Gulf inflation overshadows Paulson visit

Inflation in Qatar, one of six nations in the Gulf Cooperation Council (GCC) economic and political alliance, rose for a third quarter running in March to a near record of 14.75 per cent, official data showed.

"Things are not getting better. Action should be taken," Ibrahim al-Ibrahim, the top economic adviser to the country's ruler, told Reuters by telephone from the Qatari capital when asked about dropping the peg.

Qatar's steamy rate of inflation is symptomatic of the roaring oil-fueled growth in the Gulf Arab states, which has increased pressure on the GCC to shed the policy of pegging currencies at fixed rates to the weak US dollar.

It also partly overshadowed the last day of a four-day tour to Saudi Arabia, Qatar and the United Arab Emirates by US Treasury Secretary Henry Paulson to defend the dollar's status as the world's reserve currency.

Experts say the Gulf states are likely to review their currency pegs – which forced them to cut interest rates in lock-step with the US Fed – as persistent inflation and booming economic growth threaten to destabilise their economies.

"Given the announcement today and the increase in inflation in the GCC, it is likely in the second half of this year that they will place this decision back on the agenda," said Hany Genena, senior economist at investment bank Gulf Finance House.

Genena said a postponement of the planned 2010 GCC currency union would give the Gulf states leeway to modify their currency regimes. But he added that the weak dollar was not the unique source of inflation, with supply bottlenecks and roaring demand also contributing.

"Depegging can help but is not the panacea. There has to be some other solutions to long-term supply side factors," he said.

Booming economy

Forward currency contracts indicated that investors were betting on a 2.95 per cent appreciation in the Qatari riyal in six months, 4.2 per cent in a year and 8.4 per cent in two years, showing that market participants were betting that the riyal would either revalue or be depegged.

Qatar's Consumer Price Index reached 166.87 points at March 31, the country's planning council said on its website. The index was at 145.42 points on March 31 last year, according to earlier planning council figures.

Inflation at the end of December was 13.74 per cent. The last time it was higher was on March 31 last year when it was 14.81 per cent.

As in other Gulf Arab oil producers, Qatar's economy is booming due to a near seven-fold surge in oil prices in the last six years, while it is having to lower interest rates because of its peg to the dollar. This is fuelling speculation that the country might drop the link in favour of a basket of currencies.  Economists expect GCC economic output to surge past the $1 trillion (Dh3.68 trillion) mark in 2008 – a three-fold increase in only five years – but with the biggest risk coming from inflation due in part to the weak dollar, but also to supply bottlenecks for construction staples like cement, and to rising food costs.

Qatar faced many constraints on depegging. The main obstacle is whether Qatar should act alone or with its Gulf Arab partners, Ibrahim said.

Call for support

In nearby Abu Dhabi, Paulson appealed for support for the US currency, which hit all-time lows versus major currencies earlier this year.

"The US dollar has been the world's reserve currency since World War Two and there is a good reason for that. The United States has the largest, most open economy in the world, and our capital markets are the deepest and most liquid," Paulson told a business group in the UAE.

Paulson's comments mark a slight strengthening of his recent language on the dollar and could resonate with Gulf oil producing states.

Paulson's goodwill tour, however, may have little influence over currency policy among the five Gulf oil producers that peg their currencies to the dollar. Kuwait dropped its peg in 2007.

"Those guys will take their own decisions," said a foreign exchange trader in Dubai who declined to be named. "They rule their own world and go by their own rules... and to be honest with you, I don't think this is going to influence or speed up any decisions they make."

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