Gulf states are facing a serious challenge in their fight against inflation because the peg between their currencies and the US dollar limits their fiscal tools, according to the United Nations.
While the United States is forced to repeatedly cut interest rates to reinvigorate its slackening economy, the dollar peg is forcing Gulf Co-operation Council (GCC) states to follow suit although their economies are galloping due to high oil prices, the UN Economic and Social Commission for Western Asia (ESCWA) said in a study.
Although the UAE and Qatar have acknowledged they are the worst hit by soaring prices, their inflation rates are actually much higher than they have announced, while the other members are reeling under more inflationary pressure, it said in the 2008 study of economic prospects of its members, which groups Egypt, Syria, Iraq, Jordan, Lebanon, Yemen and Palestine.
“Currently, with the exception of Kuwait, all the GCC countries peg their national currencies to the dollar. As a result, GCC monetary authorities face a serious policy challenge, namely: they can follow the latest moves by the Fed and reduce benchmark interest rates at a time when strong economic growth and increasing inflation rates would instead require a tightening of monetary policy; or they can allow a widening spread between domestic and US interest rates, thereby stimulating capital inflows and possibly increasing the upward pressure on national currencies.”
It said such a “dilemma” has prompted calls by analysts and policy experts for the GCC countries to move to more flexible exchange rate regimes such as replacing the dollar peg by a basket of currencies.
“A less radical policy option would be a one-time revaluation of national currencies against the dollar. Given the rising concern of GCC authorities with regard to inflation, that alternative is increasingly being discussed, particularly in Saudi Arabia and the UAE,” it said.
ESCWA figures showed that inflation rates in GCC countries increased considerably in 2007.
In Qatar and the UAE, sharply rising housing costs and a rapid growth in credit to the private sector pushed inflation rates in 2007 to an estimated 12.8 per cent and 9.8 per cent, respectively.
“Given that the computations of the consumer price index (CPI) do not reflect fully the changing relative weights in expenditures, actual inflation rates in both countries could be even higher,” ESCWA said.
ESCWA’s data showed average GDP growth in the GCC stood at around 5.2 per cent in 2007. It is expected to pick up to 5.5 per cent in 2008.
“The economic prospects of the GCC continue to be favourable… Qatar and the UAE are expected to record the highest growth rates in the GCC,” the report said.
It projected growth in Qatar to accelerate from 8.2 per cent in 2007 to 9.7 per cent in 2008, while in the UAE it would slow down from around 8.3 to 7.4 per cent during the same period.
“By contrast, growth in Saudi Arabia is expected to edge higher in 2008. Based on expectations of higher average oil output, increased private investment and strong government spending, real GDP growth in is anticipated to increase to four per cent in 2008.”
Fighting inflation a challenge due to dollar peg: report