extent that interest rates are a factor in whether people save, the fact that rates are below inflation is certainly a discouragement. It will encourage people to put money in inflation hedges, for example property and equity in particular.


EPSOM: This will reduce the incentive to come to Dubai and work, which will have serious consequences on projects under construction presently. If this continues the existing labour force will begin to leave to seek employment elsewhere.


MALIK: If people find they are saving less money and are remitting less money home, then the UAE could become a less attractive place for expatriates to live.

Before, there were a lot of people who would come here for a few years, save a load of money and then leave, but that is changing and people are increasingly here for the longer term.


HOLTZHAUSEN: I don’t think it is a case of incentive, people simply end up in a position where housing takes up such a large part of income that savings become impossible.


Will high inflation have any benefits?


SAIDI: None for the UAE economy! Inflation tends to distort the economic signals to consumers, investors and policy-makers. The current danger is that inflation will get ingrained, with wages and salaries being adjusted for inflation and creating the start of a wage-price inflation spiral.


The main “benefit” is that the recent bout of inflation has been a call for policy action, prompting wide discussion of the causes, consequences and remedies to inflation.


FOX: Not really. You could argue that higher oil prices mean that GCC countries’ real exchange rates have to rise to reflect their increased wealth.


And given that exchange rates are rigid, the only way this can happen is through faster inflation. In other words, in the current policy setting, higher inflation is inevitable.


EPSOM: For Hilton and our business it is good news and we are seeing increased travel from Europe to our hotels here. It’s currently much cheaper for tourists from Europe to visit the UAE as a result of the dollar peg. It’s also cheaper for them to shop within the emirate. From this point of view, revenue from tourism continues to increase.


MALIK: People with high debts will find the value of these debts decrease.


HOLTZHAUSEN: High growth and employment.


Is inflation harming UAE exports and if so, how serious is this for the country’s economy?


SAIDI: There is no evidence that the UAE’s non-oil export performance has been affected by domestic inflation. Basically, the UAE has benefited from the weakness of the US dollar in international markets, allowing it to boost its exports.


FOX: Non-oil exports are not really that important. More important is the impact on the economy’s cost base, which makes it a more expensive destination which could, over time, discourage tourism and business location decisions, and make people think twice about buying property there.


EPSOM: Oil is maintaining a high price and incoming tourism is increasing. I am sure that these two factors more than balance the domestic inflation. If the workforce begins to dry up the consequences will be huge because various industries will be negatively affected by this.


MALIK: UAE exports are denominated by oil, which is denominated in dollars, so inflation doesn’t have that much effect. Inflation could make tourism less attractive, although this is being compensated by the weakening of the dollar, which is boosting the competitiveness of the non-oil sector.


HOLTZHAUSEN: Oil is our biggest export commodity. High inflation in oil prices is good for the economy! The weak dollar exchange rate may also help exports to stronger currency markets.