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10 December 2023

Contrasting views on rising prices

By Frank Kane

The debate about inflation has kicked off again, and policy-makers in the UAE should follow this one carefully. It could decide the outcome of the most critical economic issues the country faces today, and have serious repercussions for international relations.

A difference of emphasis – it would be an exaggeration to call it a ‘war of words’ – has become apparent between two of the world’s leading research houses on the thorny subject of rising prices. (The consensus figure seems to be in the region of a 12 per cent rise this year. Some experts put it higher.)

In statements over the past couple of days, Merrill Lynch and HSBC experts appear at odds over what causes inflation in the UAE, and consequently over what measures should be taken to deal with it.

Historically, inflation has been regarded as the economic evil par excellence. It has the power to destabilise societies and communities like no other factor. For the UAE, if unchecked it could threaten the dynamic rates of growth that have fuelled the country’s successful diversification away from energy dependency.

Which is why tackling the issue has become a number one priority for policy-makers and business people. But you must first decide what is causing the problem.

Here two distinct schools of thought are emerging.

The first received its most coherent expression in a recent research note produced by Merrill’s London office. Merrill’s case can be briefly summarised thus: while there are some supply-side factors, such as housing shortages in the UAE, the main reason for rising prices is the imported inflation that comes with the peg to the US dollar.

Further, Merrill says, any relaxation in US monetary policy – like the dramatic cuts by the Fed last week – will also be imported into the UAE, putting further upward pressure on prices. The logic is to drop the peg or revalue the currency.

Not so, according to HSBC’s Chief Executive Youssef Nasr. Inflationary pressure came about because of supply constraints, specifically lack of raw materials and workers, rather than the currency peg. Dropping the peg is not a “compelling issue”, Nasr said. The HSBC chief went on to praise the record of Hong Kong in this respect. Despite being pegged to the US dollar, the HK authorities have managed to avoid importing rate cuts from the US, and inflation, though rising, has stayed within manageable bounds.

Now the gurus at HSBC and Merrill are far more expert than I am, so I am reluctant to call a winner in this little debate. But some observations are appropriate.

First, it seems to me that Hong Kong is far less vulnerable to supply-side pressure than the UAE, due to its position as a magnet for the cheap labour and commodities of China. The UAE, on the other hand, has to compete in global markets for labour and raw materials.

Second, the HSBC team that produced the research is based in the UAE, and therefore far more aware of the subtle nuances of local policy, not least that of the UAE Central Bank, which has been steadfast against a de-pegging.

Finally, there is the “do something” factor. The UAE cannot dictate world labour or commodity prices, but it can decide to change the terms of the peg. The pressure to do this can only become greater.