High inflation is good news for some
First, a word of warning: the inflationary boom-to-bust business cycle is well understood in the business management schools. It is a historic pattern that has been repeated in many countries and at many different times.
What happens is inflation distorts investment into non-productive assets causing inflationary bubbles, which eventually burst causing huge damage to the participants. However, that dramatic conclusion can follow a long period of booming business activity and such a bust is hardly immediately in prospect for the UAE.
The best way to characterise the present boom is perhaps to say it has reached a mature stage after several years of roaring growth, and real growth levels are now being challenged by inflation and capacity constraints. Management might deliver a 30 per cent growth in revenues but what if costs are growing by the same level or more?
In this period the clear winners are the companies most exposed to benefiting from rapid price inflation, particularly higher rental costs, which are the largest single cost for most households. That means real estate and everything associated with it – contractors, building materials suppliers and even real estate agents.
Banks that supply real estate finance will also benefit strongly. For as a boom matures, borrowing becomes more of a factor in keeping it going by comparison to the early days, which are mainly equity driven.
In the UAE, interest rates are linked to US rates due to the dollar peg, and so will be kept artificially low, fuelling a further boom in lending, and making home loans highly competitive with soaring local rents.
Therefore, real estate and banking – and more specifically banking activity linked to mortgages – are likely to be the boom areas for business in 2008.
These sectors will pay the best salaries and to cope with rapid expansion they will have to pay more than some other sectors.
So the losers will be the businesses that find their best staff leaving them to go into the booming real estate and banking sectors. The multi-national companies based in Jebel Ali, for example, will find it tough to recruit and retain staff and with their products often benchmarked against global prices, their local profit margins will come under pressure from rising costs.
Say, for instance, a company imports cars from Europe. First, it has the devaluing US dollar forcing up its prices in dirhams. Then it has local staff costs surging due to competition from the booming local economy. Eventually the winners in an inflationary boom begin to choke the losers, and as these losers are ultimately the customers of the winners, the circle is completed and the boom turns to bust. But this cycle can take a long time to turn and we all have to live in the short term.
Other losers will really be any company that fails to keep their costs under control. It is only too easy to get carried away in a boom and put all efforts into increasing sales, while forgetting that rising costs could completely undermine margins.
In the worse case scenario firms can go bust through over-expansion because they forget about the marginal cost increase of production during a boom. Again this is a typical and often studied business school model and history does tend to repeat itself.
Inflation is going to be on the agenda for the boardrooms in the Gulf for some years to come, and things may get worse before they get better. It is, therefore, only appropriate that management considers the impact of rising prices now and not before it becomes too late.
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